us-irs-announcements-irb-2007-8-pdf•Internal Revenue Bulletin 2007-8 (PDF rendition): IRS Announcements
Internal Revenue Bulletin 2007-8 (PDF rendition): IRS Announcements
us-irs-announcements-irb-2007-8-pdfInternal Revenue Bulletin 2007-8 (PDF rendition): IRS AnnouncementsGuidance
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Bulletin No. 200 7-8 February 20, 200 7 HIGHLIGHTS OF THIS ISSUE These synopses are intended only as aids to the reader in identifying the subject matter covered. They may not be relied upon as authoritative interpretations. INCOME TAX T.D. 9308, page 523. Final regulations under section 671 of the Code amend regula- tions section 1.671–5, which provides reporting requirements for widely held fixed investment trusts (WHFITs) to clarify and simplify the application of those rules to both non-mortgage widely held fixed investment trusts and widely held mortgage trusts. REG–1577 11–02, page 537. Proposed r egulations under sections 358, 362, and 1502 of theCodea pply when a corporation, which is a member of a consolid ated group, transfers a loss share of subsidiary stock. First, ba sis is redetermined by reallocating investment adjust- ments to a djust for disproportionate reflection of gains and losses in the bases of members’ shares. Second, members’ bases in transferred loss shares are reduced (but not below value) b y the net positive amount of all investment adjustments applied to the bases of those shares. Finally, the attributes of the subs idiary are reduced to the extent there is a duplicated loss on transferred shares. Notice 2007–16, page 536. This notice provides for the waiver of additions to tax under section 6654(a) of the Code for underpayment of estimated taxes by certain citizens or residents of the United States living abroad. The notice explains the changes in the law as enacted by the passage of the Tax Increase Prevention and Reconcilia- tion Act of 2005 (TIPRA) in May 2006 and who is eligible for the penalty waiver and to what extent. ADMINISTRATIVE Notice 2007–16, page 536. This notice provides for the waiver of additions to tax under section 6654(a) of the Code for underpayment of estimated taxes by certain citizens or residents of the United States living abroad. The notice explains the changes in the law as enacted by the passage of the Tax Increase Prevention and Reconcilia- tion Act of 2005 (TIPRA) in May 2006 and who is eligible for the penalty waiver and to what extent. Announce ment 2007–15, page 596. This anno uncement contains changes in filing procedures for Form 8851 ,SummaryofArcherMSAs.Rev. Proc. 2001–31, 2001–1 C. B. 1170, will be revised at a future date but will not be availa ble by the due date of the return, March 20, 2007. Announcement 2007–16, page 597. This announcement informs the public that the due date for filing returns and paying taxes has been extended to April 17, 2007, as a result of the Emancipation Day Holiday in the District of Columbia. Announcement 2007–17, page 597. This document contains corrections to proposed regulations (REG–121509–00, 2006–40 I.R.B. 602) that provide guidance relating to the exclusion from gross income of previously taxed earnings and profits under section 959 of the Code and related basis adjustments under section 961. Announ cement 2007–20, page 599. This doc ument contains corrections to final regulations (T.D. 9276, 2 006–37 I.R.B. 423) that provide for determining the amount of income tax withholding on supplemental wages. The regula tions apply to all employers and others making supple- mental wage payments to employees. Fi nding Lists begin on page ii. The IRS Mission Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all. Introduction The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conven- tions, legislation, court decisions, and other items of general interest. It is published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin contents are compiled semiannually into Cumulative Bulletins, which are sold on a single-copy basis. It is the policy of the Service to publish in the Bulletin all sub- stantive rulings necessary to promote a uniform application of the tax laws, including all rulings that supersede, revoke, mod- ify, or amend any of those previously published in the Bulletin. All published rulings apply retroactively unless otherwise indi- cated. Procedures relating solely to matters of internal man- agement are not published; however, statements of internal practices and procedures that affect the rights and duties of taxpayers are published. Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts stated in the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices, identifying details and information of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory requirements. Rulings and procedures reported in the Bulletin do not have the force and effect of Treasury Department Regulations, but they may be used as precedents. Unpublished rulings will not be relied on, used, or cited as precedents by Service personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances are substantially the same. The Bulletin is divided into four parts as follows: Part I.—19 86 Code. This part i ncludes rulings and decisions based on provisions of the Intern al Revenue Code of 1986. Part II.—Treaties and Tax Legislation. This part is divided into two subparts as follows: Subpart A, Tax Conventions and Other Related Items, and Subpart B, Leg- islation and Related Committee Reports. Part III.—Administrative, Procedural, and Miscellaneous. To the extent practicable, pertinent cross references to these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rul- ings. Bank Secrecy Act Administrative Rulings are issued by the Department of the Treasury’s Office of the Assistant Sec- retary (Enforcement). Part IV .—Items of General Interest. This par t includes notices of proposed rulemakings, disbar- ment an d suspension lists, and announcements. The last Bulletin for each month includes a cumulative index for the matters published during the preceding months. These monthly indexes are cumulated on a semiannual basis, and are published in the last Bulletin of each semiannual period. The c ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate. For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402. February 20, 20072007–8 I.R.B. Part I. Rulings and Decisions Under the Internal Revenue Code of 1986 Section 337.—Nonrecogni- tion for Property Distributed to Parent in Complete Liq- uidation of Subsidiary Section 337(d)(1) provides for consolidated return regulations implementing the repeal of theGeneral Utilitiesdoctrine. These regulations, previously con- tained in §§1.337(d)–1 and 1.337(d)–2, are now pro- posed under §1.1502–36. See REG-157711-02, page 537. Section 362.—Basis to Corporations Section 362(e)(2) addresses loss duplication. However, proposed regulations provide special rules to suspend application of 362(e)(2) in the consolidated return setting while investment basis adjustments operate to address loss duplication. See REG-157711-02, page 537. Section 671.—Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners 26 CFR 1.671–5: Reporting for widely held fixed in- vestment trusts. T.D. 9308 DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 Reporting Rules for Widely Held Fixed Investment Trusts AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final regulations and removal of the temporary regulations. SUMMARY: This document contains fi- nal regulations amending §1.671–5 which provides reporting rules for widely held fixed investment trusts (WHFITs). These final regulations clarify and simplify re- porting for trustees and middlemen of non-mortgage widely held fixed invest- ment trusts (NMWHFITs). These final regulations also provide temporary safe harbor reporting rules for widely held mortgage trusts (WHMTs) that are outside the WHMT safe harbor. The preamble to these regulations also provides that trustees of WHFITs are to indicate on the Form 1041, “U.S. Income Tax Return for Estates and Trusts,” filed for a WHFIT’s 2006 calendar year that the return is a final return. DATES:Effective Date:These regulations are effective December 29, 2006. Applicability Date:For date of applica- bility, see §1.671–5(n). FOR FURTHER INFORMATION CONTACT: Faith Colson, (202) 622–3060 (not a toll-free number). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act The collection of information contained in these final regulations has been previ- ously reviewed and approved by the Of- fice of Management and Budget in accor- dance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) under control number 1545–1540. The collection of in- formation in these final regulations is in §1.671–5. This information is required to be reported to beneficial owners of trust in- terests to enable them to correctly report their share of the items of income, deduc- tion, and credit of the WHFIT in which they have invested. This information is also required to be reported to the IRS to enable the IRS to verify that trustees and middlemen are accurately reporting infor- mation to beneficial owners of trust inter- ests and that beneficial owners are prop- erly reporting their ownership of a trust in- terest. 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. The estimated annual burden per recordkeeper varies from 1 to 4 hours, depending on individual circumstances, with an estimated average of 2 hours. Comments concerning the accuracy of this burden estimate should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of Treasury, Office of Infor- mation and Regulatory Affairs, Washing- ton, DC 20503. Books or records relating to a collection of information must be retained as long as their contents might 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 This document contains amendments to 26 CFR part 1. On January 24, 2006, the Internal Revenue Service (IRS) and the Treasury Department published the WHFIT reporting rules in theFederal Register(T.D. 9241, 2006–7 I.R.B. 427 [71 FR 4002]) under §1.671–5 (WHFIT reporting rules). On August 3, 2006, in response to comments received subse- quent to the publication of the WHFIT reporting rules, the IRS and the Treasury Department published final and temporary regulations (T.D. 9279, 2006–36 I.R.B. 355 [71 FR 43968]) (temporary regu- lations) as well as proposed regulations that, in part, cross-referenced the tempo- rary regulations (71 FR 43998) (proposed regulations) (REG–125071–06, 2006–36 I.R.B. 375) in theFederal Register.No public hearing was requested or held with respect to the temporary or proposed reg- ulations. Written comments responding to those regulations were received. After consideration of the comments, the pro- posed regulations, with certain revisions, are adopted as final regulations by this Treasury decision, and the corresponding temporary regulations are removed. The comments and the revisions are discussed in this preamble. 2007–8 I.R.B.523February 20, 2007 Summary of Comments and Explanation of Revisions I.Application of the WHFIT Reporting Rules to NMWHFITs A.The Qualified NMWHFIT Exception Trustees and middlemen of NMWHFITs that satisfy the qual- ified NMWHFIT exception in §1.671–5(c)(2)(iv)(E) are excepted from reporting information regarding mar- ket discount and bond premium, and are permitted to use the simplified reporting for sales and dispositions of trust assets in §1.671–5(c)(2)(iv)(B) and the simplified reporting rules for sales or redemptions of trust interests in §1.671–5(c)(2)(v)(C). The temporary regulations provide that the qualified NMWHFIT exception is satisfied if the calendar year for which the trustee is reporting begins before January 1, 2011, and the NMWHFIT meets any of the following requirements: (1) the NMWHFIT has a start-up date as defined in §1.671–5(b)(19) before February 23, 2006; (2) the registration statement for the NMWHFIT becomes effective under the Securities Act of 1933, as amended (15 U.S.C. 77a,et. seq.) (Securities Act of 1933) and trust interests are offered for sale to the public before February 23, 2006; or (3) the registration statement of the NMWHFIT becomes effective under the Securities Act of 1933 and trust interests are offered for sale to the public on or after February 23, 2006 and before July 31, 2006, and the NMWHFIT is fully funded before October 1, 2006. These final regulations retain this amendment to the WHFIT reporting rules. Addi- tionally, commentators on the temporary regulations expressed concern that certain trusts that otherwise satisfy the eligibility requirements for the qualified NMWHFIT exception would be disqualified because additional assets are deposited into the trust pursuant to a distribution reinvest- ment program. These final regulations clarify that for the purpose of determining whether a NMWHFIT is fully funded before October 1, 2006, deposits to the NMWHFIT pursuant to a distribution reinvestment program that is consistent with the requirements of §301.7701–4(c) will be disregarded. Commentators have also expressed concern regarding NMWHFITs that hold debt instruments (fixed income trusts) that were originated before the WHFIT report- ingruleswerepublishedintheFederal Register. Commentators are concerned because the simplified reporting permitted under the exception terminates after De- cember 31, 2010, and many fixed income trusts will be unable to comply with the WHFIT reporting rules once the simplified reporting permitted under the qualified NMWHFIT exception terminates because these NMWHFITs generally are not able to engage inpro-ratasales of trust as- sets to effect redemptions. Commentators have requested that these NMWHFITs be permanently permitted to report con- sistent with the qualified NMWHFIT exception. In response, these regulations amend §1.671–5(c)(2)(iv)(E) to eliminate the requirement that the trustee must be reporting for a year that begins before January 1, 2011 for the NMWHFIT to be eligible for the simplified reporting. Accordingly, NMWHFITs that satisfy the qualified NMWHFIT exception and con- tinue in existence after December 31, 2010 may report under the simplified reporting permitted under the exception until those NMWHFITs terminate. B.Simplified Reporting of Sales and Redemptions of Trust Interests With respect to the sale or redemption of a trust interest, section 1.671–5(c)(2)(v) of the WHFIT reporting rules requires trustees and middlemen to provide infor- mation regarding the sales assets proceeds (as defined in §1.671–5(b)(17)) or the re- demption assets proceeds (as defined in §1.671–5(b)(14)) as well as the income that is attributable to a redeeming, selling or purchasing beneficial owner up to the date of the sale or redemption of a trust interest. Section 1.671–5(c)(2)(v)(C) ex- cepts a NMWHFIT from the requirement to provide information to enable request- ing persons to differentiate between in- come and proceeds if substantially all the NMWHFIT’s income is comprised of div- idends (equity trusts) and the NMWHFIT is required by its governing document to distribute the cash held for distribution by the NMWHFIT at least monthly. The temporary regulations, and these final reg- ulations revise §1.671–5(c)(2)(v)(C) to provide that a NMWHFIT will be con- sidered to have satisfied the requirement that it distribute the cash held for distri- bution monthly notwithstanding the fact that, although the governing document requires monthly distributions, the gov- erning document of the NMWHFIT also permits the trustee to forego making its normally required monthly distribution if the cash held for distribution is less than 0.1 percent of the net asset value of the trust (aggregate fair market value of the trust’s assets less the trust’s liabilities) as of the date that the amount of the monthly distribution is required to be determined. Commentators have indicated that it will be extremely difficult for a certain class of NMWHFITs that are not equity trusts to comply with §1.671–5(c)(2)(v). These NMWHFITs hold assets that pro- duce income that is treated as interest income, not dividend income, for Federal income tax purposes. The assets of these NMWHFITs, however, are similar to as- sets that produce dividend income in that the assets are traded on a recognized ex- change or securities market in such a way that the price of the assets is determined without a component attributable to ac- crued interest. As with NMWHFITs that hold assets that produce dividend income, it is difficult for the trustees and middle- men of these NMWHFITs to determine the income attributable to a redeeming, selling, or purchasing beneficial owner between trust distribution dates. For these reasons, the final regulations provide that NMWHFITs that hold assets that produce income that is treated as interest income for Federal income tax purposes will also qualify for the simplified reporting under §1.671–5(c)(2)(v)(C) but only if the assets are traded on a recognized exchange or securities market in such a way that the price of the assets is determined without a component attributable to accrued interest. C.Simplified Reporting for Sales and Dispositions by Certain NMWHFITs In addition to the qualified NMWHFIT exception, the WHFIT reporting rules provide that the trustees of NMWHFITs that meet the generalde minimistest in §1.671–5(c)(2)(iv)(D)(1) are only re- quired, under §1.671–5(c)(2)(iv)(B), to provide information regarding the amount of trust sales proceeds distributed to a February 20, 20075242007–8 I.R.B. beneficial owner. A NMWHFIT meets the generalde minimistest if trust sales proceeds (as defined in §1.671–5(b)(21)) for the calendar year are not more than five percent of the net asset value of the trustasofthelaterofJanuary1oftheyear for which the trustee is reporting or the start-up date. The reason for thede min- imisexception, as stated in the preamble to the WHFIT reporting rules, is that the IRS and the Treasury Department believe that if a NMWHFIT only sells or disposes of assets infrequently, although there may be some deferral of gains and losses if sales and dispositions are not fully reported, the deferral is acceptable, in light of the burden of fully, accurately reporting the sales and dispositions. Commentators on the WHFIT reporting rules reported that trustees of NMWHFITs frequently have to sell trust assets to ob- tain cash to effect redemptions and that, because of those sales, many NMWHFITs will not be able to meet the generalde minimistest in §1.671–5(c)(2)(iv)(D)(1). Commentators on the WHFIT report- ing rules requested that those regulations be amended to provide for reduced re- porting where this will have little or no compliance impact. In response to those comments, the temporary regulations pro- vide a number of modifications to the NMWHFIT reporting rules as applied to certain sales and dispositions of trust as- sets by NMWHFITs. Those modifications, as well as additional modification made by these final regulations, include: 1.NMWHFIT Final Calendar Year Exception Section 1.671–5T(c)(2)(iv)(F) of the temporary regulations provides that all NMWHFITs qualify for the simplified reporting in §1.671–5T(c)(2)(iv)(B) in the final calendar year of the NMWHFIT, regardless of whether the NMWHFIT has otherwise satisfied the generalde minimistest, provided that a beneficial owner cannot roll over its investment in the NMWHFIT to another WHFIT. Com- mentators on the temporary regulations requested that the IRS and Treasury De- partment clarify that a taxable roll-over would not preclude a trustee from re- porting under the final year exception. Accordingly, these regulations remove the reference to a roll-over and instead require that, to be eligible for the final year excep- tion, beneficial owners of trust interests must exchange their trust interests for cash or be treated as having exchanged their trust interests for cash for Federal income tax purposes upon the termination of the trust. 2.Pro-rata Sales to Effect Redemptions Exception Section 1.671–5T(c)(2)(iv)(G) of the temporary regulations provides that a pro-ratasale of a trust asset to effect a redemption is not required to be reported under §1.671–5. The temporary regula- tions describe apro-ratasale of a trust asset as occurring when (1) a trust interest holder tenders one or more trust inter- ests for redemption; (2) the trustee sells thepro-ratashare of a trust asset that is deemed to be owned by the trust inter- est holder as a result of the trust interest holder’s ownership of the trust interest or interests tendered for redemption; (3) the trustee engages in the sale solely to obtain cash that is immediately distributed to the redeeming trust interest holder as a result of the redemption; and (4) the redemption is reported as required under §1.671–5(c)(2)(v). Commentators on the temporary reg- ulations have requested that thepro-rata sales to effect a redemption exception in the temporary regulations be adjusted to accommodate economic and practical is- sues that trustees confront in executing sales of trust assets to effect redemptions. These commentators requested that the pro-ratasales to effect a redemption ex- ception be revised toprovide the trustee with some flexibility regarding the time period in which the trustee has to exe- cute sales following the tender of trust interests for redemptions and to permit trustees to aggregate sales of assets from several redemptions for the purpose of testing whether the asset sales have been pro-rata. In response, the final regula- tions provide thatpro-ratasales to effect redemptions occur when (i) one or more trust interests are tendered for redemption; (ii) the trustee identifies thepro-ratashare of the trust assets deemed to be owned by the trust interest or interests tendered for redemption, and sells those assets as soon as practicable; (iii) proceeds from the sale of the identified assets are used solely to effect redemptions; and (iv) the redemptions are reported as required un- der §1.671–5(c)(2)(v) by the trustee. Additionally, the final regulations pro- vide that the trustee may compare the ag- gregate of thepro-ratashare of the trust assets deemed to be owned by the trust interests tendered for redemption and the sales of assets sold to effect redemptions to determine thepro-ratasales of assets to effect redemptions for a calendar month. Further, if the aggregatepro-ratashare of the assets deemed to be owned by the re- deemed trust interests for the month equals a fractional share, the trustee may round that amount to the next whole share for the purpose of determining thepro-rata sales to effect a redemption for the calen- dar month. 3.De minimis Test Modifications Section 1.671–5T(b)(21) of the tempo- rary regulations provides an amended def- inition of trust sales proceeds that excludes the gross proceeds paid to a NMWHFIT for apro-ratasale of a trust asset to effect a redemption. The effect of this change in the definition of trust sales proceeds is to exclude the proceeds frompro-rata sales of trust assets to effect redemptions when determining whether a trust has met the generalde minimistest. Since only the proceeds from nonpro-ratasales of trust assets are considered for purposes of determining whether a NMWHFIT meets the generalde minimistest, more trusts will meet the generalde minimis test and qualify for the reduced reporting in §1.671–5(c)(2)(iv)(B). This amended definition is adopted by these final regula- tions. Commentators on the temporary regu- lations requested that the final regulations also except certain other trust sales pro- ceeds for the purpose of determining whether a NMWHFIT has met the general de minimistest if these sales are fully re- ported under §1.671–5(c)(2)(iv)(A) (the general reporting rules for sales and dis- positions). These sales and dispositions include corporate reorganizations and re- structurings for which the trust receives cash, the sale of securities received by the trust in corporate reorganizations and restructurings (including conversions of closed-end investment companies to open-end investment companies), princi- 2007–8 I.R.B.525February 20, 2007 pal prepayments, bond calls, bond maturi- ties, and the sale of securities by the trustee as required by the governing document or applicable law governing fiduciaries in order to maintain the sound investment character of the trust, and any other non- volitional dispositions. The IRS and the Treasury Department agree that this exclusion may be appropri- ate but are concerned that there may be some potential for abuse if trustees can choose to fully report some of these sales and not fully report other sales. Accord- ingly, the final regulations provide that the trust sales proceeds from these sales and dispositions may be excluded when determining whether the generalde min- imistest has been met, provided that the trustee consistently reports all such sales or dispositions, other than certain small excepted sales or dispositions (described in §1.671–5(c)(2)(iv)(D)(4)(iii)), under §1.671–5(c)(2)(iv)(A) during the life of the WHFIT. The regulations currently provide that a WHFIT meets the generalde minimistest in §1.671–5(c)(2)(iv)(D)(1) for its initial year if trust sales proceeds equal five per- cent or less of the net fair market value of the trust assets as of the start-up date. The start-up date is defined as the date when substantially all of the assets have been deposited with the trustee. Commenta- tors suggested that the regulations provide trustees with an alternative date for mea- suring whether thede minimistest has been met for the initial trust year. They sug- gested that trustees be permitted to mea- sure whether thede minimistest has been met by using the net fair market value of the trust’s assets as of the date of the last deposit of trust assets into the NMWHFIT (not including any deposit of assets into the NMWHFIT pursuant to a distribution rein- vestment program), not to exceed 90 days after the date the registration statement of the WHFIT becomes effective under the Securities Act of 1933. The final regula- tions adopt this suggestion. The special WHMTde minimistest in §1.671–5(c)(2)(iv)(D)(2)oftheWHFIT reporting rules was added to the WHFIT reporting rules in response to comments from the WHMT industry indicating that WHMT trustees would have difficulty ap- plying the generalde minimistest because it would be extremely difficult for the trustee to determine the fair market value of the mortgages held by the WHMT on an annual basis, as required under the generalde minimistest. Under the spe- cial WHMTde minimistest, trustees of certain WHMTs are permitted to deter- mine whether thede minimistest has been met using the outstanding principal bal- ance of the mortgages of the trust as of January 1 rather than the net fair market value of the trust’s assets. A commenta- tor suggested that thisde minimistest be expanded so that all WHFITs with hard to value debt instruments be permitted to use thisde minimistest. In response, the IRS and Treasury Department request that trustees of WHFITs that hold hard to value debt instruments and that believe the application of the WHMTde min- imistest to the instruments held by the WHFIT for which the trustees act would be useful, submit additional comments on this issue. The final regulations amend §1.671–5(c)(2)(iv)(D)(2)toprovidethat the application of the specialde minimis test may be expanded by revenue ruling or other published guidance. 