Td 9040

Federal Register / Vol. 66, No. 30 / Tuesday, February 13, 2001 / Rules and Regulations
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8940]
RIN 1545–AY73

Purchase Price Allocations in Deemed
and Actual Asset Acquisitions
AGENCY: Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations and removal of
temporary regulations.
SUMMARY: This document contains final
regulations relating to deemed and
actual asset acquisitions under sections
338 and 1060. The final regulations
affect sellers and buyers of corporate
stock that are eligible to elect to treat the
transaction as a deemed asset
acquisition. The final regulations also
affect sellers and buyers of assets that
constitute a trade or business.
DATES: Effective Date: These regulations
are effective March 16, 2001.
Applicability Dates: For dates of
applicability of these regulations, see
§§ 1.338(i)–1 and 1.1060–1(a)(2).
FOR FURTHER INFORMATION CONTACT:
Richard Starke of the Office of Associate
Chief Counsel (Corporate), (202) 622–
7790 (not a toll-free number).
SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act
The collections of information
contained in these final regulations have
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C.
3507(d)) under the control number
1545–1658.
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.
The collections of information in
these regulations are in §§ 1.338–2(d),
1.338–2(e)(4), 1.338–5(d)(3), 1.338–
10(a)(4), 1.338(h)(10)–1(d)(2), and
1.1060–1(e)(ii)(A) and (B). The
collections of information are necessary
to make an election to treat a sale of
stock as a sale of assets, to calculate and
collect the appropriate amount of tax in
a deemed or actual asset acquisition,
and to determine the bases of assets
acquired in a deemed or actual asset
acquisition.
These collections of information are
required to obtain a benefit. The likely
respondents and/or recordkeepers are

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small businesses or organizations,
businesses, or other for-profit
institutions, and farms.
The regulations provide that a section
338 election is made by filing Form
8023. The burden for this requirement is
reflected in the burden of Form 8023.
The regulations also provide that both a
seller and a purchaser must each file an
asset acquisition statement on Form
8594. The burden for this requirement is
reflected in the burden of Form 8594.
With respect to Form 8023, the IRS
estimated that 201 forms would be filed
each year and that each taxpayer would
require 12.98 hours to comply. With
respect to Form 8594, the IRS estimated
that 20,000 forms would be filed each
year and that each taxpayer would
require 12.25 hours to comply. These
estimates have been made available for
public comment and no public
comments have been received.
The burden for the collection of
information in § 1.338–2(e)(4) is as
follows:
Estimated total annual reporting/
recordkeeping burden: 25 hours.
Estimated average annual burden per
respondent/recordkeeper: 0.56 hours.
Estimated number of respondents/
recordkeepers: 45.
Estimated annual frequency of
responses: On occasion.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to
the Internal Revenue Service, Attn: IRS
Reports Clearance Officer,
W:CAR:MP:FP:S:O, Washington, DC
20224, and to the Office of Management
and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503.
Books or records relating to a
collection of information must be
retained as long as their contents 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
On August 10, 1999, the IRS and the
Department of Treasury (Treasury)
published a notice of proposed
rulemaking in the Federal Register
(REG–107069–97, 64 FR 43462 (1999–36
I.R.B. 346)) containing proposed
regulations under sections 338 and 1060
of the Internal Revenue Code of 1986.
On January 7, 2000, the IRS and
Treasury published temporary
regulations in the Federal Register
(REG–107069–97, 65 FR 1236 (2000–4
I.R.B. 332)) that are virtually the same
as the proposed regulations published

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on August 10, 1999. The preamble to the
temporary regulations notes that the
proposed regulations generally were
favorably received and that the IRS and
Treasury believe that the proposed
regulations provided clearer guidance
and better rules than the prior
regulations under sections 338 and
1060. However, the preamble also notes
that the comments received warranted
further consideration.
Explanation of Provisions
In general, the final regulations
adopted herein are very similar to the
proposed and temporary regulations in
their organization and substance.
However, changes have been made in
several areas, largely in response to the
comments received. The principal
changes are discussed below, in the
order in which they appear in the
regulations.
Insurance Transactions
Although section 338 treats a target as
having sold all its assets in the deemed
asset sale, proposed § 1.338–1(a)(2)
provides that other rules of law may
characterize the transaction as
something other than or in addition to
a sale and purchase of assets. Proposed
§ 1.338–1(a)(2) states: ‘‘[f]or example, if
target is an insurance company for
which a section 338 election is made,
the deemed asset sale would be
characterized and taxed as an
assumption-reinsurance transaction
under applicable Federal income tax
law.’’ Several comments urged removal
of the quoted sentence in the final
regulations and recommended that the
treatment of transactions involving
insurance companies under section 338
be reserved pending more complete
analysis and guidance. The IRS and
Treasury believe that generally it is
appropriate to view the deemed asset
sale by an insurance company as
involving an assumption-reinsurance
transaction and, therefore, have retained
the sentence in the final regulations.
The IRS and Treasury, however, intend
to provide additional guidance in a
separate project.
Residual Method Anti-abuse Rule
The proposed regulations include a
new anti-abuse rule intended to prevent
taxpayers from changing the results of
applying the residual method by
engaging in transactions that have a
transitory economic effect with respect
to the ownership or use of assets. The
anti-abuse rule is intended to apply only
to an asset transfer exhibiting objective
characteristics suggesting the transfer
was engaged in to manipulate the
operation of the residual method.

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Notwithstanding the limited scope of
the anti-abuse rule, several
commentators suggested further limiting
or eliminating the rule. After studying
the comments, the IRS and Treasury
continue to believe that the anti-abuse
rule serves a useful purpose in
protecting the operation of the residual
method. Several changes have been
made, however, to clarify the intended
scope of the rule. Thus, the phrase ‘‘to
more than an insignificant extent’’ is
changed in the final regulation to
‘‘primarily.’’ This change is meant to
clarify that some continuing use in its
original location of an asset transferred
to or from the target is permitted.
A comment requested that the final
regulations elaborate further on the
statement that the Commissioner has the
authority to make appropriate
correlative adjustments and that the
final regulations include an example.
The final regulations do not do so,
because the nature of any correlative
adjustments would depend on the
particular factual circumstances in
which the rule is applied. Thus, any
additional guidance would provide only
limited assistance. However, the final
regulations state that correlative
adjustments should avoid duplication or
omission of any item of income, gain,
loss, deduction, or basis. See § 1.338–
1(c).
Closing Date Issues
Concerns have been raised about the
possibility that buyers can effectuate
transactions outside the ordinary course
of business after acquiring target stock
that, to the detriment of an unsuspecting
seller, must be reported by the seller on
its return, which normally covers the
entire day on which the acquisition
occurs. Some of these concerns derive
from a reading of § 1.1502–76(b) to
preclude operation of the ‘‘next day
rule’’ whenever a section 338 election is
made for a target. The ‘‘next day rule’’
of § 1.1502–76(b) provides that if, on the
day of a group member’s change in
status as a member, a transaction occurs
that is properly allocable to the portion
of the member’s day after the event
resulting in the change, the member and
all related persons must treat the
transaction as occurring at the beginning
of the following day.
Commentators have suggested that a
purchaser acquiring stock of a
subsidiary member of a consolidated
group could, after acquiring the target
stock, cause the target to sell all of its
assets to another person later on the
closing date and then make a unilateral
section 338(g) election. It is suggested
that the effect of the election is to
preclude the operation of the next day

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rule, causing the results of the actual
asset sale to fall onto the selling
consolidated group’s tax return. The IRS
and Treasury do not believe that
§ 1.1502–76(b), as written, automatically
precludes the operation of the next day
rule in a section 338 context, but
nevertheless have provided a new rule
in these final regulations that requires
the application of the next day rule in
a section 338 context where the target
engages in a transaction outside the
ordinary course of business on the
acquisition date after the event resulting
in the qualified stock purchase (QSP).
See § 1.338–1(d).
Purchase Definition
Proposed § 1.338–3(b)(2) provides
rules concerning the definition of a
‘‘purchase’’ that require more than a
nominal amount to be paid for the stock
of the target. Several comments
requested reconsideration of the
proposed rule. Accordingly, in the
temporary regulations, at § 1.338–
3T(b)(2), a definition is given for the
term purchase of target affiliate, while
the definition of the term purchase of
target is reserved. The final regulations
include a single definition of purchase
applicable to both targets and target
affiliates, which definition generally
conforms to the definition of purchase
of target affiliate in the temporary
regulations. Under this definition, stock
in a target (or target affiliate) may be
considered purchased if, under general
principles of tax law, the purchasing
corporation is considered to own stock
of the target (or target affiliate) meeting
the requirements of section 1504(a)(2),
notwithstanding that no amount may be
paid for (or allocated to) the stock.
Transactions After QSPs
Since 1995, the regulations under
section 338 have provided special rules
that apply, by virtue of section 338, to
certain transfers of target assets
following a QSP of the target’s stock if
a section 338 election is not made for
the target. These provisions modify the
normal operation of the continuity of
interest requirement under section 368
and the interpretation of the term
shareholder for purposes of section
368(a)(1)(D), as applied to certain
taxpayers. These rules were adopted to
effectuate Congressional intent, in
replacing former section 334(b)(2) with
section 338, that the deemed sale results
provided by section 338 not be available
through transactions within the
purchasing group after the acquisition.
In the final regulations, these rules are
located at § 1.338–3(d).
The 1995 amendments did not
provide any special rule to modify the

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application of the statutory
requirements for reorganizations under
section 368(a)(1)(C). However, the
considerations that justify the modified
application of the continuity of interest
rule and the shareholder definition for
‘‘D’’ reorganizations also justify an
analogous modification of the ‘‘solely
for voting stock’’ requirement for postacquisition ‘‘C’’ reorganizations.
Accordingly, the final regulations
provide that consideration other than
voting stock issued in connection with
a QSP is ignored in determining
whether a subsequent transfer of assets
by the target corporation to a member of
its new affiliated group satisfies the
solely for voting stock requirement of a
‘‘C’’ reorganization. See § 1.338–3(d)(4).
Treatment of Liabilities
The proposed regulations eliminate
the prior distinction between ‘‘modified
aggregate deemed sale price’’ (or
MADSP) and ‘‘aggregate deemed sale
price’’ (or ADSP), a distinction that
appeared to have been based on the
premise that the new target generally
will not bear the tax liability for the
deemed sale where a section 338(h)(10)
election is made, but that it generally
will bear the liability where a section
338 (but not section 338(h)(10)) election
is made. However, these generalizations
were not universally correct in either
situation. Proposed §§ 1.338–4 and
1.338–5 clarify the treatment of taxes as
liabilities in computing ADSP and
‘‘adjusted grossed-up basis’’ (or AGUB).
Commentators asked for further
clarification of the standards for taking
certain taxes into account. Rather than
providing more specific guidance,
which would be inconsistent with the
overall philosophy of deferring to
general tax principles governing actual
transactions, the final regulations
further simplify the discussion of
liabilities. Except for the fact that new
target remains liable for old target’s tax
liabilities (see § 1.338–1(b)(3)(i)) and
that a buyer’s assumption of a seller’s
income tax liability with respect to the
sale causes the consideration to ‘‘gross
up’’ or ‘‘pyramid,’’ a tax liability is like
any other type of liability and the status
of any particular type of tax liability as
a liability includible in ADSP or AGUB
should be determined under general
principles as applied to the facts
relating to the incidence of the tax
liability.
Valuation Rules
Proposed § 1.338–6(a)(2)(iii) retains a
statement from prior versions of the
regulations that ‘‘[i]n certain cases the
IRS may make an independent showing
of the value of goodwill and going

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Federal Register / Vol. 66, No. 30 / Tuesday, February 13, 2001 / Rules and Regulations
concern value as a means of calling into
question the validity of the taxpayer’s
valuation of other assets.’’ This
authority was intended to provide a
means of ensuring that taxpayers do not
overvalue assets in higher classes that
are allocated consideration before the
residual class. As a factual matter, the
IRS and Treasury understand that a low
(or no) allocation to goodwill and going
concern value may result from causes
other than a taxpayer’s overvaluation of
assets in higher classes. Moreover, the
IRS and Treasury accept the soundness
of the fundamental premise of the
residual method that goodwill and going
concern value are the most difficult
assets to value independently and that
their value should be computed as the
residue after all other assets are valued.
The final regulations delete the sentence
about valuing goodwill and going
concern value. Under the final
regulations, the IRS retains the ability to
challenge a taxpayer’s valuation of
assets in Classes I through VI, but will
do so on grounds consistent with the
residual method of allocation.
Top-Down Allocation
Changes to the rules for allocating
purchase price to the stock and assets of
lower tier subsidiaries were not
proposed, although, as noted in the
preamble to the proposed regulations,
considerable study was given to
alternative approaches. Comments were
requested, but none was received, and
the IRS and Treasury to date have been
unable to develop a fully successful
alternative. Accordingly, the final
regulations continue to apply the ‘‘topdown’’ allocation system, under which
the stock of a lower tier subsidiary is
allocated purchase price in the general
asset category (now Class V) and the
deemed purchase price of its assets is in
turn computed from that stock price and
then allocated within the subsidiary.
In the final regulations, the scope of
Class II assets described in § 1.338–
6(b)(2)(ii) is modified to provide that
Class II assets do not include stock of
target affiliates, other than actively
traded stock described in section
1504(a)(4) (certain preferred stock).
Instead, stock of target affiliates is
included in Class V. This would
exclude target affiliate stock from Class
II where the target holds an 80 percent
or greater interest in the target affiliate
but a minority interest in target affiliate
stock of the same class is actively
traded. It is not clear that the trading
price for shares of a class of stock less
than 20 percent of which is in the hands
of the public, and which consequently
may experience thinner trading
volumes, necessarily is indicative of the

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fair market value of the 80 percent or
greater majority interest.

treatment more consistent with that of
an actual asset sale.

Class III Assets

First Year Price Adjustments

Like-kind Exchanges
A commentator suggested that the
final regulations should apply section
1031 to old target in its deemed asset
sale if the purchaser pays for target
stock with property of like kind to old
target’s assets or with cash put in
escrow for a successor to old target to
designate for purchase of assets of like
kind. This rule would be an exception
to the requirement in § 1.338–1(a)(2)
that the transaction between old target
and new target must be a taxable
transaction, and inconsistent with the
requirement of section 338(a)(1) that
target ‘‘shall be treated as having sold all
of its assets at the close of the
acquisition date at fair market value
* * *’’ After considering the policy
concerns and the administrative
difficulties in creating and
administering an exception for section
1031 exchanges, the IRS and Treasury
have not adopted this suggestion.

Proposed § 1.338–7 provides rules for
allocating the ADSP or AGUB when
increases or decreases are required after
the close of new target’s first taxable
year. For increases or decreases required
before the end of new target’s first
taxable year, proposed § 1.338–
4(b)(2)(ii) provides that ‘‘[i]ncreases or
decreases with respect to the elements
of ADSP that are taken into account
before the close of new target’s first
taxable year are taken into account for
purposes of determining ADSP and the
deemed sale tax consequences as if they
had been taken into account at the
beginning of the day after the
acquisition date.’’ Proposed § 1.338–
5(b)(2)(ii) contains a similar rule for
redeterminations of AGUB. These rules
originated in predecessor versions of the
regulations under section 338.
Although no commentator requested
removal of these rules, one comment
highlighted the difficulties posed for the
seller in section 338(h)(10) transactions
in applying a rule based on new target’s
year-end, and requested relief. After
reviewing this comment, the final
regulations remove the rules providing
special treatment for changes in ADSP
or AGUB occurring before the close of
new target’s first taxable year. Instead,
the general rule in § 1.338–7 governs the
allocation of all changes in ADSP or
AGUB after the acquisition date. This
change is consistent with the IRS’s and
Treasury’s expressed intent in drafting
the proposed regulations to eliminate, to
the extent possible, any special
accounting rules in the section 338
regulations, as it should result in

S Corporations
A purchaser may agree to compensate
the sellers of an S corporation target for
adverse tax consequences resulting from
a section 338(h)(10) election. When
more than one shareholder in an S
corporation sells stock in the same
transaction, the different shareholders
may negotiate different prices for their
stock based on varying Federal and state
tax liabilities they will bear as a result
of the transaction. Some commentators
have noted that, in other cases, different
prices may be paid for control
premiums or other reasons. Under
section 1361(b)(1)(D), an S corporation
is permitted to have only one class of
stock. A potential second class of stock
issue arises because the fiction of a
section 338(h)(10) election is that the
target sells its assets to a new target and
then liquidates. Applying that fiction, if
the shareholders are treated as receiving
differing amounts per share in the
deemed liquidation, a second class of
stock could result.
Some commentators have
recommended that the final regulations
clarify that the payment of varying
amounts per share to S corporation
shareholders will not cause the S
corporation to violate the single class of
stock requirement. The final regulations
respond to these comments by including
a statement in § 1.1361–1(l)(2)(v) that
the payment of varying amounts to S
corporation shareholders in a
transaction for which a section
338(h)(10) election is made will not
cause the S corporation to violate the
single class of stock requirement of

Proposed § 1.338–6(b)(2) provides that
Class III assets consist of ‘‘accounts
receivable, mortgages, and credit card
receivables from customers which arise
in the ordinary course of business.’’
Comments suggested that these
categories were too limited. Under the
rationales expressed in the preamble to
the proposed regulations, the IRS and
Treasury believe that other types of debt
instruments, and even other types of
assets, should be included in Class III.
As revised in the final regulations, Class
III assets generally consist of assets that
the taxpayer marks to market at least
annually and debt instruments
(including receivables). However, debt
instruments issued by related parties,
and certain contingent payment and
convertible debt instruments, are not
included in Class III.

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section 1361(b)(1)(D) and § 1.1361–1(l),
provided that the varying amounts are
negotiated in arm’s length negotiations
with the purchaser.
One commentator requested
clarification regarding the calculation
and allocation of the purchaser’s AGUB
for a target that was an S corporation
that owned a qualified subchapter S
subsidiary (QSub), where the QSub
status does not continue after the
acquisition date and the QSub is treated
as becoming a separate subsidiary of
new target. Although the regulations
require allocation of the AGUB among
the target’s assets held at the beginning
of the day after the acquisition date,
they also require results consistent with
those that would occur if the parties had
actually engaged in the transactions
deemed to occur because of section
338(h)(10), and taking into account
other transactions that actually occurred
or are deemed to occur. See
§ 1.338(h)(10)–1(d)(9). An actual sale of
the assets of the S corporation target,
including the stock of the QSub, to a
corporation would be treated as a sale
by the S corporation of all of its assets,
including those of the QSub. If the QSub
status does not continue after the
acquisition, the buyer would be treated
as forming a new subsidiary containing
the assets held by the former QSub. See
§ 1.1361–5(b)(3) Example 9.
Accordingly, the AGUB for the former S
corporation target would be allocated
among the assets of the former QSub as
though they were assets of the target,
and then the target would be treated as
having formed a new subsidiary
containing the assets of the former
QSub.
Clarification was also requested
regarding the possibility of making a
section 338(h)(10) election for the sale
by an S corporation of stock of a QSub.
As noted above, Example 9 of § 1.1361–
5(b)(3) indicates that the sale by an S
corporation of all of the stock of a QSub
is treated as an asset sale by the S
corporation to the purchaser of the
QSub stock. No further guidance is
provided in these regulations. The sale
of an 80 percent or greater (but less than
100 percent) interest in the stock of a
QSub is not expected to be a common
transaction because it generally will
result in a taxable transaction with
respect to all the assets of the QSub.
Forms 8023 and 8594
The current temporary regulations
provide that a section 338(h)(10)
election for an S corporation target must
be made jointly by the purchaser and
the S corporation shareholders. These
regulations specifically require
nonselling S corporation shareholders to

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consent to the election. See
§ 1.338(h)(10)–1T(c)(2). However, the
instructions for the election form (Form
8023) do not clearly require the
nonselling shareholders to sign the
election form. Moreover, the prior
regulations were less clear in requiring
nonselling S corporation shareholders to
consent to the election. Commentators
have requested that the IRS recognize
the validity of section 338(h)(10)
elections for S corporation targets even
if not signed by nonselling shareholders.
The IRS will revise Form 8023 to make
clear that nonselling S corporation
shareholders must also sign. The IRS
will recognize the validity of otherwise
valid elections made on the current
version of the form even if not signed
by the nonselling shareholders,
provided that the S corporation and all
of its shareholders (including nonselling
shareholders) report the tax
consequences consistently with the
results under section 338(h)(10). See
§ 1.338(i)–1(b).
The preamble to the proposed
regulations indicates that the IRS and
Treasury were considering requiring
that the information about the allocation
of ADSP and AGUB currently submitted
on the election form (Form 8023)
instead be submitted by the purchaser
and seller(s) separately on their income
tax returns. Such a change will be
effectuated when Form 8023 is revised.
The information about ADSP and AGUB
will be reported by each party
separately on Form 8594, which also
will be revised. With respect to a
transaction subject to a section 338
election, Form 8594 will be filed with
the income tax returns of the old and
new target for the tax periods including
the deemed sale and purchase. Where
an election under section 338(g) is made
for a controlled foreign corporation
(CFC), the purchaser and seller (or their
U.S. shareholder(s)) will be required to
submit separately, on Form 8594,
information about ADSP and AGUB.
The Form 8594 will be required to be
attached to the last Form 5471 filed by
the seller for old target, and to the first
Form 5471 filed by the purchaser for
new target.
Special Analyses
It has been determined that these final
regulations are not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
has been determined that a final
regulatory flexibility analysis is required
for the collection of information in this
Treasury decision under 5 U.S.C. 604.
This analysis is set forth below under
the heading ‘‘Final Regulatory

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Flexibility Act Analysis.’’ Pursuant to
section 7805(f) of the Internal Revenue
Code, these final regulations will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on their
impact on small business.
Final Regulatory Flexibility Act
Analysis
This analysis is required under the
Regulatory Flexibility Act (5 U.S.C.
chapter 6). This regulatory action is
intended to simplify and clarify the
current rules relating to both deemed
and actual asset acquisitions. The
current rules were developed over a
long period of time and have been
repeatedly amended. The IRS and
Treasury believe these final regulations
will significantly improve the clarity of
the rules relating to both deemed and
actual asset acquisitions.
The major objective of these final
regulations is to modify the rules for
allocating purchase price in both
deemed and actual asset acquisitions. In
addition, these final regulations replace
the general rules for electing to treat a
stock sale as an asset sale.
These collections of information may
affect small businesses if the stock of a
corporation which is a small entity is
acquired in a qualified stock purchase
or if a trade or business which is also
a small business is transferred in a
taxable transaction. Form 8023 (on
which an election to treat a stock sale
as an asset sale is filed) has been
submitted to and approved by the Office
of Management and Budget. With
respect to Form 8023, the IRS estimated
that 201 forms would be filed each year
and that each taxpayer would require
12.98 hours to comply. Form 8594 (on
which a sale or acquisition of assets
constituting a trade or business is
reported) has also been submitted to and
approved by the Office of Management
and Budget. With respect to Form 8594,
the IRS estimated that 20,000 forms
would be filed each year and that each
taxpayer would require 12.25 hours to
comply. These estimates have been
made available for public comment and
no public comments have been
received. The regulations do not impose
new requirements on small businesses
and, in fact, should lessen any
difficulties associated with the existing
reporting requirements by clarifying the
rules associated with deemed and actual
asset acquisitions.
The collections of information require
taxpayers to file an election in order to
treat a stock sale as an asset sale. In
addition, taxpayers must file a statement
regarding the amount of consideration
allocated to each class of assets under

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Federal Register / Vol. 66, No. 30 / Tuesday, February 13, 2001 / Rules and Regulations
the residual method. The professional
skills that would be necessary to make
the election or allocate the
consideration would be the same as
those required to prepare a return for
the small business.
Drafting Information
The principal author of these
regulations is Richard Starke, Office of
the Associate Chief Counsel (Corporate).
However, other personnel from the IRS
and Treasury Department participated
extensively in their development.

List of Subjects

entries for Sections 1.338–6T, 1.338–7T,
1.338–10T and 1.1060–1T and by
adding entries in numerical order to
read in part as follows:

26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping
requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by removing the

Section

9929

Authority: 26 U.S.C. 7805 * * * Section
1.338–6 also issued under 26 U.S.C. 337(d),
338, and 1502. Section 1.338–7 also issued
under 26 U.S.C. 337(d), 338, and 1502.,
Section 1.338–10 also issued under 26 U.S.C.
337(d), 338, and 1502.* * * Section 1.1060–
1 also issued under 26 U.S.C. 1060.* * *

Par. 2. In the list below, for each
section indicated in the left column,
remove the language in the middle
column and add the language in the
right column:

Remove

Add

1.56(g)–1(k)(1), second sentence ......................
1.56(g)–1(k)(1), last sentence ............................
1.197–2(e)(1), second sentence ........................
1.197–2(k), Example 6, paragraph (i), last sentence.
1.197–2(k), Example 6, paragraph (ii), second
sentence.
1.197–2(k), Example 6, paragraph (ii), last sentence.
1.197–2(k), Example 23, paragraph (iv), first
sentence.
1.338–8(h)(1), last sentence ..............................

of § 1.338–6T(b), if otherwise
of § 1.338–6T(c)(1) and (2) also
See § 1.1060–1T(b)(2)
See § 1.338–6T(b)

of § 1.338–6(b), if otherwise
of § 1.338–6(c)(1) and (2) also
See § 1.1060–1(b)(2)
See § 1.338–6(b)

Under §§ 1.1060–1T(c)(2) and 1.338–6T(c)(1)

Under §§ 1.1060–1(c)(2) and 1.338–6(c)(1)

See §§ 1.1060–1T(c)(2) and 1.338–6T(b)

See §§ 1.1060–1(c)(2) and 1.338–6(b)

(as these terms are defined as in defined in
§ 1.338–1(c)(13))
nomenclature of § 1.338–1(b) and (c) and

1.338–9(a), penultimate sentence ......................
1.338–9(b)(1), first sentence ..............................

provided in § 1.338–1(c)(14),
the deemed sale gain, as defined in § 1.338–
3(b)(4),
the deemed sale gain
under § 1.338(b)–1(e)(2)
reflect deemed sale gain)
under § 1.338(b)–1(e)(2),
and § 1.338(b)–1(e)(2)

(as these terms are defined as in defined in
§ 1.338–2(c)(17))
nomenclature of sentence § 1.338–2(b) and
(c) and
provided in § 1.338–2(c)(18),
the deemed sale tax sentence consequences,
as defined in § 1.338–2(c)(7),
the deemed sale tax consequences.
under § 1.338–5(d).
reflect deemed sale tax consequences)
under § 1.338–5(d),
and § 1.338–5(d).

