Notice 99-43

Part III. Administrative, Procedural, and Miscellaneous
Rule to be Included in Final
Regulations Under Section
897(e) of the Code
Notice 99–43
This notice announces a modification
of the current rules under Temp. Reg.
§1.897–6T(a)(1) regarding transfers, exchanges, and other dispositions of U.S.
real property interests in nonrecognition
transactions occurring after June 18,
1980. The new rule will be included in
regulations finalizing the temporary regulations.
SECTION I. BACKGROUND
Section 897(a) of the Code provides
generally that the disposition of a U.S.
real property interest by a nonresident
alien individual or a foreign corporation is
taxable as effectively connected income
under section 871(b)(1) or section
882(a)(1), respectively, as if the taxpayer
was engaged in a trade or business within
the United States and the gain or loss was
effectively connected with the trade or
business.
Section 897(c)(1) of the Code defines a
U.S. real property interest as including an
interest (other than an interest solely as a
creditor) in any domestic corporation, unless the taxpayer establishes that such corporation was at no time a U.S. real property holding corporation during the
shorter of the period the taxpayer held
such interest or the 5-year period ending
on the date of the disposition of such interest. Under section 897(c)(2), a U.S.
real property holding corporation is defined as any corporation if the fair market
value of its U.S. real property interests
equals or exceeds 50-percent of the sum
of (i) its U.S. real property interests, (ii)
its real property interests located outside
the United States, and (iii) any of its other
assets used or held for use in a trade or
business.
Section 897(e)(1) of the Code provides
generally that a nonrecognition provision
applies only in the case of an exchange of
a U.S. real property interest for an interest
the sale of which would be taxable under
Chapter 1 of the Code. Under section
897(e)(2), the Secretary may prescribe

September 7, 1999

regulations providing the extent to which
nonrecognition provisions apply to transfers of U.S. real property interests.
Pursuant to the regulatory authority
under section 897(e)(2), Temp. Reg.
§1.897–6T(a)(1) provides that, subject to
certain exceptions, any nonrecognition
provision shall apply to a transfer by a
foreign person of a U.S. real property interest on which gain is realized only to the
extent that the transferred U.S. real property interest is exchanged for a U.S. real
property interest which, immediately following the exchange, would be subject to
U.S. taxation upon its disposition (and the
transferor complies with the filing requirement of Temp. Reg. §1.897–5). In
the case of an exchange of a U.S. real
property interest for stock in a domestic
corporation (that is otherwise treated as a
U.S. real property interest), such stock
shall not be considered a U.S. real property interest unless the domestic corporation is a U.S. real property holding corporation immediately after the exchange.
Thus, if an interest in a U.S. real property
holding corporation is exchanged in a
nonrecognition transaction for stock of a
domestic corporation, that is not a U.S.
real property holding corporation immediately after the exchange, the exchange
would be taxable under section 897.
Under Temp. Reg. §1.897–6T(a)(2), a
nonrecognition provision for purposes of
section 897(e) is any provision of the
Code which provides that gain or loss is
not recognized if the requirements of that
provision are met. Thus, section 897(e)
applies only to an exchange that receives
nonrecognition treatment pursuant to another provision of the Code and does not
create (or expand) a nonrecognition provision.
SECTION II. FINALIZATION OF
TEMP. REG. §1.897-–6T(a)(1)
It is recognized that the requirement in
Temp. Reg. §1.897–6T(a)(1), providing
that the corporation whose stock is received in a nonrecognition exchange must
be a U.S. real property holding corporation immediately after the exchange, may
not be appropriate for stock exchanges
under section 354(a) in certain reorganizations described in sections 368(a)(1)(E)

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and (F) of the Code. This may be illustrated by two examples. In both examples, the corporation, the stock of which
was received in the exchange, is not a
U.S. real property holding corporation
immediately after the exchange, but was a
U.S. real property holding corporation
within the period provided in section
897(c)(1)(A)(ii) (the shorter of five years
or the taxpayer’s holding period prior to
the exchange).
In example one, a domestic corporation
engages in a recapitalization, whereby
one share of common stock is issued in
exchange for two outstanding shares of
the existing common stock (in what is
commonly referred to as a “reverse stock
split”), pursuant to a section 354(a) exchange in a section 368(a)(1)(E) reorganization. The shares received in the exchange are substantially identical to the
shares exchanged therefor, possessing (in
the aggregate and with respect to any
other outstanding stock of the corporation) the same dividend rights, voting
power, liquidation preference (if any),
convertibility and other legal and economic entitlements as the shares exchanged, and do not contain any additional rights or obligations.
In example two, a domestic corporation
changes its state of incorporation from
State A to State B, pursuant to a state law
merger of the corporation into a corporation newly incorporated in State B solely
to facilitate the transaction, and which is
the survivor in the merger. In the merger,
stock of the merged corporation is exchanged for stock in the surviving corporation, possessing (in the aggregate and
with respect to any other outstanding
stock of the corporation) substantially
identical dividend rights, voting power,
liquidation preference (if any), convertibility and other legal and economic entitlements as the shares exchanged, and
does not contain any additional rights or
obligations. The reincorporation qualifies
as a reorganization under section
368(a)(1)(F).
Under Temp. Reg. §1.897–6T(a)(1),
the exchange of stock in both examples
would be taxable to foreign shareholders
because, with respect to the interests exchanged, the domestic corporation whose

