The final regulations generally adopt substantive rules of regulations proposed in 2006, and are applicable to transactions occurring after Tuesday, September 3, 2013 (the date of publication in the Federal Register).
The final regulations revise the structure of the proposed rules to clarify the application of section 362(e)(2) and to provide a framework for better coordination of the provisions of section 362(e)(1) and the related regulations. As noted in the preamble to today’s final regulations, these are “not substantive changes,” but are intended to simply the application of section 362(e)(2).
Read the final regulations [PDF 285 KB]
Before the American Jobs Creation Act of 2004, the basis of property received by a corporation—whether from domestic or foreign transferors—in a tax-free section 351 exchange, a tax-free reorganization, or a tax-free liquidation of a subsidiary corporation was the same as the adjusted basis of that property in the hands of the transferor, adjusted for gain or loss recognized by the transferor.
The 2004 Act included changes providing, in general, that in certain transactions involving transfers of built-in loss property, the basis of the property in the hands of the transferee would not be transferred basis but, rather, would be the fair market value of the transferred property immediately after the transfer.
Accordingly, with the 2004 Act changes, a corporation’s basis in property acquired in a section 362 transfer is fixed at fair market value. The limitation generally applies in certain situations:
- Importations of net built-in loss properties into the U.S. tax system subject to section 362 (that is, section 351 exchanges and reorganizations)
- Transfers of net built-in loss property into the U.S. tax system subject to section 334(b) (that is, section 332 subsidiary liquidations)
In October 2006, regulations were proposed to apply to transfers of net built-in loss property within the U.S. tax system that otherwise would duplicate the net built-in loss in the stock of the transferee.
The proposed regulations also included provisions concerning:
- Application of the limitation rules to transfers outside of the U.S. tax system and to reorganizations
- Establishment of an exception for transactions in which net built-in loss is eliminated without recognition
- Application of the limitation rules to transfers in exchange for securities
- Clarification of the election to reduce stock basis
- Effect of the limitation rules on partnerships and S corporations
- Application of the section 336(d) to property previously transferred in a section 362(e)(2) transaction and to section 304 transactions
After the release of the proposed regulations, the IRS received questions concerning the application of section 362(e)(2) to transactions involving S corporations and partnerships and concerning the election with respect to transactions between persons outside the United States. As noted in the preamble to the final regulations, the IRS became aware of “certain ambiguities” relating to the proper operation of section 362(e)(2).
The preamble notes the following changes and additions, with the final regulations:
- Adopting a general operative rule and related definitions—e.g., “loss duplication transaction” and “loss duplication property”—to facilitate identifying transactions subject to section 362(e)(2)
- Defining the term “U.S. return” as an income tax return or an information return that must be filed (not to include returns or forms that are merely elective)
- Clarifying the time for filing and the person that must file a statement that the transferor and acquiring entities are making a section 362(e)(2)(C) election
- Modifying the term “controlling U.S. shareholder”
- Conforming the formulation of the rule for excepting transactions wholly outside the U.S. tax system to the formulation of the exception for transactions in which duplicated loss is eliminated; thus, not presuming that basis and value are equal (with the result that no loss is transferred and so section 362(e)(2) does not apply)
- Determining that controlled foreign partnerships (CFPs) are not eligible for administrative relief for transactions that occur outside the U.S. tax system
- Imposing same reporting requirements on reporting U.S. partners of CFPs as controlling U.S. shareholders of a controlled foreign corporation (CFC) otherwise have
- Expanding an example to illustrate the application of the rules to transactions involving the assumption of fixed and contingent liabilities
- Modifying the definition of “value” (generally fair market value) to take liabilities into account when determining whether a partnership interest is a loss asset
- Expanding the rules “significantly” to address questions concerning elections under section 362(e)(2)(C)
- Confirming and clarifying application of the rules to transactions involving partnerships and S corporations