(k) and 1.338–3T(c)(3)
see § 1.338–3T(c)(3) (which

(k) and 1.338–3(d).
see § 1.338–3(d) (which

(see § 1.338–7T)
under § 1.338–6T(b), (c)(1) and (2)
under § 1.338–6T(b), (c)(1) and (2)
and § 1.338–2T(d)

(see § 1.338–7)
under § 1.338–6(b), (c)(1) and (2).
under § 1.338–6(b), (c)(1) and (2).
and § 1.338–2(d)

see § 1.1060–1T(b), (c), and (d) Example 1
in § 1.338–6T(b), to which reference is made
by § 1.1060–1T(c)(2)
Under section 338(a) and § 1.338(h)(10)–
1T(d)(3),
See § 1.338(h)(10)–1T(d)(7) for
See § 1.338–10T(a)(5) (deemed

see § 1.1060–1(b), (c), and (d) Example 1.
in § 1.338–6(b), to which reference is made
by § 1.1060–1(c)(2).
Under section 338(a) and § 1.338(h)(10)–
1(d)(3),
See § 1.338(h)(10)–1(d)(7) for
See § 1.338–10(a)(5) (deemed

1.338–9(b)(1), last sentence ..............................
1.338–9(b)(3)(i)(B) ..............................................
1.338–9(b)(3)(ii) ..................................................
1.338–9(b)(4) ......................................................
1.338–9(f)(2), Example 1, paragraph (a), last
sentence.
1.368–1(a), third sentence .................................
1.368–1(e)(6), Example 4, paragraph (ii), last
sentence.
1.597–2(d)(5)(iii)(B) ............................................
1.597–5(c)(3)(i) ...................................................
1.597–5(d)(2)(i) ...................................................
1.921–1T(b)(1), A–1, immediately proceding the
penultimate sentence.
1.1031(d)–1T, last sentence ..............................
1.1031(j)–1(b)(2)(iii), penultimate sentence .......
1.1361–4(d), Example 3, third sentence ............
1.1502–75(k) ......................................................
1.1502–76(b)(1)(ii)(A)(1), last sentence .............

Par. 3. Sections 1.338–0 through
1.338–7 are added to read as follows:
§ 1.338–0

Outline of topics.

This section lists the captions
contained in the regulations under
section 338 as follows:
§ 1.338–1 General principles; status of old
target and new target.
(a) In general.
(1) Deemed transaction.

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(2) Application of other rules of law.
(3) Overview.
(b) Treatment of target under other
provisions of the Internal Revenue Code.
(1) General rule for subtitle A.
(2) Exceptions for subtitle A.
(3) General rule for other provisions of the
Internal Revenue Code.
(c) Anti-abuse rule.
(1) In general.
(2) Examples.
(d) Next day rule for post-closing
transactions.

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§ 1.338–2 Nomenclature and definitions;
mechanics of the section 338 election.
(a) Scope.
(b) Nomenclature.
(c) Definitions.
(1) Acquisition date.
(2) Acquisition date assets.
(3) Affiliated group.
(4) Common parent.
(5) Consistency period.
(6) Deemed asset sale.
(7) Deemed sale tax consequences.
(8) Deemed sale return.

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(9) Domestic corporation.
(10) Old target’s final return.
(11) Purchasing corporation.
(12) Qualified stock purchase.
(13) Related persons.
(14) Section 338 election.
(15) Section 338(h)(10) election.
(16) Selling group.
(17) Target; old target; new target.
(18) Target affiliate.
(19) 12-month acquisition period.
(d) Time and manner of making election.
(e) Special rules for foreign corporations or
DISCs.
(1) Elections by certain foreign purchasing
corporations.
(i) General rule.
(ii) Qualifying foreign purchasing
corporation.
(iii) Qualifying foreign target.
(iv) Triggering event.
(v) Subject to United States tax.
(2) Acquisition period.
(3) Statement of section 338 may be filed
by United States shareholders in certain
cases.
(4) Notice requirement for U.S. persons
holding stock in foreign target.
(i) General rule.
(ii) Limitation.
(iii) Form of notice.
(iv) Timing of notice.
(v) Consequence of failure to comply.
(vi) Good faith effort to comply.

§ 1.338–4 Aggregate deemed sale price;
various aspects of taxation of the deemed
asset sale.
(a) Scope.
(b) Determination of ADSP.
(1) General rule.
(2) Time and amount of ADSP.
(i) Original determination.
(ii) Redetermination of ADSP.
(iii) Example.
(c) Grossed-up amount realized on the sale
to the purchasing corporation of the
purchasing corporation’s recently purchased
target stock.
(1) Determination of amount.
(2) Example.
(d) Liabilities of old target.
(1) In general.
(2) Time and amount of liabilities.
(e) Deemed sale tax consequences.
(f) Other rules apply in determining ADSP.
(g) Examples.
(h) Deemed sale of target affiliate stock.
(1) Scope.
(2) In general.
(3) Deemed sale of foreign target affiliate by
a domestic target.
(4) Deemed sale producing effectively
connected income.
(5) Deemed sale of insurance company
target affiliate electing under section 953(d).
(6) Deemed sale of DISC target affiliate.
(7) Anti-stuffing rule.
(8) Examples.

§ 1.338–3 Qualification for the section 338
election.
(a) Scope.
(b) Rules relating to qualified stock
purchases.
(1) Purchasing corporation requirement.
(2) Purchase.
(3) Acquisitions of stock from related
corporations.
(i) In general.
(ii) Time for testing relationship.
(iii) Cases where section 338(h)(3)(C)
applies—acquisitions treated as purchases.
(iv) Examples.
(4) Acquisition date for tiered targets.
(i) Stock sold in deemed asset sale.
(ii) Examples.
(5) Effect of redemptions.
(i) General rule.
(ii) Redemptions from persons unrelated to
the purchasing corporation.
(iii) Redemptions from the purchasing
corporation or related persons during 12month acquisition period.
(A) General rule.
(B) Exception for certain redemptions from
related corporations.
(iv) Examples.
(c) Effect of post-acquisition events on
eligibility for section 338 election.
(1) Post-acquisition elimination of target.
(2) Post-acquisition elimination of the
purchasing corporation.
(d) Consequences of post-acquisition
elimination of target where section 338
election not made.
(1) Scope.
(2) Continuity of interest.
(3) Control requirement.
(4) Solely for voting stock requirement.
(5) Example.

§ 1.338–5 Adjusted grossed-up basis.
(a) Scope.
(b) Determination of AGUB.
(1) General rule.
(2) Time and amount of AGUB.
(i) Original determination.
(ii) Redetermination of AGUB.
(iii) Examples.
(c) Grossed-up basis of recently purchased
stock.
(d) Basis of nonrecently purchased stock;
gain recognition election.
(1) No gain recognition election.
(2) Procedure for making gain recognition
election.
(3) Effect of gain recognition election.
(i) In general.
(ii) Basis amount.
(iii) Losses not recognized.
(iv) Stock subject to election.
(e) Liabilities of new target.
(1) In general.
(2) Time and amount of liabilities.
(3) Interaction with deemed sale tax
consequences.
(f) Adjustments by the Internal Revenue
Service.
(g) Examples.

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§ 1.338–6 Allocation of ADSP and AGUB
among target assets.
(a) Scope.
(1) In general.
(2) Fair market value.
(i) In general.
(ii) Transaction costs.
(iii) Internal Revenue Service authority.
(b) General rule for allocating ADSP and
AGUB.
(1) Reduction in the amount of
consideration for Class I assets.

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(2) Other assets.
(i) In general.
(ii) Class II assets.
(iii) Class III assets.
(iv) Class IV assets.
(v) Class V assets.
(vi) Class VI assets.
(vii) Class VII assets.
(3) Other items designated by the Internal
Revenue Service.
(c) Certain limitations and other rules for
allocation to an asset.
(1) Allocation not to exceed fair market
value.
(2) Allocation subject to other rules.
(3) Special rule for allocating AGUB when
purchasing corporation has nonrecently
purchased stock.
(i) Scope.
(ii) Determination of hypothetical purchase
price.
(iii) Allocation of AGUB.
(4) Liabilities taken into account in
determining amount realized on subsequent
disposition.
(d) Examples.
§ 1.338–7 Allocation of redetermined
ADSP and AGUB among target assets.
(a) Scope.
(b) Allocation of redetermined ADSP and
AGUB.
(c) Special rules for ADSP.
(1) Increases or decreases in deemed sale
tax consequences taxable notwithstanding
old target ceases to exist.
(2) Procedure for transactions in which
section 338(h)(10) is not elected.
(i) Deemed sale tax consequences included
in new target’s return.
(ii) Carryovers and carrybacks.
(A) Loss carryovers to new target taxable
years.
(B) Loss carrybacks to taxable years of old
target.
(C) Credit carryovers and carrybacks.
(3) Procedure for transactions in which
section 338(h)(10) is elected.
(d) Special rules for AGUB.
(1) Effect of disposition or depreciation of
acquisition date assets.
(2) Section 38 property.
(e) Examples.
§ 1.338–8 Asset and stock consistency.
(a) Introduction.
(1) Overview.
(2) General application.
(3) Extension of the general rules.
(4) Application where certain dividends
are paid.
(5) Application to foreign target affiliates.
(6) Stock consistency.
(b) Consistency for direct acquisitions.
(1) General rule.
(2) Section 338(h)(10) elections.
(c) Gain from disposition reflected in basis
of target stock.
(1) General rule.
(2) Gain not reflected if section 338
election made for target.
(3) Gain reflected by reason of
distributions.
(4) Controlled foreign corporations.
(5) Gain recognized outside the
consolidated group.

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(d) Basis of acquired assets.
(1) Carryover basis rule.
(2) Exceptions to carryover basis rule for
certain assets.
(3) Exception to carryover basis rule for de
minimis assets.
(4) Mitigation rule.
(i) General rule.
(ii) Time for transfer.
(e) Examples.
(1) In general.
(2) Direct acquisitions.
(f) Extension of consistency to indirect
acquisitions.
(1) Introduction.
(2) General rule.
(3) Basis of acquired assets.
(4) Examples.
(g) Extension of consistency if dividends
qualifying for 100 percent dividends received
deduction are paid.
(1) General rule for direct acquisitions from
target.
(2) Other direct acquisitions having same
effect.
(3) Indirect acquisitions.
(4) Examples.
(h) Consistency for target affiliates that are
controlled foreign corporations.
(1) In general.
(2) Income or gain resulting from asset
dispositions.
(i) General rule.
(ii) Basis of controlled foreign corporation
stock.
(iii) Operating rule.
(iv) Increase in asset or stock basis.
(3) Stock issued by target affiliate that is a
controlled foreign corporation.
(4) Certain distributions.
(i) General rule.
(ii) Basis of controlled foreign corporation
stock.
(iii) Increase in asset or stock basis.
(5) Examples.
(i) [Reserved]
(j) Anti-avoidance rules.
(1) Extension of consistency period.
(2) Qualified stock purchase and 12-month
acquisition period.
(3) Acquisitions by conduits.
(i) Asset ownership.
(A) General rule.
(B) Application of carryover basis rule.
(ii) Stock acquisitions.
(A) Purchase by conduit.
(B) Purchase of conduit by corporation.
(C) Purchase of conduit by conduit.
(4) Conduit.
(5) Existence of arrangement.
(6) Predecessor and successor.
(i) Persons.
(ii) Assets.
(7) Examples.
§ 1.338–9 International aspects of section
338.
(a) Scope.
(b) Application of section 338 to foreign
targets.
(1) In general.
(2) Ownership of FT stock on the
acquisition date.
(3) Carryover FT stock.
(i) Definition.
(ii) Carryover of earnings and profits.

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(iii) Cap on carryover of earnings and
profits.
(iv) Post-acquisition date distribution of
old FT earnings and profits.
(v) Old FT earnings and profits unaffected
by post-acquisition date deficits.
(vi) Character of FT stock as carryover FT
stock eliminated upon disposition.
(4) Passive foreign investment company
stock.
(c) Dividend treatment under section
1248(e).
(d) Allocation of foreign taxes.
(e) Operation of section 338(h)(16).
[Reserved]
(f) Examples.
§ 1.338–10 Filing of returns.
(a) Returns including tax liability from
deemed asset sale.
(1) In general.
(2) Old target’s final taxable year otherwise
included in consolidated return of selling
group.
(i) General rule.
(ii) Separate taxable year.
(iii) Carryover and carryback of tax
attributes.
(iv) Old target is a component member of
purchasing corporation’s controlled group.
(3) Old target is an S corporation.
(4) Combined deemed sale return.
(i) General rule.
(ii) Gain and loss offsets.
(iii) Procedure for filing a combined return.
(iv) Consequences of filing a combined
return.
(5) Deemed sale excluded from purchasing
corporation’s consolidated return.
(6) Due date for old target’s final return.
(i) General rule.
(ii) Application of § 1.1502–76(c).
(A) In general.
(B) Deemed extension.
(C) Erroneous filing of deemed sale return.
(D) Erroneous filing of return for regular
tax year.
(E) Last date for payment of tax.
(7) Examples.
(b) Waiver.
(1) Certain additions to tax.
(2) Notification.
(3) Elections or other actions required to be
specified on a timely filed return.
(i) In general.
(ii) New target in purchasing corporation’s
consolidated return.
(4) Examples.
§ 1.338(h)(10)–1 Deemed asset sale and
liquidation.
(a) Scope.
(b) Definitions.
(1) Consolidated target.
(2) Selling consolidated group.
(3) Selling affiliate; affiliated target.
(4) S corporation target.
(5) S corporation shareholders.
(6) Liquidation.
(c) Section 338(h)(10) election.
(1) In general.
(2) Simultaneous joint election
requirement.
(3) Irrevocability.
(4) Effect of invalid election.
(d) Certain consequences of section
338(h)(10) election.

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9931

(1) P.
(2) New T.
(3) Old T—deemed sale.
(i) In general.
(ii) Tiered targets.
(4) Old T and selling consolidated group,
selling affiliate, or S corporation
shareholders—deemed liquidation; tax
characterization.
(i) In general.
(ii) Tiered targets.
(5) Selling consolidated group, selling
affiliate, or S corporation shareholders.
(i) In general.
(ii) Basis and holding period of T stock not
acquired.
(iii) T stock sale.
(6) Nonselling minority shareholders other
than nonselling S corporation shareholders.
(i) In general.
(ii) T stock sale.
(iii) T stock not acquired.
(7) Consolidated return of selling
consolidated group.
(8) Availability of the section 453
installment method.
(i) In deemed asset sale.
(ii) In deemed liquidation.
(9) Treatment consistent with an actual
asset sale.
(e) Examples.
(f) Inapplicability of provisions.
(g) Required information.
§ 1.338(i)–1

Effective dates.

§ 1.338–1 General principles; status of old
target and new target.

(a) In general—(1) Deemed
transaction. Elections are available
under section 338 when a purchasing
corporation acquires the stock of
another corporation (the target) in a
qualified stock purchase. One type of
election, under section 338(g), is
available to the purchasing corporation.
Another type of election, under section
338(h)(10), is, in more limited
circumstances, available jointly to the
purchasing corporation and the sellers
of the stock. (Rules concerning
eligibility for these elections are
contained in §§ 1.338–2, 1.338–3, and
1.338(h)(10)–1.) Although target is a
single corporation under corporate law,
if a section 338 election is made, then
two separate corporations, old target
and new target, generally are considered
to exist for purposes of subtitle A of the
Internal Revenue Code. Old target is
treated as transferring all of its assets to
an unrelated person in exchange for
consideration that includes the
discharge of its liabilities (see § 1.1001–
2(a)), and new target is treated as
acquiring all of its assets from an
unrelated person in exchange for
consideration that includes the
assumption of those liabilities. (Such
transaction is, without regard to its
characterization for Federal income tax
purposes, referred to as the deemed
asset sale and the income tax

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consequences thereof as the deemed
sale tax consequences.) If a section
338(h)(10) election is made, old target is
deemed to liquidate following the
deemed asset sale.
(2) Application of other rules of law.
Other rules of law apply to determine
the tax consequences to the parties as if
they had actually engaged in the
transactions deemed to occur under
section 338 and the regulations
thereunder except to the extent
otherwise provided in those regulations.
See also § 1.338–6(c)(2). Other rules of
law may characterize the transaction as
something other than or in addition to
a sale and purchase of assets; however,
the transaction between old and new
target must be a taxable transaction. For
example, if target is an insurance
company for which a section 338
election is made, the deemed asset sale
would be characterized and taxed as an
assumption-reinsurance transaction
under applicable Federal income tax
law. See § 1.817–4(d).
(3) Overview. Definitions and special
nomenclature and rules for making the
section 338 election are provided in
§ 1.338–2. Qualification for the section
338 election is addressed in § 1.338–3.
The amount for which old target is
treated as selling all of its assets (the
aggregate deemed sale price, or ADSP)
is addressed in § 1.338–4. The amount
for which new target is deemed to have
purchased all its assets (the adjusted
grossed-up basis, or AGUB) is addressed
in § 1.338–5. Section 1.338–6 addresses
allocation both of ADSP among the
assets old target is deemed to have sold
and of AGUB among the assets new
target is deemed to have purchased.
Section 1.338–7 addresses allocation of
ADSP or AGUB when those amounts
subsequently change. Asset and stock
consistency are addressed in § 1.338–8.
International aspects of section 338 are
covered in § 1.338–9. Rules for the filing
of returns are provided in § 1.338–10.
Eligibility for and treatment of section
338(h)(10) elections is addressed in
§ 1.338(h)(10)–1.
(b) Treatment of target under other
provisions of the Internal Revenue
Code—(1) General rule for subtitle A.
Except as provided in this section, new
target is treated as a new corporation
that is unrelated to old target for
purposes of subtitle A of the Internal
Revenue Code. Thus—
(i) New target is not considered
related to old target for purposes of
section 168 and may make new
elections under section 168 without
taking into account the elections made
by old target; and
(ii) New target may adopt, without
obtaining prior approval from the

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Commissioner, any taxable year that
meets the requirements of section 441
and any method of accounting that
meets the requirements of section 446.
Notwithstanding § 1.441–1T(b)(2), a
new target may adopt a taxable year on
or before the last day for making the
election under section 338 by filing its
first return for the desired taxable year
on or before that date.
(2) Exceptions for subtitle A. New
target and old target are treated as the
same corporation for purposes of—
(i) The rules applicable to employee
benefit plans (including those plans
described in sections 79, 104, 105, 106,
125, 127, 129, 132, 137, and 220),
qualified pension, profit-sharing, stock
bonus and annuity plans (sections
401(a) and 403(a)), simplified employee
pensions (section 408(k)), tax qualified
stock option plans (sections 422 and
423), welfare benefit funds (sections
419, 419A, 512(a)(3), and 4976), and
voluntary employee benefit associations
(section 501(c)(9) and the regulations
thereunder);
(ii) Sections 1311 through 1314
(relating to the mitigation of the effect
of limitations), if a section 338(h)(10)
election is not made for target;
(iii) Section 108(e)(5) (relating to the
reduction of purchase money debt);
(iv) Section 45A (relating to the
Indian Employment Credit), section 51
(relating to the Work Opportunity
Credit), section 51A (relating to the
Welfare to Work Credit), and section
1396 (relating to the Empowerment
Zone Act);
(v) Sections 401(h) and 420 (relating
to medical benefits for retirees);
(vi) Section 414 (relating to
definitions and special rules); and
(vii) Any other provision designated
in the Internal Revenue Bulletin by the
Internal Revenue Service. See
§ 601.601(d)(2)(ii) of this chapter. See,
for example, § 1.1001–3(e)(4)(i)(F)
providing that an election under section
338 does not result in the substitution
of a new obligor on target’s debt.
(3) General rule for other provisions of
the Internal Revenue Code. Except as
provided in the regulations under
section 338 or in the Internal Revenue
Bulletin by the Internal Revenue Service
(see § 601.601(d)(2)(ii) of this chapter),
new target is treated as a continuation
of old target for purposes other than
subtitle A of the Internal Revenue Code.
For example—
(i) New target is liable for old target’s
Federal income tax liabilities, including
the tax liability for the deemed sale tax
consequences and those tax liabilities of
the other members of any consolidated
group that included old target that are
attributable to taxable years in which

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those corporations and old target joined
in the same consolidated return (see
§ 1.1502–6(a));
(ii) Wages earned by the employees of
old target are considered wages earned
by such employees from new target for
purposes of sections 3101 and 3111
(Federal Insurance Contributions Act)
and section 3301 (Federal
Unemployment Tax Act); and
(iii) Old target and new target must
use the same employer identification
number.
(c) Anti-abuse rule—(1) In general.
The rules of this paragraph (c) apply for
purposes of applying the residual
method as provided for under the
regulations under sections 338 and
1060. The Commissioner is authorized
to treat any property (including cash)
transferred by old target in connection
with the transactions resulting in the
application of the residual method (and
not held by target at the close of the
acquisition date) as, nonetheless,
property of target at the close of the
acquisition date if the property so
transferred is, within 24 months after
the deemed asset sale, owned by new
target, or is owned, directly or
indirectly, by a member of the affiliated
group of which new target is a member
and continues after the acquisition date
to be held or used primarily in
connection with one or more of the
activities of new target. In addition, the
Commissioner is authorized to treat any
property (including cash) transferred to
old target in connection with the
transactions resulting in the application
of the residual method (and held by
target at the close of the acquisition
date) as, nonetheless, not being property
of target at the close of the acquisition
date if the property so transferred is,
within 24 months after the deemed asset
sale, not owned by new target but
owned, directly or indirectly, by a
member of the affiliated group of which
new target is a member, or owned by
new target but held or used primarily in
connection with an activity conducted,
directly or indirectly, by another
member of the affiliated group of which
new target is a member in combination
with other property retained by or
acquired, directly or indirectly, from the
transferor of the property (or a member
of the same affiliated group) to old
target. For purposes of this paragraph
(c)(1), an interest in an entity is
considered held or used in connection
with an activity if property of the entity
is so held or used. The authority of the
Commissioner under this paragraph
(c)(1) includes the making of any
appropriate correlative adjustments
(avoiding, to the extent possible, the

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duplication or omission of any item of
income, gain, loss, deduction, or basis).
(2) Examples. The following examples
illustrate this paragraph (c):
Example 1. Prior to a qualified stock
purchase under section 338, target transfers
one of its assets to a related party. The
purchasing corporation then purchases the
target stock and also purchases the
transferred asset from the related party. After
its purchase of target, the purchasing
corporation and target are members of the
same affiliated group. A section 338 election
is made. Under an arrangement with the
purchaser, the separately transferred asset is
used primarily in connection with target’s
activities. Applying the anti-abuse rule of
this paragraph (c), the Commissioner may
consider target to own the transferred asset
for purposes of applying the residual method
under section 338.
Example 2. T owns all the stock of T1. T1
leases intellectual property to T, which T
uses in connection with its own activities. P,
a purchasing corporation, wishes to buy the
T–T1 chain of corporations. P, in connection
with its planned purchase of the T stock,
contracts to consummate a purchase of all the
stock of T1 on March 1 and of all the stock
of T on March 2. Section 338 elections are
thereafter made for both T and T1.
Immediately after the purchases, P, T and T1
are members of the same affiliated group. T
continues to lease the intellectual property
from T1 and that is the primary use of the
intellectual property. Thus, an asset of T, the
T1 stock, was removed from T’s own assets
prior to the qualified stock purchase of the
T stock, T1’s own assets are used after the
deemed asset sale in connection with T’s
own activities, and the T1 stock is after the
deemed asset sale owned by P, a member of
the same affiliated group of which T is a
member. Applying the anti-abuse rule of this
paragraph (c), the Commissioner may, for
purposes of application of the residual
method under section 338 both to T and to
T1, consider P to have bought only the stock
of T, with T at the time of the qualified stock
purchases of both T and T1 (the qualified
stock purchase of T1 being triggered by the
deemed sale under section 338 of T’s assets)
owning T1. The Commissioner accordingly
would allocate consideration to T’s assets as
though the T1 stock were one of those assets,
and then allocate consideration within T1
based on the amount allocated to the T1
stock at the T level.

(d) Next day rule for post-closing
transactions. If a target corporation for
which an election under section 338 is
made engages in a transaction outside
the ordinary course of business on the
acquisition date after the event resulting
in the qualified stock purchase of the
target or a higher tier corporation, the
target and all persons related thereto
(either before or after the qualified stock
purchase) under section 267(b) or
section 707 must treat the transaction
for all Federal income tax purposes as
occurring at the beginning of the day
following the transaction and after the
deemed purchase by new target.

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§ 1.338–2 Nomenclature and definitions;
mechanics of the section 338 election.

(a) Scope. This section prescribes
rules relating to elections under section
338.
(b) Nomenclature. For purposes of the
regulations under section 338 (except as
otherwise provided):
(1) T is a domestic target corporation
that has only one class of stock
outstanding. Old T refers to T for
periods ending on or before the close of
T’s acquisition date; new T refers to T
for subsequent periods.
(2) P is the purchasing corporation.
(3) The P group is an affiliated group
of which P is a member.
(4) P1, P2, etc., are domestic
corporations that are members of the P
group.
(5) T1, T2, etc., are domestic
corporations that are target affiliates of
T. These corporations (T1, T2, etc.) have
only one class of stock outstanding and
may also be targets.
(6) S is a domestic corporation
(unrelated to P and B) that owns T prior
to the purchase of T by P. (S is referred
to in cases in which it is appropriate to
consider the effects of having all of the
outstanding stock of T owned by a
domestic corporation.)
(7) A, a U.S. citizen or resident, is an
individual (unrelated to P and B) who
owns T prior to the purchase of T by P.
(A is referred to in cases in which it is
appropriate to consider the effects of
having all of the outstanding stock of T
owned by an individual who is a U.S.
citizen or resident. Ownership of T by
A and ownership of T by S are mutually
exclusive circumstances.)
(8) B, a U.S. citizen or resident, is an
individual (unrelated to T, S, and A)
who owns the stock of P.
(9) F, used as a prefix with the other
terms in this paragraph (b), connotes
foreign, rather than domestic, status. For
example, FT is a foreign corporation (as
defined in section 7701(a)(5)) and FA is
an individual other than a U.S. citizen
or resident.
(10) CFC, used as a prefix with the
other terms in this paragraph (b)
referring to a corporation, connotes a
controlled foreign corporation (as
defined in section 957, taking into
account section 953(c)). A corporation
identified with the prefix F may be a
controlled foreign corporation. (The
prefix CFC is used when the
corporation’s status as a controlled
foreign corporation is significant.)
(c) Definitions. For purposes of the
regulations under section 338 (except as
otherwise provided):
(1) Acquisition date. The term
acquisition date has the same meaning
as in section 338(h)(2).