4.Non Taxable Exchanges of Assets Commentators suggested that the final regulations provide an exception to the re- porting rules for sales and dispositions of trust assets for exchanges of trust assets that result from non taxable corporate re- organizations. The final regulations adopt this suggestion. D.Market Discount Commentators requested amendments to the information required to be re- ported under the NMWHFIT safe har- bor with respect to market discount. If a NMWHFIT is required to provide infor- mation regarding market discount under the general rules in §1.671–5(c)(2)(vii), the NMWHFIT safe harbor provides that a trustee’s requirement to provide informa- tion regarding market discount is satisfied by providing information regarding the portion of the trust that the assets sold represented. Assuming that a trust interest holder purchased its interest at a discount, it was contemplated that the trust interest holder would allocate the same portion of its discount to the sale as the assets represented to the NMWHFIT. This information was incomplete, how- ever, with respect to a NMWHFIT holding debt instruments with original issue dis- count (OID). Under both the general pro- visions (§1.671–5(c)(2)(ii)(A) and (vii)) and the safe harbor (§1.671–5(f)(1)(vii) and (viii)), OID information and mar- ket discount information are required to be calculated and provided separately. Accordingly, for beneficial owners to de- termine the amount of market discount an owner must allocate to a particular sale or disposition of a debt instrument by the NMWHFIT, §1.671–5(f)(1)(viii)(A) is amended with respect to NMWHFITs that hold debt instruments with OID, to include a requirement that trustees pro- vide a list of the aggregate adjusted issue prices of the debt instruments held by the NMWHFIT per trust interest as of the start-up date or the measuring date (as defined in §1.671–5(c)(2)(iv)(D)(1)) whichever will provide the more accurate information, as well as of January 1 of each subsequent year of the NMWHFIT. The IRS and the Treasury Department expect that beneficial owners of trust in- terests will use the adjusted issue price for the trust’s debt instruments per trust interest for the year in which the beneficial owner purchased its interest to determine whether a trust interest has market dis- count. II.Applicability of the WHFIT Reporting Rules to WHMTs A.Temporary WHMT safe harbor for WHMTs that hold interests in a REMIC, hold interests in another WHFIT, or hold or issue stripped interests The WHFIT reporting rules include a safe harbor for WHMTs that directly hold mortgages (as defined in §1.671–5(b)(11)) and issue trust interests that represent an equalpro-rataright to payments of interest and principal on the underlying mortgages. WHMTs that hold or issue stripped interests, hold interests in another WHFIT, or hold interests in a REMIC, are not eligible to report under the WHMT safe harbor. The IRS and the Treasury Department received comments express- ing concern about the application of the WHFIT reporting rules to WHMTs that are outside the WHMT safe harbor because trustees and middlemen of these WHMTs are required to comply with the general WHFIT reporting rules in §1.671–5(c). February 20, 20075262007–8 I.R.B. The commentators contended that some of the information required to be reported under the general information rules would be burdensome to obtain and moreover, is not required by beneficial owners to accurately report the tax consequences of owning a trust interest. In response to these concerns, pending the issuance of additional WHMT safe harbors, these final regulations provide a temporary safe harbor for all WHMTs that are outside the WHMT safe harbor in §1.671–5(g) of the WHFIT reporting rules because they hold or issue stripped interests, hold interests in a REMIC or hold an interest in another WHMT. Under the safe harbor, a trustee will be deemed to satisfy the requirements of §1.671–5(c)(1) if the trustee calculates and provides trust information in a manner that enables a requesting person to provide trust information to a beneficial owner of a trust interest that enables the owner to reasonably accurately report the tax consequences of its ownership of a trust interest on the Federal income tax return of the beneficial owner. Additionally, in order to be deemed to have satisfied the requirements of §1.671–5(c)(1), the trustee must provide information regarding market discount and original issue discount (OID) that is calculated in any reasonable manner consistent with section 1272(a)(6). Pend- ing the issuance of additional guidance, it is intended that this safe harbor except trustees from any penalties that may apply for not fully complying with paragraph (c) of the WHFIT reporting rules where it can be shown that full compliance with paragraph (c) is unnecessary in order to provide trust interest holders with appro- priate information. A trustee or middle- man required to provide information to the IRS under §1.671–5(d) and to beneficial owners under paragraph §1.671–5(e) may satisfy those obligations by calculating and providing trust information consis- tent with the information provided by the trustee under this safe harbor. B.Application of the requirement to provide market discount and OID information for existing WHMTs Section 1.671–5(c)(2)(ii)(A) requires a trustee of a WHFIT to provide information regarding OID. Commentators have ex- pressed concern regarding the application of this requirement to existing WHMTs be- cause the historical information that would enable the trustee to provide OID informa- tion has never been provided or maintained by the trustee or the persons responsible for information reporting. Commenta- tors contend that it is unlikely that these trustees will be able to comply with this re- quirement for existing WHMTs. The IRS and the Treasury Department recognize that, in some cases, the information nec- essary for a WHMT to comply with this provision may not be available. If it can be demonstrated that a trustee of a WHMT with a start up date on or after August 13, 1998 and on or before January 24, 2006, has attempted in good faith, but without success, to obtain the historical informa- tion required to provide OID information, the IRS will not impose any penalties that would apply under §1.671–5(l) of the WHFIT reporting rules (redesignated §1.671–5(m) by these final regulations) as a result of a trustee’s failure to comply with the requirement to provide OID in- formation. Further, §1.671–5(c)(2)(ii)(A) of these final regulations excepts a trustee ofaWHMTwithastartupdatepriorto August 13, 1998 from the requirement to provide OID information. For pur- poses of calculating the market discount fraction under the WHMT safe harbor in §1.671–5(g)(1)(v), these trustees may assume that the WHMT is holding mort- gages that were issued without OID. The WHMT safe harbor provisions for calculating OID information in §1.671–5(g)(i)(iv) and market discount information in §1.671–5(g)(1)(v) require trustees to use the prepayment assumption used in pricing the original issue of trust interests. Commentators have indicated that trustees of existing WHMTs may not know the prepayment assumption used in pricing the original issue of trust in- terests. In response, the safe harbor is amended to provide that if the trustee does not know the prepayment assumption used in pricing the original issue of trust in- terests for a WHMT with a start-up date prior to January 24, 2006, and the trustee makes a good faith effort without success to obtain the prepayment assumption, the trustee may use any reasonable prepay- ment assumption when calculating OID and market discount information for that WHMT. III.Requirement to Register and Continued Consideration of a WHFIT Directory Prior to the publication of the WHFIT reporting rules, commentators expressed concern that middlemen would not be able to identify a client’s investment as an investment in a WHFIT and sug- gested that the IRS publish a directory or list of WHFITs that would include the name and CUSIP number of each WHFIT, along with the name, address and telephone number of the WHFIT’s representative. Commentators noted that a publicly available directory or list would assist middlemen and brokers in identify- ing a client’s investment as an investment inaWHFITandinlocatingtheWHFIT’s representative. The WHFIT reporting rules did not provide for a directory and instead, required the trustee to identify a representative of the trust to provide trust information in a publication generally read by and available to requesting persons, in the trust’s prospectus, or on the trustee’s Internet website. Following the publication of the WHFIT reporting rules, additional com- ments were received regarding the need for a directory of WHFITs. In response to those comments, the proposed regu- lations indicated that the IRS and Trea- sury Department considered expanding Publication 938, “Real Estate Mortgage Investment Conduits (REMICs) Reporting Information (And Other Collateralized Debt Obligations (CDOs)),” or creat- ingaseparatepublicationtolistWHMT trustees and NMWHFITs. The IRS and Treasury Department continue to consider how a directory of WHFITs could be im- plemented. Pending the publication of such a directory, trustees must provide information regardinga trust representa- tive in the manner provided in the WHFIT reporting rules. IV.Form 1041 Reporting A trustee of a WHFIT must indicate on the Form 1041 filed for the 2006 calendar year that the return is a final return. Effective Date These final amendments are effective December 29, 2006. In general, these 2007–8 I.R.B.527February 20, 2007 final regulations are applicable to the re- porting required under §1.671–5 as of January 1, 2007 (see §1.671–5(m) (re- designated §1.671–5(n) by these final regulations)) and will be applied as though these amendments were included in the WHFIT reporting rules. The IRS and the Treasury Department are aware that some trustees and middlemen were unable to complete updates to their computer and information reporting systems to comply with the WHFIT reporting rules until the amendments to the WHFIT reporting rules included in these regulations are finalized. Accordingly, the IRS will not impose any penalties that would apply under §1.671–5(l) (redesignated §1.671–5(m) by these final regulations) of the WHFIT reporting rules as a result of the failure to comply with the WHFIT reporting rules as amended by these final regulations with respect to the 2007 calendar year in cases where a trustee or middleman was unable to change its information reporting sys- tems to comply with the WHFIT reporting rules because of uncertainty regarding the application of certain provisions of those rules pending the publication of these final regulations. For example, penal- ties will not be imposed on a trustee of a NMWHFIT that reports the amount of trust sales proceeds distributed to trust interest holders for the 2007 calendar year under §1.671–5(c)(2)(iv)(B) even though the trustee is unable to determine whether the NMWHFIT has met thede minimistest for the 2007 calendar year, provided that the trustee’s failure to determine whether aNMWHFIThasmetthede minimistest results from the trustee’s inability to alter its existing information reporting sys- tems by January 1, 2007, to capture the necessary information. As an additional example, penalties will not be imposed on the trustees or the middlemen of WHMTs that are unable to comply with certain pro- visions of the WHFIT reporting rules with respect to the 2007 calendar year because those trustees and middlemen were not able to change their existing reporting sys- tems to comply with the WHFIT reporting rules pending the publication of these final regulations. Special Analyses It has been determined that these fi- nal regulations are not a significant regu- latory action as defined in Executive Or- der 12866. Therefore, a regulatory assess- ment is not required. It is hereby certi- fied that this regulation will not have a sig- nificant economic impact on a substantial number of small entities. This certifica- tion is based on the fact that the regulations will not have a significant economic im- pact on small entities because the report- ing burdens in these regulations will fall primarily on large brokerage firms, large banks, and other large entities acting as trustees or middlemen, most of which are not small entities within the meaning of the Regulatory Flexibility Act (5 U.S.C. chapter 6). Thus, a substantial number of small entities are not expected to be af- fected. Therefore, a Regulatory Flexibility Analyses under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Inter- nal Revenue Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advo- cacy of the Small Business Administration for comment on its impact on small busi- ness. Drafting Information The principal author of these regula- tions is Faith Colson, Office of Associate Chief Counsel (Passthroughs & Special In- dustries). However, other personnel from the IRS and the Treasury Department par- ticipated in their development. ***** Adoption of Amendments to the Regulations Accordingly, 26 CFR part 1 is amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read, in part, as follows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.671–5 is amended by: 1. Revising paragraph (a) by redesig- nating entries for paragraphs (h), (j), (k), (l), and (m) as entries for paragraphs (j), (k), (l), (m) and (n) and adding a new en- try for paragraph (h). 2. Revising paragraphs (b)(5), (b)(8), (b)(21), (c)(2)(ii)(A), (c)(2)(iv), (c)(2)(v), (c)(2)(vi), (c)(2)(vii), (d)(2)(ii)(C), (d)(2)(ii)(F),(d)(2)(ii)(G),(f)(1), (f)(1)(i)(A), (f)(1)(viii)(A), (f)(2)(viii)(A), (f)(3)(i)(A)(1), (f)(3)(i)(B)(5), (f)(3)(i) (B)(9), (f)(3)(ii)(B)(4)(i), (f)(3)(ii)(B)(5), (f)(3)(ii)(B)(6), (g)(1)(iv)(A)(2), and (g)(1)(v)(A). 3. Redesignating paragraphs (h), (j), (k), (l), and (m) as (j), (k), (l), (m) and (n) respectively. 4. Adding new paragraph (h). The additions and revisions read as fol- lows: §1.671–5 Reporting for widely held fixed investment trusts. (a) * * * (h) Additional safe harbors. (1) Temporary safe harbors. (2) Additional safe harbors provided by other published guidance. ***** (b) * * * (5) Thecash held for distributionis the amount of cash held by the WHFIT (other than trust sales proceeds and pro- ceeds from sales described in paragraphs (c)(2)(iv)(D)(4), (G), and (H) of this sec- tion) less reasonably required reserve funds as of the date that the amount of a distribution is required to be determined under the WHFIT’s governing document. ***** (8) Anin-kind redemptionis a redemp- tion in which a beneficial owner receives apro-ratashare of each of the assets of the WHFIT that the beneficial owner is deemed to own under section 671. For example, for purposes of this paragraph (b)(8), if beneficial owner A owns a one percent interest in a WHFIT that holds 100 shares of X corporation stock, so that A is considered to own a one percent interest in each of the 100 shares, A’spro-ratashare of the X corporation stock for this purpose is one share of X corporation stock. ***** (21)Trust sales proceedsequal the amount paid to a WHFIT for the sale or disposition of an asset held by the WHFIT, including principal payments received by the WHFIT that completely retire a debt instrument (other than a final scheduled principal payment) andpro-ratapartial principal prepayments described under §1.1275–2(f)(2). Trust sales proceeds do not include amounts paid for any interest income that would be required to be re- February 20, 20075282007–8 I.R.B. ported under §1.6045–1(d)(3). Trust sales proceeds also do not include amounts paid to a NMWHFIT as the result ofpro-rata sales of trust assets to effect a redemp- tion described in paragraph (c)(2)(iv)(G) of this section or the value of assets re- ceived as a result of a tax-free corporate reorganization as described in paragraph (c)(2)(iv)(H) of this section. ***** (c) * * * (2) * * * (ii) * * * (A)Allitemsofgrossincome(includ- ing OID, except that OID is not required to be included for a WHMT that has a start-up date (as defined in paragraph (b)(19) of this section) prior to August 13, 1998). ***** (iv)Asset sales and dispositions.The trustee must report information regarding sales and dispositions of WHFIT assets as required in this paragraph (c)(2)(iv). For purposes of this paragraph (c)(2)(iv), a payment (other than a final scheduled payment) that completely retires a debt in- strument (including a mortgage held by a WHMT)orapro-rataprepayment on a debt instrument (see §1.1275–2(f)(2)) held by a WHFIT must be reported as a full or partial sale or disposition of the debt instrument.Pro-ratasales of trust assets to effect redemptions, as defined in para- graph (c)(2)(iv)(G) ofthis section, or ex- changes of trust assets as the result of a corporate reorganization under paragraph (c)(2)(iv)(H) of this section, are not re- ported as sales or dispositions under this paragraph (c)(2)(iv). (A)General rule. Except as provided in paragraph (c)(2)(iv)(B) (regarding the ex- ception for certain NMWHFITs) or para- graph (c)(2)(iv)(C) (regarding the excep- tion for certain WHMTs) of this section, the trustee must report with respect to each sale or disposition of a WHFIT asset— (1) The date of each sale or disposition; (2) Information that enables a request- ingpersontodeterminetheamountoftrust sales proceeds (as defined in paragraph (b)(21) of this section) attributable to a beneficial owner as a result of each sale or disposition; and (3) Information that enables a beneficial owner to allocate, with reasonable accu- racy, a portion of the owner’s basis in its trust interest to each sale or disposition. (B)Exception for certain NMWHFITs. If a NMWHFIT meets paragraph (c)(2)(iv)(D)(1) (regarding the general de minimistest), paragraph (c)(2)(iv)(E) (regarding the qualified NMWHFIT ex- ception), or paragraph(c)(2)(iv)(F) (re- garding the NMWHFIT final calendar year exception) of this section, the trustee is not required to report under paragraph (c)(2)(iv)(A) of this section. Instead, the trustee must report sufficient information to enable a requesting person to deter- mine the amount of trust sales proceeds distributed to a beneficial owner during the calendar year with respect to each sale or disposition of a trust asset. The trustee also must provide requesting per- sons with a statement that the NMWHFIT is permitted to report under this paragraph (c)(2)(iv)(B). (C)Exception for certain WHMTs. If a WHMT meets either the general or the specialde minimistest of paragraph (c)(2)(iv)(D) of this section for the cal- endar year, the trustee is not required to report under paragraph (c)(2)(iv)(A) of this section. Instead, the trustee must re- port information to enable a requesting person to determine the amount of trust sales proceeds attributable to a beneficial owner as a result of the sale or disposition. The trustee also must provide requesting persons with a statement that the WHMT is permitted to report under this paragraph (c)(2)(iv)(C). (D)De minimis tests—(1)General WHFIT de minimis test. The general WHFITde minimistest is satisfied if trust sales proceeds for the calendar year are not more than five percent of the net asset value of the trust (aggregate fair market value of the trust’s assets less the trust’s liabilities) as of the later of January 1 and the start-up date (as defined paragraph (b)(19) of this section); or, if the trustee chooses, the later of January 1 and the measuring date. The measuring date is the date of the last deposit of assets into the WHFIT (not including any deposit of assets into the WHFIT pursuant to a distribution reinvestment program), not to exceed 90 days after the date the regis- tration statement of the WHFIT becomes effective under the Securities Act of 1933. (2)Special WHMT de minimis test.A WHMT that meets the asset requirement of paragraph (g)(1)(ii)(E) of this section satisfies the special WHMTde minimis test in this paragraph (c)(2)(iv)(D)(2)if trust sales proceeds for the calendar year are not more than five percent of the aggregate outstanding principal balance of the WHMT (as defined in paragraph (g)(1)(iii)(D) of this section) as of the later of January 1 of that year or the trust’s start-up date. For purposes of applying the special WHMTde minimistest in this paragraph (c)(2)(iv)(D)(2), amounts that result from the complete or partial payment of the outstanding principal bal- ance of the mortgages held by the trust are not included in the amount of trust sales proceeds. The IRS and the Trea- sury Department may provide by revenue ruling, or by other published guidance, that the specialde minimistest of this paragraph (c)(2)(iv)(D)(2) may be ap- plied to WHFITs holding debt instruments other than those described in paragraph (g)(1)(ii)(E) of this section. ( 3)Effect of clean-up call.IfaWHFIT fails to meet eitherde minimistest de- scribedinthisparagraph (c)(2)(iv)(D) solely as the result of a clean-up call, as defined in paragraph (b)(6) of this section, the WHFIT will be treated as having met thede minimistest. (4)Exception for certain fully re- ported sales—(i)Rule. If a trustee of a NMWHFIT reports the sales described in paragraph (c)(2)(iv)(D)(4)(ii)ofthis section as provided under paragraph (c)(2)(iv)(A) of this section (regardless of whether the generalde minimistest in paragraph (c)(2)(iv)(D)(1) of this section is satisfied for a particular calendar year) consistently throughout the life of the WHFIT, a trustee may exclude the trust sales proceeds received by the WHFIT as a result of those sales from the trust sales proceeds used to determine whether a WHFIT has satisfied the generalde min- imistest in paragraph (c)(2)(iv)(D)(1)of this section. (ii)Applicable sales and dispositions. This paragraph (c)(2)(iv)(D)(4)appliesto sales and dispositions resulting from cor- porate reorganizations and restructurings for which the trust receives cash, the sale of assets received by the trust in corporate reorganizations and restructurings (includ- ing conversions of closed-end investment companies to open-end investment compa- nies), principal prepayments, bond calls, bond maturities, and the sale of securities by the trustee as required by the govern- 2007–8 I.R.B.529February 20, 2007 ing document or applicable law governing fiduciaries in order to maintain the sound investment character of the trust, and any other nonvolitional dispositions of trust as- sets. (iii)Certain small sales and disposi- tions. If the amount of trust sales proceeds from a sale or disposition described in paragraph (c)(2)(iv)(D)(4)(ii) of this sec- tion is less than .01 percent of the net fair market value of the WHFIT as de- termined for applying thede minimistest for the calendar year, the trustee is not required to report the sale or disposition under paragraph (c)(2)(iv)(A) of this sec- tion provided the trustee includes the trust sales proceeds, received for purposes of determining whether the trust has met the generalde minimistest of paragraph (c)(2)(iv)(D)(1) of this section. (E)Qualified NMWHFIT exception. The qualified NMWHFIT exception is satisfied if— (1) The NMWHFIT has a start-up date (as defined in paragraph (b)(19) of this sec- tion) before February 23, 2006; (2) The registration statement of the NMWHFIT becomes effective under the Securities Act of 1933, as amended (15 U.S.C. 77a,et. seq.) and trust interests are offered for sale to the public before February 23, 2006; or (3) The registration statement of the NMWHFIT becomes effective under the Securities Act of 1933 and trust interests are offered for sale to the public on or after February 23, 2006, and before July 31, 2006, and the NMWHFIT is fully funded before October 1, 2006. For purposes of determining whether a NMWHFIT is fully funded under this paragraph (c)(2)(iv)(E), deposits to the NMWHFIT after Octo- ber 1, 2006, that are made pursuant to a distribution reinvestment program that is consistent with the requirements of §301.7701–4(c) of this chapter are disre- garded. (F)NMWHFIT final calendar year ex- ception. The NMWHFIT final calendar year exception is satisfied if— (1) The NMWHFIT terminates on or before December 31 of the year for which the trustee is reporting; (2) Beneficial owners exchange their interests for cash or are treated as having exchanged their interests for cash upon ter- mination of the trust; and (3) The trustee makes reasonable efforts to engage inpro-ratasales of trust assets to effect redemptions. (G)Pro-rata sales of trust assets to effect a redemption—(1)Rule.Pro-rata sales of trust assets to effect redemptions are not required to be reported under this paragraph (c)(2)(iv). (2)Definition.Pro-ratasales of trust assets to effect redemptions occur when— (i) One or more trust interests are ten- dered for redemption; (ii) The trustee identifies thepro-rata shares of the trust assets that are deemed to be owned by the trust interest or in- terests tendered for redemption (See para- graph (b)(8) of this section for a descrip- tion of howpro-ratais to be applied for purposes of this paragraph (c)(2)(iv)(G)) and sells those assets as soon as practica- ble; (iii) Proceeds from the sales of the assets identified in paragraph (c)(2)(iv)(G)(2)(ii)ofthissectionareused solely to effect redemptions; and (iv) The redemptions are reported as re- quired under paragraph (c)(2)(v) of this section by the trustee. (3)Additional rules—(i)Calendar month aggregation. The trustee may com- pare the aggregatepro-ratashare of the assets deemed to be owned by the trust in- terests tendered for redemption during the calendar month with the aggregate sales of assets to effect redemptions for the calen- dar month to determine thepro-ratasales of trust assets to effect redemptions for the calendar month. If the aggregatepro-rata share of an asset deemed to be owned by the trust interests tendered for redemption for the month is a fractional amount, the trustee may round that number up to the next whole number for the purpose of determining thepro-ratasales to effect redemptions for the calendar month; (ii)Sales of assets to effect redemptions may be combined with sales of assets for other purposes. Sales of assets to effect re- demptions may be combined with the sales of assets to obtain cash for other purposes but the proceeds from the sales of assets to effect redemptions must be used solely to provide cash for redemptions and the sales of assets to obtain cash for other pur- poses must be reported as otherwise pro- vided in this paragraph (c)(2)(iv). For ex- ample, if a trustee sells assets and the pro- ceeds are used by the trustee to pay trust expenses, these amounts are to be included in the amounts reported under paragraph (c)(2)(iv)(A) or (B), as appropriate. (4)Example—(i)January 1, 2008. Trust has one million trust interests and all interests have equal value and equal rights. The number of shares of stock in corporations A through J and thepro-rata share of each stock that a trust interest is deemed to own as of the January 1, 2008, is as follows: STOCKTOTAL SHARESPER TRUST INTEREST A 24,845.024845 B28,273.028273 C 35,575.035575 D13,866.013866 E 25,082.025082 F 39,154.039154 G16,137.016137 H14,704.014704 I17,436.017436 J31,133.031133 February 20, 20075302007–8 I.R.B. (ii)Transactions of January 2, 2008.OnJanuary 2, 2008, 50,000 trust interests are tendered for re- demption. The deemedpro-rataownership of stocks A through J represented by the 50,000 redeemed trust interests and the stocks sold to provide cash for the re- demptions are set out in the following table: STOCKDEEMED PRO-RATA OWNERSHIPSHARES SOLD A 1,242.25 1,242 B 1,413.65 1,413 C 1,778.75 1,779 D693.30694 E 1,254.101,254 F 1,957.701,957 G 806.85 807 H 735.20735 I871.80872 J 1,556.651,557 (iii)Transactions on January 15 through 17, 2008. On January 15, 2008, 10,000 trust interests are tendered for redemption. Trustee lends money to Trust for redemptions. On January 16, B merges into C at a rate of .55 per share. On January 17, Trusteesellsstocktoobtaincashtobereimbursed the cash loaned to Trust to effect the redemptions. Thepro-ratashare of the stock deemed to be owned by the 10,000 redeemed trust interests and the stock sold by the trustee to effect the redemptions are set out in the following table: STOCKDEEMED PRO-RATA OWNERSHIPSHARES SOLD A 248.45 249 B00 C 511.25512 D138.66138 E 250.82251 F 391.54 392 G161.37162 H147.04148 I174.36174 J311.33 311 (iv)Transactions on January 28 and 29, 2008.On January 28, 2008, the value of the H stock is $30.00 per share and Trustee, pursuant to Trust’s governing document, sells the H stock to preserve the financial integrity of Trust and receives $414,630. Trustee in- tends to report this sale under paragraph (c)(2)(iv)(A) of this section and to distribute the proceeds of the salepro-ratato trust interest holders on Trust’s next scheduled distribution date. On January 29, 2008, while trustee still holds the proceeds from the Jan- uary 28 sale, 10,000 trust interests are tendered for redemption. Thepro-ratashare of the stock deemed to be owned by the 10,000 redeemed trust interests andthestocksoldbythetrusteetoeffecttheredemp- tions are set out in the following table: STOCKDEEMED PRO-RATA OWNERSHIPSHARES SOLD A 248.45 248 B00 C 511.25511 D138.66139 E 250.82251 F 391.54 391 G161.37161 H0 Share of cash proceeds: $4,458.39 0 2007–8 I.R.B.531February 20, 2007 STOCKDEEMED PRO-RATA OWNERSHIPSHARES SOLD I174.36 175 J311.33 312 (v)Monthly amounts. To determine thepro-rata sales to effect redemptions for January, trustee compares the aggregatepro-ratashare of stocks A through J (rounded to the next whole number) deemed to be owned by the trust interests tendered for redemption during the month of January with the sales of stocks A through J to effect redemptions: STOCKDEEMED PRO-RATA OWNERSHIPSHARES SOLD A17401739 B00 C 35793579 D971971 E 17561756 F27412741 G11301130 H883883 I12211221 J21802180 (vi)Pro-rata sales to effect redemptions for the month of January. For the month of January, the de emedpro-rataownership of shares of stocks A through J equal or exceed the sales of stock to ef- fect redemptions for the month. Accordingly, all of th e sales to effect redemptions during the month of January are considered to bepro-rataand are not re- quired to be reported under this paragraph (c)(2)(iv). (H)Corporate Reorganizations.The exchange of trust assets for other assets of equivalent value pursuant to a tax free corporate reorganization is not required to be reported as a sale or disposition under this paragraph (c)(2)(iv). (v)Redemptions and sales of WHFIT interests—(A)Redemptions—(1)In gen- eral. Unless paragraph (c)(2)(v)(C) of this section applies, for each date on which the amount of a redemption proceeds for the redemption of a trust interest is deter- mined, the trustee must provide informa- tion to enable a requesting person to deter- mine— (i) The redemption proceeds (as defined in paragraph (b)(15) of this section) per trust interest on that date; (ii) The redemption asset proceeds (as defined in paragraph (b)(14) of this sec- tion) per trust interest on that date; and (iii) The gross income that is attribut- able to the redeeming beneficial owner for the portion of the calendar year that the re- deeming beneficial owner held its interest (including income earned by the WHFIT after the date of the last income distribu- tion). (2)In kind redemptions. The value of the assets received with respect to an in-kind redemption (as defined in para- graph (b)(8) of this section) is not re- quired to be reported under this paragraph (c)(2)(v)(A). Information regarding the income attributable to a redeeming bene- ficial owner must, however, be reported under paragraph (c)(2)(v)(A)(1)(iii)ofthis section. (B)Sale of a trust interest. Unless para- graph (c)(2)(v)(C) of this section applies, if a secondary market for interests in the WHFIT is established, the trustee must provide, for each day of the calendar year, information to enable requesting persons to determine— (1) The sale assets proceeds (as defined in paragraph (b)(17) of this section) per trust interest on that date; and (2) The gross income that is attributable to a selling beneficial owner and to a pur- chasing beneficial owner for the portion of the calendar year that each held the trust interest. (C)Simplified Reporting for Certain NMWHFITs—(1)In general. The trustee of a NMWHFIT described in paragraph (c)(2)(v)(C)(2)ofthissectionisnotre- quired to report the information described in paragraph (c)(2)(v)(A) of this section (regarding redemptions) or (c)(2)(v)(B) of this section (regarding sales). However, the trustee must report to requesting per- sons, for each date on which the amount of redemption proceeds to be paid for the re- demption of a trust interest is determined, information that will enable requesting persons to determine the redemption pro- ceeds per trust interest on that date. The trustee also must provide requesting per- sons with a statement that this paragraph applies to the NMWHFIT. (2)NMWHFITs that qualify for the ex- ception. This paragraph (c)(2)(v)(C) ap- plies to a NMWHFIT if— (i) Substantially all the assets of the NMWHFIT produce income that is treated as interest income (but only if these as- sets trade on a recognized exchange or securities market without a price compo- nent attributable to accrued interest) or produce dividend income (as defined in section 6042(b) and the regulations un- der that section). (Trust sales proceeds and gross proceeds from sales described in paragraphs (c)(2)(iv)(G) and (H) of this section are ignored for the purpose of determining if substantially all of a NMWHFIT’s assets produce dividend or the interest income described in this para- graph); and (ii) The qualified NMWHFIT exception of paragraph (c)(2)(iv)(E) of this section is satisfied, or the trustee is required by the governing document of the NMWHFIT February 20, 20075322007–8 I.R.B. to determine and distribute all cash held for distribution (as defined in paragraph (b)(5) of this section) no less frequently than monthly. A NMWHFIT will be con- sidered to have satisfied this paragraph (c)(2)(v)(C)(2)(i) notwithstanding that the governing document of the NMWHFIT permits the trustee to forego making a required monthly or more frequent dis- tribution, if the cash held for distribution is less than 0.1 percent of the aggregate net asset value of the trust as of the date specified in the governing document for calculating the amount of the monthly distribution. (vi)Information regarding bond pre- mium. The trustee generally must re- port information that enables a beneficial owner to determine, in any manner that is reasonably consistent with section 171, the amount of the beneficial owner’s amor- tizable bond premium, if any, for each calendar year. However, if a NMWHFIT meets the generalde minimistest in para- graph (c)(2)(iv)(D)(1) of this section, the qualified NMWHFIT exception of para- graph (c)(2)(iv)(E) of this section, or the NMWHFIT final calendar year exception of paragraph (c)(2)(iv)(F) of this section, the trustee of the NMWHFIT is not re- quired to report information regarding bond premium. (vii)Information regarding market discount. The trustee generally must report information that enables a benefi- cial owner to determine, in any manner reasonably consistent with section 1276 (including section 1276(a)(3)), the amount of market discount that has accrued dur- ing the calendar year. However, if a NMWHFIT meets the generalde minimis test in paragraph (c)(2)(iv)(D) of this sec- tion, the qualified NMWHFIT exception of paragraph (c)(2)(iv)(E) of this section, or the NMWHFIT final calendar year ex- ception of paragraph (c)(2)(iv)(F) of this section, the trustee of such NMWHFIT isnotrequiredtoprovideinformationre- garding market discount. ***** (d) * * * (2) * * * (ii) * * * (C)Gross income.Allitemsofgross income of the WHFIT attributable to the TIH for the calendar year (including OID (unless the exception for certain WHMTs applies (see paragraph (c)(2)(ii)(A) of this section)) and all amounts of income attrib- utable to a selling, purchasing, or redeem- ing TIH for the portion of the calendar year that the TIH held its interest (unless para- graph (c)(2)(v)(C) of this section (regard- ing an exception for certain NMWHFITs) applies)); ***** (F)Reporting Redemptions.Allre- demption asset proceeds (as defined in paragraph (b)(14) of this section) paid to the TIH for the calendar year, if any, or, if paragraph (c)(2)(v)(C) of this sec- tion (regarding an exception for certain NMWHFITs) applies, all redemption pro- ceeds (as defined in paragraph (b)(15) of this section) paid to the TIH for the calen- dar year; (G)Reporting sales of a trust interest on a secondary market. All sales asset pro- ceeds (as defined in paragraph (b)(17) of this section) paid to the TIH for the sale of a trust interest or interests on a secondary market established for the NMWHFIT for the calendar year, if any, or, if paragraph (c)(2)(v)(C) of this section (regarding an exception for certain NMWHFITs) ap- plies, all sales proceeds (as defined in paragraph (b)(18) of this section) paid to the TIH for the calendar year; and ***** (f)Safe harbor for providing informa- tion for certain NMWHFITs—(1)Safe harbor for trustee reporting of NMWHFIT information. The trustee of a NMWHFIT that meets the requirements of paragraph (f)(1)(i) of this section is deemed to satisfy paragraph (c)(1)(i) of this section, if the trustee calculates and provides WHFIT information in the manner described in this paragraph (f) and provides a statement toarequestingpersongivingnoticethat information has been calculated in accor- dance with this paragraph (f)(1). (i)In general—(A)Eligibility to report under this safe harbor.OnlyNMWHFITs that meet the requirements set forth in paragraphs (f)(1)(i)(A)(1)and(2)ofthis section may report under this safe harbor. For purposes of determining whether the requirements of paragraph (f)(1)(i)(A)(1) of this section are met, trust sales proceeds and gross proceeds from sales described in paragraphs (c)(2)(iv)(G) and (H) of this section are ignored. (1) Substantially all of the NMWHFIT’sincomeisfromdivi- dends or interest; and (2) All trust interests have identical value and rights. ***** (viii)Reporting market discount in- formation under the safe harbor—(A)In general—(1)Trustee required to provide market discount information. If the trustee is required to provide information re- garding market discount under paragraph (c)(2)(vii) of this section, the trustee must provide— (i) The information required to be pro- vided under paragraph (f)(1)(iv)(A)(1)(iii) of this section; and (ii) If the NMWHFIT holds debt in- struments with OID, a list of the aggre- gate adjusted issue prices of the debt in- struments per trust interest calculated as of the start-up date or measuring date (see paragraph (c)(2)(iv)(D)(4)ofthissection) (whichever provides more accurate infor- mation) and as of January 1 for each sub- sequent year of the NMWHFIT. (2)Trustee not required to provide mar- ket discount information. If the trustee is not required to provide market discount information under paragraph (c)(2)(vii) of this section (because the NMWHFIT meets the generalde minimistest of para- graph (c)(2)(iv)(D)(1) of this section, the qualified NMWHFIT exception of paragraph (c)(2)(iv)(E) of this section, or the NMWHFIT final year exception of paragraph (c)(2)(iv)(F) of this section), the trustee is not required under this paragraph (f) to provide any information regarding market discount. ***** (2) * * * (viii) * * * (A) Except as provided in paragraph (f)(2)(viii)(B) of this section, the trustee or middleman must provide the TIH with the information provided under paragraph (f)(1)(viii) of this section. (3) * * * (i) * * * (A) * * * (1) Trust is a NMWHFIT that holds common stock in ten different corporations and has 100 trust interests outstanding. The start-up date for Trust is December 15, 2006, and Trust’s registration statement under the Securities Act of 1933 became effective after July 31, 2006. Trust terminates on March 15, 2008. The agreement governing Trust 2007–8 I.R.B.533February 20, 2007 requires Trust to distribute cash held by Trust re- duced by accrued but unpaid expenses on April 15, July 15, and October 15 of the 2007 calendar year. The agreement also provides that the trust interests will be redeemed by the Trust for an amount equal to the value of the trust interest, as of the close of business, on the day the trust interest is tendered for redemption. There is no reinvestment plan. A sec- ondary market for interests in Trust will be created by Trust’s sponsor and Trust’s sponsor will provide Trustee with a list of dates on which sales occurred on this secondary market. (B)*** (5) On June 1, 2007, Trustee sells shares of stock for $1000x to preserve the soundness of the trust. The stock sold on June 1, 2007, equaled 20% of the aggre- gate fair market value of the assets held by Trust on the start-up date of Trust. Trustee has chosen not to report sales described in paragraph (c)(2)(iv)(4)(ii)of Trust’s assets under paragraph (c)(2)(iv)(D)(4) of this section. ***** (9) On December 10, 2007,Jtenders a trust interest to Trustee for redemption through Broker1. Trustee determines that the amount of the redemption proceeds to be paid for a trust interest that is tendered for redemption on December 10, 2007 is $116x, of which $115x represents the redemption asset pro- ceeds. Trustee pays this amount to Broker1 onJ’s behalf. On December 12, 2007, trustee engages in anonpro-ratasale of shares of common stock for $115x to effectJ’s redemption of a trust interest. The stock sold on December 12, 2007, equals 2% of the aggregate fair market value of all the assets of Trust as of the start-up date. ***** (ii) * * * (B)*** (4)***(i)Application of the de minimis test. The aggregate fair market value of the assets of Trust as of January 1, 2007, was $10,000x. During the 2007 calendar year, Trust received trust sales pro- ceeds of $1115x. The trust sales proceeds received by Trust for the 2007 calendar year equal 11.15% of Trust’s fair market value as of January 1, 2007. Accordingly, thede minimistest is not satisfied for the 2007 calendar year. The qualified NMWHFIT exception in paragraph (c)(2)(iv)(E) of this section and the NMWHFIT final calendar year exception in (c)(2)(iv)(F) of this section also do not apply to Trust for the 2007 calendar year. ***** (5)Reporting redemptions. Because Trust is not required to make distributions at least as frequently as monthly, and Trust does not satisfy the qualified NMWHFIT exception in paragraph (c)(2)(iv)(E) of this section, the exception in paragraph (c)(2)(v)(C) does not apply to Trust. To satisfy the requirements of paragraph (f)(1) of this section, Trustee provides a list of dates for which the redemption proceeds to be paid for the redemption of a trust interest was de- termined for the 2007 calendar year and the redemp- tions asset proceeds paid for each date. During 2007, Trustee only determined the amount of redemption proceeds paid for the redemption of a trust interest once, for December 10, 2007 and the redemption as- set proceeds determined for that date was $115x. (6)Reporting sales of trust interests. Because trust is not required to make distributions at least as frequently as monthly, and Trust does not satisfy the qualified NMWHFIT exception in paragraph (c)(2)(iv)(E) of this section, the exception in para- graph (c)(2)(v)(C) of this section does not apply to Trust. Sponsor, in accordance with the trust agree- ment, provides Trustee with a list of dates on which sales on the secondary market occurred. To satisfy the requirements of paragraph (f)(1) of this section, Trustee provides requesting persons with a list of dates on which sales on the secondary market oc- curred and the amount of cash held for distribution, per trust interest, on each date. The first sale during the 2007 calendar year occurred on September 30, 2007, and the amount of cash held for distribution, per trust interest, on that date is $1.35x. The second sale occurred on December 10, 2007, and the amount of cash held for distribution, per trust interest, on that date is $1.00x. (g) * * * (1) * * * (iv)***(A)*** (2) In calculating the daily portion of OID, the trustee must use the prepayment assumption used in pricing the original is- sue of trust interests. If the WHMT has a start-up date prior to January 24, 2006, and the trustee, after a good faith effort to as- certain that information, does not know the prepayment assumption used in pricing the original issue of trust interests, the trustee may use any reasonable prepayment as- sumption to calculate OID provided it con- tinues to use the same prepayment assump- tion consistently thereafter. ***** (v)***(A)*** (3)Computing the total amount of stated interest remaining to be paid and the total remaining OID at the beginning of the month. To compute the total amount of stated interest remaining to be paid to the WHMT as of the beginning of the month and the total remaining OID as of the beginning of the month, the trustee must use the prepayment assumption used in pricing the original issue of trust in- terests. If the WHMT has a start-up date prior to January 24, 2006, and the trustee, after a good faith effort to ascertain that in- formation, does not know the prepayment assumption used in pricing the original issue of trust interests, the trustee may use any reasonable prepayment assump- tion to calculate these amounts provided it continues to use the same prepayment assumption consistently thereafter. ***** (h)Additional safe harbors—(1)Tem- porary safe harbor for WHMTs—(i)Ap- plication. Pending the issuance of ad- ditional guidance, the safe harbor in this paragraph applies to trustees and middle- men of WHMTs that are not eligible to re- port under the WHMT safe harbor in para- graph (g) of this section because they hold interests in another WHFIT, in a REMIC, or hold or issue stripped interests. (ii)Safe harbor. A trustee is deemed to satisfy the requirements of paragraph (c) of this section, if the trustee calculates and provides trust information in a manner that enables a requesting person to provide trust information to a beneficial owner of a trust interest that enables the owner to reasonably accurately report the tax conse- quences of its ownership of a trust interest on its federal income tax return. Addition- ally, to be deemed to satisfy the require- ments of paragraph (c) of this section, the trustee must calculate and provide trust in- formation regarding market discount and OID by any reasonable manner consistent with section 1272(a)(6). A middleman or a trustee may satisfy its obligation to fur- nish information to the IRS under para- graph (d) of this section and to the trust interest holder under paragraph (e) of this section by providing information consis- tent with the information provided under this paragraph by the trustee. (2)Additional safe harbors provided by other published guidance. The IRS and the Treasury Department may provide ad- ditional safe harbor reporting procedures for complying with this section or a spe- cific paragraph of this section by other published guidance (see §601.601(d)(2) of this chapter). ***** (m)Penalties for failure to comply—(1) In general. Every trustee or middleman who fails to comply with the reporting obligations imposed by this section is sub- ject to penalties under sections 6721, 6722, and any other applicable penalty provi- sions. (2)Penalties not imposed on trustees and middlemen of certain WHMTs for failure to report OID. Penalties will not be imposed as a result of a failure to provide OID information for a WHMT that has a start-up date on or after August 13, 1998 and on or before January 24, 2006, if the trustee of the WHMT does not have the February 20, 20075342007–8 I.R.B. historic information necessary to provide this information and the trustee demon- strates that it has attempted in good faith, but without success, to obtain this infor- mation. For purposes of calculating a market discount fraction under paragraph (g)(1)(v) of this section, for a WHMT described in this paragraph, it may be assumed that the WHMT is holding mort- gages that were issued without OID. A trustee availing itself of this paragraph must include a statement to that effect when providing information to requesting persons under paragraph (c) of these reg- ulations. ***** §1.671–5T [Removed] Par. 3. Section 1.671–5T is removed. Kevin M. Brown, Deputy Commissioner for Services and Enforcement. Approved December 21, 2006. Eric Solomon, Assistant Secretary (Tax Policy). (Filed by the Office of the Federal Register on December 26, 2006, 10:22 a.m., and published in the issue of the Federal Register for December 29, 2006, 71 F.R. 78351) Section 1502.—Regulations Consolidated corporate returns, unified rule for loss on subsidiary stock. See REG-157711-02, page 537. 2007–8 I.R.B.535February 20, 2007 Part III. Administrative, Procedural, and Miscellaneous Estimated Tax Penalty for Citizens or Residents of the United States Living Abroad Notice 2007–16 Section 1: Purpose This notice addresses the foreign earned income exclusion and housing cost amount for certain citizens and residents of the United States living abroad as modified by the Tax Increase Prevention and Reconcil- iation Act of 2005, Pub. L. No. 109–222, 120 Stat. 345, (TIPRA). This notice pro- vides that, under certain circumstances, the Internal Revenue Service (Service) will waive section 6654 penalties for un- derpayment of estimated tax by certain citizens and residents of the United States living abroad. Section 2: Background Generally, the Internal Revenue Code requires individuals to pay federal income tax as they earn income. To the extent these taxes are not withheld from an in- dividual’s wages, an individual taxpayer must pay estimated taxes in four install- ments. Section 6654(a) of the Code pro- vides for an addition to tax where a tax- payer fails to make a sufficient and timely payment of “estimated tax.” In general, estimated taxes are required in four installments and the amount of any required installment shall be 25 percent of the “required annual payment.”Seesec- tion 6654(c) and (d)(1)(A). The term “re- quired annual payment” means the lesser of 90 percent of tax shown on the return for the taxable year (or, if no return is filed, 90 percent of tax for such year), or 100 percent of tax shown on the return of the individual for the preceding taxable year if the adjusted gross income (AGI) shown on the return of the individual for the pre- ceding taxable year is less than or equal to $150,000. If the AGI shown on the return of the individual forthe preceding taxable year exceeds $150,000, the required an- nual payment is 110 percent of tax shown on that return. If the preceding taxable year was not a taxable year of 12 months or if the individ- ual did not file a return for such preceding taxable year, the required annual payment is 90 percent of tax shown on the return for the current taxable year.Seesection 6654(d)(1)(B). Section 911(a) of the Code allows a qualified individual to elect to exclude from U.S. gross income the foreign earned income and housing cost amount of that individual. Prior to the enactment of TIPRA, the maximum amount of foreign earned income that could be excluded under section 911 in 2006 was $80,000. The housing cost amount that an individ- ual could exclude under section 911 was the taxpayer’s “reasonable” housing ex- penses over a floor equal to 16% of the salary of a GS–14 federal worker. The exclusions for foreign earned income and housing cost amounts operated like other exclusions in the Code and were ignored when determining the tax rate applicable to non-excluded income. On May 17, 2006, TIPRA was enacted into law. Section 515 of TIPRA made sev- eral changes to section 911 of the Code. First, TIPRA increased the foreign earned income exclusion cap by indexing it for in- flation after 2005. Thus, the amount of for- eign earned income that may be excluded in 2006 is $82,400. Second, TIPRA mod- ified the housing cost amount by chang- ing the manner in which the floor is cal- culated and by generally imposing a cap equal to 30% of the maximum amount of the taxpayer’s foreign earned income ex- clusion. Third, TIPRA imposed a “stack- ing” rule on the amounts excluded under section 911, so that income not excluded by section 911 is subject to the same rate of tax as would have been applicable had the taxpayer not elected the section 911 ex- clusion. Thus, an individual with $82,400 of excluded income and $20,000 of taxable income will be taxed at rates that apply to taxable income in the range of $82,400 to $102,400 (25% or 28%), rather than $0 to $20,000 (10% or 15%). Section 3: Transitional Penalty Relief for Underpayment of Estimated Taxes The TIPRA changes to section 911 were enacted in May 2006, but they are effective for taxable years beginning after December 31, 2005. Therefore, taxpayers relying on the law as it existed prior to the retroactive change may have underpaid their estimated tax liabilities for 2006. Section 6654(e)(3) authorizes the Ser- vice to waive section 6654 penalties for underpayments of estimated tax in unusual circumstances to the extent its imposition would be against equity and good con- science. Pursuant to this authority, the Ser- vice will waive the section 6654 penalty for calendar year 2006 for an underpay- ment of estimated tax to the extent that the underpayment is attributable to the modi- fications made by section 515 of TIPRA. This waiver is available only to qualified individuals who file a Form 2555,For- eign Earned Income, or Form 2555–EZ, Foreign Earned Income Exclusion,with their timely filed Form 1040,U.S. Individ- ual Income Tax Return, or Form 1040X, Amended U.S. Individual Income Tax Re- turn. Section 4: Contact Information The principal author of this notice is Karen E. Briscoe of the Office of Associate Chief Counsel (Procedure & Administration). For further information regarding this notice, contact Mrs. Briscoe at (202) 622–8117 (not a toll-free call). February 20, 20075362007–8 I.R.B. Part IV. Items of General Interest Notice of Proposed Rulemaking Unified Rule for Loss on Subsidiary Stock REG–157711–02 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking. SUMMARY: This document contains proposed regulations under secti ons 358, 362(e)(2) and 1502 of the Interna lRev- enue Code (Code). The regulation sapply to corporations filing consolid ated re- turns. The regulations implemen t aspects of the repeal of theGeneral Utili tiesdoc- trine by redetermining members ’ bases in subsidiary stock and requiri ng certain reductions in subsidiary stoc kbasisona transfer of the stock. The regu lations also promote the clear reflection o fincome by redetermining members’ bas es in sub- sidiary stock and reducing th e subsidiary’s attributes to prevent the dup lication of loss. Additionally, the regu lations provide guidance limiting the applic ation of sec- tion 362(e)(2) with respect to transactions between members of a consoli dated group. DATES: Written or electronic comments or a request for a public hearing must be received by April 23, 2007. ADDRESSES: Send submissions to: CC:PA:LPD:PR(REG–157711–02), room 5203, Internal Revenue Ser- vice, PO Box 7604, Ben Franklin Sta- tion, Washington, DC 20044. Submis- sions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–157711–02), Courier’s Desk, In- ternal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC, or sent electronically, via the IRS Internet site at www.irs.gov/regsor via the Federal eRule- making Portal atwww.regulations.gov (IRS/REG–157711–02). FOR FURTHER INFORMATION CONTACT: Concerning the pro- posed regulations, Theresa Abell (202) 622–7700 or Phoebe Bennett (202) 622–7770; concerning submis- sions of comments, Richard Hurst, Richard.A.Hurst@irscounsel.treas.gov, (202) 622–7180 (not toll-free numbers). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Manage- ment and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to theOffice of Management and Bud- get, Attn: Desk Officer for the Depart- ment of the Treasury, Office of Informa- tion and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Rev- enue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washing- ton, DC 20224. Comments on the collec- tion of information should be received by March 26, 2007. Comments are specifically requested concerning: Whether the proposed collection of in- formation is necessary for the proper per- formance of the functions of the IRS, in- cluding whether the information will have practical utility; The accuracy of the estimated burden associated with the proposed collection of information; How the quality, utility, and clarity of the information to be collected may be en- hanced; How the burden of complying with the proposed collection of information may be minimized, including through the appli- cation of automated collection techniques or other forms of information technology; and Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide informa- tion. The collection of informa- tion in these proposed regulations is in §§1.1502–13(e)(4)(v) and 1.1502–36(d)(6).The respondents are corporations filing consolidated returns. The collection of information is requiredtoallowacorporationtopreserve a subsidiary’s attributes by foregoing a stock loss. The collection of information is required to obtain a benefit. Estimated total annual reporting and/or recordkeeping burden: 25 hours. Estimated average annual burden per respondent and/or recordkeeper: 15 min- utes. Estimated number of respondents and/or recordkeepers: 100. Estimated annual frequency of re- sponses: Once. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Of- fice of Management and Budget. Books or records relating to the col- lection of information must be retained as long as their contents may become mate- rial in the administration of any Internal Revenue law. Generally, tax returns and tax return informationare confidential, as required by 26 U.S.C. 6103. Background The discussion in this preamble begins with an overview of the history of the regulatory attempts to address both the circumvention ofGeneral Utilitiesrepeal and the duplication of loss by consolidated groups, in particular, in §1.1502–20 (the Loss Disallowance Rule, or LDR). The discussion then turns toRite Aid Corp. v. United States, 255 F.3d 1357 (Fed. Cir. 2001), which rejected the loss duplica- tion rule in the LDR. Section A.4 of this preamble discusses the immediate admin- istrative responses toRite Aid. Section A.5 of this preamble discusses the legisla- tive response toRite Aid. Following the Rite Aiddecision, the IRS and Treasury Department undertook a study to recon- sider the issues addressed by §1.1502–20. Section B of this preamble discusses the various issues considered in that study, including both the original noneconomic and duplicated stock loss specifically ad- dressed by the LDR and certain related issues with which the Internal Revenue Service and Treasury Department have grown concerned since the LDR was pro- mulgated. Section C of this preamble describes the various approaches that were 2007–8 I.R.B.537February 20, 2007 considered to address noneconomic stock loss and sets forth the conclusions reached regarding each. Section D of this pream- ble describes the various approaches that were considered to address loss duplica- tion and sets forth the conclusions reached regarding each. Section E of this preamble describes the various approaches that were considered to address the noneconomic and duplicated loss that can arise from the general operation of the investment adjust- ment system and sets forth the conclusions reached regarding each. Section F of this preamble describes the specific provisions of this proposed regulation §1.1502–36. Section G of this preamble discusses the proposed removal of §§1.337(d)–1, 1.337(d)–2, and 1.1502–35. The IRS and Treasury Department are also proposing regulations to address the application of section 362(e)(2) to mem- bers of consolidated groups. These pro- posed regulations are described in section H of this preamble. Finally, the IRS and Treasury Depart- ment are proposing various technical and administrative revisions to the consoli- dated return regulations. These proposed regulations are described in section I of this preamble. The IRS and Treasury Department re- quest comments on the proposed regula- tions and other approaches that could be adopted, as well as other issues currently under study. See section J of this pream- ble for further discussion of comments re- quested. A.History of General Utilities Repeal and Loss Disallowance under §1.1502–20. 1.TherepealoftheGeneralUtilities doctrine. In 1986, Congress enacted section 337(d), which directs the Secretary to pre- scribe such regulations as may be neces- sary or appropriate to carry out the repeal of theGeneral Utilitiesdoctrine (GUre- peal). See Tax Reform Act of 1986, Public Law 99–514 (100 Stat. 2085 (1986)). The legislative history states that Congress was concerned that theGeneral Utilities doctrine allowed “assets to leave corporate solution and to take a stepped-up basis in the hands of the transferee without the imposition of a corporate-level tax” and thus “tend[ed] to undermine the corpo- rate income tax.” H.R. Rep. No. 99–426, 99 th Cong., 1 st Sess. 282 (1985). The General Utilitiesdoctrine andGUrepeal are discussed extensively in the Treasury Decisions referencedin this preamble; in addition, see generally, H.R. Rep. No. 99–426 at 274–282 for a discussion of the history of theGeneral Utilitiesdoctrine; see alsoGeneral Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935). 2.The administrative response to GU repeal: §1.1502–20. The IRS and Treasury Department first responded toGUrepeal by issuing No- tice 87–14, 1987–1 C.B. 445, which set forth the intent to promulgate regulations affecting adjustments to members’ bases in stock of any subsidiary acquired when the subsidiary held an appreciated asset. No- tice 87–14 indicated that, in general, ad- justments to subsidiary stock basis would not reflect gains on such assets. Thus, Notice 87–14 implied that a tracing-based regime would be adopted to determine ad- justments to members’ bases in shares of subsidiary stock. After several years of study, the IRS and Treasury Department concluded that any approach relying on the identification and tracing of appreciation on particular assets, while theoretically accurate, would impose substantial administrative burdens on taxpayers and on the government. See T.D. 8294, 1990–1 C.B. 66 [55 FR 9426, 9428] (March 14, 1990). As a result, the tracing-based approach envisioned in No- tice 87–14 was implemented only in regu- lations promulgated under section 337(d). Those regulations applied only for the pe- riod of time between the issuance of No- tice 87–14 and the effective date of fi- nal regulations under §1.1502–20 (Feb- ruary 1, 1991). See T.D. 8364, 1991–2 C.B. 43 [56 FR 47379] (September 19, 1991), §§1.337(d)–1 and 1.337(d)–2 (as contained in 26 CFR part 1 revised as of April 1, 1991). In lieu of tracing, the LDR used certain operating presumptions to determine the extent to which investment adjustments wouldbepermittedtogiverisetoallow- able stock loss. Because the LDR only disallowed loss, noneconomic investment adjustments were able to increase stock basis and thus reduce gain without lim- itation. As a result, the LDR reduced the duplication of gain in the tax system. The IRS and Treasury Department con- sidered the reduction of gain duplication an important balance to the imprecision inherent in the LDR’s use of irrebuttable presumptions. The study following the issuance of Notice 87–14 led the IRS and Treasury Department to consider the issue of loss duplication by members of consolidated groups. Their conclusion was that loss duplication was inappropriate in the con- solidated setting. Further, the IRS and Treasury Department recognized that there were administrative advantages to addressing both issues in a single inte- grated rule. Thus, unlike the regulations under section 337(d), the LDR was at once directed at both the circumvention ofGU repeal through the use of noneconomic stock loss and the duplication of loss. See T.D. 8294 and T.D. 8364. 