1999–36 I.R.B.

stock is received is not a U.S. real property
holding corporation immediately after the
exchange. Accordingly, when the final
regulations under section 897(e) are issued, the regulations will include an exception that will provide that a foreign taxpayer will not recognize gain under section
1.897–6T(a)(1) (as finalized) for a stock
exchange under section 354(a) in certain
reorganizations described in section
368(a)(1)(E) or (F). The exception will
apply where the taxpayer receives stock in
the corporation that is substantially identical to the shares exchanged, possessing (in
the aggregate and with respect to any other
outstanding stock of the corporation) the
same dividend rights, voting power, liquidation preferences (if any), and convertibility as the shares exchanged without any
additional rights or obligations.
The final regulations will provide, for
purposes of section 897(a) and (e), that
stock received in a section 368(a)(1)(E) or
(F) reorganization qualifying for nonrecognition pursuant to section 354(a) under the
examples described above, constitutes the
same interest in the corporation whose
stock was exchanged for purposes of determining whether the interest received is a
U.S. real property interest under section
897(c)(1)(A)(ii). Thus, the determination
of whether the interest received in such an
exchange is a U.S. real property interest
under section 897(c)(1)(A)(ii) will include
the period prior to the exchange.
For example, if a foreign person receives substantially identical stock in a
section 354(a) exchange pursuant to the
recapitalization of a domestic corporation
that qualifies as a reorganization within

1999–36 I.R.B.

the meaning of section 368(a)(1)(E), and
the corporation ceased to be a U.S. real
property holding corporation two years
prior to the exchange, the sale of the stock
by the foreign person two years after the
exchange will constitute the disposition of
a U.S. real property interest that is subject
to tax under section 897(a). If the same
interest were to be sold by the foreign person four years after the exchange, the sale
would not be subject to tax under section
897(a), because the interest would not
have been a U.S. real property interest. In
such case, the interest would not have
been an interest in a domestic corporation
that was a U.S. real property holding corporation during the period specified in
section 897(c)(1)(A)(ii).
The rule described in this notice is effective for transfers occurring on or after
September 6, 1999 (the date of publication of this notice), although a taxpayer
may elect to apply the rule of this notice
to transfers occurring after June 18, 1980.
SECTION III. PAPERWORK
REDUCTION ACT
The collections of information required
by this notice have been reviewed and approved by the Office of Management and
Budget in accordance with the Paperwork
Reduction Act (44 U.S.C. 3507) under
control number 1545–1660.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the collection of information displays a valid
OMB control number.
The collections of information required
by this notice are in Temp. Reg. §1.897–

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6T(a)(1) and 1.897–5T(d)(1)(iii), Treas.
Reg. §1.1445–2(d)(2)(i)(A) and Temp.
Reg. §1.1445–9T. This information will
be used to obtain exemptions from tax
under certain nonrecognition transactions
and to satisfy reporting requirements regarding these nonrecognition transactions. This information will be used by
the Internal Revenue Service to verify
whether a taxpayer is entitled to exemption from tax under a nonrecognition
transaction. The likely respondents are
individuals, corporations, and business or
other for-profit institutions.
The estimated total annual reporting
burden is 200 hours. The estimated annual burden per respondent is 2 hours.
The estimated number of respondents is
100. The estimated frequency of responses is on occasion.
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.
SECTION IV. DRAFTING
INFORMATION
The principal author of this notice is
Robert Lorence of the Office of Associate
Chief Counsel (International). For further
information regarding this notice, contact
Mr. Lorence at (202) 622-3860 (not a tollfree call). Comments are requested regarding this Notice, including the application of the exception to be provided for in
the final regulations as described herein to
other nonrecognition transactions.

September 7, 1999