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9933

(2) Acquisition date assets.
Acquisition date assets are the assets of
the target held at the beginning of the
day after the acquisition date (but see
§ 1.338–1(d) (regarding certain
transactions on the acquisition date)).
(3) Affiliated group. The term
affiliated group has the same meaning
as in section 338(h)(5). Corporations are
affiliated on any day they are members
of the same affiliated group.
(4) Common parent. The term
common parent has the same meaning
as in section 1504.
(5) Consistency period. The
consistency period is the period
described in section 338(h)(4)(A) unless
extended pursuant to § 1.338–8(j)(1).
(6) Deemed asset sale. The deemed
asset sale is the transaction described in
§ 1.338–1(a)(1) that is deemed to occur
for purposes of subtitle A of the Internal
Revenue Code if a section 338 election
is made.
(7) Deemed sale tax consequences.
Deemed sale tax consequences refers
to, in the aggregate, the Federal income
tax consequences (generally, the
income, gain, deduction, and loss) of the
deemed asset sale. Deemed sale tax
consequences also refers to the Federal
income tax consequences of the transfer
of a particular asset in the deemed asset
sale.
(8) Deemed sale return. The deemed
sale return is the return on which
target’s deemed sale tax consequences
are reported that does not include any
other items of target. Target files a
deemed sale return when a section 338
election (but not a section 338(h)(10)
election) is filed for target and target is
a member of a selling group (defined in
paragraph (c)(16) of this section) that
files a consolidated return for the period
that includes the acquisition date. See
§ 1.338–10. If target is an S corporation
for the period that ends on the day
before the acquisition date and a section
338 election (but not a section
338(h)(10) election) is filed for target,
see § 1.338–10(a)(3).
(9) Domestic corporation. A domestic
corporation is a corporation—
(i) That is domestic within the
meaning of section 7701(a)(4) or that is
treated as domestic for purposes of
subtitle A of the Internal Revenue Code
(e.g., to which an election under section
953(d) or 1504(d) applies); and
(ii) That is not a DISC, a corporation
described in section 1248(e), or a
corporation to which an election under
section 936 applies.
(10) Old target’s final return. Old
target’s final return is the income tax
return of old target for the taxable year
ending at the close of the acquisition
date that includes the deemed sale tax

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consequences. However, if a deemed
sale return is filed for old target, the
deemed sale return is considered old
target’s final return.
(11) Purchasing corporation. The term
purchasing corporation has the same
meaning as in section 338(d)(1). The
purchasing corporation may also be
referred to as purchaser. Unless
otherwise provided, any reference to the
purchasing corporation is a reference to
all members of the affiliated group of
which the purchasing corporation is a
member. See sections 338(h)(5) and (8).
Also, unless otherwise provided, any
reference to the purchasing corporation
is, with respect to a deemed purchase of
stock under section 338(a)(2), a
reference to new target with respect to
its own deemed purchase of stock in
another target.
(12) Qualified stock purchase. The
term qualified stock purchase has the
same meaning as in section 338(d)(3).
(13) Related persons. Two persons are
related if stock in a corporation owned
by one of the persons would be
attributed under section 318(a) (other
than section 318(a)(4)) to the other.
(14) Section 338 election. A section
338 election is an election to apply
section 338(a) to target. A section 338
election is made by filing a statement of
section 338 election pursuant to
paragraph (d) of this section. The form
on which this statement is filed is
referred to in the regulations under
section 338 as the Form 8023,
‘‘Elections Under Section 338 For
Corporations Making Qualified Stock
Purchases.’’
(15) Section 338(h)(10) election. A
section 338(h)(10) election is an election
to apply section 338(h)(10) to target. A
section 338(h)(10) election is made by
making a joint election for target under
§ 1.338(h)(10)–1 on Form 8023.
(16) Selling group. The selling group
is the affiliated group (as defined in
section 1504) eligible to file a
consolidated return that includes target
for the taxable period in which the
acquisition date occurs. However, a
selling group is not an affiliated group
of which target is the common parent on
the acquisition date.
(17) Target; old target; new target.
Target is the target corporation as
defined in section 338(d)(2). Old target
refers to target for periods ending on or
before the close of target’s acquisition
date. New target refers to target for
subsequent periods.
(18) Target affiliate. The term target
affiliate has the same meaning as in
section 338(h)(6) (applied without
section 338(h)(6)(B)(i)). Thus, a
corporation described in section
338(h)(6)(B)(i) is considered a target

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affiliate for all purposes of section 338.
If a target affiliate is acquired in a
qualified stock purchase, it is also a
target.
(19) 12-month acquisition period. The
12-month acquisition period is the
period described in section 338(h)(1),
unless extended pursuant to § 1.338–
8(j)(2).
(d) Time and manner of making
election. The purchasing corporation
makes a section 338 election for target
by filing a statement of section 338
election on Form 8023 in accordance
with the instructions to the form. The
section 338 election must be made not
later than the 15th day of the 9th month
beginning after the month in which the
acquisition date occurs. A section 338
election is irrevocable. See
§ 1.338(h)(10)–1(c)(2) for section
338(h)(10) elections.
(e) Special rules for foreign
corporations or DISCs—(1) Elections by
certain foreign purchasing
corporations—(i) General rule. A
qualifying foreign purchasing
corporation is not required to file a
statement of section 338 election for a
qualifying foreign target before the
earlier of 3 years after the acquisition
date and the 180th day after the close of
the purchasing corporation’s taxable
year within which a triggering event
occurs.
(ii) Qualifying foreign purchasing
corporation. A purchasing corporation
is a qualifying foreign purchasing
corporation only if, during the
acquisition period of a qualifying
foreign target, all the corporations in the
purchasing corporation’s affiliated
group are foreign corporations that are
not subject to United States tax.
(iii) Qualifying foreign target. A target
is a qualifying foreign target only if
target and its target affiliates are foreign
corporations that, during target’s
acquisition period, are not subject to
United States tax (and will not become
subject to United States tax during such
period because of a section 338
election). A target affiliate is taken into
account for purposes of the preceding
sentence only if, during target’s 12month acquisition period, it is or
becomes a member of the affiliated
group that includes the purchasing
corporation.
(iv) Triggering event. A triggering
event occurs in the taxable year of the
qualifying foreign purchasing
corporation in which either that
corporation or any corporation in its
affiliated group becomes subject to
United States tax.
(v) Subject to United States tax. For
purposes of this paragraph (e)(1), a

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foreign corporation is considered
subject to United States tax—
(A) For the taxable year for which that
corporation is required under § 1.6012–
2(g) (other than § 1.6012–2(g)(2)(i)(B)(2))
to file a United States income tax return;
or
(B) For the period during which that
corporation is a controlled foreign
corporation, a passive foreign
investment company for which an
election under section 1295 is in effect,
a foreign investment company, or a
foreign corporation the stock ownership
of which is described in section
552(a)(2).
(2) Acquisition period. For purposes
of this paragraph (e), the term
acquisition period means the period
beginning on the first day of the 12month acquisition period and ending on
the acquisition date.
(3) Statement of section 338 election
may be filed by United States
shareholders in certain cases. The
United States shareholders (as defined
in section 951(b)) of a foreign
purchasing corporation that is a
controlled foreign corporation (as
defined in section 957 (taking into
account section 953(c))) may file a
statement of section 338 election on
behalf of the purchasing corporation if
the purchasing corporation is not
required under § 1.6012–2(g) (other than
§ 1.6012–2(g)(2)(i)(B)(2)) to file a United
States income tax return for its taxable
year that includes the acquisition date.
Form 8023 must be filed as described in
the form and its instructions and also
must be attached to the Form 5471,
‘‘Information Returns Of U.S. Persons
With Respect To Certain Foreign
Corporations,’’ filed with respect to the
purchasing corporation by each United
States shareholder for the purchasing
corporation’s taxable year that includes
the acquisition date (or, if paragraph
(e)(1)(i) of this section applies to the
election, for the purchasing
corporation’s taxable year within which
it becomes a controlled foreign
corporation). The provisions of § 1.964–
1(c) (including § 1.964–1(c)(7)) do not
apply to an election made by the United
States shareholders.
(4) Notice requirement for U.S.
persons holding stock in foreign target—
(i) General rule. If a target subject to a
section 338 election was a controlled
foreign corporation, a passive foreign
investment company, or a foreign
personal holding company at any time
during the portion of its taxable year
that ends on its acquisition date, the
purchasing corporation must deliver
written notice of the election (and a
copy of Form 8023, its attachments and
instructions) to—

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(A) Each U.S. person (other than a
member of the affiliated group of which
the purchasing corporation is a member
(the purchasing group member)) that, on
the acquisition date of the foreign target,
holds stock in the foreign target; and
(B) Each U.S. person (other than a
purchasing group member) that sells
stock in the foreign target to a
purchasing group member during the
foreign target’s 12-month acquisition
period.
(ii) Limitation. The notice
requirement of this paragraph (e)(4)
applies only where the section 338
election for the foreign target affects
income, gain, loss, deduction, or credit
of the U.S. person described in
paragraph (e)(4)(i) of this section under
section 551, 951, 1248, or 1293.
(iii) Form of notice. The notice to U.S.
persons must be identified prominently
as a notice of section 338 election and
must—
(A) Contain the name, address, and
employer identification number (if any)
of, and the country (and, if relevant, the
lesser political subdivision) under the
laws of which are organized the
purchasing corporation and the relevant
target (i.e., the target the stock of which
the particular U.S. person held or sold
under the circumstances described in
paragraph (e)(4)(i) of this section);
(B) Identify those corporations as the
purchasing corporation and the foreign
target, respectively; and
(C) Contain the following declaration
(or a substantially similar declaration):
THIS DOCUMENT SERVES AS NOTICE
OF AN ELECTION UNDER SECTION 338
FOR THE ABOVE CITED FOREIGN TARGET
THE STOCK OF WHICH YOU EITHER HELD
OR SOLD UNDER THE CIRCUMSTANCES
DESCRIBED IN TREASURY REGULATIONS
SECTION 1.338–2(e)(4). FOR POSSIBLE
UNITED STATES FEDERAL INCOME TAX
CONSEQUENCES UNDER SECTION 551,
951, 1248, OR 1293 OF THE INTERNAL
REVENUE CODE OF 1986 THAT MAY
APPLY TO YOU, SEE TREASURY
REGULATIONS SECTION 1.338–9(b). YOU
MAY BE REQUIRED TO ATTACH THE
INFORMATION ATTACHED TO THIS
NOTICE TO CERTAIN RETURNS.

(iv) Timing of notice. The notice
required by this paragraph (e)(4) must
be delivered to the U.S. person on or
before the later of the 120th day after the
acquisition date of the particular target
or the day on which Form 8023 is filed.
The notice is considered delivered on
the date it is mailed to the proper
address (or an address similar enough to
complete delivery), unless the date it is
mailed cannot be reasonably
determined. The date of mailing will be
determined under the rules of section
7502. For example, the date of mailing

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is the date of U.S. postmark or the
applicable date recorded or marked by
a designated delivery service.
(v) Consequence of failure to comply.
A statement of section 338 election is
not valid if timely notice is not given to
one or more U.S. persons described in
this paragraph (e)(4). If the form of
notice fails to comply with all
requirements of this paragraph (e)(4),
the section 338 election is valid, but the
waiver rule of § 1.338–10(b)(1) does not
apply.
(vi) Good faith effort to comply. The
purchasing corporation will be
considered to have complied with this
paragraph (e)(4), even though it failed to
provide notice or provide timely notice
to each person described in this
paragraph (e)(4), if the Commissioner
determines that the purchasing
corporation made a good faith effort to
identify and provide timely notice to
those U.S. persons.
§ 1.338–3
election.

Qualification for the section 338

(a) Scope. This section provides rules
on whether certain acquisitions of stock
are qualified stock purchases and on
other miscellaneous issues under
section 338.
(b) Rules relating to qualified stock
purchases—(1) Purchasing corporation
requirement. An individual cannot
make a qualified stock purchase of
target. Section 338(d)(3) requires, as a
condition of a qualified stock purchase,
that a corporation purchase the stock of
target. If an individual forms a
corporation (new P) to acquire target
stock, new P can make a qualified stock
purchase of target if new P is considered
for tax purposes to purchase the target
stock. Facts that may indicate that new
P does not purchase the target stock
include new P’s merging downstream
into target, liquidating, or otherwise
disposing of the target stock following
the purported qualified stock purchase.
(2) Purchase. The term purchase has
the same meaning as in section
338(h)(3). Stock in a target (or target
affiliate) may be considered purchased
if, under general principles of tax law,
the purchasing corporation is
considered to own stock of the target (or
target affiliate) meeting the requirements
of section 1504(a)(2), notwithstanding
that no amount may be paid for (or
allocated to) the stock.
(3) Acquisitions of stock from related
corporations—(i) In general. Stock
acquired by a purchasing corporation
from a related corporation (R) is
generally not considered acquired by
purchase. See section 338(h)(3)(A)(iii).
(ii) Time for testing relationship. For
purposes of section 338(h)(3)(A)(iii), a

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purchasing corporation is treated as
related to another person if the
relationship specified in section
338(h)(3)(A)(iii) exists—
(A) In the case of a single transaction,
immediately after the purchase of target
stock;
(B) In the case of a series of
acquisitions otherwise constituting a
qualified stock purchase within the
meaning of section 338(d)(3),
immediately after the last acquisition in
such series; and
(C) In the case of a series of
transactions effected pursuant to an
integrated plan to dispose of target
stock, immediately after the last
transaction in such series.
(iii) Cases where section 338(h)(3)(C)
applies—acquisitions treated as
purchases. If section 338(h)(3)(C)
applies and the purchasing corporation
is treated as acquiring stock by purchase
from R, solely for purposes of
determining when the stock is
considered acquired, target stock
acquired from R is considered to have
been acquired by the purchasing
corporation on the day on which the
purchasing corporation is first
considered to own that stock under
section 318(a) (other than section
318(a)(4)).
(iv) Examples. The following
examples illustrate this paragraph (b)(3):
Example 1. (i) S is the parent of a group
of corporations that are engaged in various
businesses. Prior to January 1, Year 1, S
decided to discontinue its involvement in
one line of business. To accomplish this, S
forms a new corporation, Newco, with a
nominal amount of cash. Shortly thereafter,
on January 1, Year 1, S transfers all the stock
of the subsidiary conducting the unwanted
business (T) to Newco in exchange for 100
shares of Newco common stock and a Newco
promissory note. Prior to January 1, Year 1,
S and Underwriter (U) had entered into a
binding agreement pursuant to which U
would purchase 60 shares of Newco common
stock from S and then sell those shares in an
Initial Public Offering (IPO). On January 6,
Year 1, the IPO closes.
(ii) Newco’s acquisition of T stock is one
of a series of transactions undertaken
pursuant to one integrated plan. The series of
transactions ends with the closing of the IPO
and the transfer of all the shares of stock in
accordance with the agreements.
Immediately after the last transaction effected
pursuant to the plan, S owns 40 percent of
Newco, which does not give rise to a
relationship described in section
338(h)(3)(A)(iii). See § 1.338–2(b)(3)(ii)(C).
Accordingly, S and Newco are not related for
purposes of section 338(h)(3)(A)(iii).
(iii) Further, because Newco’s basis in the
T stock is not determined by reference to S’s
basis in the T stock and because the
transaction is not an exchange to which
section 351, 354, 355, or 356 applies,
Newco’s acquisition of the T stock is a

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purchase within the meaning of section
338(h)(3).
Example 2. (i) On January 1 of Year 1, P
purchases 75 percent in value of the R stock.
On that date, R owns 4 of the 100 shares of
T stock. On June 1 of Year 1, R acquires an
additional 16 shares of T stock. On December
1 of Year 1, P purchases 70 shares of T stock
from an unrelated person and 12 of the 20
shares of T stock held by R.
(ii) Of the 12 shares of T stock purchased
by P from R on December 1 of Year 1, 3 of
those shares are deemed to have been
acquired by P on January 1 of Year 1, the date
on which 3 of the 4 shares of T stock held
by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e.,
4 × .75). The remaining 9 shares of T stock
purchased by P from R on December 1 of
Year 1 are deemed to have been acquired by
P on June 1 of Year 1, the date on which an
additional 12 of the 20 shares of T stock
owned by R on that date were first
considered owned by P under section
318(a)(2)(C) (i.e., (20 × .75)¥3). Because
stock acquisitions by P sufficient for a
qualified stock purchase of T occur within a
12-month period (i.e., 3 shares constructively
on January 1 of Year 1, 9 shares
constructively on June 1 of Year 1, and 70
shares actually on December 1 of Year 1), a
qualified stock purchase is made on
December 1 of Year 1.
Example 3. (i) On February 1 of Year 1, P
acquires 25 percent in value of the R stock
from B (the sole shareholder of P). That R
stock is not acquired by purchase. See
section 338(h)(3)(A)(iii). On that date, R owns
4 of the 100 shares of T stock. On June 1 of
Year 1, P purchases an additional 25 percent
in value of the R stock, and on January 1 of
Year 2, P purchases another 25 percent in
value of the R stock. On June 1 of Year 2, R
acquires an additional 16 shares of the T
stock. On December 1 of Year 2, P purchases
68 shares of the T stock from an unrelated
person and 12 of the 20 shares of the T stock
held by R.
(ii) Of the 12 shares of the T stock
purchased by P from R on December 1 of
Year 2, 2 of those shares are deemed to have
been acquired by P on June 1 of Year 1, the
date on which 2 of the 4 shares of the T stock
held by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e.,
4 × .5). For purposes of this attribution, the
R stock need not be acquired by P by
purchase. See section 338(h)(1). (By contrast,
the acquisition of the T stock by P from R
does not qualify as a purchase unless P has
acquired at least 50 percent in value of the
R stock by purchase. Section 338(h)(3)(C)(i).)
Of the remaining 10 shares of the T stock
purchased by P from R on December 1 of
Year 2, 1 of those shares is deemed to have
been acquired by P on January 1 of Year 2,
the date on which an additional 1 share of
the 4 shares of the T stock held by R on that
date was first considered owned by P under
section 318(a)(2)(C) (i.e., (4 × .75)¥2). The
remaining 9 shares of the T stock purchased
by P from R on December 1 of Year 2, are
deemed to have been acquired by P on June
1 of Year 2, the date on which an additional
12 shares of the T stock held by R on that
date were first considered owned by P under

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section 318(a)(2)(C) (i.e., (20 × .75)¥3).
Because a qualified stock purchase of T by
P is made on December 1 of Year 2 only if
all 12 shares of the T stock purchased by P
from R on that date are considered acquired
during a 12-month period ending on that date
(so that, in conjunction with the 68 shares of
the T stock P purchased on that date from the
unrelated person, 80 of T’s 100 shares are
acquired by P during a 12-month period) and
because 2 of those 12 shares are considered
to have been acquired by P more than 12
months before December 1 of Year 2 (i.e., on
June 1 of Year 1), a qualified stock purchase
is not made. (Under § 1.338–8(j)(2), for
purposes of applying the consistency rules, P
is treated as making a qualified stock
purchase of T if, pursuant to an arrangement,
P purchases T stock satisfying the
requirements of section 1504(a)(2) over a
period of more than 12 months.)
Example 4. Assume the same facts as in
Example 3, except that on February 1 of Year
1, P acquires 25 percent in value of the R
stock by purchase. The result is the same as
in Example 3.

(4) Acquisition date for tiered
targets—(i) Stock sold in deemed asset
sale. If an election under section 338 is
made for target, old target is deemed to
sell target’s assets and new target is
deemed to acquire those assets. Under
section 338(h)(3)(B), new target’s
deemed purchase of stock of another
corporation is a purchase for purposes
of section 338(d)(3) on the acquisition
date of target. If new target’s deemed
purchase causes a qualified stock
purchase of the other corporation and if
a section 338 election is made for the
other corporation, the acquisition date
for the other corporation is the same as
the acquisition date of target. However,
the deemed sale and purchase of the
other corporation’s assets is considered
to take place after the deemed sale and
purchase of target’s assets.
(ii) Example. The following example
illustrates this paragraph (b)(4):
Example. A owns all of the T stock. T owns
50 of the 100 shares of X stock. The other 50
shares of X stock are owned by corporation
Y, which is unrelated to A, T, or P. On
January 1 of Year 1, P makes a qualified stock
purchase of T from A and makes a section
338 election for T. On December 1 of Year
1, P purchases the 50 shares of X stock held
by Y. A qualified stock purchase of X is made
on December 1 of Year 1, because the deemed
purchase of 50 shares of X stock by new T
because of the section 338 election for T and
the actual purchase of 50 shares of X stock
by P are treated as purchases made by one
corporation. Section 338(h)(8). For purposes
of determining whether those purchases
occur within a 12-month acquisition period
as required by section 338(d)(3), T is deemed
to purchase its X stock on T’s acquisition
date, i.e., January 1 of Year 1.

(5) Effect of redemptions—(i) General
rule. Except as provided in this
paragraph (b)(5), a qualified stock

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purchase is made on the first day on
which the percentage ownership
requirements of section 338(d)(3) are
satisfied by reference to target stock that
is both—
(A) Held on that day by the
purchasing corporation; and
(B) Purchased by the purchasing
corporation during the 12-month period
ending on that day.
(ii) Redemptions from persons
unrelated to the purchasing corporation.
Target stock redemptions from persons
unrelated to the purchasing corporation
that occur during the 12-month
acquisition period are taken into
account as reductions in target’s
outstanding stock for purposes of
determining whether target stock
purchased by the purchasing
corporation in the 12-month acquisition
period satisfies the percentage
ownership requirements of section
338(d)(3).
(iii) Redemptions from the purchasing
corporation or related persons during
12-month acquisition period—(A)
General rule. For purposes of the
percentage ownership requirements of
section 338(d)(3), a redemption of target
stock during the 12-month acquisition
period from the purchasing corporation
or from any person related to the
purchasing corporation is not taken into
account as a reduction in target’s
outstanding stock.
(B) Exception for certain redemptions
from related corporations. A redemption
of target stock during the 12-month
acquisition period from a corporation
related to the purchasing corporation is
taken into account as a reduction in
target’s outstanding stock to the extent
that the redeemed stock would have
been considered purchased by the
purchasing corporation (because of
section 338(h)(3)(C)) during the 12month acquisition period if the
redeemed stock had been acquired by
the purchasing corporation from the
related corporation on the day of the
redemption. See paragraph (b)(3) of this
section.
(iv) Examples. The following
examples illustrate this paragraph (b)(5):
Example 1. QSP on stock purchase date;
redemption from unrelated person during 12month period. A owns all 100 shares of T
stock. On January 1 of Year 1, P purchases
40 shares of the T stock from A. On July 1
of Year 1, T redeems 25 shares from A. On
December 1 of Year 1, P purchases 20 shares
of the T stock from A. P makes a qualified
stock purchase of T on December 1 of Year
1, because the 60 shares of T stock purchased
by P within the 12-month period ending on
that date satisfy the 80-percent ownership
requirements of section 338(d)(3) (i.e., 60/75
shares), determined by taking into account
the redemption of 25 shares.

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Example 2. QSP on stock redemption date;
redemption from unrelated person during 12month period. The facts are the same as in
Example 1, except that P purchases 60 shares
of T stock on January 1 of Year 1 and none
on December 1 of Year 1. P makes a qualified
stock purchase of T on July 1 of Year 1,
because that is the first day on which the T
stock purchased by P within the preceding
12-month period satisfies the 80-percent
ownership requirements of section 338(d)(3)
(i.e., 60/75 shares), determined by taking into
account the redemption of 25 shares.
Example 3. Redemption from purchasing
corporation not taken into account. On
December 15 of Year 1, T redeems 30 percent
of its stock from P. The redeemed stock was
held by P for several years and constituted
P’s total interest in T. On December 1 of Year
2, P purchases the remaining T stock from A.
P does not make a qualified stock purchase
of T on December 1 of Year 2. For purposes
of the 80-percent ownership requirements of
section 338(d)(3), the redemption of P’s T
stock on December 15 of Year 1 is not taken
into account as a reduction in T’s
outstanding stock.
Example 4. Redemption from related
person taken into account. On January 1 of
Year 1, P purchases 60 of the 100 shares of
X stock. On that date, X owns 40 of the 100
shares of T stock. On April 1 of Year 1, T
redeems X’s T stock and P purchases the
remaining 60 shares of T stock from an
unrelated person. For purposes of the 80percent ownership requirements of section
338(d)(3), the redemption of the T stock from
X (a person related to P) is taken into account
as a reduction in T’s outstanding stock. If P
had purchased the 40 redeemed shares from
X on April 1 of Year 1, all 40 of the shares
would have been considered purchased
(because of section 338(h)(3)(C)(i)) during the
12-month period ending on April 1 of Year
1 (24 of the 40 shares would have been
considered purchased by P on January 1 of
Year 1 and the remaining 16 shares would
have been considered purchased by P on
April 1 of Year 1). See paragraph (b)(3) of this
section. Accordingly, P makes a qualified
stock purchase of T on April 1 of Year 1,
because the 60 shares of T stock purchased
by P on that date satisfy the 80-percent
ownership requirements of section 338(d)(3)
(i.e., 60/60 shares), determined by taking into
account the redemption of 40 shares.

(c) Effect of post-acquisition events on
eligibility for section 338 election—(1)
Post-acquisition elimination of target. (i)
The purchasing corporation may make
an election under section 338 for target
even though target is liquidated on or
after the acquisition date. If target
liquidates on the acquisition date, the
liquidation is considered to occur on the
following day and immediately after
new target’s deemed purchase of assets.
The purchasing corporation may also
make an election under section 338 for
target even though target is merged into
another corporation, or otherwise
disposed of by the purchasing
corporation provided that, under the
facts and circumstances, the purchasing

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corporation is considered for tax
purposes as the purchaser of the target
stock.
(ii) The following examples illustrate
this paragraph (c)(1):
Example 1. On January 1 of Year 1, P
purchases 100 percent of the outstanding
common stock of T. On June 1 of Year 1, P
sells the T stock to an unrelated person.
Assuming that P is considered for tax
purposes as the purchaser of the T stock, P
remains eligible, after June 1 of Year 1, to
make a section 338 election for T that results
in a deemed asset sale of T’s assets on
January 1 of Year 1.
Example 2. On January 1 of Year 1, P
makes a qualified stock purchase of T. On
that date, T owns the stock of T1. On March
1 of Year 1, T sells the T1 stock to an
unrelated person. On April 1 of Year 1, P
makes a section 338 election for T.
Notwithstanding that the T1 stock was sold
on March 1 of Year 1, the section 338
election for T on April 1 of Year 1 results in
a qualified stock purchase by T of T1 on
January 1 of Year 1. See paragraph (b)(4)(i)
of this section.