3.The Rite Aid opinion. Ten years after the promulgation of the LDR, the validity of the duplicated loss component of the LDR was considered in Rite Aid,supra. Under the duplicated loss component of the LDR, Rite Aid had been disallowed a deduction for an economic loss on subsidiary stock solely because the stock loss could be duplicated by the sub- sidiary after it left the group. The Federal Circuit stated that theSecretary’s authority to change the application of a Code provi- sion to a consolidated group was limited to situations in which the change was neces- sary to address a problem created by the filing of a consolidated return. Because duplicated stock loss occurs and is allow- able in the separate return setting, the court concluded that the duplicated loss compo- nent of the LDR was not addressing a prob- lem arising from the filing of a consoli- dated return. Accordingly, the court held that the Secretary did not have the author- ity to change the Code rule allowing a de- duction for the stock loss. 4.The administrative response to Rite Aid. In response to theRite Aiddecision, on February 19, 2002, the IRS announced that it would not continue to litigate the validity of the duplicated loss rule in §1.1502–20. See Notice 2002–11, 2002–1 C.B. 526. February 20, 20075382007–8 I.R.B. On March 7, 2002, the IRS and Treasury Department promulgated §1.1502–20T(i) (to suspend the application of the LDR) and §1.337(d)–2T (to provide an interim rule addressing noneconomic stock loss). See T.D. 8984, 2002–1 C.B. 668 [67 FR 11034] (March 12, 2002). Concurrently with the promulgation of §§1.337(d)–2T and 1.1502–20T(i), the IRS issued No- tice 2002–18, 2002–1 C.B. 644, announc- ing that loss duplication regulations would also be promulgated. Following the publi- cation of T.D. 8984, the IRS and Treasury Department undertook a study of the issues underlying both noneconomic and dupli- cated loss on subsidiary stock. In general, §1.337(d)–2T disallowed stock loss and reduced stock basis (to value) upon the disposition or deconsol- idation of subsidiary stock by a member of a consolidated group. However, under §1.337(d)–2T(c)(2), loss disallowance and basis reduction were avoided to the extent the taxpayer could establish that the loss or basis “is not attributable to the recognition of built-in gain on the disposition of an asset.” Section 1.337(d)–2T(c)(2) defined the term “built-in gain” as gain that is “at- tributable, directly or indirectly, in whole or in part, to any excess of value over basis that is reflected, before the disposition of the asset, in the basis of the share, directly or indirectly, in whole or in part.” On March 14, 2003, the IRS and Treasury Department promulgated §1.1502–35T as an interim measure to address the problem of loss duplica- tion in consolidated groups. See T.D. 9048, 2003–1 C.B. 644 [68 FR 12287] (March 14, 2003). In the preamble to T.D. 9048, the IRS and Treasury Department announced that the issues addressed in §1.1502–35T were still under study. The provisions of §1.1502–35 are discussed in more detail in section D.1 of this pream- ble. Further guidance on the interim rules was issued August 25, 2004, in the form of Notice 2004–58, 2004–2 C.B. 520. In Notice 2004–58, the IRS announced that it would accept the “basis disconformity” method as an alternative approach to de- termining whether stock loss or basis was attributable to “built-in gain” within the meaning of §1.337(d)–2T. Under the basis disconformity method described in Notice 2004–58, stock loss or basis is treated as attributable to built-in gain to the extent of the least of (i) the net positive investment adjustment applied to the stock basis (disregarding distribu- tions), (ii) the aggregate gain (net of di- rectly related expenses) recognized on as- set dispositions by the subsidiary, and (iii) the disconformity amount (generally, the amount by which the basis of the share ex- ceeds the share’s proportionate interest in the subsidiary’s net inside asset basis; for this purpose, net inside asset basis is de- fined as the excess of the sum of the sub- sidiary’s money, asset basis, loss carryfor- wards, and deferred deductions over its li- abilities). Notice 2004–58 also requested comments on the general scope ofGUre- peal and on other approaches that could be adopted to safeguard the purposes ofGU repeal in the consolidated return context. 5.The legislative response to Rite Aid. Congress responded to theRite Aid opinion on October 22, 2004, in the Amer- ican Jobs Creation Act (the AJCA), Pub- lic Law No. 108–357 (118 Stat. 1418 (2004)). In the AJCA, Congress added a sentence at the end of section 1502 of the Code, so that the section now reads: The Secretary shall prescribe such reg- ulations as he may deem necessary in order that the tax liability of any af- filiated group of corporations making a consolidated return and of the each corporation in the group, both during and after the period of affiliation, may be returned, determined, computed, as- sessed, collected, and adjusted, in such manner as clearly to reflect the income tax liability and the various factors nec- essary for the determination of such lia- bility, and in order to prevent avoidance of such tax liability. In carrying out the preceding sentence, the Secretary may prescribe rules that are different from the provisions of chapter 1 that would apply if such corporations filed separate returns. In the legislative history to the AJCA, Congress stated that the Secretary is autho- rized to change the application of a Code provision when the Secretary determines it is necessary to clearly reflect the income tax liability of the group and each corpora- tion in the group, both during and after the period of affiliation. See H.R. Conf. Rep. No. 108–755, 108th Cong., 2d Sess. 653 (2004). Congress thus rejected the sugges- tion in theRite Aidopinion that the Secre- tary’s authority to change the general ap- plication of the Code is limited to promul- gating regulations that address problems created by the filing of a consolidated re- turn. In the AJCA legislative history, Con- gress also spoke to the proper scope of future regulations. Regarding the promul- gation of regulations addressing noneco- nomic stock loss, Congress stated that “presumptions and other simplifying con- ventions” could be used to prevent the circumvention ofGUrepeal. See H.R. Conf. Rep. No. 108–755, fn. 595. In ad- dition, Congress indicated two acceptable methods for addressing loss duplication by group members. The first would dis- allow subsidiary stock loss to the extent it duplicates losses thatremain available to the group. The second would reduce the subsidiary’s attributes in order to prevent the subsidiary from using losses outside the group, to the extent the losses dupli- cate stock loss. But Congress also stated its intention that the result of theRite Aid decision is to be preserved. The IRS and Treasury Department interpret this state- ment to mean that regulations addressing loss duplication by consolidated groups must not disallow a deduction for an eco- nomic loss on subsidiary stock solely because the stock lossduplicates unrecog- nized or unabsorbed losses that later could be used outside the group. 6.Further administrative response to Rite Aid. On March 3, 2005, the IRS and Trea- sury Department finalized §1.337(d)–2. See T.D. 9187, 2005–1 C.B. 778 [70 FR 10319] (March 3, 2005). In T.D. 9187, the IRS and Treasury Department stated that the issues addressed in §1.337(d)–2 were still under study and that an alter- native approach would be proposed. On March 14, 2006, the IRS and Treasury Department finalized §1.1502–35. See T.D. 9254, 2006–13 I.R.B. 662 [71 FR 13008] (March 14, 2006). In T.D. 9254, the IRS and Treasury Department stated that both noneconomic and duplicated loss were still under study, and that regulations would be proposed adopting a singe inte- grated approach to addressing both issues. The results of that study and the proposed 2007–8 I.R.B.539February 20, 2007 integrated approach are described below in sections D through H of this preamble. B.Issues Considered in the Post-Rite Aid Study. 1.GU repeal and noneconomic investment adjustments under the LDR. Section 337(d) generally directs the Secretary to prescribe regulations to pre- vent the circumvention ofGUrepeal and, in particular, section 337(d)(1) directs the Secretary to promulgate regulations to prevent the circumvention ofGUrepeal through the use of the consolidated re- turn regulations. Congress’ concern stems from the general operation of the invest- ment adjustment system of §1.1502–32. The purpose of the investment ad- justment system is to promote the clear reflection of the group’s income. See §1.1502–32(a)(1). One of the princi- pal ways that the investment adjustment system promotes clear reflection is by preventing a subsidiary’s items of income, gain, deduction and loss from giving rise to duplicative gain or loss on the subsidiary’s stock. To that end, the investment ad- justment system adjusts members’ bases in shares of subsidiary stock to reflect such items once they have been taken into account by the group.See T.D. 8560, 1994–2 C.B. 200 [59 FR 41666] (August 15, 1994). Example 1.Economic adjustment to stock basis prevents duplication.P,thecommonparentofacon- solidated group, purchasesall 100 outstanding shares of S common stock for $100 cash, taking a basis of $1 in each share. At the time, S owns one asset, A1, with a basis and value of $100. Later, the value of A1 in- creases to $150. S sells A1 to a nonmember for $150 and recognizes a $50 gain, which the P group takes into account. Under the investment adjustment sys- tem, P increases its basis in its S stock to reflect the $50 taken into account by the group. As a result, the basis of each share increases to $1.50, its fair market value. P can then sell all or any portion of its S stock for its fair market value without recognizing duplica- tive gain on the disposition. The result inExample 1is that the group takes its economic gain into account only once, on the disposition of S’s asset, and not again on the subsequent disposition of the S stock. Thus the group’s income is clearly reflected and there is no circum- vention ofGUrepeal. The investment adjustment system is not a tracing regime. Rather, it is a pre- sumptive regime based on certain operat- ing assumptions. A principal assumption is that all of a subsidiary’s items taken into account represent economic accruals (of gain or loss) to the group. Another princi- pal assumption is that all such items accrue equally to all outstanding shares, at least within a class. When these assumptions correspond to the facts of a particular situ- ation, as inExample 1, the investment ad- justment system produces appropriate re- sults: stock basis, which reflects only the investment in the stock, increases to re- flect economic accrual (the group’s return on its stock investment), and, as a result, stock basis can then shelter that return on the group’s investment, protecting it from being taken into account again when the stock is sold. The assumptions, however, do not cor- respond to the facts of all situations. For example, if stock of a subsidiary is pur- chased for its fair market value when the subsidiary holds appreciated assets, the items of income or gain generated when that appreciation is recognized do not rep- resent an economic accrual on the group’s investment (because the appreciation was already reflected in the basis of the stock). Nevertheless, the presumptive rules of the investment adjustment system treat such items as economic accruals and include them in the investment adjustment to be applied to the basis of the stock. Example 2.Noneconomic adjustment to stock ba- sis creates noneconomic stock loss.Assumethesame facts as inExample 1except that P does not purchase the stock of S until the value of A1 has increased to $150. Accordingly, P purchases the stock for $150, taking a basis of $1.50 in each share. As inExample 1, when S sells A1, the investment adjustment sys- tem again increases P’s basis in its S stock to reflect the $50 taken into account by the group. As a result, P’s basis in each of its shares increases to $2, even though the fair market value of each share remains $1.50. If P were then to sell all or some portion of the S stock for its fair market value, P would recognize a $.50 loss on each share ($50 loss in the aggregate). In this situation, a deduction for the stock loss would be inappropriate because neither the group nor its members have suffered any economic loss. If P were al- lowed to deduct that noneconomic loss, the deduction would offset the gain recognized on S’s asset and, effectively, eliminate the corporate-level tax on the gain on S’s as- set. This is the circumvention ofGUre- peal that concerned Congress in 1986. AtthetimeNotice87–14wasissued, the IRS and Treasury Department had identified the creation of noneconomic stock loss in situations similar to those illustrated inExample 2. Thus, Notice 87–14 referred specifically to investment adjustments attributable to the disposition of assets that, at the time of the acqui- sition of the subsidiary stock, had a fair market value in excess of adjusted ba- sis. For that reason, §1.337(d)–1, which implemented Notice 87–14, disallowed subsidiary stock loss unless the taxpayer could show that the loss was not attribut- able to the recognition of appreciation on assets owned, directly or indirectly, by a subsidiary when it became a member. 2.Duplicated loss and the clear reflection of group income under the LDR. In the study that followed the issuance of Notice 87–14, the IRS and Treasury De- partment also considered the issue of loss duplication by members of a consolidated group. The specific concern of the IRS and Treasury Department was the loss duplica- tion that occurs when an economic loss is reflected in both a member’s basis in sub- sidiary stock and in the subsidiary’s assets or operations, and the loss is first recog- nized with respect to the stock. Example 3.Duplication of loss. P forms S by contributing $110 to S in exchange for all 100 out- standing shares of S stock. S uses the cash to pur- chase an asset, A1. The value of A1 later declines to $10. If P were then to sell all or some portion of the S stock for its fair market value, P would recognize a $1 loss on each share. In this situation, even though P would have recognized the group’s economic loss on its disposition of the S stock, the loss continues to be reflected in the basis of A1. Asaresult,thatlosswouldremain available for use by P (if the stock sale did not deconsolidate S) or S (if the stock sale deconsolidated S). Upon the disposi- tion of A1, the group’s single economic loss would thus be recognized and taken into account more than once by the group and its members or former members. In contrast, if the duplicated loss had first been taken into account with respect to A1, the investment adjustment system would have prevented a duplicative ben- efit to the group and its members by re- ducing P’s basis in S stock by the amount of the loss. In that case, the group would have enjoyed the tax benefit attributable to the loss, but that benefit would not remain available for another use by the group and its members or former members. February 20, 20075402007–8 I.R.B. The IRS and Treasury Department con- cluded that the duplication of a group’s tax benefit (represented by a single eco- nomic loss) distorts income without re- gard to whether the duplicated loss is taken into account first with respect to the subsidiary’s stock or first with respect to the subsidiary’s assets and operations. The IRS and Treasury Department fur- ther concluded that, even if the duplicated loss is used by a former member outside the group, that duplicative use distorts the income of the group and its mem- bers. Accordingly, the IRS and Treasury Department decided to promulgate regu- lations that would complement the invest- ment adjustment system by addressing the stock-first recognition of a duplicated loss and that such regulations would apply to both deconsolidating and nondecon- solidating dispositions. Recognizing the administrative benefits of addressing both noneconomic and duplicated stock loss in asingleintegratedrule, the IRS and Trea- sury Department promulgated the LDR as a single rule with components directed at both. The method adopted by the LDR to address loss duplication was the disal- lowance of stock loss (or reduction of stock basis) that duplicated unrecognized inside loss, such as that illustrated inEx- ample 3. However, groups had several mechanisms available to recognize or pre- serve the inside loss and thereby avoid loss disallowance (by eliminating loss dupli- cation). Inside losses could be recognized through an actual asset sale or a deemed asset sale under section 338(h)(10), and, following the sale, the subsidiary’s un- absorbed losses would be available to the group. In addition, the LDR allowed the common parent to elect to reattribute the subsidiary’s losses (to itself) under §1.1502–20(g). If the group chose not to exercise those options, then the stock loss was denied, but the inside loss was preserved for a nonduplicative use by the subsidiary, in or out of the group. At the time the LDR was promulgated, the duplication potential illustrated inEx- ample 3was the principal form of loss du- plication with which the IRS and Treasury Department were concerned. Thus it is the only form of loss duplication specifically addressed by the LDR. The anti-abuse rule in the LDR did, however, provide a limited mechanism for expanding the scope of that provision. 3.Noneconomic and duplicated loss resulting from investment adjustments allocated to shares with disparate bases. Since the promulgation of the LDR, the IRS and Treasury Department have become increasingly concerned with the noneconomic and duplicated loss potential arising from the interaction of §1.1502–32 and the disparate reflection of gain or loss in members’ bases in individual shares of subsidiary stock. As discussed in section B.1 of this pre- amble, the investment adjustment system is a presumptive regime that allocates a subsidiary’s items of income, gain, deduc- tion, and loss taken into account by the group. It operates in accordance with the assumption that all such items reflect eco- nomic accruals to all shares equally within each class. When its underlying assump- tions correspond to the facts of a partic- ular situation, the investment adjustment system produces appropriate results, as il- lustrated inExample 1.Butwhenitsun- derlying assumptions do not correspond to the facts of a situation because shares held by members have disparate bases, the general operation of the investment adjust- ment system can give rise to both noneco- nomic and duplicated loss on individual shares of subsidiary stock. Example 4.Noneconomic loss. P and M (a mem- ber of the P group) form S by contributing property to S in exchange for all 100 outstanding shares of S stock. P contributes A1, with a basis and value of $80, in exchange for 80 shares of S stock. M con- tributes A2, with a basis of $0 and a value of $20, to S in exchange for 20 shares of S stock. S then sells A2 for $20 and recognizes a $20 gain that is taken into account by the group. As a result, the basis of each share increases by $.20. P’s basis in each of its shares is then $1.20 (or, $96 in the aggregate), and M’s basis in each of its shares is then $.20 (or, $4 in the aggre- gate), even though the value of each share remains $1. P then sells all or some portion of its shares to X, a nonmember, and, under general principles of tax law, recognizes a $.20 noneconomic loss on each share, effectively eliminating up to $16 of the gain on A2. Example 5(a).Duplicated loss, inside recogni- tion precedes stock disposition. P forms S with $100 and receives all 50 shares of S common stock. S uses the $100 to buy A1, which then declines in value to $50. P contributes another $50 for a second 50 shares of common stock. S then sells A1 and recognizes a loss of $50 that is taken into account on the P group return. The absorption of the $50 loss results in a $.50 reduction to the basis of each share (original and newly issued). P then sells all or some portion of the original shares to X for $1 each (each with a basis of $1.50) and recognizes a $.50 loss on each share (up to $25 total). Although the $50 asset loss and the $25 stock loss both reflect an economic loss of the group, they are both reflecting the same loss. The group has actually experienced only $50 of economic loss. Therefore, the $.50 loss recognized on each of the original shares (up to $25 total) is duplicative. Example 5(b).Duplicated loss, stock disposition precedes inside recognition. The facts are the same as inExample 5(a), except that, before S sells A1, P sells 20 of its original 50 shares to X for $20 (aggre- gate basis $40), recognizing a $20 loss that is taken into account on the P group return, and S remains a member of the group. S then sells A1, recognizing a $50 loss that is taken into account on the P group return. Although the $50 asset loss and the $20 stock loss both reflect an economic loss of the group, they are both reflecting the same loss. As inExample 5(a), the group has actually experienced only $50 of eco- nomic loss. Therefore, $20 of the recognized loss is duplicative. Alternatively, if P sold all its original 50 shares, P would recognize a $50 loss even though the entire $50 group loss would remain available to S for a duplicative use against its separate year income. The IRS and Treasury Department rec- ognize that, in each case where the dispro- portionate reflection of an item in a par- ticular share causes an inappropriate stock loss, whether noneconomic or duplicated, that loss is offset by unrecognized gain in other shares. However, that gain can be deferred indefinitely or even eliminated by the group. Accordingly, the IRS and Trea- sury Department do not believe that the system is appropriately balanced in such cases. The IRS and Treasury Department fur- ther recognize that these issues could be addressed by adopting a tracing-based approach to the allocation of investment adjustments. However, the complexity and burden of a tracing-based approach would render such an approach generally inadministrable for consolidated taxpay- ers and for the government. As a result, the system would be prone to error and, in practice, inconsistently applied. More- over, the IRS and Treasury Department continue to believe that the assumptions on which the investment adjustment sys- tem is based are appropriate for typical commercial transactions, as the IRS and Treasury Department understand that typi- cally subsidiaries have only common stock outstanding, that their stock is wholly owned by group members, and that mem- bers’ bases in shares of subsidiary stock are uniform, as under the facts ofExam- ple 1. See section E.2 of the preamble of CO–30–92, 1992–2 C.B. 627 [57 FR 53634, 53639] (November 12, 1992). 2007–8 I.R.B.541February 20, 2007 Because a tracing-based approach to the allocation of investment adjustments would not be administrable, the IRS and Treasury Department are not considering revising the investment adjustment system to adopt such an approach. Instead, the IRS and Treasury Department have con- sidered various presumptive approaches that could be adopted to mitigate the cre- ation of noneconomic and duplicated loss when members hold subsidiary stock with disparate bases. The approaches consid- ered and decisions reached are discussed in section E of this preamble. 4.Redetermination events: changes in the extent that unrecognized gain or loss is effectively reflected in the basis of individual shares. Because the investment adjustment sys- tem adjusts the basis of each share in accor- dance with its proportionate interest in S’s assets and operations, the relationship be- tween a share’s basis and its allocable por- tion of unrecognized appreciation or de- preciation determines the extent to which such amounts are effectively reflected in the basis of the share. This relationship, however, is not fixed at the time that stock is acquired. The reason is that there are many transactions, referred to here as re- determination events, that alter either the basis of a share or the interest it repre- sents. These events generally occur in one of three types of situations. a.Stock basis is reallocated. The relationship between the basis of a share and the interest represented by the share can be altered whenever stock ba- sis is reallocated among shares, including when it is allocated to shares of stock of other members. Example 6.Intragroup spin-off. P forms S by contributing $100 to S in exchange for all the stock of S. S purchases two assets, A1 and A2, for $50 each. Subsequently, A1 appreciates to $75 and A2 depreciates to $25. In a transaction qualifying under sections 355 and 368(a)(1)(D), S transfers A2 to C in exchange for all of the C stock and S then distributes all the C stock to P. Under section 358 and §1.358–2, P’s basis in the S stock is allocated among the S and C stockinproportiontothevalueofthestockofSand C. As a result, P’s basis in its S stock is $75 (75/100 x $100) and P’s basis in its C stock is $25 (25/100 x $100). S sells A1 for $75, recognizing a $25 gain that is taken into account on the P group return. P’s basis in its S stock increases by $25, from $75 to $100. P then sells its S stock for $75 and recognizes a $25 loss. In thisExample 6, after the realloca- tion of stock basis, P’s basis in its S stock reflects the unrecognized appreciation on A1, just as P’s basis in its S stock reflected unrecognized appreciation on A1 inExam- ple 2. As a result, P’s reallocated S stock basis protects the appreciation on A1 from being recognized as both asset gain and stock gain. Increasing P’s basis in its S stock to reflect the recognition of S’s gain on A1 is not only unnecessary, it inflates stock basis and thereby gives rise to either noneconomic loss or noneconomic reduc- tion of gain when the stock is sold. Basis reallocations, and the conse- quences described, can occur for a num- ber of reasons, including, for example, under rules like §1.1502–32(c)(4) (cu- mulative redetermination of investment adjustments) and §1.1502–35(b) (basis re- determination to reduce disparity) and the corresponding provision in these proposed regulations. b.Capital transactions expand or contract the subsidiary’s pool of assets. The relationship between the basis of a shareandthenatureoftheinterestrepre- sented by the share can also be altered by capital transactions that have no effect on the basis or value of outstanding shares, but that nevertheless alter the interest rep- resented by those share. Some common examples arise in the context of section 351 exchanges, even though, as illustrated inExample 7(a), a section 351 exchange in its simplest form cannot give rise to stock basis that reflects unrecognized apprecia- tion. Example 7(a).Contribution of appreciated asset in section 351 exchange. P forms S by contributing an asset, A1, to S in exchange for all 80 outstanding shares of S stock. The basis of A1 is $40 and its value is $80. S sells A1 and recognizes a $40 gain that is taken into account by the P group. As a result, P’s aggregate basis in its S shares is increased by $40, from $40 to $80. Subsequently, P sells its S stock for $80, the stock’s fair market value, and recognizes $0 on the sale. The group is thus taxed once on its $40 economic gain. InExample 7(a), P holds appreciated S stock and S holds an appreciated asset, but that appreciation is not reflected in either P’s basis in its S stock or S’s basis in its as- set. Each share has a basis of $.50 and an interest in 1/80 of S’s asset, A1, which has $40 of unrecognized appreciation (alloca- ble $.50 to each share). If this relationship between P’s basis in its S shares and the interest represented by the shares remains constant, as inExample 7(a), the invest- ment adjustment system produces appro- priate results. But if there is a change in that relationship, the underlying assump- tions of the investment adjustment system may no longer correspond to the facts of the situation and, as a result, the general operation of the system could produce in- appropriate results. Such changes can oc- cur whenever S acquires property in ex- change for additional shares of its stock. Example 7(b).Contribution of appreciated asset in subsequent section 351 exchange creates discon- formity in original shares.Thefactsarethesameas inExample 7(a), except that, before A1 is sold, P con- tributes a second asset, A2, to S in exchange for an additional 20 shares of S stock. A2 has a basis of $0 and a value of $20. S sells both assets and recognizes a $60 gain that is taken into account by the P group. As a result, P’s basis in its original shares increases by $48 ($.60 per share), from $40 to $88 (or, from $.50 to $1.10 per share), and P’s basis in its new shares in- creases by $12, from $0 to $12 (or, from $0 to $.60 per share). P then sells 20 of its original shares (basis of $22) for $20, their fair market value, and recog- nizes a $2 loss. InExample 7(b), P’s basis in the origi- nal S stock reflected no unrecognized ap- preciation when the stock was issued. Af- ter the second contribution, however, P’s basis in those shares reflects a portion of the unrecognized appreciation on A2. The reason is that each share represents an in- terest in S’s entire pool of assets. When the pool changes, the nature of the inter- est represented by the shares changes, even though the share’s basis and value remain constant. Thus, inExample 7(b),while each original share’s basis ($.50) and value ($1) remain constant, the interest repre- sented by each share changed from 1/80 of an asset with unrecognized appreciation of $40 (or, $.50 per share), to 1/100 of assets with unrecognized appreciation of $60 (or, $.60 per share). This shift causes the ba- sis of each original share to reflect $.10 of unrecognized appreciation. When the gain is recognized, $.10 of the gain allocated to each original share under the investment adjustment system is a noneconomic in- crease in the share’s basis. That increase will give rise to noneconomic stock loss or gain reduction. Although this (noneco- nomic) allocation of the (economic) item results in an offsetting stock gain on the basis of the new shares, that gain can be indefinitely deferred and even eliminated. The principles that increase the reflec- tion of unrecognized appreciation in the February 20, 20075422007–8 I.R.B. original shares inExample 7(b)can also cause the reflection of unrecognized ap- preciation in the basis of shares that are received in exchange for property that is not appreciated, including cash. Although such shares would have a substituted ba- sis (which generally precludes the reflec- tion of unrecognized appreciation, as il- lustrated inExample 7(a)), the reflection of unrecognized appreciation is prevented only if the shares represent, wholly and solely, the transferee’s interest in its trans- ferred property. If there are previously is- sued shares outstanding, or if other shares are issued in the exchange, the shares rep- resent an interest in a pool of assets that includes more than the transferred assets. As a result, the interest represented by each such share may be significantly different from what it would be if the subsidiary held only the transferred property. Example 7(c).Multiple transferors in single sec- tion 351 exchange. The facts are the same as inEx- ample 7(a), except that, when P contributes A1 to S in exchange for 80 shares of S stock, M (another mem- ber in the group), also contributes $20 cash to S in exchange for 20 shares of S stock. S sells A1 for $80 and recognizes a $40 gain that is taken into account by the group. Accordingly, P’s aggregate basis in its shares increases by $32 (80/100 x $40), from $40 to $72, and M’s aggregate basis in its shares increases by $8 (20/100 x $40), from $20 to $28. M then sells its shares for $20, their fair market value, and recog- nizes an $8 noneconomic loss. Similar changes in the extent to which unrecognized amounts are reflected in ba- sis can occur whenever the subsidiary’s pool of assets is increased or decreased by a capital transaction. The reason is that the interest represented by each share, and thus the relationship between a share’s basis and the interest represented by the share, changes whenever the subsidiary’s pool of assets changes. Such transactions include acquisitive reorganizations (if new shares are issued) and redemptions. c.Assets are acquired with a basis that reflects unrecognized appreciation. The relationship between the basis of a share and the nature of the interest rep- resented by the share can also be altered by transactions in which S acquires assets with a basis that reflects unrecognized ap- preciation, such as stock of a new member. The reason is that, after the lower-tier ac- quisition, the S shares have an interest in unrecognized appreciation and the invest- ment adjustment system will increase the basis of the S shares when those lower-tier items are recognized. Example 8.Acquisition of lower-tier subsidiary with appreciated assets. P forms S by contributing $100 to S in exchange for all the stock of S. S then purchases all the stock of T for $100 when T holds one asset, A1, with a basis of $0 and a value of $100. T sells A1, recognizing a $100 gain that is taken into account on the P group return. As a result, both S’s basis in its T stock and P’s basis in its S stock are increased by $100, from $100 to $200. P then sells its S stock, recognizing a $100 loss. The result is the same noneconomic loss illustrated inExample 2. d.Other redetermination events. The IRS and Treasury Department ex- pect that other transactions and events can alter the extent to which unrecognized as- set appreciation is reflected in stock basis. Accordingly, the preceding discussion is not intended to present an exhaustive list of possible redetermination events. e.Conclusions regarding redetermination events. The IRS and Treasury Department rec- ognize that redetermination events occur as the result ofbona fidebusiness transac- tions engaged in frequently and routinely throughout the time a share is held by any member of the group, and that these trans- actions are typically not tax-structured transactions. Still, these events generate a significant potential for noneconomic stock loss or gain reduction that facilitates the circumvention ofGUrepeal. Accord- ingly, the IRS and Treasury Department believe that all such events, whether de- scribed in this preamble or not, must be taken into account in any model that is adopted to address the circumvention of GUrepeal. Nevertheless, the IRS and Treasury Department recognize, and are concerned that, the factual analysis necessary to identify all redetermination events for all members’ shares would be an extensive, complex, difficult,and, therefore, ex- pensive undertaking and, as such, would impose a substantial burden on both tax- payers and the government. Moreover, the nature of the undertaking would make it prone to error and, as a result, the rule would be unevenly administered and sim- ilarly situated taxpayers would not be similarly treated. The IRS and Treasury Department rec- ognize that redetermination events can also create or increase the extent to which the basis of an individual share duplicates an inside loss. However, because dupli- cated loss is measured at the time that a stock loss is either recognized or pre- served for later use, loss duplication rules by their operation account for redetermi- nation events. Accordingly, regulations addressing loss duplication do not gener- ally require specific provisions to address redetermination events. C.Methods Considered to Implement GU Repeal. The IRS and Treasury Department con- sidered a number of approaches to address the circumvention ofGUrepeal indepen- dently from the issue of loss duplication. The approaches fall into two broad cate- gories: tracing-based and presumptive ap- proaches. 1.Tracing-based methods. Under a tracing-based method, the ex- tent to which a member can enjoy the ben- efit of subsidiary stock basis attributable to the recognition of an item of income or gain is determined by the extent to which the recognized item is reflected in the ba- sis of the share and thus already protected from duplicative recognition on a later dis- position of the stock. The IRS and Trea- sury Department continue to believe that tracing is a theoretically correct method for implementingGUrepeal in the consol- idated return settingand so considered var- ious tracing-based proposals. a.Pure tracing. In general, a tracing approach would look solely to the connection between a subsidiary’s recognized items and any ap- preciation reflected in stock basis in order to determine the extent to which the group will be allowed the benefit of stock ba- sis attributable to those items. However, such an approach would require taxpayers to create and maintain (and the IRS to ex- amine) records to establish: •the identity of every “tainted asset,” that is, every asset held by the sub- sidiary and any lower-tier subsidiaries on every “measuring date,” which 2007–8 I.R.B.543February 20, 2007 includes the date on which the mem- ber (or its predecessor) purchased the share and all subsequent dates on which the subsidiary has a redetermi- nation event; •the “tainted appreciation,” that is, the appreciation on each tainted asset held by the subsidiary and any lower-tier subsidiaries on each measuring date; and •the extent to which tainted apprecia- tion is recognized, whether as income or gain, and included in an adjustment to the basis of the share. In addition, to fully benefit from a trac- ing regime, taxpayers would need to cre- ate and maintain similar records for tainted assets with unrecognized depreciation on a measuring date, because the recognition of that depreciation would be allowed to reduce the amount of recognized appreci- ation treated as tainted. These records would have to be cre- ated and maintained for each share of stock of each subsidiary and each share of lower-tier subsidiary stock held by a subsidiary on each measuring date. In addition, these records would need to be created and maintained not just for sub- sidiaries, but for all corporations the stock of which is acquired by a member, because the information would be necessary if the corporation becomes a member at some later date. In administering thevarious temporary and final regulations promulgated as loss limitation rules under §1.337(d)–1 and §1.337(d)–2, the IRS has found that tax- payers encounter substantial difficulty in attempting to satisfy these requirements. To begin, taxpayers are generally un- able to accurately identify all of a sub- sidiary’s tainted assets. One reason is sim- ply the vast number of assets implicated. Another reason is that many assets are accounted for in mass accounts and thus cannot be separately identified. Problems are exacerbated if appropriate records are not created contemporaneously; taxpayers have found this a particular concern when subsidiaries have been acquired with inad- equate records. Furthermore, the commonplace nature of many redetermination events makes it difficult to identify all such dates. For example, many taxpayers routinely issue stock when a member contributes cash or property to a subsidiary, even if the is- suance of stock would not be required for section 351 to apply, and each such occur- rence is a redetermination event. Valuation also imposes significant fi- nancial and administrative burdens on both taxpayers and the government. These problems are exacerbated because the cor- poration’s assets are not themselves the subject of an arms-length transaction and, in most cases, the date on which the assets are actually valued is long after the stock transaction. The most problematic aspect of tracing, however, has typically been establishing the connection, or lack thereof, between items taken into account by the group and particular amounts of tainted appreciation. If much time has elapsed between a mea- suring date and the disposition of a tainted asset, or if an asset is held in a mass ac- count, this can be difficult or even impossi- ble. If tainted appreciation is recognized as income earned through the wasting or con- sumption of the appreciation, instead of as gain on the disposition of the asset, there are additional difficulties. In those cases, tracing is possible only if the tainted ap- preciation generatesan identifiable stream of income. However, this is frequently not the case. For example, intangible assets, like patents or goodwill, are the source of significant taintedappreciation and they typically do not generate identifiable in- come streams. i.Conclusions regarding tracing. For all the reasons set forth in this pre- amble, the IRS and Treasury Department have again, as in 1990, concluded that tracing is not a viable method for pre- venting the circumvention ofGUrepeal in consolidation. This conclusion, while arguably based on theoretical concerns in 1990, is now based on several years of ad- ministering §1.337(d)–2 (in both its tem- porary and final form) as a tracing regime. The IRS found that the difficulties encoun- tered, by taxpayers and the government alike, in administering §1.337(d)–2 as a tracing-based rule were overwhelmingly greater than those encountered in admin- istering it as a presumption-based rule un- der the basis disconformity method per- mitted under Notice 2004–58. Accord- ingly, the IRS and Treasury Department are not proposing to adopt a tracing-based approach. ii.Tracing in other contexts. The IRS and Treasury Department recognize that tracing-based regimes are used to implement other provisions in the Code. For example, section 382(h), which prescribes the tax treatment of built-in items recognized by a corporation that has had an ownership change, and section 1374, which prescribes the tax treatment of built-in items recognized by an S corpo- ration that was formerly a C corporation, both use tracing-based regimes. Further, the IRS and Treasury Department are proposing regulations implementing sec- tion 362(e)(2) in a consolidated return context that require certain items to be traced. See section H of this preamble. The tracing regimes appropriate for those sections, however, do not present compliance and administrative concerns of the scope and magnitude presented by a tracing regime appropriate forGUrepeal in the consolidated setting for at least three reasons. To begin, both sections 382(h) and 1374 apply only for a limited period of time—five years in the case of section 382(h) and ten years in the case of section 1374—and so whatever burden is imposed is more limited in nature. More importantly, sections 382(h) and 1374 are generally concerned only with the unrecognized appreciation and depre- ciation in a pool of assets held by a cor- poration on a single date—the date the C corporation convertstoanScorporation or the date the S corporation acquires as- sets of a C corporation in the case of sec- tion 1374, and the date a corporation has an ownership change in the case of sec- tion 382(h). Similarly, section 362(e)(2) is only concerned with net unrecognized de- preciation in a pool of assets on the date of the transaction to which section 362(e)(2) applies. But the ability to circumventGU repeal using the consolidated return pro- visions can be created any time the sub- sidiary has a redetermination event. Thus, any rule implementingGUrepeal in the consolidated context, unlike rules imple- menting sections 362(e)(2), 382(h), and 1374, must trace the pool of assets held on all measuring dates, and not just the pool February 20, 20075442007–8 I.R.B. of assets held when subsidiary stock is ac- quired (or when assets are transferred). Finally, unlike regulations implement- ingGUrepeal, regulations implementing those other sections do not need to take into account the changing relationship be- tween the basis in a particular share of stock and the unrecognized appreciation and depreciation in the corporation’s as- sets. For these reasons, any tracing-based regime appropriately implementingGU repeal in the consolidated setting would be much more expansive and complex, and therefore much less administrable, than the tracing regimes appropriately im- plementing sections 382(h) or 1374 (or proposed to implement section 362(e)(2)). b.Modified tracing. The IRS and Treasury Department con- sidered several approaches that could be adopted to modify a tracing model by lim- iting the extent to which tracing would be required, in order to mitigate the adminis- trative burdens of a pure tracing model. i.Exclusion for items attributable to after-acquired assets. Several commentators have suggested an approach, generally called the “after-ac- quired asset exception,” which allows tax- payers to identify assets acquired after the acquisition of subsidiary stock, in order to treat any gain realized on those assets as economic to the group. In general, all other items of gain and income would be deemed to be noneconomic, that is, attributable to the recognition of appreciation that was al- ready reflected in basis. Stock loss would be allowed only to the extent that stock ba- sis was attributable to the amounts deemed economic to the group. In response to con- cerns raised by the IRS and Treasury De- partment about redetermination events, the proposal was modified to provide that only assets acquired after the latest measuring date would be treated as giving rise to eco- nomic amounts. The principal advantage of this approach is that it identifies some untainted items with no need for valuation. To begin, the IRS and Treasury Depart- ment are concerned with the burden and er- ror potential presented by the need to iden- tify all redetermination events. Moreover, because these events can occur with con- siderable frequency in the ordinary course of business, it is unlikely that a great deal of time will typically elapse between the last redetermination date and the date of a stock disposition. Thus, the amount of gain recognized on an asset acquired and sold during such periods of time will not likely be significant.As a result, it appears unlikely that this approach would afford much relief to taxpayers (in terms of ad- ministrative burden or reducing the disal- lowance amount) or to the government (in terms of administrative burden). Furthermore, in order to implementGU repeal appropriately, such an approach must take into accountnot only gains, but also losses, recognized on after-acquired assets. But the identification of such losses imposes an additional administrative bur- den that taxpayers have no incentive to facilitate. In any event, a requirement to take losses into account could be easily manipulated by the timing and structuring of redetermination events. ii.Exclusion for items recognized after prescribed period of time. Several commentators also suggested a tracing-based approach that would apply to investment adjustments taken into ac- count only during a prescribed period of time following the acquisition of a share. The chief advantage to this approach is that, regardless howburdensome the ad- ministration of the rule, it would not ex- tend indefinitely. Like the proposed after-acquired-asset approach, however, this approach would need to take redetermination events into account. The tracing period would then begin again on the date of each redetermi- nation event. Thus, like the after-acquired- asset exception, this approach is unlikely to afford much relief to taxpayers (in terms of administrative or tax burden) or the gov- ernment (in terms of administrative bur- den) because the period for tracing may never close. Moreover, the IRS and Treasury De- partment are concerned that such an ap- proach does not adequately respond toGU repeal. The reason is that noneconomic in- vestment adjustments circumventGUre- peal whenever they are taken into account. Thus, the IRS and Treasury Department continue to believe that, in the absence of any direction from Congress, such as in the case of section 1374, imposing time limits on the implementation ofGUrepeal would be inappropriate. See T.D. 8294. iii.Exclusion for basis conforming acquisitions. Commentators have also suggested adopting a tracing-based approach that excepted any stock acquired in either a section 351 exchange or a qualified stock purchase for which an election was made under section 338. The rationale for this approach is that, by operation of statute, the basis of stock acquired in these transactions can reflect no unrecognized appreciation. The IRS and Treasury Department agree that, in certain circumstances, the structure of a stock acquisition will, by operation of law, preclude the reflection of unrecognized appreciation in stock ba- sis. The IRS and Treasury Department are concerned, however, that many acqui- sitions under section 351 or section 338 actually do not preclude the reflection of unrecognized asset appreciation in stock basis. For example, if subsidiary stock is acquired in a section 351 exchange in multiple transactions or by multiple trans- ferors, as illustrated inExample 7(b)and Example 7(c), respectively, the basis of the shares received can reflect unrecognized appreciation. Similarly, because only 80 percent of the stock of a subsidiary need be acquired to elect section 338 treatment, the basis of up to 20 percent of a sub- sidiary’s shares mayreflect unrecognized appreciation. Moreover, even if the ini- tial acquisition precludes the reflection of unrecognized gain, once there is a redeter- mination event, the form of the acquisition no longer prevents the reflection of unrec- ognized appreciation in stock basis. Thus, very few, if any, such transactions would ultimately qualify for this exception. Thus, like the two previously described approaches to modified tracing, this ap- proach has the inaccuracy and burden as- sociated with identifying redetermination dates and a limited potential for relief to either taxpayers or the government. iv.Conclusions regarding modified tracing. Each approach considered would in- crease the administrative burden signif- icantly without significantly increasing precision or relief. Accordingly, the IRS 2007–8 I.R.B.545February 20, 2007 and Treasury Department are not propos- ing to adopt any of these approaches. 2.Hybrid tracing-presumptive model: asset tracing. The IRS and Treasury Department also considered a hybrid tracing-presumptive approach that would identify all assets held when a share is acquired and on each redetermination date thereafter (again, the “tainted assets”) and then presume all items of income, gain, deduction, and loss traced to those assets to be tainted. The in- tent was to design an approach that would be more precise than either a modified tracing or purely presumptive approach, while being more administrable than a pure tracing-based approach. The chief advantages of this approach are that it may enhance precision and, like the after-ac- quired asset exception described in section C.1.b.i of this preamble, may eliminate any need for valuation. However, like the modified tracing ap- proaches described above, this approach would require the identification of all rede- termination events. Furthermore, it would require the identification of all assets held at the time of each such event and the trac- ing of those assets to particular investment adjustments. Thus, it presents even more complexity, burden, and expense than the modified tracing regimes considered. Furthermore, the IRS and Treasury De- partment are concerned that this approach could be easily abused, either by the ma- nipulation of redetermination dates or the use of intercompany transactions to make valuation elective.(That is, taxpayers could selectively engage in intercompany transactions so that, in effect, some assets would be valued and not others.) Finally, the IRS and Treasury Depart- ment are not convinced that the approach in fact significantly enhances the precision of a pure presumptive model in light of the fact that there is no actual valuation (and therefore no actual determination that there was any gain reflected in stock ba- sis). For all these reasons, the IRS and Trea- sury Department concluded that the poten- tial advantages of this hybrid tracing-pre- sumptive approach are outweighed by its disadvantages. Accordingly, the IRS and Treasury Department are not proposing to adopt this approach. 3.Presumptive-based models. Recognizing that even the hybrid trac- ing-presumptive model would present significant burden and imprecision, the IRS and Treasury Department considered various presumptive models that, like the LDR, would eliminate all elements of tracing. A principal advantage of such approaches is that they are readily admin- istrable by both taxpayers and the IRS. Thus, the rules can apply uniformly and consistently, with the result that simi- larly situated taxpayers will be similarly treated, increasing theoverall fairness of the system. The elimination of any tracing element, however, increases the impor- tance of limitations, where appropriate, on the nature and amount of items treated as noneconomic to a share. The approaches considered are discussed in this section C.3 and in section C.4 of this preamble. a.Basis disconformity under Notice 2004–58. One model considered was the ba- sis disconformity model described in Notice 2004–58, presently available as a method to avoid disallowance under §1.337(d)–2. AsnotedinsectionA.4of this preamble, the basis disconformity model treats as built-in gain (within the meaning of §1.337(d)–2) the smallest of three amounts. The first is the basis dis- conformity amount (which identifies the minimum amount of built-in gain that could be reflected in the share), the sec- ond is the net positive adjustment amount (which identifies the actual amount of stock basis attributable to the consoli- dated return system), and the total gains on property dispositions (which responds to the definition of the term built-in gain in §1.337(d)–2). A significant advantage of this approach is that both taxpayers and the IRS find it readily administrable with information that taxpayers are already re- quired to maintain. However, the Notice 2004–58 basis dis- conformity model, because it is an inter- pretation of the current loss limitation rule in §1.337(d)–2, reflects limitations that in- hibit the extent to which the rule addresses the circumvention ofGUrepeal and pro- motes the clear reflection of group income. For example, the model did not account for the consumption of unrecognized appreci- ation reflected in stock basis (the “wasting asset” problem). Thus, if unrealized gain reflected in stock basis was recognized as income (for example through a lease, in- stead of a disposition of the property), the resulting noneconomic stock loss was not disallowed under the current rule. In ad- dition, the model did not address the prob- lem of basis disparity. (See, for example, Example 4.) A more significant concern, however, is that the basis disconformity approach is underinclusive in that it can only address noneconomic stock loss to the extent of net appreciation reflected in stock basis, which is, by its nature, reduced by unrec- ognized depreciation reflected in basis. As a result, a potentially significant amount of noneconomic stock loss remained un- addressed, particularly in deconsolidating dispositions of subsidiary stock. Example 9.Unrecognized loss reflected in stock basis. P purchases all the outstanding stock of S for $150. At the time, S owns one asset, A1, with a basis of $25 and value of $100, and one asset, A2, with a basis of $100 and a value of $50. S sells A1 to a non- member for $100 and recognizes a $75 gain, which the P group takes into account. Under the investment adjustment system, P increases its basis in the S stock by $75, to $225, to reflect the $75 taken into account by the group. If P then sells the S stock for $150 (its fair market value), P will recognize a $75 loss. Un- der the basis disconformity approach, only $25, the excess of P’s S stock basis ($225) over S’s net inside asset basis ($100 cash plus S’s $100 basis in A2, or, $200), of the $75 gain is treated as a noneconomic in- vestment adjustment. Thus, although the entire loss is noneconomic, only $25 of that loss would be dis- allowed under this approach. b.Modified basis disconformity. The IRS and Treasury Department con- sidered several modifications to the basis disconformity model, all of which were in- tended to address the underinclusivity of that model. One approach suggested by commentators would mitigate the wasting assets concern by first, for a prescribed pe- riod of time, treating the sum of all prop- erty gains and, up to the disconformity amount, all income as noneconomic (and thus included in the disallowance amount). After the prescribed time, all gains and in- come would be treated as noneconomic, but only to the extent of the disconformity amount. Other approaches considered re- flected variations on this suggestion. The IRS and Treasury Department rec- ognize that the model described, and any similar models, would be readily adminis- February 20, 20075462007–8 I.R.B. trable, but are concerned that such a model would not adequately preserve the group’s ability to deduct economic loss sustained by the group. The reason is that stock loss could be attributable to economic in- vestment adjustments (adjustments attrib- utable to the recognition of items of in- come and gain that were not reflected in stock basis) that were followed by eco- nomic loss (attributable to a decline in the value of the subsidiary’s assets). For ex- ample, assume that P contributed an asset to S (basis and value of $10), the asset ap- preciated and S sold it for $100 (recogniz- ing a $90 gain that increased P’s basis in S stock to $100), S reinvested the $100 in an asset that declined in value to $10, and P then sold the stock for $10. P would rec- ognize a $90 loss that would be disallowed because S had a $90 gainon the disposition of an asset. Yet the entire loss was an eco- nomic loss. As a result, the IRS and Trea- sury Department are concerned that the re- sult inRite Aid(that the group receive the tax benefit of its economic loss) would not be adequately protected. Ultimately, the IRS and Treasury De- partment concluded that the basis discon- formity model in Notice 2004–58 would not be modified, but that elements of the model would be incorporated in a new ap- proach. 4.The presumptions and simplifying conventions adopted in these proposed regulations. a.Loss limitation model. AsdiscussedinsectionA.2ofthis preamble, when the IRS and Treasury Department rejected a tracing approach in favor of the presumptive approach in 1990, the decision was made to balance the use of irrebuttable presumptions by adopting a loss limitation model. Under a loss limitation model, losses attributable to noneconomic investment adjustments are disallowed, but gain reduction (or elimination) attributable to noneconomic investment adjustments is not. The IRS and Treasury Department believed that allowing noneconomic gain reduction not only balanced the benefits and burdens of the presumptive approach, it also provided the considerable advantage of reducing gain duplication in consolidated groups. Example 10.Noneconomic gain reduction, elim- ination of gain duplication. P purchases all the stock of S for $150 when S holds one asset, A1, with a ba- sis of $100. S sells A1 for $150, recognizing $50 of gain. S uses the $150 proceeds from the sale of A1 to purchase A2. The value of A2 appreciates to $200, and P then sells its S stock for $200. If the investment adjustment system did not adjust stock basis for items attributable to appreciation reflected in basis, P’s basis in S stock would remain $150 and, when P sells the S stock, P would recognize a gain of $50 (reflecting the $50 appreciation in A2). When S sells A2, S would recognize the same $50 of economic gain a second time. However, because P’s basis in S is increased by the $50 gain recognized on the sale of A1, P will recognize no gain or loss on its sale of S stock. The gain on A2 is therefore taxed once, when there is a recognition event with respect to A2. These proposed regulations adopt a loss limitation model for the same reasons such a model was adopted in 1990, in the regu- lations promulgated under section 337(d) and the LDR (to balance the use of a pre- sumptive approach). However, the LDR, as well as §§1.337(d)–1 and 1.337(d)–2, applied the loss limitation model by disallow- ing loss recognized on the disposition of subsidiary stock and reducing basis on the deconsolidation of subsidiary stock. The IRS and Treasury Department recog- nize that the effect of a loss disallowance rule can be achieved by applying a ba- sis reduction rule immediately before the disposition of loss stock. Modifying the loss limitation model to reduce basis in all cases simplifies the structure of the rule by avoiding the need for two distinct rules. b.Amount of basis reduction. The IRS and Treasury Department con- sidered two basic approaches to determin- ing the amount of basis reduction. One would be determined with reference to a share’s adjusted basis and the other would be determined with reference to the dis- conformity between the share’s basis and its allocable portion of the subsidiary’s at- tributes. i.Adj usted purchase price cap. Under this approach, the basis of a transferred loss share would be reduced by the amount that the subsidiary’s items increased the share’s basis, but only to the extent of the adjusted purchase price. For purposes of this rule, the adjusted purchase price would be defined as the holder’s original basis in the stock, ad- justed to take into account all redetermi- nation events. The rationale for this rule is that the adjusted purchase price represents the maximum amount of unrecognized gain that could be reflected in stock ba- sis. However, this cap does not establish that, in fact, there was any appreciation reflected in stock basis and, therefore, it could prove to be substantially overinclu- sive. The IRS and Treasury Department con- sidered several rules that could be com- bined with the adjusted purchase price cap in order to mitigate its potential for over- inclusiveness. One approach would com- bine this cap with the asset tracing model described in this preamble. Another ap- proach would combine this cap with rules that treat income items as included in the basis reduction amount under a different rate (for example, using a declining per- centage over time) or amount (for exam- ple, using an annual income cap, perhaps based on a percentage of the gross items). The IRS and Treasury Department ulti- mately concluded that the limitations ei- ther imposed unacceptable burdens (be- cause of the need to identify redetermina- tion dates and trace assets) or did not sig- nificantly increase the theoretical sound- ness of the approach, and that the poten- tial for overinclusiveness prevented the ap- proach from responding adequately to the Congressional mandate to preserve the re- sult inRite Aid. ii.Modified adjusted purchase price cap. To address the potential overinclusiv- ity of the adjusted purchase price cap, the IRS and Treasury Department considered modifying the rule by reducing the cap by the basis of any tainted assets sold at a gain. The rationale for this modification is that the maximum potential amount of appreciation reflected in basis is reduced by the basis of tainted assets as they are sold. While this modification reduced the potential for overinclusiveness in a theo- retically sound manner, it exacerbated the administrative difficulties by requiring not only the identification of all redetermina- tion dates, but also of all assets held on such dates. Moreover, the IRS and Trea- sury Department ultimately concluded that 2007–8 I.R.B.547February 20, 2007 the basic premise (that the limitation