(2) Post-acquisition elimination of the
purchasing corporation. An election
under section 338 may be made for
target after the acquisition of assets of
the purchasing corporation by another
corporation in a transaction described in
section 381(a), provided that the
purchasing corporation is considered for
tax purposes as the purchaser of the
target stock. The acquiring corporation
in the section 381(a) transaction may
make an election under section 338 for
target.
(d) Consequences of post-acquisition
elimination of target where section 338
election not made—(1) Scope. The rules
of this paragraph (d) apply to the
transfer of target assets to the
purchasing corporation (or another
member of the same affiliated group as
the purchasing corporation) (the
transferee) following a qualified stock
purchase of target stock, if the
purchasing corporation does not make a
section 338 election for target.
Notwithstanding the rules of this
paragraph (d), section 354(a) (and so
much of section 356 as relates to section
354) cannot apply to any person other
than the purchasing corporation or
another member of the same affiliated
group as the purchasing corporation
unless the transfer of target assets is
pursuant to a reorganization as
determined without regard to this
paragraph (d).
(2) Continuity of interest. By virtue of
section 338, in determining whether the
continuity of interest requirement of
§ 1.368–1(b) is satisfied on the transfer
of assets from target to the transferee,
the purchasing corporation’s target stock
acquired in the qualified stock purchase

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9937

represents an interest on the part of a
person who was an owner of the target’s
business enterprise prior to the transfer
that can be continued in a
reorganization.
(3) Control requirement. By virtue of
section 338, the acquisition of target
stock in the qualified stock purchase
will not prevent the purchasing
corporation from qualifying as a
shareholder of the target transferor for
the purpose of determining whether,
immediately after the transfer of target
assets, a shareholder of the transferor is
in control of the corporation to which
the assets are transferred within the
meaning of section 368(a)(1)(D).
(4) Solely for voting stock
requirement. By virtue of section 338,
the acquisition of target stock in the
qualified stock purchase for
consideration other than voting stock
will not prevent the subsequent transfer
of target assets from satisfying the solely
for voting stock requirement for
purposes of determining if the transfer
of target assets qualifies as a
reorganization under section
368(a)(1)(C).
(5) Example. The following example
illustrates this paragraph (d):
Example. (i) Facts. P, T, and X are
domestic corporations. T and X each operate
a trade or business. A and K, individuals
unrelated to P, own 85 and 15 percent,
respectively, of the stock of T. P owns all of
the stock of X. The total adjusted basis of T’s
property exceeds the sum of T’s liabilities
plus the amount of liabilities to which T’s
property is subject. P purchases all of A’s T
stock for cash in a qualified stock purchase.
P does not make an election under section
338(g) with respect to its acquisition of T
stock. Shortly after the acquisition date, and
as part of the same plan, T merges under
applicable state law into X in a transaction
that, but for the question of continuity of
interest, satisfies all the requirements of
section 368(a)(1)(A). In the merger, all of T’s
assets are transferred to X. P and K receive
X stock in exchange for their T stock. P
intends to retain the stock of X indefinitely.
(ii) Status of transfer as a reorganization.
By virtue of section 338, for the purpose of
determining whether the continuity of
interest requirement of § 1.368–1(b) is
satisfied, P’s T stock acquired in the qualified
stock purchase represents an interest on the
part of a person who was an owner of T’s
business enterprise prior to the transfer that
can be continued in a reorganization through
P’s continuing ownership of X. Thus, the
continuity of interest requirement is satisfied
and the merger of T into X is a reorganization
within the meaning of section 368(a)(1)(A).
Moreover, by virtue of section 338, the
requirement of section 368(a)(1)(D) that a
target shareholder control the transferee
immediately after the transfer is satisfied
because P controls X immediately after the
transfer. In addition, all of T’s assets are
transferred to X in the merger and P and K

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receive the X stock exchanged therefor in
pursuance of the plan of reorganization.
Thus, the merger of T into X is also a
reorganization within the meaning of section
368(a)(1)(D).
(iii) Treatment of T and X. Under section
361(a), T recognizes no gain or loss in the
merger. Under section 362(b), X’s basis in the
assets received in the merger is the same as
the basis of the assets in T’s hands. X
succeeds to and takes into account the items
of T as provided in section 381.
(iv) Treatment of P. By virtue of section
338, the transfer of T assets to X is a
reorganization. Pursuant to that
reorganization, P exchanges its T stock solely
for stock of X, a party to the reorganization.
Because P is the purchasing corporation,
section 354 applies to P’s exchange of T stock
for X stock in the merger of T into X. Thus,
P recognizes no gain or loss on the exchange.
Under section 358, P’s basis in the X stock
received in the exchange is the same as the
basis of P’s T stock exchanged therefor.
(v) Treatment of K. Because K is not the
purchasing corporation (or an affiliate
thereof), section 354 cannot apply to K’s
exchange of T stock for X stock in the merger
of T into X unless the transfer of T’s assets
is pursuant to a reorganization as determined
without regard to this paragraph (d). Under
general principles of tax law applicable to
reorganizations, the continuity of interest
requirement is not satisfied because P’s stock
purchase and the merger of T into X are
pursuant to an integrated transaction in
which A, the owner of 85 percent of the stock
of T, received solely cash in exchange for A’s
T stock. See, e.g., § 1.368–1(e)(1)(i); Yoc
Heating v. Commissioner, 61 T.C. 168 (1973);
Kass v. Commissioner, 60 T.C. 218 (1973),
aff’d, 491 F.2d 749 (3d Cir. 1974). Thus, the
requisite continuity of interest under § 1.368–
1(b) is lacking and section 354 does not apply
to K’s exchange of T stock for X stock. K
recognizes gain or loss, if any, pursuant to
section 1001(c) with respect to its T stock.
§ 1.338–4 Aggregate deemed sale price;
various aspects of taxation of the deemed
asset sale.

(a) Scope. This section provides rules
under section 338(a)(1) to determine the
aggregate deemed sale price (ADSP) for
target. ADSP is the amount for which
old target is deemed to have sold all of
its assets in the deemed asset sale.
ADSP is allocated among target’s assets
in accordance with § 1.338–6 to
determine the amount for which each
asset is deemed to have been sold.
When a subsequent increase or decrease
is required under general principles of
tax law with respect to an element of
ADSP, the redetermined ADSP is
allocated among target’s assets in
accordance with § 1.338–7. This
§ 1.338–4 also provides rules regarding
the recognition of gain or loss on the
deemed sale of target affiliate stock.
Notwithstanding section 338(h)(6)(B)(ii),
stock held by a target affiliate in a
foreign corporation or in a corporation
that is a DISC or that is described in

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section 1248(e) is not excluded from the
operation of section 338.
(b) Determination of ADSP—(1)
General rule. ADSP is the sum of—
(i) The grossed-up amount realized on
the sale to the purchasing corporation of
the purchasing corporation’s recently
purchased target stock (as defined in
section 338(b)(6)(A)); and
(ii) The liabilities of old target.
(2) Time and amount of ADSP—(i)
Original determination. ADSP is
initially determined at the beginning of
the day after the acquisition date of
target. General principles of tax law
apply in determining the timing and
amount of the elements of ADSP.
(ii) Redetermination of ADSP. ADSP
is redetermined at such time and in
such amount as an increase or decrease
would be required, under general
principles of tax law, for the elements
of ADSP. For example, ADSP is
redetermined because of an increase or
decrease in the amount realized for
recently purchased stock or because
liabilities not originally taken into
account in determining ADSP are
subsequently taken into account.
Increases or decreases with respect to
the elements of ADSP result in the
reallocation of ADSP among target’s
assets under § 1.338–7.
(iii) Example. The following example
illustrates this paragraph (b)(2):
Example. In Year 1, T, a manufacturer,
purchases a customized delivery truck from
X with purchase money indebtedness having
a stated principal amount of $100,000. P
acquires all of the stock of T in Year 3 for
$700,000 and makes a section 338 election
for T. Assume T has no liabilities other than
its purchase money indebtedness to X. In
Year 4, when T is neither insolvent nor in a
title 11 case, T and X agree to reduce the
amount of the purchase money indebtedness
to $80,000. Assume further that the reduction
would be a purchase price reduction under
section 108(e)(5). T and X’s agreement to
reduce the amount of the purchase money
indebtedness would not, under general
principles of tax law that would apply if the
deemed asset sale had actually occurred,
change the amount of liabilities of old target
taken into account in determining its amount
realized. Accordingly, ADSP is not
redetermined at the time of the reduction.
See § 1.338–5(b)(2)(iii) Example 1 for the
effect on AGUB.

(c) Grossed-up amount realized on the
sale to the purchasing corporation of the
purchasing corporation’s recently
purchased target stock—(1)
Determination of amount. The grossedup amount realized on the sale to the
purchasing corporation of the
purchasing corporation’s recently
purchased target stock is an amount
equal to—
(i) The amount realized on the sale to
the purchasing corporation of the

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purchasing corporation’s recently
purchased target stock determined as if
the selling shareholder(s) were required
to use old target’s accounting methods
and characteristics and the installment
method were not available and
determined without regard to the selling
costs taken into account under
paragraph (c)(1)(iii) of this section;
(ii) Divided by the percentage of target
stock (by value, determined on the
acquisition date) attributable to that
recently purchased target stock;
(iii) Less the selling costs incurred by
the selling shareholders in connection
with the sale to the purchasing
corporation of the purchasing
corporation’s recently purchased target
stock that reduce their amount realized
on the sale of the stock (e.g., brokerage
commissions and any similar costs to
sell the stock).
(2) Example. The following example
illustrates this paragraph (c):
Example. T has two classes of stock
outstanding, voting common stock and
preferred stock described in section
1504(a)(4). On March 1 of Year 1, P
purchases 40 percent of the outstanding T
stock from S1 for $500, 20 percent of the
outstanding T stock from S2 for $225, and 20
percent of the outstanding T stock from S3
for $275. On that date, the fair market value
of all the T voting common stock is $1,250
and the preferred stock $750. S1, S2, and S3
incur $40, $35, and $25 respectively of
selling costs. S1 continues to own the
remaining 20 percent of the outstanding T
stock. The grossed-up amount realized on the
sale to P of P’s recently purchased T stock
is calculated as follows: The total amount
realized (without regard to selling costs) is
$1,000 (500 + 225 + 275). The percentage of
T stock by value on the acquisition date
attributable to the recently purchased T stock
is 50% (1,000/(1,250 + 750)). The selling
costs are $100 (40 + 35 + 25). The grossedup amount realized is $1,900 (1,000/.5 ¥
100).

(d) Liabilities of old target—(1) In
general. In general, the liabilities of old
target are measured as of the beginning
of the day after the acquisition date.
(But see § 1.338–1(d) (regarding certain
transactions on the acquisition date).) In
order to be taken into account in ADSP,
a liability must be a liability of target
that is properly taken into account in
amount realized under general
principles of tax law that would apply
if old target had sold its assets to an
unrelated person for consideration that
included the discharge of its liabilities.
See § 1.1001–2(a). Such liabilities may
include liabilities for the tax
consequences resulting from the
deemed sale.
(2) Time and amount of liabilities.
The time for taking into account
liabilities of old target in determining

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ADSP and the amount of the liabilities
taken into account is determined as if
old target had sold its assets to an
unrelated person for consideration that
included the discharge of the liabilities
by the unrelated person. For example, if
no amount of a target liability is
properly taken into account in amount
realized as of the beginning of the day
after the acquisition date, the liability is
not initially taken into account in
determining ADSP (although it may be
taken into account at some later date).
(e) Deemed sale tax consequences.
Gain or loss on each asset in the deemed
sale is computed by reference to the
ADSP allocated to that asset. ADSP is
allocated under the rules of § 1.338–6.
Though deemed sale tax consequences
may increase or decrease ADSP by
creating or reducing a tax liability, the
amount of the tax liability itself may be
a function of the size of the deemed sale
tax consequences. Thus, these
determinations may require trial and
error computations.
(f) Other rules apply in determining
ADSP. ADSP may not be applied in
such a way as to contravene other
applicable rules. For example, a capital
loss cannot be applied to reduce
ordinary income in calculating the tax
liability on the deemed sale for
purposes of determining ADSP.
(g) Examples. The following examples
illustrate this section. For purposes of
the examples in this paragraph (g),
unless otherwise stated, T is a calendar

year taxpayer that files separate returns
and that has no loss, tax credit, or other
carryovers to Year 1. Depreciation for
Year 1 is not taken into account. T has
no liabilities other than the Federal
income tax liability resulting from the
deemed asset sale, and the T
shareholders have no selling costs.
Assume that T’s tax rate for any
ordinary income or net capital gain
resulting from the deemed sale of assets
is 34 percent and that any capital loss
is offset by capital gain. On July 1 of
Year 1, P purchases all of the stock of
T and makes a section 338 election for
T. The examples are as follows:
Example 1. One class. (i) On July 1 of Year
1, T’s only asset is an item of section 1245
property with an adjusted basis to T of
$50,400, a recomputed basis of $80,000, and
a fair market value of $100,000. P purchases
all of the T stock for $75,000, which also
equals the amount realized for the stock
determined as if the selling shareholder(s)
were required to use old target’s accounting
methods and characteristics.
(ii) ADSP is determined as follows (for
purposes of this section (g), G is the grossedup amount realized on the sale to P of P’s
recently purchased T stock, L is T’s liabilities
other than T’s tax liability for the deemed
sale tax consequences, TR is the applicable
tax rate, and B is the adjusted basis of the
asset deemed sold):
ADSP = G + L + TR ‘‘ (ADSP¥B)
ADSP = ($75,000/1) + $0 + .34 × (ADSP ¥
$50,400)
ADSP = $75,000 + .34ADSP ¥ $17,136
.66ADSP = $57,864
ADSP = $87,672.72

9939

(iii) Because ADSP for T ($87,672.72) does
not exceed the fair market value of T’s asset
($100,000), a Class V asset, T’s entire ADSP
is allocated to that asset. Thus, T’s deemed
sale results in $37,272.72 of taxable income
(consisting of $29,600 of ordinary income
and $7,672.72 of capital gain).
(iv) The facts are the same as in paragraph
(i) of this Example 1, except that on July 1
of Year 1, P purchases only 80 of the 100
shares of T stock for $60,000. The grossedup amount realized on the sale to P of P’s
recently purchased T stock (G) is $75,000
($60,000/.8). Consequently, ADSP and the
deemed sale tax consequences are the same
as in paragraphs (ii) and (iii) of this Example
1.
(v) The facts are the same as in paragraph
(i) of this Example 1, except that T also has
goodwill (a Class VII asset) with an appraised
value of $10,000. The results are the same as
in paragraphs (ii) and (iii) of this Example 1.
Because ADSP does not exceed the fair
market value of the Class V asset, no amount
is allocated to the Class VII asset (goodwill).
Example 2. More than one class. (i) P
purchases all of the T stock for $140,000,
which also equals the amount realized for the
stock determined as if the selling
shareholder(s) were required to use old
target’s accounting methods and
characteristics. On July 1 of Year 1, T has
liabilities (not including the tax liability for
the deemed sale tax consequences) of
$50,000, cash (a Class I asset) of $10,000,
actively traded securities (a Class II asset)
with a basis of $4,000 and a fair market value
of $10,000, goodwill (a Class VII asset) with
a basis of $3,000, and the following Class V
assets:

Asset

Basis

FMV

Ratio of
asset FMV
to total
Class V
FMV

Land .........................................................................................................................................................
Building ....................................................................................................................................................
Equipment A (Recomputed basis $80,000) ............................................................................................
Equipment B (Recomputed basis $20,000) ............................................................................................

$5,000
10,000
5,000
10,000

$35,000
50,000
90,000
75,000

.14
.20
.36
.30

Totals ................................................................................................................................................

$30,000

$250,000

1.00

(ii) ADSP exceeds $20,000. Thus, $10,000
of ADSP is allocated to the cash and $10,000
to the actively traded securities. The amount
allocated to an asset (other than a Class VII
asset) cannot exceed its fair market value
(however, the fair market value of any
property subject to nonrecourse indebtedness
is treated as being not less than the amount
of such indebtedness; see § 1.338–6(a)(2)).
See § 1.338–6(c)(1) (relating to fair market
value limitation).
(iii) The portion of ADSP allocable to the
Class V assets is preliminarily determined as
follows (in the formula, the amount allocated
to the Class I assets is referred to as I and the
amount allocated to the Class II assets as II):

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ADSPV = (G¥(I + II)) + L+ TR × [(II ¥ BII)
+ (ADSPV ¥ BV)]
ADSPV = ($140,000 ¥ ($10,000 + $10,000))
+ $50,000 + .34 × [($10,000 ¥ $4,000) +
(ADSPV ¥ ($5,000 + $10,000 + $5,000 +
$10,000))]
ADSPV = $161,840 + .34ADSPV
.66 ADSPV = $161,840
ADSPV = $245,212.12
(iv) Because, under the preliminary
calculations of ADSP, the amount to be
allocated to the Class I, II, III, IV, V, and VI
assets does not exceed their aggregate fair
market value, no ADSP amount is allocated
to goodwill. Accordingly, the deemed sale of
the goodwill results in a capital loss of

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$3,000. The portion of ADSP allocable to the
Class V assets is finally determined by taking
into account this loss as follows:
ADSPV = (G ¥ (I + II)) + L + T R × [(II
¥ BII) + (ADSPV ¥ BV) + (ADSPVII ¥ B VII)]
ADSPV = ($140,000 ¥ ($10,000 +
$10,000))+ $50,000 + .34 × [($10,000 ¥
$4,000) + (ADSPV ¥ $30,000) + ($0 ¥
$3,000)]
ADSPV = $160,820 + .34ADSPV
.66 ADSPV = $160,820
ADSPV = $243,666.67
(v) The allocation of ADSPV among the
Class V assets is in proportion to their fair
market values, as follows:

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Asset

ADSP

Gain

Land ..........................................................................................
Building .....................................................................................
Equipment A .............................................................................
Equipment B .............................................................................

$34,113.33
48,733.34
87,720.00
73,100.00

$29,113.33 (capital gain).
38,733.34 (capital gain).
82,720.00 (75,000 ordinary income 7,720 capital gain).
63,100.00 (10,000 ordinary income 53,100 capital gain).

Totals .................................................................................

243,666.67

213,666.67.

Example 3. More than one class. (i) The
facts are the same as in Example 2, except
that P purchases the T stock for $150,000,
rather than $140,000. The amount realized
for the stock determined as if the selling
shareholder(s) were required to use old
target’s accounting methods and
characteristics is also $150,000.
(ii) As in Example 2, ADSP exceeds
$20,000. Thus, $10,000 of ADSP is allocated
to the cash and $10,000 to the actively traded
securities.
(iii) The portion of ADSP allocable to the
Class V assets as preliminarily determined
under the formula set forth in paragraph (iii)
of Example 2 is $260,363.64. The amount
allocated to the Class V assets cannot exceed
their aggregate fair market value ($250,000).
Thus, preliminarily, the ADSP amount
allocated to Class V assets is $250,000.
(iv) Based on the preliminary allocation,
the ADSP is determined as follows (in the
formula, the amount allocated to the Class I
assets is referred to as I, the amount allocated
to the Class II assets as II, and the amount
allocated to the Class V assets as V):
ADSP = G + L + TR × [(II ¥ BII) + (V ¥
BV) + (ADSP ¥ (I + II + V + BVII))]
ADSP = $150,000 + $50,000 + .34 ×
[($10,000 ¥ $4,000) + ($250,000 ¥ $30,000)
+ (ADSP ¥ ($10,000 + $10,000 + $250,000
+ $3,000))]
ADSP = $200,000 + .34ADSP ¥ $15,980
.66ADSP = $184,020
ADSP = $278,818.18
(v) Because ADSP as determined exceeds
the aggregate fair market value of the Class
I, II, III, IV, V, and VI assets, the $250,000
amount preliminarily allocated to the Class V
assets is appropriate. Thus, the amount of
ADSP allocated to Class V assets equals their
aggregate fair market value ($250,000), and
the allocated ADSP amount for each Class V
asset is its fair market value. Further, because
there are no Class VI assets, the allocable
ADSP amount for the Class VII asset
(goodwill) is $8,818.18 (the excess of ADSP
over the aggregate ADSP amounts for the
Class I, II, III, IV, V and VI assets).
Example 4. Amount allocated to T1 stock.
(i) The facts are the same as in Example 2,
except that T owns all of the T1 stock
(instead of the building), and T1’s only asset
is the building. The T1 stock and the
building each have a fair market value of
$50,000, and the building has a basis of
$10,000. A section 338 election is made for
T1 (as well as T), and T1 has no liabilities
other than the tax liability for the deemed
sale tax consequences. T is the common
parent of a consolidated group filing a final
consolidated return described in § 1.338–
10(a)(1).
(ii) ADSP exceeds $20,000. Thus, $10,000
of ADSP is allocated to the cash and $10,000
to the actively traded securities.

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(iii) Because T does not recognize any gain
on the deemed sale of the T1 stock under
paragraph (h)(2) of this section, appropriate
adjustments must be made to reflect
accurately the fair market value of the T and
T1 assets in determining the allocation of
ADSP among T’s Class V assets (including
the T1 stock). In preliminarily calculating
ADSPV in this case, the T1 stock can be
disregarded and, because T owns all of the
T1 stock, the T1 asset can be treated as a T
asset. Under this assumption, ADSPV is
$243,666.67. See paragraph (iv) of Example
2.
(iv) Because the portion of the preliminary
ADSP allocable to Class V assets
($243,666.67) does not exceed their fair
market value ($250,000), no amount is
allocated to Class VII assets for T. Further,
this amount ($243,666.67) is allocated among
T’s Class V assets in proportion to their fair
market values. See paragraph (v) of Example
2. Tentatively, $48,733.34 of this amount is
allocated to the T1 stock.
(v) The amount tentatively allocated to the
T1 stock, however, reflects the tax incurred
on the deemed sale of the T1 asset equal to
$13,169.34 (.34×($48,733.34¥$10,000)).
Thus, the ADSP allocable to the Class V
assets of T, and the ADSP allocable to the T1
stock, as preliminarily calculated, each must
be reduced by $13,169.34. Consequently,
these amounts, respectively, are $230,497.33
and $35,564.00. In determining ADSP for T1,
the grossed-up amount realized on the
deemed sale to new T of new T’s recently
purchased T1 stock is $35,564.00.
(vi) The facts are the same as in paragraph
(i) of this Example 4, except that the T1
building has a $12,500 basis and a $62,500
value, all of the outstanding T1 stock has a
$62,500 value, and T owns 80 percent of the
T1 stock. In preliminarily calculating ADSPV,
the T1 stock can be disregarded but, because
T owns only 80 percent of the T1 stock, only
80 percent of T1 asset basis and value should
be taken into account in calculating T’s
ADSP. By taking into account 80 percent of
these amounts, the remaining calculations
and results are the same as in paragraphs (ii),
(iii), (iv), and (v) of this Example 4, except
that the grossed-up amount realized on the
sale of the recently purchased T1 stock is
$44,455.00 ($35,564.00/0.8).

(h) Deemed sale of target affiliate
stock—(1) Scope. This paragraph (h)
prescribes rules relating to the treatment
of gain or loss realized on the deemed
sale of stock of a target affiliate when a
section 338 election (but not a section
338(h)(10) election) is made for the
target affiliate. For purposes of this
paragraph (h), the definition of domestic
corporation in § 1.338–2(c)(9) is applied

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without the exclusion therein for DISCs,
corporations described in section
1248(e), and corporations to which an
election under section 936 applies.
(2) In general. Except as otherwise
provided in this paragraph (h), if a
section 338 election is made for target,
target recognizes no gain or loss on the
deemed sale of stock of a target affiliate
having the same acquisition date and for
which a section 338 election is made
if—
(i) Target directly owns stock in the
target affiliate satisfying the
requirements of section 1504(a)(2);
(ii) Target and the target affiliate are
members of a consolidated group filing
a final consolidated return described in
§ 1.338–10(a)(1); or
(iii) Target and the target affiliate file
a combined return under § 1.338–
10(a)(4).
(3) Deemed sale of foreign target
affiliate by a domestic target. A
domestic target recognizes gain or loss
on the deemed sale of stock of a foreign
target affiliate. For the proper treatment
of such gain or loss, see, e.g., sections
1246, 1248, 1291 et seq., and 338(h)(16)
and § 1.338–9.
(4) Deemed sale producing effectively
connected income. A foreign target
recognizes gain or loss on the deemed
sale of stock of a foreign target affiliate
to the extent that such gain or loss is
effectively connected (or treated as
effectively connected) with the conduct
of a trade or business in the United
States.
(5) Deemed sale of insurance
company target affiliate electing under
section 953(d). A domestic target
recognizes gain (but not loss) on the
deemed sale of stock of a target affiliate
that has in effect an election under
section 953(d) in an amount equal to the
lesser of the gain realized or the
earnings and profits described in section
953(d)(4)(B).
(6) Deemed sale of DISC target
affiliate. A foreign or domestic target
recognizes gain (but not loss) on the
deemed sale of stock of a target affiliate
that is a DISC or a former DISC (as
defined in section 992(a)) in an amount
equal to the lesser of the gain realized
or the amount of accumulated DISC
income determined with respect to such
stock under section 995(c). Such gain is

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Federal Register / Vol. 66, No. 30 / Tuesday, February 13, 2001 / Rules and Regulations
included in gross income as a dividend
as provided in sections 995(c)(2) and
996(g).
(7) Anti-stuffing rule. If an asset the
adjusted basis of which exceeds its fair
market value is contributed or
transferred to a target affiliate as
transferred basis property (within the
meaning of section 7701(a)(43)) and a
purpose of such transaction is to reduce
the gain (or increase the loss) recognized
on the deemed sale of such target
affiliate’s stock, the gain or loss
recognized by target on the deemed sale
of stock of the target affiliate is
determined as if such asset had not been
contributed or transferred.
(8) Examples. The following examples
illustrate this paragraph (h):
Example 1. (i) P makes a qualified stock
purchase of T and makes a section 338
election for T. T’s sole asset, all of the T1
stock, has a basis of $50 and a fair market
value of $150. T’s deemed purchase of the T1
stock results in a qualified stock purchase of
T1 and a section 338 election is made for T1.
T1’s assets have a basis of $50 and a fair
market value of $150.
(ii) T realizes $100 of gain on the deemed
sale of the T1 stock, but the gain is not
recognized because T directly owns stock in
T1 satisfying the requirements of section
1504(a)(2) and a section 338 election is made
for T1.
(iii) T1 recognizes gain of $100 on the
deemed sale of its assets.
Example 2. The facts are the same as in
Example 1, except that P does not make a
section 338 election for T1. Because a section
338 election is not made for T1, the $100 gain
realized by T on the deemed sale of the T1
stock is recognized.
Example 3. (i) P makes a qualified stock
purchase of T and makes a section 338
election for T. T owns all of the stock of T1
and T2. T’s deemed purchase of the T1 and
T2 stock results in a qualified stock purchase
of T1 and T2 and section 338 elections are
made for T1 and T2. T1 and T2 each own 50
percent of the vote and value of T3 stock. The
deemed purchases by T1 and T2 of the T3
stock result in a qualified stock purchase of
T3 and a section 338 election is made for T3.
T is the common parent of a consolidated
group and all of the deemed asset sales are
reported on the T group’s final consolidated
return. See § 1.338–10(a)(1).
(ii) Because T, T1, T2 and T3 are members
of a consolidated group filing a final
consolidated return, no gain or loss is
recognized by T, T1 or T2 on their respective
deemed sales of target affiliate stock.
Example 4. (i) T’s sole asset, all of the FT1
stock, has a basis of $25 and a fair market
value of $150. FT1’s sole asset, all of the FT2
stock, has a basis of $75 and a fair market
value of $150. FT1 and FT2 each have $50
of accumulated earnings and profits for
purposes of section 1248(c) and (d). FT2’s
assets have a basis of $125 and a fair market
value of $150, and their sale would not
generate subpart F income under section 951.
The sale of the FT2 stock or assets would not
generate income effectively connected with

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the conduct of a trade or business within the
United States. FT1 does not have an election
in effect under section 953(d) and neither
FT1 nor FT2 is a passive foreign investment
company.
(ii) P makes a qualified stock purchase of
T and makes a section 338 election for T. T’s
deemed purchase of the FT1 stock results in
a qualified stock purchase of FT1 and a
section 338 election is made for FT1.
Similarly, FT1’s deemed purchase of the FT2
stock results in a qualified stock purchase of
FT2 and a section 338 election is made for
FT2.
(iii) T recognizes $125 of gain on the
deemed sale of the FT1 stock under
paragraph (h)(3) of this section. FT1 does not
recognize $75 of gain on the deemed sale of
the FT2 stock under paragraph (h)(2) of this
section. FT2 recognizes $25 of gain on the
deemed sale of its assets. The $125 gain T
recognizes on the deemed sale of the FT1
stock is included in T’s income as a dividend
under section 1248, because FT1 and FT2
have sufficient earnings and profits for full
recharacterization ($50 of accumulated
earnings and profits in FT1, $50 of
accumulated earnings and profits in FT2, and
$25 of deemed sale earnings and profits in
FT2). Section 1.338–9(b). For purposes of
sections 901 through 908, the source and
foreign tax credit limitation basket of $25 of
the recharacterized gain on the deemed sale
of the FT1 stock is determined under section
338(h)(16).
§ 1.338–5

Adjusted grossed-up basis.