rep- resented the maximum possible noneco- nomic income) remained an inadequate re- sponse to the Congressional directive that the group be allowed to deduct its eco- nomic loss. iii.Disconformity cap. Thismodelwouldalsoreducebasis by the amount that the subsidiary’s items increased the share’s basis, but only to the extent of the disconformity amount. For this purpose, the disconformity amount would generally be the same as the basis disconformity amount described in Notice 2004–58. The rationale for this limitation is that the disconformity amount identifies the minimum amount of unrecognized appreciation actually reflected in the ba- sis of a share of subsidiary stock at the relevant time. Thus, although the amount of such appreciation could actually be considerably greater (as inExample 9), and could even be equal to the adjusted purchase price (assuming a subsidiary was purchasedwithnobasisinanyofitsas- sets), it is not lower. Not only does the disconformity cap have the advantage of identifying an amount of appreciation ac- tually reflected in stock basis, it allows for the computation of that amount with infor- mation taxpayers are already required to know. Additionally, it avoids the need to identify redetermination events because, by computing disconformity immediately before a transfer, this approach automat- ically takes the effect of all such events into account. iv.Modified disconformity cap. Because the use of a disconformity cap raises significant potential for under- inclusivity, as illustrated inExample 9, the IRS and Treasury Department con- sidered increasing the disconformity cap by the amount of unrecognized loss on any tainted assets held by the subsidiary. The rationale for this increase is that those losses could prevent an equal amount of recognized tainted appreciation from be- ing treated as noneconomic. Thus, the rule would not undermine the theoretical foundation of the disconformity cap. However, this approach would require the identification of redetermination dates, as well as the identification and valuation of all assets held on the last such date. Rec- ognizing the imprecision inherent in this approach, the IRS and Treasury Depart- ment considered increasing the disconfor- mity cap by only a discounted portion of those unrecognized losses. The IRS and Treasury Department concluded that this approach would introduce burden and im- precision much greater than the potential benefit obtained by increasing the cap on basis reductions, at least in the majority of commercially typical cases. The IRS and Treasury Department also considered implementing this modifica- tion not as a general rule, but only as an anti-abuse rule, so that it would apply only in circumstances that indicated a signif- icant amount of tainted income or gain might be sheltered by unrecognized loss on tainted assets. For example, such a rule could require an increase to the dis- conformity cap if there was a significant loss in stock, if the subsidiary recognized significant gain shortly before stock sale, or if the stock was held for only a short period of time before it was sold. The IRS and Treasury Department were concerned, however, that the increased uncertainty and burden introduced by such an ap- proach could not be justified in light of the protections against manipulation that exist in the Code and other rules of law. For example, see sections269, 362(e)(2), and 482, as well as variousanti-avoidance and anti-abuse provisions in the regulations, including these proposed regulations. v.Disconformity cap with duplication rule. In considering the structural potential for underinclusivity in the disconformity cap, the IRS and Treasury Department observed that the recognition of noneco- nomic gains in excess of the disconformity amount causes the subsidiary’s unrecog- nized losses to be expressed in stock basis. The facts ofExample 9illustrate this point. In that example, P purchased S for $150 when S held A1 (basis $25, value $100) and A2 (basis $100, value $50). S sold A1 and recognized $75 gain, which increased P’s basis in S to $225. P then sold the S stock and recognized a $75 loss. At the time of the stock sale, S’s net asset basis was $200 (the $100 received for A1 and the basis of A2), which exceeds the value of the stock by $50. Thus, the basis disconformity amount is $25 (the excess of the $225 stock basis over the $200 net asset basis), and so (although there is a $75 recognized gain), only $25 is disal- lowed. However, at that point, S’s $200 net asset basis exceeds S’s $150 value by $50. The $50 of unrecognized loss on A2 is reflected in both P’s basis in S stock and S’s basis in its assets. That is, the loss on A2 has been duplicated. As a result, the underinclusivity of the disconformity cap can be measured and addressed as duplicated loss. The IRS and Treasury Department rec- ognize that addressing this loss as a dupli- cated loss allows taxpayers to accelerate the benefit of a subsidiary’s unrecognized losses (that is, obtain the benefit of the loss without a recognition event with respect to its loss assets). However, this approach allows taxpayers the benefit of their eco- nomic loss while limiting any arguably ex- cessive benefit to the ability to accelerate inside loss. In the end, loss duplication is prevented. (The IRS and Treasury Depart- ment have long recognized that it is ap- propriate for a group to offset recognized built-in gains and losses, see §§1.337(d)–1 and 1.337(d)–2, as promulgated in 1990 and again as temporary and final regula- tions following theRite Aiddecision). vi.Conclusion. In light of the concerns raised by any method that would reduce basis beyond the disconformity amount, the IRS and Treasury Department have concluded that the amount of basis reduction should be limited to the disconformity amount and that combining the disconformity cap with a loss duplication rule to address its un- derinclusivity provides the most appropri- ate balancing of interests. Under this ap- proach, the group’s economic loss is ap- propriately protectedand neither the group nor its members will receive more than one benefit for the subsidiary’s economic loss. c.Items applied to reduce basis. i.Character of items applied to reduce basis. In general, the IRS and Treasury De- partment have concluded, and commenta- tors have generally agreed, that all gains on property dispositions, as well as various February 20, 20075482007–8 I.R.B. gain equivalents, should be fully available to reduce basis under a presumptive rule. Questions arose, however, regarding whether income items should also be fully available to reduce basis. The reasons for these questions center on the general difficulty of tracing income items (which is limited in the best of circumstances) and the observation that the likelihood of a particular income item being attrib- utable to tainted appreciation generally decreases over time. Accordingly, the IRS and Treasury Department considered several proposals to limit both the amount and the rate of inclusion for income items. All of these approaches would segre- gate income that could be traced to par- ticular appreciation reflected in stock basis and treat those amounts in the same man- ner as items of gain. The net income re- maining would be applied to reduce basis according to prescribed limits. For exam- ple, one proposal would apply net income to reduce basis for a prescribed period of time following a measuring date, but, after that time, net income would be so applied only according to a declining percentage. The IRS and Treasury Department are concerned, however, that the approaches considered could be readily manipulated, forexample,byconvertinggainintoin- come that cannot be readily traced to par- ticular assets or by delaying the recogni- tion of income items until after the appli- cable time period. Therefore, any such rule would inappropriately influence the struc- ture of business transactions and, at the same time, fail to provide adequate pro- tection forGUrepeal. In addition, the need to account for redetermination dates would add complexity and diminish the potential relief afforded under any such ap- proach. Moreover, the IRS and Treasury Department identified no theoretical basis for any particular rule and were concerned that the increased precision may be more perceived than real. ii.Capital transfers. Adjustments to reflect transfers of capital, whether contributions or distribu- tions, are not adjustments attributable to the recognition of appreciation or depre- ciation. Accordingly, these adjustments do not increase or decrease the extent to which stock basis is noneconomic or facil- itates the circumvention ofGUrepeal. For that reason, such amounts are not taken into account in determining the extent to which subsidiary stock basis is subject to reduction. Commentators have suggested that the nature of an intercompany cancellation of indebtedness is similar to that of a capital contribution and thus should not be taken into account in determining basis reduc- tion. The IRS and Treasury Department recognize that this may often be the case, but are concerned that, under some circum- stances, this may not be the case. Because it will be administratively very difficult to identify situations in which intercompany cancellation of indebtedness is not simi- lar to a capital contribution, and to distin- guish intercompany cancellation of indebt- edness from other arguably similar cases, these proposed regulations treat items re- lated to intercompany cancellation of in- debtedness like all other items of income or loss. However, the IRS and Treasury Department continue to study the issue and invite further comments. d.Netting of items from different tax periods. Under the LDR, there was no cross-year netting of investment adjustments. Pos- itive investment adjustments were taken into account in determining the loss disal- lowance amount, negative investment ad- justments were not. The IRS and Treasury Department have reconsidered whether items from different tax periods should be considered together in determining basis reduction. The IRS and Treasury Department rec- ognize that the particular circumvention of GUrepeal at issue here is a product of the manner in which the investment ad- justment system adjusts stock basis to re- flect a subsidiary’s amounts that are taken into account by the group. Thus, the IRS and Treasury Department have concluded that the appropriate measure of the con- cern must take into account the net extent to which the basis of a share has been in- creased or decreased by the investment ad- justment system. Whether a loss is taken into account in the same year in which a gain is taken into account or in a separate year does not change the net effect of the investment adjustment system. Thus, un- like the LDR, these proposed regulations allow netting of all investment adjustments made to a share for all periods. e.Summary and conclusions. Only a presumptive approach can elim- inate the substantial administrative bur- dens imposed by the tracing-based and hybrid regimes discussed above. As a result, only a presumptive approach can be applied consistently among taxpayers and thus achieve the overall fairness nec- essary to these regulations. Importantly, if presumptions are rebuttable, the adminis- trative burdens associated with a tracing system are not avoided. In fact, they are exacerbated, because taxpayers will feel it necessary to be prepared to establish, and the government will then need to be prepared to examine, returns using both systems. Accordingly, the proposed regu- lations reflect a presumptive approach that does not permit the rebuttal of its operating presumptions. As noted in section A.5 of this preamble, Congress has specifically sanctioned the use of presumptions and other simplifying conventions to address the circumvention ofGUrepeal. To balance the use of irrebuttable pre- sumptions, the proposed regulations adopt several provisions that are intended to en- hance their overall fairness and theoreti- cal soundness. First, the proposed regu- lations adopt the disconformity amount as the maximum amount of potential stock basis reduction. The reason, as discussed, is that only the disconformity amount both establishes the fact that the taxpayer had unrealized gain reflected in stock basis and identifies the minimum amount of such gain. Second, the proposed regulations in- clude all items taken into account, from all years, in the determination of the basis re- duction amount. Thus, basis is not reduced for certain amounts (such as capital trans- fers) that cannot be attributable to noneco- nomic investment adjustments. In addi- tion, by presuming all items of income, gain, deduction and loss as attributable to appreciation or depreciation reflected in basis, the proposed regulations avoid the administrative burden and other concerns inherent in various tracing and hybrid ap- proaches. Moreover, by presuming all items to be reflected in basis, the benefits and burdens inherent in the use of irrebut- table presumptions are fairly balanced be- tween taxpayers and the government. Pre- 2007–8 I.R.B.549February 20, 2007 suming all items ofincome and gain are noneconomic favors the fisc, while pre- suming all items of deduction and loss are noneconomic favors taxpayers. D.Loss Duplication. The IRS and Treasury Department con- tinue to believe that a group’s income is distorted when the group enjoys more than one tax benefit from an economic loss. Further, the IRS and Treasury Department believe that a subsidiary’s use of a group loss in a separate return year, after the group has already recognized the benefit of the loss, distorts the subsidiary’s sepa- rate year income. Moreover, the IRS and Treasury De- partment do not believe that the manner or order in which a group takes its losses into account affects the extent to which loss duplication is inappropriate. Thus, loss duplication is inappropriate and must be addressed whether arising in situations like that illustrated inExample 3(loss re- flected in both stock and assets) or inEx- ample 5(duplication attributable to dis- parate stock basis). In addition, loss du- plication is inappropriate and must be ad- dressed whether the group chooses to rec- ognize loss first as an inside loss, on the subsidiary’s assets and operations (which is addressed by §1.1502–32), or as a stock loss (which is currently addressed, at least partially, by §1.1502–35). Accordingly, the IRS and Treasury De- partment have returned to a fundamental premise of the LDR and again concluded that a loss duplication rule that operates without regard to members’ continued af- filiation is a necessary complement to the investment adjustment system. The IRS and Treasury Department have also con- cluded that such a rule must also address the potential for loss duplication presented when loss is disproportionately reflected in the bases of individual shares. Importantly, as noted in section A.5 of this preamble, Congress has indicated that it, too, views the prevention of loss duplication, including in deconsolidating stock dispositions, as an area that is ap- propriately addressed by regulation. See H.R. Conf. Rep. No. 108–755 at 652. Therefore, the IRS and Treasury De- partment have reviewed the current rules and considered alternative approaches to address the duplication of loss. 1.Reconsideration of §1.1502–35. Loss duplication is currently addressed in §1.1502–35. That rule generally ap- plies whenever there is a disposition of loss shares of subsidiary stock. To ad- dress the loss duplication problems arising when loss is disproportionately reflected in stock basis, the rule first redetermines members’ bases to reduce that disparity (to address the problems illustrated inEx- ample 5). Different rules apply depending on the subsidiary’s status as a group mem- ber following the stock disposition. If the subsidiary remains a member, the full blending rule of §1.1502–35(b)(1) applies and all members’ bases in shares of the subsidiary’s stock are combined and then allocated evenly to preferred (to value) and then to common (equally). If the sub- sidiary ceases to be a member, the basis redetermination rule of §1.1502–35(b)(2) applies and members’ bases are redeter- minedtoreducelossonallmembers’ shares. However, this rule only rede- termines basis to the extent of items of deduction and loss included in negative adjustments applied to nonloss shares. As under the full blending rule, redeter- mination under this rule first reduces or eliminates loss on preferred shares and then equalizes members’ bases in com- mon shares. The potential for loss duplication fol- lowing the redetermination of members’ bases is addressed only if the subsidiary remains a member of the group. In that case, stock loss (to the extent of loss du- plication) is suspended, the suspended loss is reduced as the subsidiary’s items of de- duction and loss are taken into account, and any suspended loss remaining when the subsidiary ceases to be a member is al- lowed at that time. The regulation does not address the duplication of loss when the subsidiary ceases to be a member, other than to prevent the reimportation of dupli- cated losses backinto the group. The IRS and Treasury Department un- derstand that certain administrability con- cerns have arisen under §1.1502–35. For example, taxpayers have commented that the rules relating to the suspension of loss in nondeconsolidating dispositions and the treatment of reimported losses present sub- stantial compliance issues. The experience of the IRS is consistent with those com- ments. Moreover, the IRS and Treasury De- partment have reconsidered the appropri- ateness of allowing subsidiaries to dupli- cate group losses after the period of con- solidation. Under this approach, former members can use group losses (that have already been used by the group) to off- set their separate year income. This du- plicative use of group losses distorts the former member’s separate income. Under section 1502, consolidated return regula- tions are directed to promote the clear re- flection of not only the income of a group, but also of its members, including former members. Accordingly, as in 1990, the IRS and Treasury Department have con- cluded that a group loss, once used by the group, should not be available to a former member for a second, duplicative use out- side the group. For these reasons, the IRS and Trea- sury Department propose to remove §1.1502–35 and replace it with a more eas- ily administered and more comprehensive approach to addressing loss duplication among members of a consolidated group. 2.Other methods considered for addressing loss duplication. As discussed in section D of this pream- ble, the IRS and Treasury Department have concluded that loss duplication is an in- appropriate distortion of income (of either a group or its members, including former members) regardless of the subsidiary’s status after a transfer of its stock. Ac- cordingly, these proposed regulations ad- dress loss duplication in both nondecon- solidating and deconsolidating stock trans- fers. Several approaches were considered. a.Disallowance of stock loss. As a general matter, the IRS and Trea- sury Department believe that disallowing duplicative stock loss better implements single entity principles because it results in the recognition of the subsidiaries’ economic gain or loss on its assets and operations, instead of on its stock. How- ever, to preserve the result inRite Aid, stock loss could only be disallowed for nondeconsolidating transfers and addi- tional rules would be necessary to address both the loss remaining in the group and the duplication of loss in deconsolidat- ing transfers (which could not be subject to the loss disallowance rule). Thus, a February 20, 20075502007–8 I.R.B. rule implementing this approach would need to include a provision comparable to §1.1502–35(c), which taxpayers and the IRS have found to present significant compliance issues. In addition, this ap- proach would need to include a provision to address loss duplication in deconsoli- dating transfers. b.Loss duplication accounts. The IRS and Treasury Department also considered an approach that would allow stock loss, but identify the amount of loss duplication and create a suspended ac- count to limit the deductibility of items as they are taken into account. One advan- tage of this approach is that it only requires one set of rules to address both nondecon- solidating and deconsolidating transfers. This approach also has the advantage of increasing the precision in identifying (and disallowing) losses that are actually duplicated. However, unless the rule were to use presumptions to treat items as chargeable against the loss duplication account, it would present considerable tracing issues. In addition, this approach raises adminis- trability issues comparable to those asso- ciated with the loss suspension regime in §1.1502–35(c). These difficulties are ex- acerbated by the need to have the account follow the subsidiary, possibly through subsequent acquisitions, until the account is eliminated. The IRS and Treasury Department are also concerned that, because this approach would reduce or eliminate duplication only when inside losses were recognized, tax- payers could avoid the effect of the rule by waiting until assets appreciated before dis- posing of them. To mitigate this concern, the rule could require the subsidiary to take into account the duplication account, either ratably over time or at some specified time, but this could give rise to income in the ab- sence of any loss duplication. c.Attribute reduction. The IRS and Treasury Department also considered a presumptive rule that would identify the extent of duplicated loss and then reduce the subsidiary’s attributes by that amount. This approach, like the loss duplication account, has the advan- tage of needing only one set of rules to govern both deconsolidating and nonde- consolidating transfers. It has the added advantage of being similar to regimes that are already familiar to taxpayers, such as the attribute reduction rules of sections 108 and 1017, and §1.1502–28. Although attribute reduction could be based on val- uation, like the rule in section 362(e)(2), the IRS and Treasury Department believe that mandatory valuation would present a significant administrative burden and expense for both taxpayers and the IRS. d.Conclusions. The IRS and Treasury Department have concluded that the complexity, adminis- trative burden, and expense of the loss disallowance and the loss duplication ac- count approaches outweighed their respec- tive advantages. Accordingly, these pro- posed regulations adopt an attribute reduc- tion rule. The IRS and Treasury Depart- ment recognize that the attribute reduction approach allows taxpayers to accelerate economic losses of the subsidiary, but be- lieve that this approach best preserves the result inRite Aidwhile addressing loss du- plication. In general, the approach adopted operates as an irrebuttable presumption, to avoid the burden of mandatory valuation in all cases, but taxpayers continue to have several mechanisms available to structure their transactions to permit valuation (for example, by using actual or deemed asset sales). 3.Gain duplication. Notwithstanding the conclusions re- garding duplication of loss, for the reasons set forth in the LDR preambles, the IRS and Treasury Department have tentatively concluded that adequate protections, and the incentive to use them, already exist to prevent the duplication of gain. See T.D. 8294, T.D. 8364 and T.D. 8984. For example, see sections332, 336(e) (which is the subject of another current guidance project), and 338(h)(10). Accordingly, the duplication of gain is not addressed in these proposed regulations, except as a re- sult of the adoption of a loss disallowance model. The IRS and Treasury Department continue to study the issues, however, and invite further comment. See section J of this preamble for further discussion of the issues on which comments are requested. E.Noneconomic and Duplicated Loss from Investment Adjustment System. For all the reasons discussed in this preamble, the IRS and Treasury De- partment believe that the approaches to noneconomic and duplicated loss that are adopted in these proposed regulations rep- resent the best approach to the (original) noneconomic and duplicated loss concerns described in sections B.1 and B.2 of this preamble. However, those rules alone do not adequately address the problem of noneconomic and duplicated loss attribut- able to investment adjustments applied to shares of stock with disparate bases. This is the concern described in section B.3 of this preamble and illustrated inExample 4andExample 5,aswellasExample 7(b) andExample 7(c). The IRS and Treasury Department be- lieve it is essential to address this concern. One reason is that stock basis would be inappropriately eliminated when, in cases likeExample 4, there is noneconomic loss on one share because appreciated assets were contributed to a corporation in ex- change for other shares. In those cases, the noneconomic loss should not be allowed, but a rule that only prevents that loss does not address the problem that there is insuf- ficient basis on the shares received in the exchange. The result would be noneco- nomic gain on the sale of those shares. An equally important reason is that loss could otherwise be duplicated when, in cases like Example 5, loss is disproportionately re- flected in the basis of some shares. Al- though regulations could prevent duplica- tion in such cases (by eliminating inside loss to the full extent of duplicated stock loss), allowing a deduction for dispropor- tionate stock loss in such cases permits the acceleration of a disproportionate amount of inside loss. To the extent that loss is dis- proportionately reflected in the basis of an individual share, acceleration is generally unwarranted and should be prevented to the extent possible. Accordingly, the IRS and Treasury Department have considered various approaches to mitigating these ef- fects. 1.Revise investment adjustment system to adopt a tracing approach. The IRS and Treasury Department rec- ognize that one approach to this problem 2007–8 I.R.B.551February 20, 2007 would be to revise the investment ad- justment system so that it would allocate subsidiaries’ items of income, gain, deduc- tion, and loss to their shares in accordance with the actual reflection of those items in the each share’s basis. This approach would be similar to the section 704(c) regime applicable to partnerships. How- ever, this approach is a tracing model and, as discussed in section C of this preamble, the IRS and Treasury Department do not believe that tracing is administrable in the consolidated setting. Moreover, as noted above, the IRS and Treasury Department continue to be- lieve that the presumptive-based rules of §1.1502–32 are not only administrable, but appropriate in the vast majority of cases because typically subsidiary stock is common stock owned entirely by members with uniform bases. Where subsidiaries have issued preferred stock, it is gener- ally section 1504(a)(4) stock. In addition, the investment adjustment system con- tains some guidance for situations that do not reflect the general assumptions on which the rules are based (for example, the cumulative redetermination rule in §1.1502–32(c)(4)). In such cases, tracing would be unnecessary. Moreover, the IRS and Treasury Department do not believe that typical commercial transactions gen- erally require groups to alter a subsidiary’s capital structure in a manner that would require tracing. Accordingly, the IRS and Treasury Department are not considering revising the investment adjustment system to implement a tracing regime. 2.Presumptive approaches to reduce basis disparity. The two presumptive approaches con- sidered to reduce basis disparity were a full blending rule similar to that in §1.1502–35(b)(1) and a rule that would redetermine investment adjustments made under §1.1502–32, similar to the rule in §1.1502–35(b)(2). a.Full basis blending. Under the full basis blending approach, all members’ bases are aggregated and then allocated among members’ shares in a manner that results in the elimination of loss on preferred shares and of basis dis- parity on all other shares, at least within each class. As a result, members’ bases are aligned with the operating premises of the investment adjustment system. Full basis blending not only mitigates the effects of previous noneconomic in- vestment adjustments, addressing the con- cern illustrated inExample 4andExam- ple 5(a), it also prevents the acceleration of disproportionate amounts of unrecognized loss, addressing the concern illustrated in Example 5(b). A full basis blending rule is, however, a significant departure from the rules gen- erally applicable under the Code. Com- mentators have suggested that this depar- ture from generally applicable law may be more significant than is warranted in light of the extent to which the concerns can be addressed under the investment adjust- ment redetermination approach described in this preamble. b.Redetermination of investment adjustments previously made to stock basis. The investment adjustment redetermi- nation approach is less a departure from Code provisions as it is a departure from the general operation of §1.1502–32. In general, this approach would reallocate in- vestment adjustments previously applied to members’ bases in subsidiary stock with the goal of reducing, to the greatest extent possible, the disparity in members’ bases in subsidiary stock. Thus, like the full blending approach, this approach would bring members’ bases closer into align- ment with the assumptions underlying the investment adjustment system. However, itwoulddosotoamorelimitedextentthan the full blending rule and in a manner that is less of a departure from general Code rules. i.Recomputation of individual investment adjustments. Presently, §1.1502–35(b)(2) addresses duplicated loss by redetermining invest- ment adjustments when there is a decon- solidating disposition of subsidiary stock. To achieve the greatest reduction in basis disparity possible, §1.1502–35(b)(2) in ef- fect deconstructs investment adjustments in order to remove negative items (that is, items of deduction and expense) from ad- justments to the bases of gain shares and then apply those items to reduce members’ bases in loss shares. Taxpayers have raised concerns with the complexity and admin- istrability of this approach. The IRS has observed compliance and audit difficulties with this approach. Accordingly, the IRS and Treasury De- partment have reconsidered whether this general approach, redetermining invest- ment adjustments, could be adopted in a simpler form. The principal method con- sidered was a presumptive reallocation of entire investment adjustments (exclusive of distributions), instead of the individual items that comprise them. The approach is similar to that used in the cumulative redetermination rule of §1.1502–32(c)(4). A significant advantage to this simplified approach is that it is readily administered with information that taxpayers are already required to know (§1.1502–32 already re- quires taxpayers to determine investment adjustments exclusive of distributions). The IRS and Treasury Department recognize that this general approach, in whichever form adopted, does not address the acceleration illustrated inExample 5(b)to the extent that full blending would. However, this approach is less disruptive to the general determination of basis. ii.Reallocations to loss shares that are not transferred. Presently, §1.1502–35(b)(2) realloca- tions can result in the reduction of any member’s basis in a loss share of sub- sidiary stock. The IRS and Treasury Department have reconsidered whether reallocated investmentadjustments should be applied to reduce loss on shares that are not transferred in the transaction. The IRS and Treasury Department have concluded that reallocating investment ad- justments to reduce the basis of only transferred loss shares better implements the loss disallowance model. The reason is that this approach allows subsidiary stock basis to remain intact until there is a taxable disposition, deconsolidation, or worthlessness of the share, thereby permit- ting that basis to enjoy the full protection of subsequent appreciation as long as it re- mains in the group and otherwise subject to the consolidated return system. This approach has the added benefit of afford- ing the maximum potential to eliminate disparate reflection of loss on transferred shares because all thereallocations are directed to transferred shares. As a result, February 20, 20075522007–8 I.R.B. this approach reduces the amount of loss that can be accelerated (as illustrated in Example 5(b)). iii.Reallocations of positive and negative investment adjustments. Under the basis redetermination rule in §1.1502–35(b)(2), only negative items are reallocated. However, the sole purpose of §1.1502–35, and thus the basis redetermi- nation rules in §1.1502–35(b), is to address the duplication of loss. (The full blending approach of §1.1502–35(b)(1) addresses noneconomic loss attributable to basis dis- parity as well as loss duplication, but only incidentally as a result of its broad opera- tion.) The IRS and Treasury Department believe that, although it is appropriate for a rule addressing only loss duplication to reallocate just negative items (or negative investment adjustments), a rule address- ing both noneconomic and duplicated loss must reallocate both negative and positive items (or investment adjustments). As illustrated inExample 4andExample 5, reallocations of both positive and nega- tive amounts are necessary to prevent the noneconomic and duplicated stock loss that results from the disparate reflection of unrecognized gain and to do so without causing inappropriate results to taxpayers (specifically, noneconomic gain). For the foregoing reasons, the IRS and Treasury Department have concluded that the reallocation of both positive and neg- ative adjustments isappropriate and nec- essary to balance the use of a presump- tive system. Accordingly, these proposed regulations provide for the reallocation of both positive and negative investment ad- justments to minimize the potential over- and under-application of the noneconomic and duplicated loss rules. Explanation of Provisions F.Explanation of the Proposed Regulations. 