(a) Scope. This section provides rules
under section 338(b) to determine the
adjusted grossed-up basis (AGUB) for
target. AGUB is the amount for which
new target is deemed to have purchased
all of its assets in the deemed purchase
under section 338(a)(2). AGUB is
allocated among target’s assets in
accordance with § 1.338–6 to determine
the price at which the assets are deemed
to have been purchased. When a
subsequent increase or decrease with
respect to an element of AGUB is
required under general principles of tax
law, redetermined AGUB is allocated
among target’s assets in accordance with
§ 1.338–7.
(b) Determination of AGUB—(1)
General rule. AGUB is the sum of—
(i) The grossed-up basis in the
purchasing corporation’s recently
purchased target stock;
(ii) The purchasing corporation’s basis
in nonrecently purchased target stock;
and
(iii) The liabilities of new target.
(2) Time and amount of AGUB—(i)
Original determination. AGUB is
initially determined at the beginning of
the day after the acquisition date of
target. General principles of tax law
apply in determining the timing and
amount of the elements of AGUB.
(ii) Redetermination of AGUB. AGUB
is redetermined at such time and in

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9941

such amount as an increase or decrease
would be required, under general
principles of tax law, with respect to an
element of AGUB. For example, AGUB
is redetermined because of an increase
or decrease in the amount paid or
incurred for recently purchased stock or
nonrecently purchased stock or because
liabilities not originally taken into
account in determining AGUB are
subsequently taken into account. An
increase or decrease to one element of
AGUB also may cause an increase or
decrease to another element of AGUB.
For example, if there is an increase in
the amount paid or incurred for recently
purchased stock after the acquisition
date, any increase in the basis of
nonrecently purchased stock because a
gain recognition election was made is
also taken into account when AGUB is
redetermined. Increases or decreases
with respect to the elements of AGUB
result in the reallocation of AGUB
among target’s assets under § 1.338–7.
(iii) Examples. The following
examples illustrate this paragraph (b)(2):
Example 1. In Year 1, T, a manufacturer,
purchases a customized delivery truck from
X with purchase money indebtedness having
a stated principal amount of $100,000. P
acquires all of the stock of T in Year 3 for
$700,000 and makes a section 338 election
for T. Assume T has no liabilities other than
its purchase money indebtedness to X. In
Year 4, when T is neither insolvent nor in a
title 11 case, T and X agree to reduce the
amount of the purchase money indebtedness
to $80,000. Assume that the reduction would
be a purchase price reduction under section
108(e)(5). T and X’s agreement to reduce the
amount of the purchase money indebtedness
would, under general principles of tax law
that would apply if the deemed asset sale had
actually occurred, change the amount of
liabilities of old target taken into account in
determining its basis. Accordingly, AGUB is
redetermined at the time of the reduction.
See paragraph (e)(2) of this section. Thus the
purchase price reduction affects the basis of
the truck only indirectly, through the
mechanism of §§ 1.338–6 and 1.338–7. See
§ 1.338–4(b)(2)(iii) Example for the effect on
ADSP.
Example 2. T, an accrual basis taxpayer, is
a chemical manufacturer. In Year 1, T is
obligated to remediate environmental
contamination at the site of one of its plants.
Assume that all the events have occurred that
establish the fact of the liability and the
amount of the liability can be determined
with reasonable accuracy but economic
performance has not occurred with respect to
the liability within the meaning of section
461(h). P acquires all of the stock of T in Year
1 and makes a section 338 election for T.
Assume that, if a corporation unrelated to T
had actually purchased T’s assets and
assumed T’s obligation to remediate the
contamination, the corporation would not
satisfy the economic performance
requirements until Year 5. Under section
461(h), the assumed liability would not be

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treated as incurred and taken into account in
basis until that time. The incurrence of the
liability in Year 5 under the economic
performance rules is an increase in the
amount of liabilities properly taken into
account in basis and results in the
redetermination of AGUB. (Respecting ADSP,
compare § 1.461–4(d)(5), which provides that
economic performance occurs for old T as the
amount of the liability is properly taken into
account in amount realized on the deemed
asset sale. Thus ADSP is not redetermined
when new T satisfies the economic
performance requirements.)

(c) Grossed-up basis of recently
purchased stock. The purchasing
corporation’s grossed-up basis of
recently purchased target stock (as
defined in section 338(b)(6)(A)) is an
amount equal to—
(1) The purchasing corporation’s basis
in recently purchased target stock at the
beginning of the day after the
acquisition date determined without
regard to the acquisition costs taken into
account in paragraph (c)(3) of this
section;
(2) Multiplied by a fraction, the
numerator of which is 100 minus the
number that is the percentage of target
stock (by value, determined on the
acquisition date) attributable to the
purchasing corporation’s nonrecently
purchased target stock, and the
denominator of which is the number
equal to the percentage of target stock
(by value, determined on the acquisition
date) attributable to the purchasing
corporation’s recently purchased target
stock;
(3) Plus the acquisition costs the
purchasing corporation incurred in
connection with its purchase of the
recently purchased stock that are
capitalized in the basis of such stock
(e.g., brokerage commissions and any
similar costs incurred by the purchasing
corporation to acquire the stock).
(d) Basis of nonrecently purchased
stock; gain recognition election—(1) No
gain recognition election. In the absence
of a gain recognition election under
section 338(b)(3) and this section, the
purchasing corporation retains its basis
in the nonrecently purchased stock.
(2) Procedure for making gain
recognition election. A gain recognition
election may be made for nonrecently
purchased stock of target (or a target
affiliate) only if a section 338 election is
made for target (or the target affiliate).
The gain recognition election is made by
attaching a gain recognition statement to
a timely filed Form 8023 for target. The
gain recognition statement must contain
the information specified in the form
and its instructions. The gain
recognition election is irrevocable. If a
section 338(h)(10) election is made for
target, see § 1.338(h)(10)–1(d)(1)

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(providing that the purchasing
corporation is automatically deemed to
have made a gain recognition election
for its nonrecently purchased T stock).
(3) Effect of gain recognition
election—(i) In general. If the
purchasing corporation makes a gain
recognition election, then for all
purposes of the Internal Revenue
Code—
(A) The purchasing corporation is
treated as if it sold on the acquisition
date the nonrecently purchased target
stock for the basis amount determined
under paragraph (d)(3)(ii) of this
section; and
(B) The purchasing corporation’s basis
on the acquisition date in nonrecently
purchased target stock immediately
following the deemed sale in paragraph
(d)(3)(i)(A) of this section is the basis
amount.
(ii) Basis amount. The basis amount is
equal to the amount in paragraph (c)(1)
of this section (the purchasing
corporation’s basis in recently
purchased target stock at the beginning
of the day after the acquisition date
determined without regard to the
acquisition costs taken into account in
paragraph (c)(3) of this section)
multiplied by a fraction the numerator
of which is the percentage of target
stock (by value, determined on the
acquisition date) attributable to the
purchasing corporation’s nonrecently
purchased target stock and the
denominator of which is 100 percent
minus the numerator amount. Thus, if
target has a single class of outstanding
stock, the purchasing corporation’s basis
in each share of nonrecently purchased
target stock after the gain recognition
election is equal to the average price per
share of the purchasing corporation’s
recently purchased target stock.
(iii) Losses not recognized. Only gains
(unreduced by losses) on the
nonrecently purchased target stock are
recognized.
(iv) Stock subject to election. The gain
recognition election applies to—
(A) All nonrecently purchased target
stock; and
(B) Any nonrecently purchased stock
in a target affiliate having the same
acquisition date as target if such target
affiliate stock is held by the purchasing
corporation on such date.
(e) Liabilities of new target—(1) In
general. The liabilities of new target are
the liabilities of target as of the
beginning of the day after the
acquisition date (but see § 1.338–1(d)
(regarding certain transactions on the
acquisition date)). In order to be taken
into account in AGUB, a liability must
be a liability of target that is properly
taken into account in basis under

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general principles of tax law that would
apply if new target had acquired its
assets from an unrelated person for
consideration that included discharge of
the liabilities of that unrelated person.
Such liabilities may include liabilities
for the tax consequences resulting from
the deemed sale.
(2) Time and amount of liabilities.
The time for taking into account
liabilities of old target in determining
AGUB and the amount of the liabilities
taken into account is determined as if
new target had acquired its assets from
an unrelated person for consideration
that included the discharge of its
liabilities.
(3) Interaction with deemed sale tax
consequences. In general, see § 1.338–
4(e). Although ADSP and AGUB are not
necessarily linked, if an increase in the
amount realized for recently purchased
stock of target is taken into account after
the acquisition date, and if the tax on
the deemed sale tax consequences is a
liability of target, any increase in that
liability is also taken into account in
redetermining AGUB.
(f) Adjustments by the Internal
Revenue Service. In connection with the
examination of a return, the
Commissioner may increase (or
decrease) AGUB under the authority of
section 338(b)(2) and allocate such
amounts to target’s assets under the
authority of section 338(b)(5) so that
AGUB and the basis of target’s assets
properly reflect the cost to the
purchasing corporation of its interest in
target’s assets. Such items may include
distributions from target to the
purchasing corporation, capital
contributions from the purchasing
corporation to target during the 12month acquisition period, or
acquisitions of target stock by the
purchasing corporation after the
acquisition date from minority
shareholders. See also § 1.338–1(d)
(regarding certain transactions on the
acquisition date).
(g) Examples. The following examples
illustrate this section. For purposes of
the examples in this paragraph (g), T has
no liabilities other than the tax liability
for the deemed sale tax consequences, T
shareholders incur no costs in selling
the T stock, and P incurs no costs in
acquiring the T stock. The examples are
as follows:
Example 1. (i) Before July 1 of Year 1, P
purchases 10 of the 100 shares of T stock for
$5,000. On July 1 of Year 2, P purchases 80
shares of T stock for $60,000 and makes a
section 338 election for T. As of July 1 of
Year 2, T’s only asset is raw land with an
adjusted basis to T of $50,400 and a fair
market value of $100,000. T has no loss or
tax credit carryovers to Year 2. T’s marginal

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tax rate for any ordinary income or net
capital gain resulting from the deemed asset
sale is 34 percent. The 10 shares purchased
before July 1 of Year 1 constitute nonrecently
purchased T stock with respect to P’s
qualified stock purchase of T stock on July
1 of Year 2.
(ii) The ADSP formula as applied to these
facts is the same as in § 1.338–4(g) Example
1. Accordingly, the ADSP for T is $87,672.72.
The existence of nonrecently purchased T
stock is irrelevant for purposes of the ADSP
formula, because that formula treats P’s
nonrecently purchased T stock in the same
manner as T stock not held by P.
(iii) The total tax liability resulting from
T’s deemed asset sale, as calculated under
the ADSP formula, is $12,672.72.
(iv) If P does not make a gain recognition
election, the AGUB of new T’s assets is
$85,172.72, determined as follows (In the
following formula below, GRP is the grossedup basis in P’s recently purchased T stock,
BNP is P’s basis in nonrecently purchased T
stock, L is T’s liabilities, and X is P’s
acquisition costs for the recently purchased
T stock):
AGUB = GRP + BNP + L + X
AGUB = $60,000 × [(1 ¥ .1)/.8] + $5,000 +
$12,672.72 + 0
AGUB = $85,172.72
(v) If P makes a gain recognition election,
the AGUB of new T’s assets is $87,672.72,
determined as follows:
AGUB = $60,000 × [(1 ¥ .1)/.8] + $60,000 ×
[(1 ¥ .1)/.8] × [.1/(1 ¥ .1)] + $12,672.72
AGUB = $87,672.72
(vi) The calculation of AGUB if P makes a
gain recognition election may be simplified
as follows:
AGUB = $60,000/.8 + $12,672.72
AGUB = $87,672.72
(vii) As a result of the gain recognition
election, P’s basis in its nonrecently
purchased T stock is increased from $5,000
to $7,500 (i.e., $60,000 × [(1 ¥ .1)/.8] × [.1/
(1 ¥ .1)]). Thus, P recognizes a gain in Year
2 with respect to its nonrecently purchased
T stock of $2,500 (i.e., $7,500 ¥ $5,000).
Example 2. On January 1 of Year 1, P
purchases one-third of the T stock. On March
1 of Year 1, T distributes a dividend to all
of its shareholders. On April 15 of Year 1, P
purchases the remaining T stock and makes
a section 338 election for T. In appropriate
circumstances, the Commissioner may
decrease the AGUB of T to take into account
the payment of the dividend and properly
reflect the fair market value of T’s assets
deemed purchased.
Example 3. (i) T’s sole asset is a building
worth $100,000. At this time, T has 100
shares of stock outstanding. On August 1 of
Year 1, P purchases 10 of the 100 shares of
T stock for $8,000. On June 1 of Year 2, P
purchases 50 shares of T stock for $50,000.
On June 15 of Year 2, P contributes a tract
of land to the capital of T and receives 10
additional shares of T stock as a result of the
contribution. Both the basis and fair market
value of the land at that time are $10,800. On
June 30 of Year 2, P purchases the remaining
40 shares of T stock for $40,000 and makes
a section 338 election for T. The AGUB of T
is $108,800.

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(ii) To prevent the shifting of basis from the
contributed property to other assets of T, the
Commissioner may allocate $10,800 of the
AGUB to the land, leaving $98,000 to be
allocated to the building. See paragraph (f) of
this section. Otherwise, applying the
allocation rules of § 1.338–6 would, on these
facts, result in an allocation to the recently
contributed land of an amount less than its
value of $10,800, with the difference being
allocated to the building already held by T.
§ 1.338–6 Allocation of ADSP and AGUB
among target assets.

(a) Scope—(1) In general. This section
prescribes rules for allocating ADSP and
AGUB among the acquisition date assets
of a target for which a section 338
election is made.
(2) Fair market value—(i) In general.
Generally, the fair market value of an
asset is its gross fair market value (i.e.,
fair market value determined without
regard to mortgages, liens, pledges, or
other liabilities). However, for purposes
of determining the amount of old
target’s deemed sale tax consequences,
the fair market value of any property
subject to a nonrecourse indebtedness
will be treated as being not less than the
amount of such indebtedness. (For
purposes of the preceding sentence, a
liability that was incurred because of
the acquisition of the property is
disregarded to the extent that such
liability was not taken into account in
determining old target’s basis in such
property.)
(ii) Transaction costs. Transaction
costs are not taken into account in
allocating ADSP or AGUB to assets in
the deemed sale (except indirectly
through their effect on the total ADSP or
AGUB to be allocated).
(iii) Internal Revenue Service
authority. In connection with the
examination of a return, the Internal
Revenue Service may challenge the
taxpayer’s determination of the fair
market value of any asset by any
appropriate method and take into
account all factors, including any lack of
adverse tax interests between the
parties.
(b) General rule for allocating ADSP
and AGUB—(1) Reduction in the
amount of consideration for Class I
assets. Both ADSP and AGUB, in the
respective allocation of each, are first
reduced by the amount of Class I assets.
Class I assets are cash and general
deposit accounts (including savings and
checking accounts) other than
certificates of deposit held in banks,
savings and loan associations, and other
depository institutions. If the amount of
Class I assets exceeds AGUB, new target
will immediately realize ordinary
income in an amount equal to such
excess. The amount of ADSP or AGUB

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9943

remaining after the reduction is to be
allocated to the remaining acquisition
date assets.
(2) Other assets—(i) In general.
Subject to the limitations and other
rules of paragraph (c) of this section,
ADSP and AGUB (as reduced by the
amount of Class I assets) are allocated
among Class II acquisition date assets of
target in proportion to the fair market
values of such Class II assets at such
time, then among Class III assets so held
in such proportion, then among Class IV
assets so held in such proportion, then
among Class V assets so held in such
proportion, then among Class VI assets
so held in such proportion, and finally
to Class VII assets. If an asset is
described below as includible in more
than one class, then it is included in
such class with the lower or lowest class
number (for instance, Class III has a
lower class number than Class IV).
(ii) Class II assets. Class II assets are
actively traded personal property within
the meaning of section 1092(d)(1) and
§ 1.1092(d)–1 (determined without
regard to section 1092(d)(3)). In
addition, Class II assets include
certificates of deposit and foreign
currency even if they are not actively
traded personal property. Class II assets
do not include stock of target affiliates,
whether or not of a class that is actively
traded, other than actively traded stock
described in section 1504(a)(4).
Examples of Class II assets include U.S.
government securities and publicly
traded stock.
(iii) Class III assets. Class III assets are
assets that the taxpayer marks to market
at least annually for Federal income tax
purposes and debt instruments
(including accounts receivable).
However, Class III assets do not
include—
(A) Debt instruments issued by
persons related at the beginning of the
day following the acquisition date to the
target under section 267(b) or 707;
(B) Contingent debt instruments
subject to § 1.1275–4, § 1.483–4, or
section 988, unless the instrument is
subject to the non-contingent bond
method of § 1.1275–4(b) or is described
in § 1.988–2(b)(2)(i)(B)(2); and
(C) Debt instruments convertible into
the stock of the issuer or other property.
(iv) Class IV assets. Class IV assets are
stock in trade of the taxpayer or other
property of a kind that would properly
be included in the inventory of taxpayer
if on hand at the close of the taxable
year, or property held by the taxpayer
primarily for sale to customers in the
ordinary course of its trade or business.
(v) Class V assets. Class V assets are
all assets other than Class I, II, III, IV,
VI, and VII assets.

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(vi) Class VI assets. Class VI assets are
all section 197 intangibles, as defined in
section 197, except goodwill and going
concern value.
(vii) Class VII assets. Class VII assets
are goodwill and going concern value
(whether or not the goodwill or going
concern value qualifies as a section 197
intangible).
(3) Other items designated by the
Internal Revenue Service. Similar items
may be added to any class described in
this paragraph (b) by designation in the
Internal Revenue Bulletin by the
Internal Revenue Service (see
§ 601.601(d)(2) of this chapter).
(c) Certain limitations and other rules
for allocation to an asset—(1) Allocation
not to exceed fair market value. The
amount of ADSP or AGUB allocated to
an asset (other than Class VII assets)
cannot exceed the fair market value of
that asset at the beginning of the day
after the acquisition date.
(2) Allocation subject to other rules.
The amount of ADSP or AGUB allocated
to an asset is subject to other provisions
of the Internal Revenue Code or general
principles of tax law in the same
manner as if such asset were transferred
to or acquired from an unrelated person
in a sale or exchange. For example, if
the deemed asset sale is a transaction
described in section 1056(a) (relating to
basis limitation for player contracts
transferred in connection with the sale
of a franchise), the amount of AGUB
allocated to a contract for the services of
an athlete cannot exceed the limitation
imposed by that section. As another
example, section 197(f)(5) applies in
determining the amount of AGUB
allocated to an amortizable section 197
intangible resulting from an
assumption-reinsurance transaction.
(3) Special rule for allocating AGUB
when purchasing corporation has
nonrecently purchased stock—(i) Scope.
This paragraph (c)(3) applies if at the
beginning of the day after the
acquisition date—
(A) The purchasing corporation holds
nonrecently purchased stock for which
a gain recognition election under
section 338(b)(3) and § 1.338–5(d) is not
made; and
(B) The hypothetical purchase price
determined under paragraph (c)(3)(ii) of
this section exceeds the AGUB
determined under § 1.338–5(b).
(ii) Determination of hypothetical
purchase price. Hypothetical purchase
price is the AGUB that would result if
a gain recognition election were made.
(iii) Allocation of AGUB. Subject to
the limitations in paragraphs (c)(1) and
(2) of this section, the portion of AGUB
(after reduction by the amount of Class
I assets) to be allocated to each Class II,

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III, IV, V, VI, and VII asset of target held
at the beginning of the day after the
acquisition date is determined by
multiplying—
(A) The amount that would be
allocated to such asset under the general
rules of this section were AGUB equal
to the hypothetical purchase price; by
(B) A fraction, the numerator of which
is actual AGUB (after reduction by the
amount of Class I assets) and the
denominator of which is the
hypothetical purchase price (after
reduction by the amount of Class I
assets).
(4) Liabilities taken into account in
determining amount realized on
subsequent disposition. In determining
the amount realized on a subsequent
sale or other disposition of property
deemed purchased by new target,
§ 1.1001–2(a)(3) shall not apply to any
liability that was taken into account in
AGUB.
(d) Examples. The following examples
illustrate §§ 1.338–4, 1.338–5, and this
section:
Example 1. (i) T owns 90 percent of the
outstanding T1 stock. P purchases 100
percent of the outstanding T stock for $2,000.
There are no acquisition costs. P makes a
section 338 election for T and, as a result, T1
is considered acquired in a qualified stock
purchase. A section 338 election is made for
T1. The grossed-up basis of the T stock is
$2,000 (i.e., $2,000 + 1/1).
(ii) The liabilities of T as of the beginning
of the day after the acquisition date
(including the tax liability for the deemed
sale tax consequences) that would, under
general principles of tax law, properly be
taken into account at that time, are as
follows:
Liabilities (nonrecourse mortgage
plus unsecured liabilities) ...........
$700
Taxes Payable ..................................
300
Total ..........................................

1,000

(iii) The AGUB of T is determined as
follows:
Grossed-up basis .............................. $2,000
Total liabilities .................................
1,000
AGUB ........................................

3,000

(iv) Assume that ADSP is also $3,000.
(v) Assume that, at the beginning of the day
after the acquisition date, T’s cash and the
fair market values of T’s Class II, III, IV, and
V assets are as follows:
Fair
market
value

Asset
class

Asset

I ............
II ...........

Cash ...............................
Portfolio of actively traded securities.
Accounts receivable .......
Inventory ........................
Building ..........................
Land ...............................
Investment in T1 ............

III ..........
IV ..........
V ...........
V ...........
V ...........

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* $200
300
600
300
800
200
450

Asset
class

Asset
Total ........................

Fair
market
value
2,850

*Amount.
(vi) Under paragraph (b)(1) of this section,
the amount of ADSP and AGUB allocable to
T’s Class II, III, IV, and V assets is reduced
by the amount of cash to $2,800, i.e.,
$3,000—$200. $300 of ADSP and of AGUB is
then allocated to actively traded securities.
$600 of ADSP and of AGUB is then allocated
to accounts receivable. $300 of ADSP and of
AGUB is then allocated to the inventory.
Since the remaining amount of ADSP and of
AGUB is $1,600 (i.e., $3,000—($200 + $300
+ $600 + $300)), an amount which exceeds
the sum of the fair market values of T’s Class
V assets, the amount of ADSP and of AGUB
allocated to each Class V asset is its fair
market value:
Building ...........................................
$800
Land .................................................
200
Investment in T1 .............................
450
Total ..........................................

1,450

(vii) T has no Class VI assets. The amount
of ADSP and of AGUB allocated to T’s Class
VII assets (goodwill and going concern value)
is $150, i.e., $1,600–$1,450.
(viii) The grossed-up basis of the T1 stock
is $500, i.e., $450 × 1/.9.
(ix) The liabilities of T as of the beginning
of the day after the acquisition date
(including the tax liability for the deemed
sale tax consequences) that would, under
general principles of tax law, properly be
taken into account at that time, are as
follows:
General Liabilities .............................
$100
Taxes Payable ....................................
20
Total .....................................

120

(x) The AGUB of T1 is determined as
follows:
Grossed-up basis of T1 Stock ........... $ 500
Liabilities ...........................................
120
AGUB ..........................................

620

(xi) Assume that ADSP is also $620.
(xii) Assume that at the beginning of the
day after the acquisition date, T1’s cash and
the fair market values of its Class IV and VI
assets are as follows:
Fair
market
value

Asset
class

Asset

I ............
IV ..........
VI ..........

Cash ...............................
Inventory ........................
Patent .............................

*$50
200
350

Total ........................

600

* Amount.

(xiii) The amount of ADSP and of AGUB
allocable to T1’s Class IV and VI assets is first
reduced by the $50 of cash.
(xiv) Because the remaining amount of
ADSP and of AGUB ($570) is an amount
which exceeds the fair market value of T1’s

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Federal Register / Vol. 66, No. 30 / Tuesday, February 13, 2001 / Rules and Regulations
only Class IV asset, the inventory, the
amount allocated to the inventory is its fair
market value ($200). After that, the remaining
amount of ADSP and of AGUB ($370)
exceeds the fair market value of T1’s only
Class VI asset, the patent. Thus, the amount
of ADSP and of AGUB allocated to the patent
is its fair market value ($350).
(xv) The amount of ADSP and of AGUB
allocated to T1’s Class VII assets (goodwill
and going concern value) is $20, i.e., $570–
$550.
Example 2. (i) Assume that the facts are the
same as in Example 1 except that P has, for
five years, owned 20 percent of T’s stock,
which has a basis in P’s hands at the
beginning of the day after the acquisition
date of $100, and P purchases the remaining
80 percent of T’s stock for $1,600. P does not
make a gain recognition election under
section 338(b)(3).
(ii) Under § 1.338–5(c), the grossed-up
basis of recently purchased T stock is $1,600,
i.e., $1,600 × (1¥.2)/.8.

(iii) The AGUB of T is determined as
follows:
Grossed-up basis of recently purchased stock as determined
under § 1.338–5(c) ($1,600 ×
(1¥.2)/.8) ...................................... $1,600
Basis of nonrecently purchased
stock ..............................................
100
Liabilities .........................................
1,000
AGUB ........................................

Liabilities .........................................

1,000

Total ..........................................

3,000

(v) Since the hypothetical purchase price
($3,000) exceeds the AGUB ($2,700) and no
gain recognition election is made under
section 338(b)(3), AGUB is allocated under
paragraph (c)(3) of this section.
(vi) First, an AGUB amount equal to the
hypothetical purchase price ($3,000) is
allocated among the assets under the general
rules of this section. The allocation is set
forth in the column below entitled Original
Allocation. Next, the allocation to each asset
in Class II through Class VII is multiplied by
a fraction having a numerator equal to the
actual AGUB reduced by the amount of Class
I assets ($2,700¥$200 = $2,500) and a
denominator equal to the hypothetical
purchase price reduced by the amount of
Class I assets ($3,000¥$200 = $2,800), or
2,500/2,800. This produces the Final
Allocation:
Original
allocation

Final
allocation

Cash ......................................................................................................................................................................
Portfolio of actively traded securities ....................................................................................................................
Accounts receivable ..............................................................................................................................................
Inventory ................................................................................................................................................................
Building ..................................................................................................................................................................
Land ......................................................................................................................................................................
Investment in T1 ...................................................................................................................................................
Goodwill and going concern value ........................................................................................................................