1.Overview. The proposed regulation consists of three principal rules that apply when a member transfers a loss share of sub- sidiary stock. The first rule redetermines members’ bases in subsidiary stock by reallocating §1.1502–32 adjustments (to adjust for disproportionate reflection of gains and losses in the bases of mem- bers’ shares). The second rule reduces members’ bases in transferred loss shares (but not below value) by the net positive amount of all investment adjustments ap- plied to the bases of those shares, but only to the extent of the share’s disconformity amount (to address noneconomic stock loss). The third rule reduces the sub- sidiary’s attributes to prevent the duplica- tion of a loss recognized on, or preserved in the basis of, transferred stock. The three rules generally apply in the order described. If members transfer stock of multiple subsidiaries in one transaction, the basis redetermination and basis reduc- tion rules apply first with respect to trans- fers of loss shares of stock of the sub- sidiaries at the lowest tier and then suc- cessively to transferred shares at each next higher tier. These rules are not applied at any tier until any gain or loss recognized (even if disallowed) onlower-tier transfers and any items resultingfrom lower-tier ad- justments (whether required by the basis redetermination or basis reduction rule or otherwise) are taken into account and re- flected in stock basis. After the basis re- determination and reallocation rules have applied with respect to all transferred loss shares, the attribute reduction rule applies with respect to the highest-tier transferred loss shares. The attribute reduction rule then applies successively with respect to transferred loss shares at each next lower tier. For purposes of these proposed regu- lations, a transfer of stock includes any event in which gain or loss would be recog- nized (but for these proposed regulations), the holder of a share and the subsidiary cease to be members of the same group, a nonmember acquires an outstanding share from a member, or the share is treated as worthless. This rule allows the proposed regulations to prescribe one integrated set of rules that implements a loss limitation approach and that can be applied to all loss shares, regardless of the event giving rise to the application of the section. 2.The basis redetermination rule. When a member transfers a share of subsidiary (S) stock and, after the appli- cationofallotherprovisionsoftheCode and regulations, the share is a loss share, this rule subjects all members’ shares of S stock to redetermination. Under the basis redetermination rule, investment adjustments (exclusive of dis- tributions) that were previously applied to members’ bases in S stock are generally reallocated in a manner that, to the great- est extent possible, first eliminates loss on preferred shares and then eliminates basis disparity on all shares. The rule moves both positive and negative adjust- ments, and so addresses both noneconomic and duplicated losses. Because it gener- ally requires adjustments to be made to re- duce disparity, it brings members’ bases closer in line with the fundamental princi- pals underlying the investment adjustment system. As a result, there is less likeli- hood for later noneconomic or duplicated loss attributable to the investment adjust- ment system. The rule operates by first removing positive investment adjustments (up to the amount of the loss) from the bases of transferred loss shares. Then, to the extent of any remaining loss on the transferred shares, negative investment adjustments are removed from shares that are not trans- ferred loss shares and applied to reduce the loss on transferred loss shares. The positive adjustments removed from the transferred loss shares are allocated and applied only after the negative items have been reallocated. The reason is to preserve the most flexibility possible in reallocating positive adjustments, in order to minimize disparity to the greatest extent. Thus, the operation of these rules has the effect of removing basis from transferred loss shares and using it to reduce disparity in members’ bases in S shares. Redetermination is limited in several respects. First, because the premise of the rule is that the original allocation of an item did not represent the most economi- cally appropriate allocation of the item, re- determinations under the rule are limited to allocations of investment adjustments that could have been made at the time an item was taken into account. Accordingly, no adjustments can be reallocated to shares that were not held by members in the year taken into account, as members’ shares would not have been able to receive those adjustments in the original allocation. A related limitation on reallocation is that an investment adjustment cannot be reallocated except to the extent that the full 2007–8 I.R.B.553February 20, 2007 effect of the reallocation can be accom- plished. Thus, an investment adjustment can not be reallocated to the extent the resulting basis has previously been taken into account (including at a higher tier). This rule guards against double benefits from an adjustment (for example, by not allowing positive adjustments to be moved from, or negative adjustments be moved to, shares after the item would have af- fected basis that was taken into account in recognizinggainorloss). Italsoguards against the loss of a benefit (for example, by not allocating positive adjustments to previously transferred shares that can no longer benefit from the basis). The principle purpose of the rule is to reduce loss on transferred shares. How- ever, because its secondary purpose is to decrease disconformity to the greatest ex- tent possible, in certain fact patterns, the application of the rule will actually in- crease loss on some shares. Importantly, in no fact patterns will the application of the rule create gain on shares. Overall, the rule has no effect on the aggregate amount of gain or loss on members’ bases in sub- sidiary stock. In the basis reallocation rule, and in sev- eral other provisions of the proposed regu- lations, there is a direction to allocate items in a manner that reduces disparity to the greatest extent possible. The regulations do not, however, prescribe the manner in which such determinations are to be made. The IRS and Treasury Department intend that taxpayers have flexibility in choosing the methods and formulas to be employed in making these determinations and the IRS will respect any reasonable method or formula so employed. The IRS and Treasury Department rec- ognize that the redetermination of basis imposes a certain administrative burden. Thus, the rule contains two safe harbors that excuse taxpayers from reallocating ba- sis in situations in which redetermination is deemed unnecessary. One safe harbor is for situations in which redetermination would have no ultimate effect on the basis of any share held by a member. This hap- pens, for example, if only common stock is outstanding and there is no disparity in the bases of the shares. In such a case, any redetermination would result in the same bases the members had before redetermi- nation. The second safe harbor is for sit- uations in which the group disposes of its entire interest in the subsidiary to an un- related person in one or more fully tax- able transactions. In such a case, the group recognizes all the gains and losses on the shares and so obtains no benefit from the disparate reflection of gain or loss. Trans- fers that are excepted from basis redeter- mination, like transfers of shares that re- main loss shares after application of the rule, are then subject to the basis reduction rule. 3.The basis reduction rule. If, after basis redetermination, any member’s transferred share is a loss share (even if the share only became a loss share as a result of the application of the basis re- determination rule), the basis of that share is subject to reduction under this rule. This rule is intended to eliminate stock loss that is presumed noneconomic. It operates by reducing the basis of each transferred loss share (but not below value) by the lesser of the share’s disconformity amount and its net positive adjustment. A share’s disconformity amount is the excess of its basis over its allocable portion of S’s net inside attributes, determined at the time of the transfer. This amount iden- tifies the net amountof unrealized appre- ciation reflected in the basis of the share. Because the disconformity amount is com- puted at the time of the transfer, the dis- conformity amount reflects the effects of all prior redetermination events. The term net inside attributes is defined as the sum of S’s loss carryovers, deferred deductions, cash, and asset basis, reduced by S’s liabilities. This computation is used in both this basis reduction rule and the at- tribute reduction rule described in section F.4 of this preamble. Both rules do, how- ever, have special provisions that modify the computation of net inside attributes if S holds lower-tier subsidiary stock. See sec- tions F.3.a and F.4.a of this preamble for a discussion of rules relating to the stock of lower-tier subsidiaries for purposes of basis reduction and attribute reduction, re- spectively. A share’s net positive adjustment is computed as the greater of zero and the sum of all investment adjustments (ex- cluding distributions) applied to the basis of the transferred loss share, including by reason of prior basis reallocations. All items of income, gain, deduction, and loss are included fully in the net positive ad- justment amount. This rule identifies the extent to which basis has been increased by the investment adjustment provisions for items of income, gain, deduction and loss (whether taxable or not) that have been taken into account by the group. a.Special rules applicable when S holds stock of lower-tier subsidiary. For purposes of computing the dis- conformity amount, if S holds stock of a lower-tier subsidiary (S1) that was not transferred in the transaction, S’s net inside attribute amount is computed by treating S’s basis in S1 stock as “tentatively re- duced” by the lesser of the S1 share’s net positive adjustment and its disconformity amount. This reduction is made only for purposes of determining basis reduction to the S share, and has no other effect. The purpose of this adjustment is to prevent S1’s recognized items from giving rise to noneconomic loss in S stock, for example, when S1 recognizes gain that is already re- flected (indirectly) in P’s basis in S shares. This problem is illustrated inExample 8 (subsidiary holding lower-tier subsidiary stock with a basis that reflects lower-tier unrecognized appreciation). When determining the disconformity amount of a share of subsidiary stock, no tentative reduction is made to the basis of lower-tier shares that were transferred in the transaction (without regard to whether S retained the shares after the transaction, such as when S1 is transferred because S and S1 cease to be members of the same group but S continues to hold S1 stock). The reason is that the basis reduction rule applies directly to eachtransfer, starting with the lowest-tier transfer, and so any noneconomic loss in S stock that was attributable to S1’s items has been elimi- nated by the time that the basis reduction rule applies to the S Stock. In addition, the tentative basis reduction rule does not applytosharesthatarelowertiertoany shares that were transferred in the transac- tion. The application of the rule to those shares is unnecessary because, when the basis reduction rule applied to S1, it elimi- nated any inappropriate effects from items that tiered up from subsidiaries that were lower tier to S1. February 20, 20075542007–8 I.R.B. 4.The attribute reduction rule. If any transferred share remains a loss share after application of the basis reduc- tion rule, the subsidiary’s attributes (in- cluding the consolidated attributes attrib- utable to the subsidiary) are subject to re- duction. The attribute reduction rule ad- dresses the duplication of loss by mem- bers of consolidated groups. This rule is intended to insure that the group does not recognize more than one loss with re- spect to a single economic loss regardless of whether the group chooses to dispose of the subsidiary stock before or after the sub- sidiary recognizes the loss with respect to its assets or operations. Under this rule, S’s attributes are re- duced by the “attribute reduction amount,” which is computed as the lesser of the net stock loss and the aggregate inside loss. This amount reflects the total amount of unrecognized loss that is reflected in both the basis of the S stock and S’s attributes. Net stock loss is the excess of the sum of the bases (after application of the basis re- duction rule) of all S shares transferred by members in the same transaction over the value of such shares. S’s aggregate in- side loss is the excess of S’s net inside at- tributes over the value of all of the S shares. The term net inside attributes generally has the same meaning as in the basis reduction rule, subject to special rules for lower-tier subsidiaries (see section F.4.a of this pre- amble). Unlike comparable provisions in §1.1502–35 and the LDR, this rule does not limit its application to a share’s pro- portionate interest in the subsidiary’s aggregate inside loss. The reason is that when a member recognizes a stock loss, or preserves a stock loss for later recognition (for example, when the share is retained but deconsolidated), the member enjoys (or preserves for later use) the benefit of the entire amount of that stock loss. If basis is uniform, the amount of stock loss will reflect a proportionate interest in the subsidiary’s unrecognized loss. But if basis is disparate, the loss on a particular share can reflect any amount, even all, of the subsidiary’s unrecognized loss. In either case, the potential loss duplication equals the entire amount by which the stock loss is duplicated in the subsidiary’s attributes. Accordingly, the proposed reg- ulations reduce attributes to that extent. This prevents the duplication (but not ac- celeration) of loss otherwise available in situations similar toExample 5(b)by re- ducing S’s attributes by the entire amount by which the stock loss duplicates the ag- gregate inside loss. A principal goal of this regulation is to address the issues of noneconomic and duplicated stock loss in a manner that is as readily administrable as possible, by taxpayers and the government. For that reason, the proposed regulations generally avoid imposing valuation requirements whenever possible. However, the pro- posed regulations do, to the extent possi- ble, use readily available information to identify the location and amount of loss, to avoid knowingly creating gain. The order in which attributes are reduced reflects these principles. After S’s attribute reduction amount is determined, it is first applied to reduce or eliminate items that represent actual re- alized losses, such as operating loss car- ryovers, capital loss carryovers, and de- ferred deductions. If S’s attribute reduc- tion amount exceeds those items, the ex- cess is then applied to reduce or eliminate the loss in the basis of property that is pub- licly traded (other than subsidiary stock, which is subject to special rules). The rea- son that the basis of publicly traded prop- erty, unlike that of other assets, is only re- duced by the amount of loss reflected in the basis of the property is that such prop- erty can be readily and easily valued. Fi- nally, if any attribute reduction amount re- mains after eliminating those attributes, it is applied to reduce or eliminate the basis in assets, other than publicly traded prop- erty (which then reflects no loss) and other than cash and equivalents (which also re- flect no loss). This reduction is made pro- portionately according to the basis in each property. The proposed regulations provide a special rule that applies to the extent a subsidiary has liabilities that have not been taken into account as of the time of the transfer. Under the general rule, if the attribute reduction amount exceeds at- tributes available forreduction, that excess attribute reduction amount has no further effect. However, a special rule applies if the attribute reduction amount exceeds the attributes available for reduction and the subsidiary has a liability that has not been taken into account. Typically this will happen when cash or other liquid assets are held to fund future expenses related to the liability. Because the assets held by S do not reflect attributes that can be reduced, loss can be duplicated later, when the liability is taken into account. To pre- vent the duplication of loss in such cases, the excess attribute reduction amount is suspendedandappliedtopreventthede- duction or capitalization of payments later made by S or another person with respect to the liability. a.Special rules applicable when S holds stock of lower-tier subsidiary. When S holds stock of lower-tier sub- sidiaries, the attribute reduction amount is computed in a manner that identifies the maximum potential amount of loss dupli- cation and attributes are reduced to that ex- tent. However, the rule incorporates two restrictions to prevent excessive reduction of attributes that could otherwise result from this approach. These rules are set forth in this section 4.a. First, to facilitate the computation of S’s attribute reduction amount, all of S’s shares of S1 stock are treated as a sin- gle share (generally referred to as the S1 stock). To identify the maximum poten- tial duplication, the computation of the at- tribute reduction amount is made treating S’s basis in S1 stock as its “deemed ba- sis” in that stock. The proposed regula- tions define deemed basis as the greater of S’s actual aggregate basis in the S1 shares (adjusted for any gain or loss recognized onatransferoftheS1shares)andtheS1 shares’ allocable portion of S1’s net in- side attributes. For example, assume P owns all the stock of S with a basis of $150, S owns all the stock of S1 with a basis of $100, and S1 owns an asset with a basis of $150. S’s deemed basis in S1 stock is $150, the greater of $100 (S’s ac- tual basis in S1 stock) and $150 (the S1 shares’ allocable portion of S1’s net in- side attribute amount), which is the max- imum amount of inside loss that S can recognize. The proposed regulation uses deemed basis not only to identify the max- imum potential amount of loss duplication ($150 in the example), but also to reduce attributes on the assumption that taxpayers will act in their best interest when decid- ing how lower-tier attributes will be recog- 2007–8 I.R.B.555February 20, 2007 nized (subject to certain limits discussed in this section F.4.a). S’s deemed basis in S1 stock is also used for purposes of allocating S’s at- tribute reduction amount between S’s S1 stock and S’s other attributes. However, for this purpose, deemed basis is treated as reduced by certain amounts that, by their nature, do not reflect loss. These excluded amounts include the value of S1 shares transferred in the transaction and the portion of S1’s cash, S1’s cash equivalents, and the value of S1’s publicly traded property (net ofS1’s liabilities) that is attributable to S’snontransferred shares of S1 stock. The excluded amounts also include the corresponding amounts with respect to all shares of stock of lower-tier subsidiaries. These modifications pre- vent nonloss assets from inappropriately increasing the allocation of attribute re- ductiontoS1stock. The attribute reduction amount allo- cated to S’s block of S1 stock is then apportioned and applied to reduce the bases of S’s individual shares of S1 stock in a manner that, to the greatest extent possible, reduces disparity. This general rule is subject to two modifications. First, no allocated amount is apportioned to any transferred S1 share if gain or loss is recognized on the transfer of that share. The reason is that the recognition of gain or loss (even if not allowed) establishes that the basis of that share does not reflect (or no longer reflects) unrecognized loss. This modification thus directs attribute re- duction to other shares that are the source of the potential duplication. The second modification is that no allocated amount that is apportioned to any transferred S1 share is to be applied to reduce the basis of the share below its value. This modi- fication prevents attribute reduction from knowinglycreatinggainonsuchshares. To fully implement the loss duplication rule, any portion of S’s attribute reduc- tion amount that is allocated to S1 stock, whether or not it is apportioned or ap- plied to reduce the basis of any S1 shares, tiers down and becomes an attribute re- duction amount of S1. The attribute re- duction rules then apply to reduce S1’s at- tributes in the same manner that they ap- ply S’s attribute reduction amount to re- duce S’s attributes. However, because the attribute reduction amount represents the maximum potential amount of duplication in the lower-tier subsidiary, the proposed regulations include two modifications to prevent the reduction of attributes beyond the amount necessary to eliminate dupli- cated loss. The first modification is the conforming limit rule, which prevents the tier down of attribute reduction from reducing S1’s net inside attributes below the sum of the value of the S1 shares transferred by members and the aggregate bases that members have in nontransferred S1 stock (after any re- duction to those shares by the direct appli- cation of S’s attribute reduction amount). The second modification is the basis restoration rule. This rule applies after the attribute reduction rule has been applied with respect to all transfers and all result- ing reductions (whether as a result of direct or tier-down attribute reduction) have been given effect. This rule reverses stock ba- sis reductions made by the attribute reduc- tion rule, but only to the extent necessary to conform inside (net inside attributes) and outside (stock) basis at each tier, taking into account the effect of any prior section 362(e)(2) transactions. Because net inside attributes can be a negative number, stock basis may be a negative number even af- ter basis restoration. In such cases, the ba- sis of the share will remain an excess loss account in the hands of the owning mem- ber after the transaction (the regulations specifically provide that the excess loss ac- count created by this rule is not taken into account under §1.1502–19). Basis restora- tion adjustments are made at each tier, but they do not give rise to any upper-tier ad- justments. With these two modifications, the at- tribute reduction rulecan reduce lower-tier attributes in an amount that eliminates the full duplication potential reflected in S’s basis in S1 stock and S1’s net inside at- tributes without creating a noneconomic gain in the corresponding attribute. b.Election to reduce stock basis and/or reattribute loss. Finally, the attribute reduction rule con- tains an elective provision under which groups can reduce the potential for loss du- plication and thereby reduce or completely avoid attribute reduction under these regu- lations. Under this rule, the common par- ent of a group can elect to reduce stock ba- sis, reattribute attributes, or do some com- bination of basis reduction and attribute reattribution in order to prevent the reduc- tion of attributes otherwise required un- der these proposed regulations. The total amount that can be the subject of the elec- tion is limited to the amount that S’s at- tributes would otherwise be subject to re- duction. The election to reattribute attributes can only be made if S ceases to be a mem- ber of the P group as a result of the trans- fer. The reason is that the election is not intended to be merely a mechanism for changing location of items within a group (and its continuing members). The elec- tion can be made with respect to loss car- ryforwards and deferred deductions of S or any of S’s lower-tier subsidiaries, but only to the extent and in the order that such attributes would otherwise have been re- duced under the attribute reduction rule. However, P may only reattribute attributes of lower-tier subsidiaries that would other- wise be reduced as a result of tier-down at- tribute reduction to the extent that the reat- tribution does not create an excess loss ac- count in the stock of any lower-tier sub- sidiary. When this election is made, P is treated as succeeding to the attributes as though it had acquired them in a section 381(a) transaction. Proposedregulationsunder §1.1502–32 treat the reattributed at- tributes as absorbed and tiering up to reduce the basis of shares such that the full amount tiers up through the transferred S shares for which the election is made. This amount is allocated to shares in the chain with positive basis in a manner that reduces the disparity in the basis of the shares to the greatest extent possible. However, this amount is not allocated to any lower-tier subsidiary shares that were transferred in a transfer in which gain or loss was recognized. The IRS and Treasury Department recognize and are concerned with the potential complexity of this election and request comments regarding both the administrability and the benefit of the election, particularly as it relates to attributes of lower-tier subsidiaries. Although the maximum amount of the election is computed by tentatively apply- ing the attribute reduction rule to S, the election is actually given effect immedi- ately before the application of the attribute reduction rule. Thus, to the extent loss du- February 20, 20075562007–8 I.R.B. plication has not been eliminated by the election, the attribute reduction rules apply in their general manner. 5.Over-ride provisions. These proposed regulations contain two over-ride provisions. One, found in the general introductory provisions of the proposed regulation, requires that the provisions of these proposed regulations be interpreted and applied in accordance with their stated purposes. The other, an anti-abuse and anti-avoidance rule, pro- vides that “appropriate adjustments” will be made if a taxpayer acts with a view to avoid the purposes of this section or use this section to avoid another rule of law. The anti-abuse rule includes several examples that illustrate general principles. The examples are not intended to specify particular transactions that will be treated as abusive in all cases or to prevent the IRS from treating other transactions as abusive. This rule is an important safe- guard to ensure that only transfers made in the ordinary course of business enjoy the benefits and avoid the burdens arising from the principles adopted in these pro- posed regulations. 