$200
300
600
300
800
200
450
150

$200
*268
536
268
714
178
402
134

Total ...............................................................................................................................................................

3,000

2,700

Class

Asset

I ............
II ...........
III ..........
IV ..........
V ...........
V ...........
V ...........
VII .........

* All

2,700

(iv) Since P holds nonrecently purchased
stock, the hypothetical purchase price of the
T stock must be computed and is determined
as follows:
Grossed-up basis of recently purchased stock as determined
under § 1.338–5(c) ($1,600 ×
(1¥.2)/.8) ...................................... $1,600
Basis of nonrecently purchased
stock as if the gain recognition
election under § 1.338–5(d)(2)
had been made ($1,600 × .2/
(1¥.2)) ..........................................
400

9945

numbers rounded for convenience.

§ 1.338–7 Allocation of redetermined
ADSP and AGUB among target assets.

(a) Scope. ADSP and AGUB are
redetermined at such time and in such
amount as an increase or decrease
would be required under general
principles of tax law for the elements of
ADSP or AGUB. This section provides
rules for allocating redetermined ADSP
or AGUB.
(b) Allocation of redetermined ADSP
and AGUB. When ADSP or AGUB is
redetermined, a new allocation of ADSP
or AGUB is made by allocating the
redetermined ADSP or AGUB amount
under the rules of § 1.338–6. If the
allocation of the redetermined ADSP or
AGUB amount under § 1.338–6 to a
given asset is different from the original
allocation to it, the difference is added
to or subtracted from the original
allocation to the asset, as appropriate.
(See paragraph (d) of this section for
new target’s treatment of the amount so
allocated.) Amounts allocable to an
acquisition date asset (or with respect to
a disposed-of acquisition date asset) are
subject to all the asset allocation rules
(for example, the fair market value
limitation in § 1.338–6(c)(1)) as if the

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redetermined ADSP or AGUB were the
ADSP or AGUB on the acquisition date.
(c) Special rules for ADSP—(1)
Increases or decreases in deemed sale
tax consequences taxable
notwithstanding old target ceases to
exist. To the extent general principles of
tax law would require a seller in an
actual asset sale to account for events
relating to the sale that occur after the
sale date, target must make such an
accounting. Target is not precluded
from realizing additional deemed sale
tax consequences because the target is
treated as a new corporation after the
acquisition date.
(2) Procedure for transactions in
which section 338(h)(10) is not elected—
(i) Deemed sale tax consequences
included in new target’s return. If an
election under section 338(h)(10) is not
made, any additional deemed sale tax
consequences of old target resulting
from an increase or decrease in the
ADSP are included in new target’s
income tax return for new target’s
taxable year in which the increase or
decrease is taken into account. For
example, if after the acquisition date
there is an increase in the allocable

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ADSP of section 1245 property for
which the recomputed basis (but not the
adjusted basis) exceeds the portion of
the ADSP allocable to that particular
asset on the acquisition date, the
additional gain is treated as ordinary
income to the extent it does not exceed
such excess amount. See paragraph
(c)(2)(ii) of this section for the special
treatment of old target’s carryovers and
carrybacks. Although included in new
target’s income tax return, the deemed
sale tax consequences are separately
accounted for as an item of old target
and may not be offset by income, gain,
deduction, loss, credit, or other amount
of new target. The amount of tax on
income of old target resulting from an
increase or decrease in the ADSP is
determined as if such deemed sale tax
consequences had been recognized in
old target’s taxable year ending at the
close of the acquisition date. However,
because the income resulting from the
increase or decrease in ADSP is
reportable in new target’s taxable year of
the increase or decrease, not in old
target’s taxable year ending at the close
of the acquisition date, there is not a
resulting underpayment of tax in that

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past taxable year of old target for
purposes of calculation of interest due.
(ii) Carryovers and carrybacks—(A)
Loss carryovers to new target taxable
years. A net operating loss or net capital
loss of old target may be carried forward
to a taxable year of new target, under the
principles of section 172 or 1212, as
applicable, but is allowed as a
deduction only to the extent of any
recognized income of old target for such
taxable year, as described in paragraph
(c)(2)(i) of this section. For this purpose,
however, taxable years of new target are
not taken into account in applying the
limitations in section 172(b)(1) or
1212(a)(1)(B) (or other similar
limitations). In applying sections 172(b)
and 1212(a)(1), only income, gain, loss,
deduction, credit, and other amounts of
old target are taken into account. Thus,
if old target has an unexpired net
operating loss at the close of its taxable
year in which the deemed asset sale
occurred that could be carried forward
to a subsequent taxable year, such loss
may be carried forward until it is
absorbed by old target’s income.
(B) Loss carrybacks to taxable years of
old target. An ordinary loss or capital
loss accounted for as a separate item of
old target under paragraph (c)(2)(i) of
this section may be carried back to a
taxable year of old target under the
principles of section 172 or 1212, as
applicable. For this purpose, taxable
years of new target are not taken into
account in applying the limitations in
section 172(b) or 1212(a) (or other
similar limitations).
(C) Credit carryovers and carrybacks.
The principles described in paragraphs
(c)(2)(ii)(A) and (B) of this section apply
to carryovers and carrybacks of amounts
for purposes of determining the amount
of a credit allowable under part IV,
subchapter A, chapter 1 of the Internal
Revenue Code. Thus, for example, credit
carryovers of old target may offset only
income tax attributable to items
described in paragraph (c)(2)(i) of this
section.
(3) Procedure for transactions in
which section 338(h)(10) is elected. If an
election under section 338(h)(10) is
made, any changes in the deemed sale
tax consequences caused by an increase
or decrease in the ADSP are accounted
for in determining the taxable income
(or other amount) of the member of the
selling consolidated group, the selling
affiliate, or the S corporation
shareholders to which such income,
loss, or other amount is attributable for
the taxable year in which such increase
or decrease is taken into account.
(d) Special rules for AGUB—(1) Effect
of disposition or depreciation of
acquisition date assets. If an acquisition

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date asset has been disposed of,
depreciated, amortized, or depleted by
new target before an amount is added to
the original allocation to the asset, the
increased amount otherwise allocable to
such asset is taken into account under
general principles of tax law that apply
when part of the cost of an asset not
previously taken into account in basis is
paid or incurred after the asset has been
disposed of, depreciated, amortized, or
depleted. A similar rule applies when
an amount is subtracted from the
original allocation to the asset. For
purposes of the preceding sentence, an
asset is considered to have been
disposed of to the extent that its
allocable portion of the decrease in
AGUB would reduce its basis below
zero.
(2) Section 38 property. Section 1.47–
2(c) applies to a reduction in basis of
section 38 property under this section.
(e) Examples. The following examples
illustrate this section. Any amount
described in the following examples is
exclusive of interest. For rules
characterizing deferred contingent
payments as principal or interest, see
§§ 1.483–4, 1.1274–2(g), and 1.1275–
4(c). The examples are as follows:
Example 1. (i)(A) T’s assets other than
goodwill and going concern value, and their
fair market values at the beginning of the day
after the acquisition date, are as follows:
Fair
market
value

Asset
class

Asset

V ...........
V ...........

Building ........................
Stock of X (not a target).

$ 100
200

Total ......................

300

(B) T has no liabilities other than a
contingent liability that would not be taken
into account under general principles of tax
law in an asset sale between unrelated parties
when the buyer assumed the liability or took
property subject to it.
(ii)(A) On September 1, 2000, P purchases
all of the outstanding stock of T for $270 and
makes a section 338 election for T. The
grossed-up basis of the T stock and T’s AGUB
are both $270. The AGUB is ratably allocated
among T’s Class V assets in proportion to
their fair market values as follows:
Asset

$90
180

Total .............................................

270

(B) No amount is allocated to the Class VII
assets. New T is a calendar year taxpayer.
Assume that the X stock is a capital asset in
the hands of new T.

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Original
AGUB

Redetermined
AGUB

Increase

Building .............
X Stock .............
Goodwill and
going concern
value ..............

$90
180

$100
200

$10
20

0

30

30

Total ...........

270

330

60

Asset

(vi) Since the X stock was disposed of
before the contingent liability was properly
taken into account for tax purposes, no
amount of the increase in AGUB attributable
to such stock may be allocated to any T asset.
Rather, such amount ($20) is allowed as a
capital loss to T for the taxable year 2002
under the principles of Arrowsmith v.
Commissioner, 344 U.S. 6 (1952). In addition,
the $10 increase in AGUB allocated to the
building and the $30 increase in AGUB
allocated to the goodwill and going concern
value are treated as basis redeterminations in
2002. See paragraph (d)(1) of this section.
Example 2. (i) On January 1, 2002, P
purchases all of the outstanding stock of T
and makes a section 338 election for T.
Assume that ADSP and AGUB of T are both
$500 and are allocated among T’s acquisition
date assets as follows:
Asset
Class

Asset

V ...........
V ...........
VII .........

Machinery ......................
Land ...............................
Goodwill and going concern value.

$150
250
100

Total ........................

500

Basis

Building ($270 × 100/300) ..................
Stock ($270 × 200/300) ......................

PO 00000

(iii) On January 1, 2001, new T sells the X
stock and uses the proceeds to purchase
inventory.
(iv) Pursuant to events on June 30, 2002,
the contingent liability of old T is at that time
properly taken into account under general
principles of tax law. The amount of the
liability is $60.
(v) T’s AGUB increases by $60 from $270
to $330. This $60 increase in AGUB is first
allocated among T’s acquisition date assets in
accordance with the provisions of § 1.338–6.
Because the redetermined AGUB for T ($330)
exceeds the sum of the fair market values at
the beginning of the day after the acquisition
date of the Class V acquisition date assets
($300), AGUB allocated to those assets is
limited to those fair market values under
§ 1.338–6(c)(1). As there are no Class VI
assets, the remaining AGUB of $30 is
allocated to goodwill and going concern
value (Class VII assets). The amount of
increase in AGUB allocated to each
acquisition date asset is determined as
follows:

Sfmt 4700

Basis

(ii) On September 30, 2004, P filed a claim
against the selling shareholders of T in a
court of appropriate jurisdiction alleging
fraud in the sale of the T stock.
(iii) On January 1, 2007, the former
shareholders refund $140 of the purchase
price to P in a settlement of the lawsuit.

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Assume that, under general principles of tax
law, both the seller and the buyer properly
take into account such refund when paid.
Assume also that the refund has no effect on
the tax liability for the deemed sale tax
consequences. This refund results in a
decrease of T’s ADSP and AGUB of $140,
from $500 to $360.
(iv) The redetermined ADSP and AGUB of
$360 is allocated among T’s acquisition date
assets. Because ADSP and AGUB do not
exceed the fair market value of the Class V
assets, the ADSP and AGUB amounts are
allocated to the Class V assets in proportion
to their fair market values at the beginning
of the day after the acquisition date. Thus,
$135 ($150 × ($360/($150 + $250))) is
allocated to the machinery and $225 ($250 ×
($360/($150 + $250))) is allocated to the land.
Accordingly, the basis of the machinery is
reduced by $15 ($150 original allocation—
$135 redetermined allocation) and the basis
of the land is reduced by $25 ($250 original
allocation—$225 redetermined allocation).
No amount is allocated to the Class VII
assets. Accordingly, the basis of the goodwill
and going concern value is reduced by $100
($100 original allocation—$0 redetermined
allocation).
(v) Assume that, as a result of deductions
under section 168, the adjusted basis of the
machinery immediately before the decrease
in AGUB is zero. The machinery is treated as
if it were disposed of before the decrease is
taken into account. In 2007, T recognizes
income of $15, the character of which is
determined under the principles of
Arrowsmith v. Commissioner and the tax
benefit rule. No adjustment to the basis of T’s
assets is made for any tax paid on this
amount. Assume also that, as a result of
amortization deductions, the adjusted basis
of the goodwill and going concern value
immediately before the decrease in AGUB is
$40. A similar adjustment to income is made
in 2007 with respect to the $60 of previously
amortized goodwill and going concern value.

(vi) In summary, the basis of T’s
acquisition date assets, as of January 1, 2007,
is as follows:
Asset

Basis

Machinery .........................................
Land ..................................................
Goodwill and going concern value ...

$0
225
0

Example 3. (i) Assume that the facts are the
same as § 1.338–6(d) Example 2 except that
the recently purchased stock is acquired for
$1,600 plus additional payments that are
contingent upon T’s future earnings. Assume
that, under general principles of tax law,
such later payments are properly taken into
account when paid. Thus, T’s AGUB,
determined as of the beginning of the day
after the acquisition date (after reduction by
T’s cash of $200), is $2,500 and is allocated
among T’s acquisition date assets under
§ 1.338–6(c)(3)(iii) as follows:
Final
allocation

Class

Asset

I ............
II ...........

Cash ...........................
Portfolio of actively
traded securities.
Accounts receivable ...
Inventory .....................
Building .......................
Land ...........................
Investment in T1 ........
Goodwill and going
concern value.

$200
*268

Total ....................

2,700

III ..........
IV ..........
V ...........
V ...........
V ...........
VII .........

536
268
714
178
402
134

* All numbers rounded for convenience.
(ii) At a later point in time, P pays an
additional $200 for its recently purchased T
stock. Assume that the additional
consideration paid would not increase T’s tax
liability for the deemed sale tax
consequences.

9947

(iii) T’s AGUB increases by $200, from
$2,700 to $2,900. This $200 increase in
AGUB is accounted for in accordance with
the provisions of § 1.338–6(c)(3)(iii).
(iv) The hypothetical purchase price of the
T stock is redetermined as follows:
Grossed-up basis of recently purchased stock as determined
under § 1.338–5(c) ($1,800 × (1¥
.2)/.8) ............................................
Basis of nonrecently purchased
stock as if the gain recognition
election under § 1.338–5(d)(2)
had been made ($1,800 × .2/(1¥
.2)) .................................................
Liabilities .........................................
Total ..........................................

$ 1,800

450
1,000
3,250

(v) Since the redetermined hypothetical
purchase price ($3,250) exceeds the
redetermined AGUB ($2,900) and no gain
recognition election was made under section
338(b)(3), the rules of § 1.338–6(c)(3)(iii) are
reapplied using the redetermined
hypothetical purchase price and the
redetermined AGUB.
(vi) First, an AGUB amount equal to the
redetermined hypothetical purchase price
($3,250) is allocated among the assets under
the general rules of § 1.338–6. The allocation
is set forth in the column below entitled
Hypothetical Allocation. Next, the allocation
to each asset in Class II through Class VII is
multiplied by a fraction with a numerator
equal to the actual redetermined AGUB
reduced by the amount of Class I assets
($2,900 ¥ $200 = $2,700) and a denominator
equal to the redetermined hypothetical
purchase price reduced by the amount of
Class I assets ($3,250 ¥ $200 = $3,050), or
2,700/3,050. This produces the Final
Allocation:
Hypothetical
allocation

Final
allocation

Cash ......................................................................................................................................................................
Portfolio of actively traded securities ....................................................................................................................
Accounts receivable ..............................................................................................................................................
Inventory ................................................................................................................................................................
Building ..................................................................................................................................................................
Land ......................................................................................................................................................................
Investment in T1 ...................................................................................................................................................
Goodwill and going concern value ........................................................................................................................

$200
300
600
300
800
200
450
400

$200
*266
531
266
708
177
398
354

Total ...............................................................................................................................................................

3,250

2900

Class

Asset

I ............
II ...........
III ..........
IV ..........
V ...........
V ...........
V ...........
VII .........

* All numbers rounded for convenience.
(vii) As illustrated by this example,
reapplying § 1.338–6(c)(3) results in a basis

increase for some assets and a basis decrease
for other assets. The amount of redetermined

AGUB allocated to each acquisition date
asset is determined as follows:

Asset

Original
(c)(3)
allocation

Redetermined
(c)(3)
allocation

$268
536
268

$266
531
266

Portfolio of actively traded securities ...................................................................................................................
Accounts receivable .............................................................................................................................................
Inventory ..............................................................................................................................................................

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Increase
(decrease)
$(2)
(5)
(2)

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Original
(c)(3)
allocation

Redetermined
(c)(3)
allocation

Building ................................................................................................................................................................
Land .....................................................................................................................................................................
Investment in T1 ..................................................................................................................................................
Goodwill and going concern value ......................................................................................................................

714
178
402
134

708
177
398
354

(6)
(1)
(4)
220

Total ..............................................................................................................................................................

2,500

2,700

200

Asset

Example 4. (i) On January 1, 2001, P
purchases all of the outstanding T stock and
makes a section 338 election for T. P pays
$700 of cash and promises also to pay a
maximum $300 of contingent consideration
at various times in the future. Assume that,
under general principles of tax law, such
later payments are properly taken into
account by P when paid. Assume also,
however, that the current fair market value of
the contingent payments is reasonably
ascertainable. The fair market value of T’s
assets (other than goodwill and going
concern value) as of the beginning of the
following day is as follows:
Asset
class

Assets

V ...........
V ...........

Equipment ..................
Non-actively traded
securities.
Building .......................

$200
100

Total ....................

800

V ...........

Fair market value

500

(ii) T has no liabilities. The AGUB is $700.
In calculating ADSP, assume that, under
§ 1.1001–1, the current amount realized
attributable to the contingent consideration is
$200. ADSP is therefore $900 ($700 cash plus
$200).
(iii) (A) The AGUB of $700 is ratably
allocated among T’s Class V acquisition date
assets in proportion to their fair market
values as follows:
Asset

Basis

Equipment ($700 × 200/800) ........
Non-actively traded securities
($700 × 100/800) ......................
Building ($700 × 500/800) ............

$175.00

Total .......................................

700.00

87.50
437.50

(B) No amount is allocated to goodwill or
going concern value.
(iv) (A) The ADSP of $900 is ratably
allocated among T’s Class V acquisition date
assets in proportion to their fair market
values as follows:

Asset

Increase
(decrease)

Basis

Equipment .....................................
Non-actively traded securities ......
Building .........................................

$200
100
500

Total .......................................

800

(B) The remaining ADSP, $100, is allocated
to goodwill and going concern value (Class
VII).
(v) P and T file a consolidated return for
2001 and each following year with P as the
common parent of the affiliated group.
(vi) In 2004, a contingent amount of $120
is paid by P. For old T, this payment has no
effect on ADSP, because the payment is
accounted for as a separate transaction. We
have assumed that, under general principles
of tax law, the payment is properly taken into
account by P at the time made. Therefore, in
2004, there is an increase in new T’s AGUB
of $120. The amount of the increase allocated
to each acquisition date asset is determined
as follows:
Original
AGUB

Asset

Redetermined
AGUB

Increase

Equipment ............................................................................................................................................................
Land .....................................................................................................................................................................
Building ................................................................................................................................................................
Goodwill and going concern value ......................................................................................................................

$175.00
87.50
437.50
0.00

$200.00
100.00
500.00
20.00

$25.00
12.50
62.50
20.00

Total ..............................................................................................................................................................

700.00

820.00

120.00

§§ 1.338–0T through 1.338–7T

[Removed]

Par. 4. Sections 1.338–0T through
1.338–7T are removed.
Par. 5. Section 1.338–10 is added to
read as follows:
§ 1.338–10

Filing of returns.

(a) Returns including tax liability from
deemed asset sale—(1) In general.
Except as provided in paragraphs (a)(2)
and (3) of this section, any deemed sale
tax consequences are reported on the
final return of old target filed for old
target’s taxable year that ends at the
close of the acquisition date. Paragraphs
(a)(2), (3) and (4) of this section do not
apply to elections under section
338(h)(10). If old target is the common
parent of an affiliated group, the final
return may be a consolidated return
(any such consolidated return must also

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include any deemed sale tax
consequences of any members of the
consolidated group that are acquired by
the purchasing corporation on the same
acquisition date as old target).
(2) Old target’s final taxable year
otherwise included in consolidated
return of selling group—(i) General rule.
If the selling group files a consolidated
return for the period that includes the
acquisition date, old target is
disaffiliated from that group
immediately before the deemed asset
sale and must file a deemed sale return
separate from the group, which includes
only the deemed sale tax consequences
and the carryover items specified in
paragraph (a)(2)(iii) of this section. The
deemed asset sale occurs at the close of
the acquisition date and is the last
transaction of old target and the only

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transaction reported on the separate
return. Except as provided in § 1.338–
1(d) (regarding certain transactions on
the acquisition date), any transactions of
old target occurring on the acquisition
date other than the deemed asset sale
are included in the selling group’s
consolidated return. A deemed sale
return includes a combined deemed sale
return as defined in paragraph (a)(4) of
this section.
(ii) Separate taxable year. The
deemed asset sale included in the
deemed sale return under this paragraph
(a)(2) occurs in a separate taxable year,
except that old target’s taxable year of
the sale and the consolidated year of the
selling group that includes the
acquisition date are treated as the same
year for purposes of determining the

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Federal Register / Vol. 66, No. 30 / Tuesday, February 13, 2001 / Rules and Regulations
number of years in a carryover or
carryback period.
(iii) Carryover and carryback of tax
attributes. Target’s attributes may be
carried over to, and carried back from,
the deemed sale return under the rules
applicable to a corporation that ceases
to be a member of a consolidated group.
(iv) Old target is a component
member of purchasing corporation’s
controlled group. For purposes of its
deemed sale return, target is a
component member of the controlled
group of corporations including the
purchasing corporation unless target is
treated as an excluded member under
section 1563(b)(2).
(3) Old target is an S corporation. If
target is an S corporation for the period
that ends on the day before the
acquisition date and a section 338
election (but not a section 338(h)(10)
election) is filed for target, old target
files a return as a C corporation
reflecting its activities on the
acquisition date, including target’s
deemed sale. See section 1362(d)(2). For
purposes of this return, target is a
component member of the controlled
group of corporations including the
purchasing corporation unless target is
treated as an excluded member under
section 1563(b)(2).
(4) Combined deemed sale return—(i)
General rule. Under section 338(h)(15),
a combined deemed sale return
(combined return) may be filed for all
targets from a single selling
consolidated group (as defined in
§ 1.338(h)(10)–1(b)(3)) that are acquired
by the purchasing corporation on the
same acquisition date and that
otherwise would be required to file
separate deemed sale returns. The
combined return must include all such
targets. For example, T and T1 may be
included in a combined return if—
(A) T and T1 are directly owned
subsidiaries of S;
(B) S is the common parent of a
consolidated group; and
(C) P makes qualified stock purchases
of T and T1 on the same acquisition
date.
(ii) Gain and loss offsets. Gains and
losses recognized on the deemed asset
sales by targets included in a combined
return are treated as the gains and losses
of a single target. In addition, loss
carryovers of a target that were not
subject to the separate return limitation
year restrictions (SRLY restrictions) of
the consolidated return regulations
while that target was a member of the
selling consolidated group may be
applied without limitation to the gains
of other targets included in the
combined return. If, however, a target
has loss carryovers that were subject to

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the SRLY restrictions while that target
was a member of the selling
consolidated group, the use of those
losses in the combined return continues
to be subject to those restrictions,
applied in the same manner as if the
combined return were a consolidated
return. A similar rule applies, when
appropriate, to other tax attributes.
(iii) Procedure for filing a combined
return. A combined return is made by
filing a single corporation income tax
return in lieu of separate deemed sale
returns for all targets required to be
included in the combined return. The
combined return reflects the deemed
asset sales of all targets required to be
included in the combined return. If the
targets included in the combined return
constitute a single affiliated group
within the meaning of section 1504(a),
the income tax return is signed by an
officer of the common parent of that
group. Otherwise, the return must be
signed by an officer of each target
included in the combined return. Rules
similar to the rules in § 1.1502–75(j)
apply for purposes of preparing the
combined return. The combined return
must include an attachment
prominently identified as an
‘‘ELECTION TO FILE A COMBINED
RETURN UNDER SECTION 338(h)(15).’’
The attachment must—
(A) Contain the name, address, and
employer identification number of each
target required to be included in the
combined return;
(B) Contain the following declaration
(or a substantially similar declaration):
EACH TARGET IDENTIFIED IN THIS
ELECTION TO FILE A COMBINED
RETURN CONSENTS TO THE FILING
OF A COMBINED RETURN;
(C) For each target, be signed by a
person who states under penalties of
perjury that he or she is authorized to
act on behalf of such target.
(iv) Consequences of filing a
combined return. Each target included
in a combined return is severally liable
for any tax associated with the
combined return. See § 1.338–1(b)(3).
(5) Deemed sale excluded from
purchasing corporation’s consolidated
return. Old target may not be considered
a member of any affiliated group that
includes the purchasing corporation
with respect to its deemed asset sale.
(6) Due date for old target’s final
return—(i) General rule. Old target’s
final return is generally due on the 15th
day of the third calendar month
following the month in which the
acquisition date occurs. See section
6072 (time for filing income tax returns).
(ii) Application of § 1.1502–76(c)—(A)
In general. Section 1.1502–76(c) applies
to old target’s final return if old target

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9949

was a member of a selling group that did
not file consolidated returns for the
taxable year of the common parent that
precedes the year that includes old
target’s acquisition date. If the selling
group has not filed a consolidated
return that includes old target’s taxable
period that ends on the acquisition date,
target may, on or before the final return
due date (including extensions),
either—
(1) File a deemed sale return on the
assumption that the selling group will
file the consolidated return; or
(2) File a return for so much of old
target’s taxable period as ends at the
close of the acquisition date on the
assumption that the consolidated return
will not be filed.
(B) Deemed extension. For purposes
of applying § 1.1502–76(c)(2), an
extension of time to file old target’s final
return is considered to be in effect until
the last date for making the election
under section 338.
(C) Erroneous filing of deemed sale
return. If, under this paragraph (a)(6)(ii),
target files a deemed sale return but the
selling group does not file a
consolidated return, target must file a
substituted return for old target not later
than the due date (including extensions)
for the return of the common parent
with which old target would have been
included in the consolidated return. The
substituted return is for so much of old
target’s taxable year as ends at the close
of the acquisition date. Under § 1.1502–
76(c)(2), the deemed sale return is not
considered a return for purposes of
section 6011 (relating to the general
requirement of filing a return) if a
substituted return must be filed.
(D) Erroneous filing of return for
regular tax year. If, under this paragraph
(a)(6)(ii), target files a return for so much
of old target’s regular taxable year as
ends at the close of the acquisition date
but the selling group files a consolidated
return, target must file an amended
return for old target not later than the
due date (including extensions) for the
selling group’s consolidated return. (The
amended return is a deemed sale
return.)
(E) Last date for payment of tax. If
either a substituted or amended final
return of old target is filed under this
paragraph (a)(6)(ii), the last date
prescribed for payment of tax is the final
return due date (as defined in paragraph
(a)(6)(i) of this section).
(7) Examples. The following examples
illustrate this paragraph (a):
Example 1. (i) S is the common parent of
a consolidated group that includes T. The S
group files calendar year consolidated
returns. At the close of June 30 of Year 1, P
makes a qualified stock purchase of T from

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S. P makes a section 338 election for T, and
T’s deemed asset sale occurs as of the close
of T’s acquisition date (June 30).
(ii) T is considered disaffiliated for
purposes of reporting the deemed sale tax
consequences. Accordingly, T is included in
the S group’s consolidated return through T’s
acquisition date except that the tax liability
for the deemed sale tax consequences is
reported in a separate deemed sale return of
T. Provided that T is not treated as an
excluded member under section 1563(b)(2), T
is a component member of P’s controlled
group for the taxable year of the deemed asset
sale, and the taxable income bracket amounts
available in calculating tax on the deemed
sale return must be limited accordingly.
(iii) If P purchased the stock of T at 10 a.m.
on June 30 of Year 1, the results would be
the same. See paragraph (a)(2)(i) of this
section.
Example 2. The facts are the same as in
Example 1, except that the S group does not
file consolidated returns. T must file a
separate return for its taxable year ending on
June 30 of Year 1, which return includes the
deemed asset sale.

(b) Waiver—(1) Certain additions to
tax. An addition to tax or additional
amount (addition) under subchapter A
of chapter 68 of the Internal Revenue
Code arising on or before the last day for
making the election under section 338
because of circumstances that would not
exist but for an election under section
338 is waived if—
(i) Under the particular statute the
addition is excusable upon a showing of
reasonable cause; and
(ii) Corrective action is taken on or
before the last day.
(2) Notification. The Internal Revenue
Service should be notified at the time of
correction (e.g., by attaching a statement
to a return that constitutes corrective
action) that the waiver rule of this
paragraph (b) is being asserted.
(3) Elections or other actions required
to be specified on a timely filed return—
(i) In general. If paragraph (b)(1) of this
section applies or would apply if there
were an underpayment, any election or
other action that must be specified on a
timely filed return for the taxable period
covered by the late filed return
described in paragraph (b)(1) of this
section is considered timely if specified
on a late-filed return filed on or before
the last day for making the election
under section 338.
(ii) New target in purchasing
corporation’s consolidated return. If
new target is includible for its first
taxable year in a consolidated return
filed by the affiliated group of which the
purchasing corporation is a member on
or before the last day for making the
election under section 338, any election
or other action that must be specified in
a timely filed return for new target’s first
taxable year (but which is not specified

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in the consolidated return) is considered
timely if specified in an amended return
filed on or before such last day, at the
place where the consolidated return was
filed.
(4) Examples. The following examples
illustrate this paragraph (b):
Example 1. T is an unaffiliated corporation
with a tax year ending March 31. At the close
of September 20 of Year 1, P makes a
qualified stock purchase of T. P does not join
in filing a consolidated return. P makes a
section 338 election for T on or before June
15 of Year 2, which causes T’s taxable year
to end as of the close of September 20 of Year
1. An income tax return for T’s taxable period
ending on September 20 of Year 1 was due
on December 15 of Year 1. Additions to tax
for failure to file a return and to pay tax
shown on a return will not be imposed if T’s
return is filed and the tax paid on or before
June 15 of Year 2. (This waiver applies even
if the acquisition date coincides with the last
day of T’s former taxable year, i.e., March 31
of Year 2.) Interest on any underpayment of
tax for old T’s short taxable year ending
September 20 of Year 1 runs from December
15 of Year 1. A statement indicating that the
waiver rule of this paragraph is being
asserted should be attached to T’s return.
Example 2. Assume the same facts as in
Example 1. Assume further that new T
adopts the calendar year by filing, on or
before June 15 of Year 2, its first return (for
the period beginning on September 21 of
Year 1 and ending on December 31 of Year
1) indicating that a calendar year is chosen.
See § 1.338–1(b)(1). Any additions to tax or
amounts described in this paragraph (b) that
arise because of the late filing of a return for
the period ending on December 31 of Year 1
are waived, because they are based on
circumstances that would not exist but for
the section 338 election. Notwithstanding
this waiver, however, the return is still
considered due March 15 of Year 2, and
interest on any underpayment runs from that
date.
Example 3. Assume the same facts as in
Example 2, except that T’s former taxable
year ends on October 31. Although prior to
the election old T had a return due on
January 15 of Year 2 for its year ending
October 31 of Year 1, that return need not be
filed because a timely election under section
338 was made. Instead, old T must file a final
return for the period ending on September 20
of Year 1, which is due on December 15 of
Year 1.
§ 1.338–10T

[Removed]

Par. 6. Section 1.338–10T is removed.
Par. 7. Section 1.338(h)(10)–1 is
added to read as follows:
§ 1.338(h)(10)–1
liquidation.

Deemed asset sale and

(a) Scope. This section prescribes
rules for qualification for a section
338(h)(10) election and for making a
section 338(h)(10) election. This section
also prescribes the consequences of
such election. The rules of this section
are in addition to the rules of §§ 1.338–

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1 through 1.338–10 and, in appropriate
cases, apply instead of the rules of
§§ 1.338–1 through 1.338–10.
(b) Definitions—(1) Consolidated
target. A consolidated target is a target
that is a member of a consolidated group
within the meaning of § 1.1502–1(h) on
the acquisition date and is not the
common parent of the group on that
date.
(2) Selling consolidated group. A
selling consolidated group is the
consolidated group of which the
consolidated target is a member on the
acquisition date.
(3) Selling affiliate; affiliated target. A
selling affiliate is a domestic
corporation that owns on the acquisition
date an amount of stock in a domestic
target, which amount of stock is
described in section 1504(a)(2), and
does not join in filing a consolidated
return with the target. In such case, the
target is an affiliated target.
(4) S corporation target. An S
corporation target is a target that is an
S corporation immediately before the
acquisition date.
(5) S corporation shareholders. S
corporation shareholders are the S
corporation target’s shareholders.
Unless otherwise indicated, a reference
to S corporation shareholders refers
both to S corporation shareholders who
do and those who do not sell their target
stock.
(6) Liquidation. Any reference in this
section to a liquidation is treated as a
reference to the transfer described in
paragraph (d)(4) of this section
notwithstanding its ultimate
characterization for Federal income tax
purposes.
(c) Section 338(h)(10) election—(1) In
general. A section 338(h)(10) election
may be made for T if P acquires stock
meeting the requirements of section
1504(a)(2) from a selling consolidated
group, a selling affiliate, or the S
corporation shareholders in a qualified
stock purchase.
(2) Simultaneous joint election
requirement. A section 338(h)(10)
election is made jointly by P and the
selling consolidated group (or the
selling affiliate or the S corporation
shareholders) on Form 8023 in
accordance with the instructions to the
form. S corporation shareholders who
do not sell their stock must also consent
to the election. The section 338(h)(10)
election must be made not later than the
15th day of the 9th month beginning
after the month in which the acquisition
date occurs.
(3) Irrevocability. A section 338(h)(10)
election is irrevocable. If a section
338(h)(10) election is made for T, a

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Federal Register / Vol. 66, No. 30 / Tuesday, February 13, 2001 / Rules and Regulations
section 338 election is deemed made for
T.
(4) Effect of invalid election. If a
section 338(h)(10) election for T is not
valid, the section 338 election for T is
also not valid.
(d) Certain consequences of section
338(h)(10) election. For purposes of
subtitle A of the Internal Revenue Code
(except as provided in § 1.338–1(b)(2)),
the consequences to the parties of
making a section 338(h)(10) election for
T are as follows:
(1) P. P is automatically deemed to
have made a gain recognition election
for its nonrecently purchased T stock, if
any. The effect of a gain recognition
election includes a taxable deemed sale
by P on the acquisition date of any
nonrecently purchased target stock. See
§ 1.338–5(d).
(2) New T. The AGUB for new T’s
assets is determined under § 1.338–5
and is allocated among the acquisition
date assets under §§ 1.338–6 and 1.338–
7. Notwithstanding paragraph (d)(4) of
this section (deemed liquidation of old
T), new T remains liable for the tax
liabilities of old T (including the tax
liability for the deemed sale tax
consequences). For example, new T
remains liable for the tax liabilities of
the members of any consolidated group
that are attributable to taxable years in
which those corporations and old T
joined in the same consolidated return.
See § 1.1502–6(a).
(3) Old T—deemed sale—(i) In
general. Old T is treated as transferring
all of its assets to an unrelated person
in exchange for consideration that
includes the discharge of its liabilities
in a single transaction at the close of the
acquisition date (but before the deemed
liquidation). See § 1.338–1(a) regarding
the tax characterization of the deemed
asset sale. Except as provided in
§ 1.338(h)(10)–1(d)(8) (regarding the
installment method), old T recognizes
all of the gain realized on the deemed
transfer of its assets in consideration for
the ADSP. ADSP for old T is determined
under § 1.338–4 and allocated among
the acquisition date assets under
§§ 1.338–6 and 1.338–7. Old T realizes
the deemed sale tax consequences from
the deemed asset sale before the close of
the acquisition date while old T is a
member of the selling consolidated
group (or owned by the selling affiliate
or owned by the S corporation
shareholders). If T is an affiliated target,
or an S corporation target, the principles
of §§ 1.338–2(c)(10) and 1.338–10(a)(1),
(5), and (6)(i) apply to the return on
which the deemed sale tax
consequences are reported. When T is
an S corporation target, T’s S election
continues in effect through the close of

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the acquisition date (including the time
of the deemed asset sale and the deemed
liquidation) notwithstanding section
1362(d)(2)(B). Also, when T is an S
corporation target (but not a qualified
subchapter S subsidiary), any direct and
indirect subsidiaries of T which T has
elected to treat as qualified subchapter
S subsidiaries under section 1361(b)(3)
remain qualified subchapter S
subsidiaries through the close of the
acquisition date.
(ii) Tiered targets. In the case of
parent-subsidiary chains of corporations
making elections under section
338(h)(10), the deemed asset sale of a
parent corporation is considered to
precede that of its subsidiary. See
§ 1.338–3(b)(4)(i).
(4) Old T and selling consolidated
group, selling affiliate, or S corporation
shareholders—deemed liquidation; tax
characterization—(i) In general. Old T is
treated as if, before the close of the
acquisition date, after the deemed asset
sale in paragraph (d)(3) of this section,
and while old T is a member of the
selling consolidated group (or owned by
the selling affiliate or owned by the S
corporation shareholders), it transferred
all of its assets to members of the selling
consolidated group, the selling affiliate,
or S corporation shareholders and
ceased to exist. The transfer from old T
is characterized for Federal income tax
purposes in the same manner as if the
parties had actually engaged in the
transactions deemed to occur because of
this section and taking into account
other transactions that actually occurred
or are deemed to occur. For example,
the transfer may be treated as a
distribution in pursuance of a plan of
reorganization, a distribution in
complete cancellation or redemption of
all its stock, one of a series of
distributions in complete cancellation
or redemption of all its stock in
accordance with a plan of liquidation,
or part of a circular flow of cash. In most
cases, the transfer will be treated as a
distribution in complete liquidation to
which section 336 or 337 applies.
(ii) Tiered targets. In the case of
parent-subsidiary chains of corporations
making elections under section
338(h)(10), the deemed liquidation of a
subsidiary corporation is considered to
precede the deemed liquidation of its
parent.
(5) Selling consolidated group, selling
affiliate, or S corporation
shareholders—(i) In general. If T is an S
corporation target, S corporation
shareholders (whether or not they sell
their stock) take their pro rata share of
the deemed sale tax consequences into
account under section 1366 and
increase or decrease their basis in T

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9951

stock under section 1367. Members of
the selling consolidated group, the
selling affiliate, or S corporation
shareholders are treated as if, after the
deemed asset sale in paragraph (d)(3) of
this section and before the close of the
acquisition date, they received the
assets transferred by old T in the
transaction described in paragraph
(d)(4)(i) of this section. In most cases,
the transfer will be treated as a
distribution in complete liquidation to
which section 331 or 332 applies.
(ii) Basis and holding period of T
stock not acquired. A member of the
selling consolidated group (or the
selling affiliate or an S corporation
shareholder) retaining T stock is treated
as acquiring the stock so retained on the
day after the acquisition date for its fair
market value. The holding period for the
retained stock starts on the day after the
acquisition date. For purposes of this
paragraph, the fair market value of all of
the T stock equals the grossed-up
amount realized on the sale to P of P’s
recently purchased target stock. See
§ 1.338–4(c).
(iii) T stock sale. Members of the
selling consolidated group (or the
selling affiliate or S corporation
shareholders) recognize no gain or loss
on the sale or exchange of T stock
included in the qualified stock purchase
(although they may recognize gain or
loss on the T stock in the deemed
liquidation).
(6) Nonselling minority shareholders
other than nonselling S corporation
shareholders—(i) In general. This
paragraph (d)(6) describes the treatment
of shareholders of old T other than the
following: Members of the selling
consolidated group, the selling affiliate,
S corporation shareholders (whether or
not they sell their stock), and P. For a
description of the treatment of S
corporation shareholders, see paragraph
(d)(5) of this section. A shareholder to
which this paragraph (d)(6) applies is
called a minority shareholder.
(ii) T stock sale. A minority
shareholder recognizes gain or loss on
the shareholder’s sale or exchange of T
stock included in the qualified stock
purchase.
(iii) T stock not acquired. A minority
shareholder does not recognize gain or
loss under this section with respect to
shares of T stock retained by the
shareholder. The shareholder’s basis
and holding period for that T stock is
not affected by the section 338(h)(10)
election.
(7) Consolidated return of selling
consolidated group. If P acquires T in a
qualified stock purchase from a selling
consolidated group—

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(i) The selling consolidated group
must file a consolidated return for the
taxable period that includes the
acquisition date;
(ii) A consolidated return for the
selling consolidated group for that
period may not be withdrawn on or after
the day that a section 338(h)(10)
election is made for T; and
(iii) Permission to discontinue filing
consolidated returns cannot be granted
for, and cannot apply to, that period or
any of the immediately preceding
taxable periods during which
consolidated returns continuously have
been filed.
(8) Availability of the section 453
installment method. Solely for purposes
of applying sections 453, 453A, and
453B, and the regulations thereunder
(the installment method) to determine
the consequences to old T in the
deemed asset sale and to old T (and its
shareholders, if relevant) in the deemed
liquidation, the rules in paragraphs
(d)(1) through (7) of this section are
modified as follows:
(i) In deemed asset sale. Old T is
treated as receiving in the deemed asset
sale new T installment obligations, the
terms of which are identical (except as
to the obligor) to P installment
obligations issued in exchange for
recently purchased stock of T. Old T is
treated as receiving in cash all other
consideration in the deemed asset sale
other than the assumption of, or taking
subject to, old T liabilities. For example,
old T is treated as receiving in cash any
amounts attributable to the grossing-up
of amount realized under § 1.338–4(c).
The amount realized for recently
purchased stock taken into account in
determining ADSP is adjusted (and,
thus, ADSP is redetermined) to reflect
the amounts paid under an installment
obligation for the stock when the total
payments under the installment
obligation are greater or less than the
amount realized.
(ii) In deemed liquidation. Old T is
treated as distributing in the deemed
liquidation the new T installment
obligations that it is treated as receiving
in the deemed asset sale. The members
of the selling consolidated group, the
selling affiliate, or the S corporation
shareholders are treated as receiving in
the deemed liquidation the new T
installment obligations that correspond
to the P installment obligations they
actually received individually in
exchange for their recently purchased
stock. The new T installment
obligations may be recharacterized
under other rules. See for example
§ 1.453–11(a)(2) which, in certain
circumstances, treats the new T
installment obligations deemed

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distributed by old T as if they were
issued by new T in exchange for the
stock in old T owned by members of the
selling consolidated group, the selling
affiliate, or the S corporation
shareholders. The members of the
selling consolidated group, the selling
affiliate, or the S corporation
shareholders are treated as receiving all
other consideration in the deemed
liquidation in cash.
(9) Treatment consistent with an
actual asset sale. No provision in
section 338(h)(10) or this section shall
produce a Federal income tax result
under subtitle A of the Internal Revenue
Code that would not occur if the parties
had actually engaged in the transactions
deemed to occur because of this section
and taking into account other
transactions that actually occurred or
are deemed to occur. See, however,
§ 1.338–1(b)(2) for certain exceptions to
this rule.
(e) Examples. The following examples
illustrate the provisions of this section:
Example 1. (i) S1 owns all of the T stock
and T owns all of the stock of T1 and T2. S1
is the common parent of a consolidated
group that includes T, T1, and T2. P makes
a qualified stock purchase of all of the T
stock from S1. S1 joins with P in making a
section 338(h)(10) election for T and for the
deemed purchase of T1. A section 338
election is not made for T2.
(ii) S1 does not recognize gain or loss on
the sale of the T stock and T does not
recognize gain or loss on the sale of the T1
stock because section 338(h)(10) elections are
made for T and T1. Thus, for example, gain
or loss realized on the sale of the T or T1
stock is not taken into account in earnings
and profits. However, because a section 338
election is not made for T2, T must recognize
any gain or loss realized on the deemed sale
of the T2 stock. See § 1.338–4(h).
(iii) The results would be the same if S1,
T, T1, and T2 are not members of any
consolidated group, because S1 and T are
selling affiliates.
Example 2. (i) S and T are solvent
corporations. S owns all of the outstanding
stock of T. S and P agree to undertake the
following transaction: T will distribute half
its assets to S, and S will assume half of T’s
liabilities. Then, P will purchase the stock of
T from S. S and P will jointly make a section
338(h)(10) election with respect to the sale of
T. The corporations then complete the
transaction as agreed.
(ii) Under section 338(a), the assets present
in T at the close of the acquisition date are
deemed sold by old T to new T. Under
paragraph (d)(4) of this section, the
transactions described in paragraph (d) of
this section are treated in the same manner
as if they had actually occurred. Because S
and P had agreed that, after T’s actual
distribution to S of part of its assets, S would
sell T to P pursuant to an election under
section 338(h)(10), and because paragraph
(d)(4) of this section deems T subsequently
to have transferred all its assets to its

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shareholder, T is deemed to have adopted a
plan of complete liquidation under section
332. T’s actual transfer of assets to S is
treated as a distribution pursuant to that plan
of complete liquidation.
Example 3. (i) S1 owns all of the
outstanding stock of both T and S2. All three
are corporations. S1 and P agree to undertake
the following transaction. T will transfer
substantially all of its assets and liabilities to
S2, with S2 issuing no stock in exchange
therefor, and retaining its other assets and
liabilities. Then, P will purchase the stock of
T from S1. S1 and P will jointly make a
section 338(h)(10) election with respect to
the sale of T. The corporations then complete
the transaction as agreed.
(ii) Under section 338(a), the remaining
assets present in T at the close of the
acquisition date are deemed sold by old T to
new T. Under paragraph (d)(4) of this section,
the transactions described in this section are
treated in the same manner as if they had
actually occurred. Because old T transferred
substantially all of its assets to S2, and is
deemed to have distributed all its remaining
assets and gone out of existence, the transfer
of assets to S2, taking into account the related
transfers, deemed and actual, qualifies as a
reorganization under section 368(a)(1)(D).
Section 361(c)(1) and not section 332 applies
to T’s deemed liquidation.
Example 4. (i) T owns two assets: an
actively traded security (Class II) with a fair
market value of $100 and an adjusted basis
of $100, and inventory (Class IV) with a fair
market value of $100 and an adjusted basis
of $100. T has no liabilities. S is negotiating
to sell all the stock in T to P for $100 cash
and contingent consideration. Assume that
under generally applicable tax accounting
rules, P’s adjusted basis in the T stock
immediately after the purchase would be
$100, because the contingent consideration is
not taken into account. Thus, under the rules
of § 1.338–5, AGUB would be $100. Under
the allocation rules of § 1.338–6, the entire
$100 would be allocated to the Class II asset,
the actively traded security, and no amount
would be allocated to the inventory. P,
however, plans immediately to cause T to
sell the inventory, but not the actively traded
security, so it requests that, prior to the stock
sale, S cause T to create a new subsidiary,
Newco, and contribute the actively traded
security to the capital of Newco. Because the
stock in Newco, which would not be actively
traded, is a Class V asset, under the rules of
§ 1.338–6 $100 of AGUB would be allocated
to the inventory and no amount of AGUB
would be allocated to the Newco stock.
Newco’s own AGUB, $0 under the rules of
§ 1.338–5, would be allocated to the actively
traded security. When P subsequently causes
T to sell the inventory, T would realize no
gain or loss instead of realizing gain of $100.
(ii) Assume that, if the T stock had not
itself been sold but T had instead sold both
its inventory and the Newco stock to P, T
would for tax purposes be deemed instead to
have sold both its inventory and actively
traded security directly to P, with P deemed
then to have created Newco and contributed
the actively traded security to the capital of
Newco. Section 338, if elected, generally
recharacterizes a stock sale as a deemed sale

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of assets. However, paragraph (d)(9) of this
section states, in general, that no provision of
section 338(h)(10) or the regulations
thereunder shall produce a Federal income
tax result under subtitle A of the Internal
Revenue Code that would not occur if the
parties had actually engaged in the
transactions deemed to occur by virtue of the
section 338(h)(10) election, taking into
account other transactions that actually
occurred or are deemed to occur. Hence, the
deemed sale of assets under section
338(h)(10) should be treated as one of the
inventory and actively traded security

themselves, not of the inventory and Newco
stock. The anti-abuse rule of § 1.338–1(c)
does not apply, because the substance of the
deemed sale of assets is a sale of the
inventory and the actively traded security
themselves, not of the inventory and the
Newco stock. Otherwise, the anti-abuse rule
might apply.
Example 5. (i) T, a member of a selling
consolidated group, has only one class of
stock, all of which is owned by S1. On March
1 of Year 2, S1 sells its T stock to P for
$80,000, and joins with P in making a section
338(h)(10) election for T. There are no selling

Assets

Basis

9953

costs or acquisition costs. On March 1 of Year
2, T owns land with a $50,000 basis and
$75,000 fair market value and equipment
with a $30,000 adjusted basis, $70,000
recomputed basis, and $60,000 fair market
value. T also has a $40,000 liability. S1 pays
old T’s allocable share of the selling group’s
consolidated tax liability for Year 2 including
the tax liability for the deemed sale tax
consequences (a total of $13,600).
(ii) ADSP of $120,000 ($80,000 + $40,000
+ 0) is allocated to each asset as follows:

FMV

Fraction

Allocable ADSP

Land .................................................................................................
Equipment ........................................................................................

$50,000
30,000

$75,000
60,000

59
49

⁄
⁄

$66,667
53,333

Total ......................................................................................

80,000

135,000

1

120,000

(iii) Under paragraph (d)(3) of this section,
old T has gain on the deemed sale of $40,000
(consisting of $16,667 of capital gain and
$23,333 of ordinary income).
(iv) Under paragraph (d)(5)(iii) of this
section, S1 recognizes no gain or loss upon
its sale of the old T stock to P. S1 also
recognizes no gain or loss upon the deemed
liquidation of T. See paragraph (d)(4) of this
section and section 332.
(v) P’s basis in new T stock is P’s cost for
the stock, $80,000. See section 1012.
(vi) Under § 1.338–5, the AGUB for new T
is $120,000, i.e., P’s cost for the old T stock
($80,000) plus T’s liability ($40,000). This
AGUB is allocated as basis among the new
T assets under §§ 1.338–6 and 1.338–7.
Example 6. (i) The facts are the same as in
Example 5, except that S1 sells 80 percent of
the old T stock to P for $64,000, rather than
100 percent of the old T stock for $80,000.
(ii) The consequences to P, T, and S1 are
the same as in Example 5, except that:
(A) P’s basis for its 80-percent interest in
the new T stock is P’s $64,000 cost for the
stock. See section 1012.
(B) Under § 1.338–5, the AGUB for new T
is $120,000 (i.e., $64,000/.8 + $40,000 + $0).
(C) Under paragraph (d)(4) of this section,
S1 recognizes no gain or loss with respect to
the retained stock in T. See section 332.
(D) Under paragraph (d)(5)(ii) of this
section, the basis of the T stock retained by
S1 is $16,000 (i.e., $120,000 ¥ $40,000 (the
ADSP amount for the old T assets over the
sum of new T’s liabilities immediately after
the acquisition date) ‘‘ .20 (the proportion of
T stock retained by S1)).
Example 7. (i) The facts are the same as in
Example 6, except that K, a shareholder
unrelated to T or P, owns the 20 percent of
the T stock that is not acquired by P in the
qualified stock purchase. K’s basis in its T
stock is $5,000.
(ii) The consequences to P, T, and S1 are
the same as in Example 6.
(iii) Under paragraph (d)(6)(iii) of this
section, K recognizes no gain or loss, and K’s
basis in its T stock remains at $5,000.
Example 8. (i) The facts are the same as in
Example 5, except that the equipment is held
by T1, a wholly-owned subsidiary of T, and
a section 338(h)(10) election is also made for

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T1. The T1 stock has a fair market value of
$60,000. T1 has no assets other than the
equipment and no liabilities. S1 pays old T’s
and old T1’s allocable shares of the selling
group’s consolidated tax liability for Year 2
including the tax liability for T and T1’s
deemed sale tax consequences.
(ii) ADSP for T is $120,000, allocated
$66,667 to the land and $53,333 to the stock.
Old T’s deemed sale results in $16,667 of
capital gain on its deemed sale of the land.
Under paragraph (d)(5)(iii) of this section, old
T does not recognize gain or loss on its
deemed sale of the T1 stock. See section 332.
(iii) ADSP for T1 is $53,333 (i.e., $53,333
+ $0 + $0). On the deemed sale of the
equipment, T1 recognizes ordinary income of
$23,333.
(iv) Under paragraph (d)(5)(iii) of this
section, S1 does not recognize gain or loss
upon its sale of the old T stock to P.
Example 9. (i) The facts are the same as in
Example 8, except that P already owns 20
percent of the T stock, which is nonrecently
purchased stock with a basis of $6,000, and
that P purchases the remaining 80 percent of
the T stock from S1 for $64,000.
(ii) The results are the same as in Example
8, except that under paragraph (d)(1) of this
section and § 1.338–5(d), P is deemed to have
made a gain recognition election for its
nonrecently purchased T stock. As a result,
P recognizes gain of $10,000 and its basis in
the nonrecently purchased T stock is
increased from $6,000 to $16,000. P’s basis in
all the T stock is $80,000 (i.e., $64,000 +
$16,000). The computations are as follows:
(A) P’s grossed-up basis for the recently
purchased T stock is $64,000 (i.e., $64,000
(the basis of the recently purchased T stock)
× (1¥.2)/(.8) (the fraction in section
338(b)(4))).
(B) P’s basis amount for the nonrecently
purchased T stock is $16,000 (i.e., $64,000
(the grossed-up basis in the recently
purchased T stock) × (.2)/(1.0¥.2) (the
fraction in section 338(b)(3)(B))).
(C) The gain recognized on the nonrecently
purchased stock is $10,000 (i.e.,
$16,000¥$6,000).
Example 10. (i) T is an S corporation
whose sole class of stock is owned 40 percent
each by A and B and 20 percent by C. T, A,

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B, and C all use the cash method of
accounting. A and B each has an adjusted
basis of $10,000 in the stock. C has an
adjusted basis of $5,000 in the stock. A, B,
and C hold no installment obligations to
which section 453A applies. On March 1 of
Year 1, A sells its stock to P for $40,000 in
cash and B sells its stock to P for a $25,000
note issued by P and real estate having a fair
market value of $15,000. The $25,000 note,
due in full in Year 7, is not publicly traded
and bears adequate stated interest. A and B
have no selling expenses. T’s sole asset is real
estate, which has a value of $110,000 and an
adjusted basis of $35,000. Also, T’s real estate
is encumbered by long-outstanding purchasemoney indebtedness of $10,000. The real
estate does not have built-in gain subject to
section 1374. A, B, and C join with P in
making a section 338(h)(10) election for T.
(ii) Solely for purposes of application of
sections 453, 453A, and 453B, old T is
considered in its deemed asset sale to receive
back from new T the $25,000 note
(considered issued by new T) and $75,000 of
cash (total consideration of $80,000 paid for
all the stock sold, which is then divided by
.80 in the grossing-up, with the resulting
figure of $100,000 then reduced by the
amount of the installment note). Absent an
election under section 453(d), gain is
reported by old T under the installment
method.
(iii) In applying the installment method to
old T’s deemed asset sale, the contract price
for old T’s assets deemed sold is $100,000,
the $110,000 selling price reduced by the
indebtedness of $10,000 to which the assets
are subject. (The $110,000 selling price is
itself the sum of the $80,000 grossed-up in
paragraph (ii) above to $100,000 and the
$10,000 liability.) Gross profit is $75,000
($110,000 selling price ¥ old T’s basis of
$35,000). Old T’s gross profit ratio is 0.75
(gross profit of $75,000 ÷ $100,000 contract
price). Thus, $56,250 (0.75 × the $75,000
cash old T is deemed to receive in Year 1)
is Year 1 gain attributable to the sale, and
$18,750 ($75,000 ¥ $56,250) is recovery of
basis.
(iv) In its liquidation, old T is deemed to
distribute the $25,000 note to B, since B
actually sold the stock partly for that

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consideration. To the extent of the remaining
liquidating distribution to B, it is deemed to
receive, along with A and C, the balance of
old T’s liquidating assets in the form of cash.
Under section 453(h), B, unless it makes an
election under section 453(d), is not required
to treat the receipt of the note as a payment
for the T stock; P’s payment of the $25,000
note in Year 7 to B is a payment for the T
stock. Because section 453(h) applies to B,
old T’s deemed liquidating distribution of the
note is, under section 453B(h), not treated as
a taxable disposition by old T.
(v) Under section 1366, A reports 40
percent, or $22,500, of old T’s $56,250 gain
recognized in Year 1. Under section 1367,
this increases A’s $10,000 adjusted basis in
the T stock to $32,500. Next, in old T’s
deemed liquidation, A is considered to
receive $40,000 for its old T shares, causing
it to recognize an additional $7,500 gain in
Year 1.
(vi) Under section 1366, B reports 40
percent, or $22,500, of old T’s $56,250 gain
recognized in Year 1. Under section 1367,
this increases B’s $10,000 adjusted basis in
its T stock to $32,500. Next, in old T’s
deemed liquidation, B is considered to
receive the $25,000 note and $15,000 of other
consideration. Applying section 453,
including section 453(h), to the deemed
liquidation, B’s selling price and contract
price are both $40,000. Gross profit is $7,500
($40,000 selling price ¥ B’s basis of
$32,500). B’s gross profit ratio is 0.1875
(gross profit of $7,500 ÷ $40,000 contract
price). Thus, $2,812.50 (0.1875 × $15,000) is
Year 1 gain attributable to the deemed
liquidation. In Year 7, when the $25,000 note
is paid, B has $4,687.50 (0.1875 × $25,000)
of additional gain.
(vii) Under section 1366, C reports 20
percent, or $11,250, of old T’s $56,250 gain
recognized in Year 1. Under section 1367,
this increases C’s $5,000 adjusted basis in its
T stock to $16,250. Next, in old T’s deemed
liquidation, C is considered to receive
$20,000 for its old T shares, causing it to
recognize an additional $3,750 gain in Year
1. Finally, under paragraph (d)(5)(ii) of this
section, C is considered to acquire its stock
in T on the day after the acquisition date for
$20,000 (fair market value = grossed-up
amount realized of $100,000 × 20%). C’s
holding period in the stock deemed received
in new T begins at that time.

(f) Inapplicability of provisions. The
provisions of section 6043, § 1.331–1(d),
and § 1.332–6 (relating to information
returns and recordkeeping requirements
for corporate liquidations) do not apply
to the deemed liquidation of old T
under paragraph (d)(4) of this section.
(g) Required information. The
Commissioner may exercise the
authority granted in section
338(h)(10)(C)(iii) to require provision of
any information deemed necessary to
carry out the provisions of section
338(h)(10) by requiring submission of
information on any tax reporting form.
§ 1.338(h)(10)–1T

[Removed]

Par. 8. Section 1.338(h)(10)–1T is
removed.

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Par. 9. Section 1.338(i)–1 is added to
read as follows:
§ 1.338(i)–1

Effective dates.

(a) In general. The provisions of
§§ 1.338–1 through 1.338–7, 1.338–10
and 1.338(h)(10)–1 apply to any
qualified stock purchase occurring after
March 15, 2001. For rules applicable to
qualified stock purchases on or before
March 15, 2001, see §§ 1.338–1T
through 1.338–7T, 1.338–10T,
1.338(h)(10)–1T and 1.338(i)–1T in
effect prior to March 16, 2001 (see 26
CFR part 1 revised April 1, 2000).
(b) Section 338(h)(10) elections for S
corporation targets. The requirements of
§§ 1.338(h)(10)–1T(c)(2) and
1.338(h)(10)–1(c)(2) that S corporation
shareholders who do not sell their stock
must also consent to an election under
section 338(h)(10) will not invalidate an
otherwise valid election made on the
September 1997 revision of Form 8023,
‘‘Elections Under Section 338 For
Corporations Making Qualified Stock
Purchases,’’ not signed by the
nonselling shareholders, provided that
the S corporation and all of its
shareholders (including nonselling
shareholders) report the tax
consequences consistently with the
results under section 338(h)(10).
§ 1.338(i)–1T

[Removed]

Par. 10. Section 1.338(i)–1T is
removed.
Par. 11. Section 1.1060–1 is added to
read as follows:
§ 1.1060–1 Special allocation rules for
certain asset acquisitions.

(a) Scope—(1) In general. This section
prescribes rules relating to the
requirements of section 1060, which, in
the case of an applicable asset
acquisition, requires the transferor (the
seller) and the transferee (the purchaser)
each to allocate the consideration paid
or received in the transaction among the
assets transferred in the same manner as
amounts are allocated under section
338(b)(5) (relating to the allocation of
adjusted grossed-up basis among the
assets of the target corporation when a
section 338 election is made). In the
case of an applicable asset acquisition
described in paragraph (b)(1) of this
section, sellers and purchasers must
allocate the consideration under the
residual method as described in
§§ 1.338–6 and 1.338–7 in order to
determine, respectively, the amount
realized from, and the basis in, each of
the transferred assets. For rules relating
to distributions of partnership property
or transfers of partnership interests
which are subject to section 1060(d), see
§ 1.755–2T.

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(2) Effective date. The provisions of
this section apply to any asset
acquisition occurring after March 15,
2001. For rules applicable to asset
acquisitions on or before March 15,
2001, see § 1.1060–1T in effect prior to
March 16, 2001 (see 26 CFR part 1
revised April 1, 2000).
(3) Outline of topics. In order to
facilitate the use of this section, this
paragraph (a)(3) lists the major
paragraphs in this section as follows:
(a) Scope.
(1) In general.
(2) Effective date.
(3) Outline of topics.
(b) Applicable asset acquisition.
(1) In general.
(2) Assets constituting a trade or business.
(i) In general.
(ii) Goodwill or going concern value.
(iii) Factors indicating goodwill or going
concern value.
(3) Examples.
(4) Asymmetrical transfers of assets.
(5) Related transactions.
(6) More than a single trade or business.
(7) Covenant entered into by the seller.
(8) Partial non-recognition exchanges.
(c) Allocation of consideration among assets
under the residual method.
(1) Consideration.
(2) Allocation of consideration among assets.
(3) Certain costs.
(4) Effect of agreement between parties.
(d) Examples.
(e) Reporting requirements.
(1) Applicable asset acquisitions.
(i) In general.
(ii) Time and manner of reporting.
(A) In general.
(B) Additional reporting requirement.
(2) Transfers of interests in partnerships.

(b) Applicable asset acquisition—(1)
In general. An applicable asset
acquisition is any transfer, whether
direct or indirect, of a group of assets if
the assets transferred constitute a trade
or business in the hands of either the
seller or the purchaser and, except as
provided in paragraph (b)(8) of this
section, the purchaser’s basis in the
transferred assets is determined wholly
by reference to the purchaser’s
consideration.
(2) Assets constituting a trade or
business—(i) In general. For purposes of
this section, a group of assets constitutes
a trade or business if—
(A) The use of such assets would
constitute an active trade or business
under section 355; or
(B) Its character is such that goodwill
or going concern value could under any
circumstances attach to such group.
(ii) Goodwill or going concern value.
Goodwill is the value of a trade or
business attributable to the expectancy
of continued customer patronage. This
expectancy may be due to the name or
reputation of a trade or business or any

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other factor. Going concern value is the
additional value that attaches to
property because of its existence as an
integral part of an ongoing business
activity. Going concern value includes
the value attributable to the ability of a
trade or business (or a part of a trade or
business) to continue functioning or
generating income without interruption
notwithstanding a change in ownership.
It also includes the value that is
attributable to the immediate use or
availability of an acquired trade or
business, such as, for example, the use
of the revenues or net earnings that
otherwise would not be received during
any period if the acquired trade or
business were not available or
operational.
(iii) Factors indicating goodwill or
going concern value. In making the
determination in this paragraph (b)(2),
all the facts and circumstances
surrounding the transaction are taken
into account. Whether sufficient
consideration is available to allocate to
goodwill or going concern value after
the residual method is applied is not
relevant in determining whether
goodwill or going concern value could
attach to a group of assets. Factors to be
considered include—
(A) The presence of any intangible
assets (whether or not those assets are
section 197 intangibles), provided,
however, that the transfer of such an
asset in the absence of other assets will
not be a trade or business for purposes
of section 1060;
(B) The existence of an excess of the
total consideration over the aggregate
book value of the tangible and
intangible assets purchased (other than
goodwill and going concern value) as
shown in the financial accounting books
and records of the purchaser; and
(C) Related transactions, including
lease agreements, licenses, or other
similar agreements between the
purchaser and seller (or managers,
directors, owners, or employees of the
seller) in connection with the transfer.
(3) Examples. The following examples
illustrate paragraphs (b)(1) and (2) of
this section:
Example 1. S is a high grade machine shop
that manufactures microwave connectors in
limited quantities. It is a successful company
with a reputation within the industry and
among its customers for manufacturing
unique, high quality products. Its tangible
assets consist primarily of ordinary
machinery for working metal and plating. It
has no secret formulas or patented drawings
of value. P is a company that designs,
manufactures, and markets electronic
components. It wants to establish an
immediate presence in the microwave
industry, an area in which it previously has
not been engaged. P is acquiring assets of a

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number of smaller companies and hopes that
these assets will collectively allow it to offer
a broad product mix. P acquires the assets of
S in order to augment its product mix and
to promote its presence in the microwave
industry. P will not use the assets acquired
from S to manufacture microwave
connectors. The assets transferred are assets
that constitute a trade or business in the
hands of the seller. Thus, P’s purchase of S’s
assets is an applicable asset acquisition. The
fact that P will not use the assets acquired
from S to continue the business of S does not
affect this conclusion.
Example 2. S, a sole proprietor who
operates a car wash, both leases the building
housing the car wash and sells all of the car
wash equipment to P. S’s use of the building
and the car wash equipment constitute a
trade or business. P begins operating a car
wash in the building it leases from S.
Because the assets transferred together with
the asset leased are assets which constitute
a trade or business, P’s purchase of S’s assets
is an applicable asset acquisition.
Example 3. S, a corporation, owns a retail
store business in State X and conducts
activities in connection with that business
enterprise that meet the active trade or
business requirement of section 355. P is a
minority shareholder of S. S distributes to P
all the assets of S used in S’s retail business
in State X in complete redemption of P’s
stock in S held by P. The distribution of S’s
assets in redemption of P’s stock is treated as
a sale or exchange under sections 302(a) and
302(b)(3), and P’s basis in the assets
distributed to it is determined wholly by
reference to the consideration paid, the S
stock. Thus, S’s distribution of assets
constituting a trade or business to P is an
applicable asset acquisition.
Example 4. S is a manufacturing company
with an internal financial bookkeeping
department. P is in the business of providing
a financial bookkeeping service on a contract
basis. As part of an agreement for P to begin
providing financial bookkeeping services to
S, P agrees to buy all of the assets associated
with S’s internal bookkeeping operations and
provide employment to any of S’s
bookkeeping department employees who
choose to accept a position with P. In
addition to selling P the assets associated
with its bookkeeping operation, S will enter
into a long term contract with P for
bookkeeping services. Because assets
transferred from S to P, along with the related
contract for bookkeeping services, are a trade
or business in the hands of P, the sale of the
bookkeeping assets from S to P is an
applicable asset acquisition.

(4) Asymmetrical transfers of assets. A
purchaser is subject to section 1060 if—
(i) Under general principles of tax
law, the seller is not treated as
transferring the same assets as the
purchaser is treated as acquiring;
(ii) The assets acquired by the
purchaser constitute a trade or business;
and
(iii) Except as provided in paragraph
(b)(8) of this section, the purchaser’s
basis in the transferred assets is

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9955

determined wholly by reference to the
purchaser’s consideration.
(5) Related transactions. Whether the
assets transferred constitute a trade or
business is determined by aggregating
all transfers from the seller to the
purchaser in a series of related
transactions. Except as provided in
paragraph (b)(8) of this section, all
assets transferred from the seller to the
purchaser in a series of related
transactions are included in the group of
assets among which the consideration
paid or received in such series is
allocated under the residual method.
The principles of § 1.338–1(c) are also
applied in determining which assets are
included in the group of assets among
which the consideration paid or
received is allocated under the residual
method.
(6) More than a single trade or
business. If the assets transferred from a
seller to a purchaser include more than
one trade or business, then, in applying
this section, all of the assets transferred
(whether or not transferred in one
transaction or a series of related
transactions and whether or not part of
a trade or business) are treated as a
single trade or business.
(7) Covenant entered into by the
seller. If, in connection with an
applicable asset acquisition, the seller
enters into a covenant (e.g., a covenant
not to compete) with the purchaser, that
covenant is treated as an asset
transferred as part of a trade or business.
(8) Partial non-recognition exchanges.
A transfer may constitute an applicable
asset acquisition notwithstanding the
fact that no gain or loss is recognized
with respect to a portion of the group of
assets transferred. All of the assets
transferred, including the nonrecognition assets, are taken into
account in determining whether the
group of assets constitutes a trade or
business. The allocation of
consideration under paragraph (c) of
this section is done without taking into
account either the non-recognition
assets or the amount of money or other
property that is treated as transferred in
exchange for the non-recognition assets
(together, the non-recognition exchange
property). The basis in and gain or loss
recognized with respect to the nonrecognition exchange property are
determined under such rules as would
otherwise apply to an exchange of such
property. The amount of the money and
other property treated as exchanged for
non-recognition assets is the amount by
which the fair market value of the nonrecognition assets transferred by one
party exceeds the fair market value of
the non-recognition assets transferred by
the other (to the extent of the money

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and the fair market value of property
transferred in the exchange). The money
and other property that are treated as
transferred in exchange for the nonrecognition assets (and which are not
included among the assets to which
section 1060 applies) are considered to
come from the following assets in the
following order: first from Class I assets,
then from Class II assets, then from
Class III assets, then from Class IV
assets, then from Class V assets, then
from Class VI assets, and then from
Class VII assets. For this purpose,
liabilities assumed (or to which a nonrecognition exchange property is
subject) are treated as Class I assets. See
Example 1 in paragraph (d) of this
section for an example of the
application of section 1060 to a single
transaction which is, in part, a nonrecognition exchange.
(c) Allocation of consideration among
assets under the residual method—(1)
Consideration. The seller’s
consideration is the amount, in the
aggregate, realized from selling the
assets in the applicable asset acquisition
under section 1001(b). The purchaser’s
consideration is the amount, in the
aggregate, of its cost of purchasing the
assets in the applicable asset acquisition
that is properly taken into account in
basis.
(2) Allocation of consideration among
assets. For purposes of determining the
seller’s amount realized for each of the
assets sold in an applicable asset
acquisition, the seller allocates
consideration to all the assets sold by
using the residual method under
§§ 1.338–6 and 1.338–7, substituting
consideration for ADSP. For purposes of
determining the purchaser’s basis in
each of the assets purchased in an
applicable asset acquisition, the
purchaser allocates consideration to all
the assets purchased by using the
residual method under §§ 1.338–6 and
1.338–7, substituting consideration for
AGUB. In allocating consideration, the
rules set forth in paragraphs (c)(3) and
(4) of this section apply in addition to
the rules in §§ 1.338–6 and 1.338–7.
(3) Certain costs. The seller and
purchaser each adjusts the amount
allocated to an individual asset to take
into account the specific identifiable
costs incurred in transferring that asset
in connection with the applicable asset
acquisition (e.g., real estate transfer
costs or security interest perfection
costs). Costs so allocated increase, or
decrease, as appropriate, the total
consideration that is allocated under the
residual method. No adjustment is made
to the amount allocated to an individual
asset for general costs associated with
the applicable asset acquisition as a

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whole or with groups of assets included
therein (e.g., non-specific appraisal fees
or accounting fees). These latter
amounts are taken into account only
indirectly through their effect on the
total consideration to be allocated.
(4) Effect of agreement between
parties. If, in connection with an
applicable asset acquisition, the seller
and purchaser agree in writing as to the
allocation of any amount of
consideration to, or as to the fair market
value of, any of the assets, such
agreement is binding on them to the
extent provided in this paragraph (c)(4).
Nothing in this paragraph (c)(4) restricts
the Commissioner’s authority to
challenge the allocations or values
arrived at in an allocation agreement.
This paragraph (c)(4) does not apply if
the parties are able to refute the
allocation or valuation under the
standards set forth in Commissioner v.
Danielson, 378 F.2d 771 (3d Cir.), cert.
denied, 389 U.S. 858 (1967) (a party
wishing to challenge the tax
consequences of an agreement as
construed by the Commissioner must
offer proof that, in an action between
the parties to the agreement, would be
admissible to alter that construction or
show its unenforceability because of
mistake, undue influence, fraud, duress,
etc.).
(d) Examples. The following examples
illustrate this section:
Example 1. (i) On January 1, 2001, A
transfers assets X, Y, and Z to B in exchange
for assets D, E, and F plus $1,000 cash.
(ii) Assume the exchange of assets
constitutes an exchange of like-kind property
to which section 1031 applies. Assume also
that goodwill or going concern value could
under any circumstances attach to each of the
DEF and XYZ groups of assets and, therefore,
each group constitutes a trade or business
under section 1060.
(iii) Assume the fair market values of the
assets and the amount of money transferred
are as follows:
Fair
market
value

Asset
By A:
X ..................................................
Y ..................................................
Z ..................................................

$ 400
400
200

Total .........................................

1,000

under paragraph (c) of this section, the likekind assets exchanged and any money or
other property that are treated as transferred
in exchange for the like-kind property are
excluded from the application of section
1060.
(v) Since assets X, Y, and Z are like-kind
property, they are excluded from the
application of the section 1060 allocation
rules.
(vi) Since assets D, E, and F are like-kind
property, they are excluded from the
application of the section 1060 allocation
rules. Thus, the allocation rules of section
1060 do not apply in determining B’s gain or
loss with respect to the disposition of assets
D, E, and F, and the allocation rules of
section 1060 and paragraph (c) of this section
are not applied to determine A’s bases of
assets D, E, and F. In addition, $900 of the
$1,000 cash B gave to A for A’s like-kind
assets (X, Y, and Z) is treated as transferred
in exchange for the like-kind property in
order to equalize the fair market values of the
like-kind assets. Therefore, $900 of the cash
is excluded from the application of the
section 1060 allocation rules.
(vii) $100 of the cash is allocated under
section 1060 and paragraph (c) of this
section.
(viii) A received $100 that must be
allocated under section 1060 and paragraph
(c) of this section. Since A transferred no
Class I, II, III, IV, V, or VI assets to which
section 1060 applies, in determining its
amount realized for the part of the exchange
to which section 1031 does not apply, the
$100 is allocated to Class VII assets (goodwill
and going concern value).
(ix) B gave A $100 that must be allocated
under section 1060 and paragraph (c) of this
section. Since B received from A no Class I,
II, III, IV, V, or VI assets to which section
1060 applies, the $100 consideration is
allocated by B to Class VII assets (goodwill
and going concern value).
Example 2. (i) On January 1, 2001, S, a
sole proprietor, sells to P, a corporation, a
group of assets that constitutes a trade or
business under paragraph (b)(2) of this
section. S, who plans to retire immediately,
also executes in P’s favor a covenant not to
compete. P pays S $3,000 in cash and
assumes $1,000 in liabilities. Thus, the total
consideration is $4,000.
(ii) On the purchase date, P and S also
execute a separate agreement that states that
the fair market values of the Class II, Class
III, Class V, and Class VI assets S sold to P
are as follows:
Asset
class
II .......

By B:
D ..................................................
E ..................................................
F ..................................................
Cash (amount) ............................

40
30
30
1,000

Total .........................................

1,100

III ......

V .......
(iv) Under paragraph (b)(8) of this section,
for purposes of allocating consideration

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Asset
Actively traded securities

Fair
market
value
$500

Total Class II ............

500

Accounts receivable ........

200

Total Class III ...........

200

Furniture and fixtures ......
Building ............................
Land .................................

800
800
200

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(B) Additional reporting requirement.
When an increase or decrease in
consideration is taken into account after
the close of the first taxable year that
Equipment ........................
400
includes the first date assets are sold in
Total Class V ............
2,200 an applicable asset acquisition, the
seller and the purchaser each must file
VI ...... Covenant not to compete
900 a supplemental asset acquisition
statement on Form 8594 with the
Total Class VI ...........
900 income tax return or return of income
for the taxable year in which the
(iii) P and S each allocate the consideration increase (or decrease) is properly taken
in the transaction among the assets
into account.
transferred under paragraph (c) of this
(2) Transfers of interests in
section in accordance with the agreed upon
partnerships.
For reporting
fair market values of the assets, so that $500
requirements relating to the transfer of
is allocated to Class II assets, $200 is
a partnership interest, see § 1.755–2T(c).
allocated to the Class III asset, $2,200 is
Asset
class

Asset

Fair
market
value

allocated to Class V assets, $900 is allocated
to Class VI assets, and $200 ($4,000 total
consideration less $3,800 allocated to assets
in Classes II, III, V, and VI) is allocated to the
Class VII assets (goodwill and going concern
value).
(iv) In connection with the examination of
P’s return, the Commissioner, in determining
the fair market values of the assets
transferred, may disregard the parties’
agreement. Assume that the Commissioner
correctly determines that the fair market
value of the covenant not to compete was
$500. Since the allocation of consideration
among Class II, III, V, and VI assets results
in allocation up to the fair market value
limitation, the $600 of unallocated
consideration resulting from the
Commissioner’s redetermination of the value
of the covenant not to compete is allocated
to Class VII assets (goodwill and going
concern value).

(e) Reporting requirements—(1)
Applicable asset acquisitions—(i) In
general. Unless otherwise excluded
from this requirement by the
Commissioner, the seller and the
purchaser in an applicable asset
acquisition each must report
information concerning the amount of
consideration in the transaction and its
allocation among the assets transferred.
They also must report information
concerning subsequent adjustments to
consideration.
(ii) Time and manner of reporting—
(A) In general. The seller and the
purchaser each must file asset
acquisition statements on Form 8594,
‘‘Asset Allocation Statement,’’ with
their income tax returns or returns of
income for the taxable year that
includes the first date assets are sold
pursuant to an applicable asset
acquisition. This reporting requirement
applies to all asset acquisitions
described in this section. For reporting
requirements relating to asset
acquisitions occurring before March 16,
2001, as described in paragraph (a)(2) of
this section, see the temporary
regulations under section 1060 in effect
prior to March 16, 2001 (see 26 CFR part
1 revised April 1, 2000).

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19:02 Feb 12, 2001

Jkt 194001

§ 1.1060–1T

[Removed]

the end of paragraph (b)(1)(ii)(B)(3) and
before the semicolon to read as follows:
§ 1.1502–76
group.

*

*
(b) *
(1) *
(ii) *
(B) *
(3) *
*
*

*
*
*
*
*

Taxable year of members of

*
*
*
*
*
*
*
* (but see § 1.338–1(d)) * * *
*
*
*

PART 602—OMB CONTROL NUMBERS
UNDER PAPERWORK REDUCTION
ACT
Par. 16. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.

Par. 12. Section 1.1060–1T is
removed.
Par. 13. Section 1.1361–1 is amended
as follows:
1. Redesignate paragraph (l)(2)(v) as
paragraph (l)(2)(vi).
2. Add a new paragraph (l)(2)(v).
The addition reads as follows:

Par. 17. In § 602.101, paragraph (b) is
amended by removing the entries for
§§ 1.338–2T, 1.338–5T, 1.338–10T,
1.338(h)(10)–1T, and 1.1060–1T from
the table and adding new entries to the
table in numerical order to read as
follows:

§ 1.1361–1

§ 602.101

S corporation defined.

*

*
*
*
*
(l) * * *
(2) * * *
(v) Special rule for section 338(h)(10)
elections. If the shareholders of an S
corporation sell their stock in a
transaction for which an election is
made under section 338(h)(10) and
§ 1.338(h)(10)–1, the receipt of varying
amounts per share by the shareholders
will not cause the S corporation to have
more than one class of stock, provided
that the varying amounts are determined
in arm’s length negotiations with the
purchaser.
*
*
*
*
*
Par. 14. Section 1.1361–4 is amended
by removing the last two sentences of
paragraph (b)(4) and adding three
sentences to read as follows:
§ 1.1361–4

Effect of QSub election.

*

*
*
*
*
(b) * * *
(4) Coordination with section 338
election. * * * If an S corporation
makes an election under section 338
(without a section 338(h)(10) election)
with respect to a target, the target must
file a final return as a C corporation
reflecting the deemed sale. See § 1.338–
10(a). If the target was an S corporation
on the day before the acquisition date,
the final return as a C corporation must
reflect the activities of the target for the
acquisition date, including the deemed
sale. See § 1.338–10(a)(3).
*
*
*
*
*
Par. 15. Section 1.1502–76 is
amended by adding a parenthetical at

PO 00000

Frm 00051

Fmt 4700

Sfmt 4700

*

OMB Control numbers.

*
*
(b) * * *

*

*

CFR part or section where
identified and described

Current
OMB control No.

*
*
*
*
1.338–2 .......................................
1.338–5 .......................................
1.338–10 .....................................
1.338(h)(10)–1 ............................
*
*
*
*
1.1060–1 .....................................
*
*
*
*

*
1545–1658
1545–1658
1545–1658
1545–1658
*
1545–1658
*

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: January 4, 2001.
Jonathan Talisman,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. 01–981 Filed 2–12–01; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 301
[TD 8943]
RIN 1545–AY51

Disclosure of Return Information to the
Bureau of the Census
AGENCY: Internal Revenue Service (IRS),
Treasury.
ACTION: Temporary regulations.

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