6.Special rules for section 362(e)(2) transactions. The IRS and Treasury Department rec- ognize that adjustments made pursuant to section 362(e)(2) (see discussion in sec- tion H of this preamble) alter the extent to which comparisons of stock basis, net inside attributes, and value can identify both the amount of unrecognized appre- ciation reflected in stock basis and the amount of duplicated loss. For example, a reduction to asset basis under section 362(e)(2)(A) increases the disconformity amount of the shares received in the trans- action subject to section 362(e)(2), but this amount does not represent unrealized ap- preciation reflected in stock basis. Further, the reduction to asset basis under section 362(e)(2)(A) decreases the amount of loss duplication that can exist with respect to the shares received in the transaction subject to section 362(e)(2). Similarly, if stock basis is reduced pursuant to an election under section 362(e)(2)(C), there is an increase in the subsidiary’s net inside attribute amount that reduces the discon- formity amount of all shares and increases aggregate inside loss, even though there has been neither a decrease in the amount of unrealized appreciation reflected in stock basis nor an increase in duplicated loss. Accordingly, to adjust for distortions resulting from basis reduction under sec- tion 362(e)(2)(A), the proposed regula- tions adjust the disconformity amount of the shares received in the transaction to which section 362(e)(2) applied by an amount equal to the amount the basis of such shares would have been reduced had an election under section 362(e)(2)(C) been made. Further, for purposes of com- puting the attribute reduction amount on a transfer of any shares received in the sec- tion 362(e)(2) transaction, and applying the conforming limitation on the appli- cation of tier-down attribute reduction, the basis in such shares is reduced by an amount equal to the amount the basis of such shares would have been reduced had an election under section 362(e)(2)(C) been made. Similarly, to adjust for distor- tions resulting from basis reduction under section 362(e)(2)(C), for purposes of com- puting any share’s disconformity amount or the subsidiary’s aggregate inside loss, and for purposes of determining any stock basis restoration, the proposed regulations reduce S’s net inside attribute amount by an amount equal to the amount S’s at- tributes would have been reduced under section 362(e)(2)(A) had no election under section 362(e)(2)(C) been made. Further, the regulations indicate that the special application of section 362(e)(2) to inter- company transactions must be taken into account, so these adjustments only apply to the extent section 362(e)(2) has actually resulted in some basis reduction. The IRS and Treasury Department rec- ognize that the computations in these pro- posed regulations may need to take other items into account. Accordingly, the pro- posed regulations provide that the Com- missioner will make appropriate adjust- ments to account for changes in the rela- tionship between stock basis, net inside at- tributes, and value that are not the result of either §1.1502–32 or these proposed regu- lations and that are not otherwise adjusted under these proposed regulations. In addi- tion, the proposed regulations provide that taxpayers may seek a written determina- tion regarding the treatment of comparable items or adjustments. 7.Special rules considered but not adopted. a.Discounting of losses that are limited by section 382 or other provisions. The IRS and Treasury Department con- sidered whether losses could be included in the computation of the net inside at- tribute amount at a reduced rate if their use was limited, for example, by section 382. Ultimately no administrable and pre- cise method was identified for determining the extent to which losses could be con- sidered properly excluded (or included at a reduced rate), except in the most extreme cases. Accordingly, the proposed regula- tions do not provide special rules for lim- ited losses. As a result, losses are fully in- cluded in net inside attributes. The IRS and Treasury Department rec- ognize that this approach is extremely fa- vorable to taxpayers as it reduces the dis- conformity amount (and thus the extent to which stock basis may be reduced) with the only potential cost being the elimina- tion of the losses under the attribute re- duction rule. The IRS and Treasury De- partment believe that this taxpayer-favor- able result, when produced in the ordinary course of business, is not an inappropriate result as part of the overall balance reached by these regulations. Taxpayers that en- gage in transactions that have nobona fidepurpose other than to acquire limited losses to avoid the purposes of the pro- posed regulations, however, will be sub- ject to the anti-avoidance rule and the ben- efits of the transaction will be eliminated. b.Exceptions for basis conforming acquisitions. Practitioners had suggested that any proposed regulations addressing noneco- nomic loss contain anexception for trans- actions such as section 351 exchanges and acquisitions subjectto a section 338 elec- tion. These proposed regulations do not explicitly contain such an exception. One reason is that such an exception would introduce the complexity and burden of identifying all redetermination events. A more important reason, however, is that such an exception is unnecessary under the basis disconformity model because, by measuring disconformity immediately before the transfer of loss shares, this rule automatically excludes situations from 2007–8 I.R.B.557February 20, 2007 basis reduction when there is inside/out- side conformity. Thus, the effect of this suggestion is accomplished and no special rules are necessary. c.Shadow account for reduced basis. The proposed regulations do not con- tain a mechanism, suggested by practition- ers, for restoring basis to transferred shares that are retained by a member and later sold at a gain (for example, when a mem- ber retains S shares but S ceases to be a member). The IRS and Treasury De- partment are concerned that such a rule would add undue complexity to the reg- ulatory scheme. Moreover, such a rule would be inconsistent with a fundamental principle underlying these proposed regu- lations, specifically, that a transfer (as de- fined in these proposed regulations) is the appropriate time for these proposed reg- ulations to apply. Thus, the basis reduc- tion rules do not permanently reduce the basis of lower-tier subsidiary stock unless the stock is transferred in the transaction. And, moreover, similar to the general ap- plication of other provisions of the Code and regulations, subsequent events should not reverse the effects of such application. 8.Effective date. The proposed regulations would be ap- plicable as of the date they are published as final regulations in theFederal Register. G.Sections 1.337(d)–1, 1.337(d)–2, and 1.1502–35. Because proposed §1.1502–36 ad- dresses both noneconomic and duplicated loss on subsidiary stock, the IRS and Trea- sury Department are also proposing the removal of §§1.337(d)–1, 1.337(d)–2, and 1.1502–35, except to the extent neces- sary to address losses suspended under §1.1502–35(c) and losses reimported un- der §1.1502–35(g)(3). Additionally, the IRS and Treasury Department intend to publish temporary regulations that will modify the anti-abuse provisions of §1.1502–35. First, the tem- porary regulations will restate the loss reimportation rule as a principle-based rule. This change responds to comments received about the administrability of the current provision. Second, the temporary regulations will modify the loss reimpor- tation rule to provide that a duplicated loss on subsidiary stock is subject to the loss reimportation rule even if the group deconsolidates the subsidiary before sell- ing loss shares of the subsidiary stock. These modifications are reflected in these proposed regulations. These proposed regulations also revise several regulations solely to reflect the re- moval of §§1.337(d)–1, 1.337(d)–2, and 1.1502–35 (other than with respect to loss suspension and loss reimportation), and the addition of §1.1502–36. The proposed regulations described in this section G would be applicable as of the date they are published as final regulations in theFederal Register. H.Suspension of Section 362(e)(2) in Consolidation. 1.Background. As part of the AJCA, Congress en- acted section 362(e)(2) to address certain instances of loss duplication. Very gen- erally, that provision provides that if loss property is transferredtoacorporationin a section 351 exchange (or as a capital contribution or paid-in surplus), the trans- feree’s aggregate basis in the assets will be limited to the properties’ fair market value. However, section 362(e)(2) also permits the parties to elect to limit the basis of the stock received (or treated as received) in the exchange to its fair mar- ket value, so that the loss is preserved in the basis of the transferred property. Sec- tion 362(e)(2)(C). See REG–110405–05, 2006–48 I.R.B. 1004 [71 FR 62067] (Oc- tober 23, 2006), (“the 2006 proposal”) for a more detailed explanation of the general application of section 362(e)(2). Practitioners have questioned whether it is necessary to apply section 362(e)(2) to intercompany transactions where there is a consolidated return rule addressing loss duplication. The IRS and Treasury De- partment recognize that loss duplication in consolidated groups is generally addressed by §1.1502–32 (when losses are recog- nized on a subsidiary’s assets or opera- tions) and, currently, by §1.1502–35 (or by this proposed §1.1502–36 when it is fi- nalized). In general, the IRS and Trea- sury believe that these regulations together address loss duplication in a manner that is most consistent with single entity prin- ciples. Nevertheless, the IRS and Trea- sury Department are concerned that, if sec- tion 362(e)(2) were not to apply to inter- company transfers, members of consoli- datedgroupsmaybeabletoreducegain under circumstances that separate taxpay- ers could not. Accordingly, the IRS and Treasury Department have tentatively con- cluded that section 362(e)(2) should be ap- plied to intercompany transactions. How- ever, the IRS and Treasury are concerned with the administrative burden imposed by section 362(e)(2) and are continuing to study whether its provisions should be ap- plicable to such transfers. Comments are invited on this issue. 2.Suspension of section 362(e)(2) for intercompany transactions. Although the IRS and Treasury Depart- ment have tentatively concluded that sec- tion 362(e)(2) should remain applicable to transfers between members of a consoli- dated group, as noted, the IRS and Trea- sury Department are concerned with the significant complexity and administrative burden that section 362(e)(2) adds in the consolidated return context. For example, if an election is made to reduce stock ba- sis under section 362(e)(2)(C), a portion of the items attributable to the transferred loss assets can produce duplicative reductions unless traced and treated as duplicative of the section 362(e)(2) reduction to stock ba- sis. Moreover, the IRS and Treasury De- partment recognize that basis reductions are not necessary in intercompany section 362(e)(2) transactions as long as duplica- tion can effectively be eliminated by the general operation of the investment ad- justment system. Accordingly, these pro- posed regulations would suspend applica- tion of section 362(e)(2) until the occur- rence of a “section 362(e)(2) application event,” and then apply the principles of section 362(e)(2) only to the extent the in- vestment adjustment system has not elim- inated and can no longer effectively elim- inate any remaining duplication. The IRS and Treasury Department expect that this suspension will often effectively eliminate the application of section 362(e)(2) to most intercompany transactions. Nevertheless, in order to apply sec- tion 362(e)(2) upon the occurrence of a February 20, 20075582007–8 I.R.B. section 362(e)(2) application event, the group must determine the extent to which an intercompany transaction resulted in loss duplication that would have been prevented by section 362(e)(2), and track the extent to which this duplication is ef- fectively eliminated while the transferor and the transferee are members. Accord- ingly, these proposed regulations require the group to identify the amount and lo- cation of basis in the transferred assets that would have been eliminated had sec- tion 362(e)(2)(A) applied at the time of the intercompany transaction. This is the amount of the net built-in loss that is du- plicated as a result of the section 362(e)(2) transaction. The regulations refer to this amount of duplication as the “section 362(e)(2) amount.” The duplicated loss is reflected in both the transferor’s basis in the transferee stock (or securities), and in the trans- feree’s basis in the property received. The duplication is initially reflected in the basis of the transferee stock (or securities) to the extent the basis would have been reduced under section 362(e)(2)(C), if such an election was made and section 362(e)(2) was not suspended by these temporary reg- ulations. The duplication is also initially reflected in the transferee’s basis in the property received to the extent the basis of such property would have been reduced under section 362(e)(2)(A) if no election was made under section 362(e)(2)(C) and section 362(e)(2) was not suspended by these temporary regulations. Over time this amount can be reflected in other attributes of the transferee (such as unab- sorbed losses) to the extent such attributes are attributable to the transferee’s basis in the property received. 3.Elimination of the section 362(e)(2) amount. Because the investment adjustment sys- tem reduces stock basis as a subsidiary’s attributes are takeninto account, the du- plication is eliminated to this extent, and the section 362(e)(2) amount must be elim- inated to this extent. Further, if the ba- sis of the stock (or securities) received in the intercompany section 362(e)(2) trans- action is reduced as the result of a sec- tion 362(e)(2)(C) election, as a result of at- tribute reduction under these proposed reg- ulations, or is otherwise eliminated with- out the recognition of gain or loss, the du- plication is similarly eliminated. Accord- ingly, these types of basis reductions result in an elimination of all or a portion of the section 362(e)(2) amount. The proposed regulations provide specific guidance re- garding how much of any remaining sec- tion 362(e)(2) amount is reflected in the basis of the subsidiary’s stock (or securi- ties) or the subsidiary’s attributes as the section 362(e)(2) amount is eliminated. 4.Application of section 362(e)(2) to intercompany transactions. Upon the occurrence of a section 362(e)(2) application event, the regula- tions apply section 362(e)(2) only to the extent necessary. A section 362(e)(2) application event occurs when all or a portion of the duplicated amount can no longer be effectively eliminated by the operation of the investment adjustment system, and can involve either the stock (or securities) of the transferee or the assets transferred in the intercompany section 362(e)(2) transaction. Such an event is defined to include any trans- fer (as defined in proposed §1.1502–36) of the transferee’s stock received in the exchange, any satisfaction of a security received in the exchange, any transaction in which a nonmember acquires any of the transferred assets with substituted basis or succeeds to any attributes attributable to such basis, or any other transaction the result of which prevents all or a portion of any remaining section 362(e)(2) amount reflected in stock basis and attributes from being effectively eliminated by the opera- tion of the investment adjustment system when taken into account. Further, if the transferor and the transferee in the intercompany section 362(e)(2) transaction continue to be mem- bers of the same group (including as members of another group), the invest- ment adjustment system can continue to effectively eliminate the duplication. Accordingly, these proposed regulations provide a subgroup exception implicit in the definition of section 362(e)(2) applica- tion events that allows the transferor and transferee to become members of a new group without triggering the application of section 362(e)(2). In such a case, the trans- feror and transfereewill continue to track the section 362(e)(2) amount reflected in stock basis and attributes, and apply these provisions upon the occurrence of a sec- tion 362(e)(2) event. Given the fact that section 362(e)(2) is applied in this context only to the ex- tent necessary, the scope of its applica- tion varies slightly depending upon the type of section 362(e)(2) application event that occurs. If the application event in- volves a transaction in which a nonmem- ber acquires some or all of the transferee’s attributes that reflect a section 362(e)(2) amount, section 362(e)(2) applies to the extent such attributes reflect all or part of any remaining section 362(e)(2) amount. In such a case, the resulting reduction in attributes is applied to the attributes in- volved in the application event that reflect the section 362(e)(2) amount. If the ap- plication event involves all or part of the transferee stock (or securities) received in the section 362(e)(2) transaction, section 362(e)(2) applies to the extent such stock (or securities) reflect all or part of any re- maining section 362(e)(2) amount. Fur- ther, in this case, the resulting reduction in attributes is applied proportionately to the transferee’s attributes that reflect the sec- tion 362(e)(2) amount (based on the rel- ative section 362(e)(2) amount reflected). The reduction in the transferee’s attributes is not a noncapital, nondeductible expense. As is provided in section 362(e)(2)(C), the transferor and transferee may elect to reduce the basis in the transferee stock (or securities) received in the intercom- pany section 362(e)(2) transaction instead of reducing the transferee’s attributes. Similar to the provisions of the proposed regulations under section 362(e)(2), the reduction in the basis of the transferee stock (or securities) received in the in- tercompany section 362(e)(2) transaction is equal to the amount of the reduction in the transferee’s attributes absent the election. Further, if this election is made, thetypeofsection362(e)(2) application event dictates which shares (or securi- ties) receive the basis reduction. If the application event involves a transaction in which a nonmember acquires some or all of the transferee’s attributes, the re- duction is applied proportionately to all of the transferee stock (or securities) held by members immediately before the applica- tion event (based on the relative section 362(e)(2) amount reflected). However, if the application event involves all or 2007–8 I.R.B.559February 20, 2007 a part of the transferee stock (or securi- ties) received in the intercompany section 362(e)(2) transaction, the reduction is applied proportionately to the stock (or securities) so involved (based on the rel- ative section 362(e)(2) amount reflected). The reduction in the basis of the stock of the transferee as a result of this election is treated as a nondeductible basis recovery item. Under the proposed regulations, the election to reduce stock basis (in lieu of attributes) under section 362(e)(2)(C) may be made for the intercompany transaction on either the group return for the year of the intercompany section 362(e)(2) transaction or the year in which the first section 362(e)(2) application event oc- curs. In either case, the election has effect only if and to the extent there is a section 362(e)(2) application event, is irrevoca- ble once made, and applies to all section 362(e)(2) application events with respect to such intercompany section 362(e)(2) transaction (even if the application event occurs at a time when the transferor and transferee are members of another consol- idated group). 5.Special allocations under §1.1502–32. The proposed regulations also include a special allocation provision in §1.1502–32 that requires all items taken into account by a group (including tier-ups of such amounts) that reflect a section 362(e)(2) amount to be allocated entirely to mem- bers’ shares. In other words, such items are allocated as if any shares held by nonmembers were not outstanding. The reason for these special allocation rules is to prevent the general §1.1502–32 al- location of items to dilute the elimination of duplication where shares of subsidiary stock are held by nonmembers. 6.Other considerations. In the 2006 proposal, the IRS and Trea- sury Department proposed regulations that would provide that the tracing rules in §1.358–2(a)(2) will not apply to stock received in a section 362(e)(2) transaction if the transferor and transferee elect to apply section 362(e)(2)(C). The IRS and Treasury requested comments regarding whether that treatment is appropriate. As noted in section H.4 of this preamble, these proposed regulations would allow the making of a section 362(e)(2)(C) elec- tion to be deferred until the year of the first section 362(e)(2) application event. The IRS and Treasury Department are aware of the potential difficulty and administrative burden associated with retroactively not applying the provisions of §1.358–2(a)(2). The IRS and Treasury Department con- tinue to study this issue, and invite com- ments regarding whether the proposed revision to §1.358–2(a)(2)(viii) regarding section 362(e)(2)(C) elections should ap- ply to intercompany transactions. These proposed regulations would be applicable as of the date they are published as final regulations in theFederal Regis- ter. I.Other Revisions to the Consolidated Return Regulations. The IRS and Treasury Department are also proposing various technical and ad- ministrative revisions to the consolidated return regulations. 1.Removal of §1.1502–13(f)(6)(ii). Section 1.1502–13(f)(6)(ii) prevents a member from recognizing gain on the qualified disposition of parent stock. However, §1.1502–13(f)(6)(ii) only ap- plies to dispositions of parent stock occur- ring prior to May 16, 2000. Thus, the pro- vision has no current applicability. Nev- ertheless, gain on dispositions of parent stock occurring on or after May 16, 2000, may qualify to be prevented by §1.1032–3, which has fewer conditions to its appli- cation than did §1.1502–13(f)(6)(ii). To avoid confusion, the IRS and Treasury Department propose replacing the current provisions in §1.1502–13(f)(6)(ii) (and references to that provision) with a refer- ence to §1.1032–3. 2.Modification of exception to definition of deconsolidation in §1.1502–19. Section 1.1502–19 provides rules for the determination and recapture of excess loss accounts. In general, an excess loss account is recaptured (taken into account) when there is a disposition of the stock to which the account relates. Section 1.1502–19(c) defines the term disposi- tion for purposes of §1.1502–19. Under that section, the term disposition includes transfers, cancellations, deconsolidations, and worthlessness. The term deconsolida- tion is defined in §1.1502–19(c)(1)(ii). In general, the termination of a consol- idated group will give rise to the decon- solidation of the members of the group. However, §1.1502–19(c)(3)(i)(A) pro- vides that, if a group terminates because a member of another group has acquired either the assets of the common parent of the terminating group (in a reorganization described in section 381(a)(2)) or the stock of the common parent, the members of the acquired group that become members of the acquiror’s group are not treated as de- consolidated. Thus, there is no recapture of excess loss accounts in the shares of stock of subsidiaries of the acquired group that, after the acquisition, are held by a member of the acquiring group. The exception to deconsolidation treat- ment in §1.1502–19(c)(3)(i)(A) (and therefore to the recapture of excess loss accounts) is warranted because its condi- tions ensure that the consolidated return provisions will continue to apply to the members of the acquired group. Thus, the provisions of §1.1502–19 are able to continue to regulate the determination and recapture of the excess loss accounts. However, for the continued application of the consolidated return provisions to the acquired group, it is only neces- sary that the acquiror be a member of a group following the acquisition. Its sta- tus prior to the acquisition is immaterial. The IRS and Treasury Department have therefore decided to revise the rule in §1.1502–19(c)(3)(i)(A) to require only that the acquiror be a member of a group following the qualified acquisition. Thus, under the proposed regulations, the exception to deconsolidation treatment provided in §1.1502–19(c)(3)(i)(A) would be available when the acquisition is by a stand-alone corporation or a member of an affiliated, nonconsolidated group. 3.Clarification of “substantially all” standard in §1.1502–19(c)(1)(iii)(A). Section 1.1502–19(c)(1)(iii) defines the term “worthless” for purposes of ex- cess loss account recapture (resulting in the inclusion of the excess loss account in income). The definition of worthless- ness in §1.1502–19(c)(1)(iii) is adopted for determining the time when subsidiary stock with positive basis may be treated as February 20, 20075602007–8 I.R.B. worthless (and therefore deductible). See §1.1502–80(c). Section 1.1502–19(c)(1)(iii)(A) gen- erally provides that a share of subsidiary stock will be treated as worthless when substantially all the subsidiary’s assets are treated as disposed of, abandoned, or destroyed for federal tax purposes. This provision prevents an excess loss account from being included in income (and a worthless stock deduction from be- ing taken) until the subsidiary’s activities have been taken into account by the group. As a result, the group’s income is clearly reflected and single entity treatment is promoted. The current regulations do not, how- ever, define the term “substantially all” for purposes of §1.1502–19(c)(1)(iii)(A). Particular concerns have arisen because the term is used in many other areas of tax law, most notably in the area of cor- porate reorganizations. Because different policies are operative in those areas, the thresholds appropriate in those areas are not necessarily appropriate for purposes of §1.1502–19(c)(1)(iii)(A) and the consoli- dated return provisions that incorporate it. The IRS and Treasury Department believe that the single entity purpose of these consolidated return provisions is best effected by treating a subsidiary’s stock as worthless only once the sub- sidiary has recognized all items of in- come, gain, deduction, and loss attribut- able to its assets and operations. Accord- ingly, these proposed regulations clarify §1.1502–19(c)(1)(iii)(A) by providing that stock of a subsidiary will be treated as worthless when the subsidiary has dis- posed of, abandoned, or destroyed (for Federal tax purposes) all its assets other than its corporate charter and those as- sets, if any, that are necessary to satisfy state law minimum capital requirements to maintain corporate existence. 4.Triangular reorganizations that are also group structure changes. Sections 1.1502–30 and 1.1502–31 pro- vide special rules for determining the ba- sis of stock following, respectively, a tri- angular reorganization and a group struc- ture change. The provisions both generally adopt net asset basis rules, but, in the case of a triangular reorganization, taxpayers can elect other rules in certain transactions. The regulations do not specify whether a group structure change that is also a trian- gular reorganization is subject to the basis rules applicable to group structure changes (under §1.1502–31) or to triangular reor- ganizations (under§1.1502–30). Because it is appropriate to conform the basis of the stock of the former common parent to its net asset basis in the case of any group structure change, the IRS and Treasury De- partment intend the rules of §1.1502–31 to control the determination of stock ba- sis when a transaction is a group struc- ture change, without regard to whether the transaction is also a triangular reorganiza- tion. Accordingly, the proposed regula- tions add a rule to clarify that §1.1502–31 governs the determination of basis in all cases to which it applies, even those that also qualify as triangular reorganizations. 5.Allocations of investment adjustments to prevent or minimize excess loss accounts. Under §1.1502–32(c)(2)(i), positive in- vestment adjustments allocated to a mem- ber’s shares of a class of common stock are allocated first to equalize and elimi- nate excess loss accounts and then equally to all the member’s other shares in that class. In the case of a negative adjustment, that section provides for the reduction of a member’s positive basis in shares of a class of common stock before the creation or increase of an excess loss account in any such share. However, the current rule does not require that negative adjustments must be made first to equalize excess loss accounts before applying them equally to all shares. The proposed regulations add such a provision in order to better reflect themember’sinvestmentinitssharesof subsidiary stock. 6.Expired losses and attribute reduction under §1.1502–28. Section 1.1502–32(b)(3)(ii)(C)(2)pro- vides that, if the amount of a discharge of indebtedness exceeds the amount of the related attribute reduction under §1.1502–28, that excess is treated as ap- plying to reduce attributes to the extent of certain expired losses. In general, this section only applies to losses that expired without tax benefit, that were taken into account as noncapital,nondeductible ex- penses when they expired, and that would have been reduced had they not expired. The effect of this rule is to create a posi- tive adjustment to the extent of the expired losses. The purpose of the rule, as stated in T.D. 8560, is to more fully integrate expired losses into the investment adjust- ment system. As currently written, however, the rule does not explicitly state whether this spe- cial treatment of expired losses is available to all members’ expired losses or only to the debtor-subsidiary’s expired losses. Al- lowing such treatment for all members’ expired losses is beyond the intended scope of relief and undermines the purpose of sections 108 and 1017, and §1.1502–28. Accordingly, §1.1502–32(b)(3)(ii)(C)(2) is revised to state explicitly that such treat- ment is intended only for the debtor-sub- sidiary’s expired losses. The regulation is also revised to clarify that all available attributes, not just those of the debtor-sub- sidiary, must be reduced before this special rule for certain expired losses can apply. 7.Applicability of other rules of law, anti-duplicative adjustments rules. Many of the consolidated return rules include provisions stating that other rules of law continue to apply. These provi- sions are generally unnecessary in light of §1.1502–80(a), which provides that the provisions of the Code continue to apply to taxpayers filing a consolidated return un- less specifically provided otherwise in the consolidated return regulations. However, these provisions often also contain state- ments that the consolidated return provi- sions modify other rules of law and that du- plicative adjustments should not be made as a result of the consolidated return pro- visions. To simplify the regulations and remove any potential negative implication from the absence of such a provision in a particular provision, these proposed regu- lations incorporate all of these principles in §1.1502–80(a) and remove similar pro- visions from other sections of the consoli- dated return regulations. 8.Retention of, and nonsubstantive revisions to, §1.1502–80(c). Section 1.1502–80(c) provides that subsidiary stock is not treated as worth- less until the earlier of the time that the subsidiary ceases to be a mem- ber of the group and the time that the 2007–8 I.R.B.561February 20, 2007 stock is worthless within the meaning of §1.1502–19(c)(1)(iii). This rule, with its companion rule postponing the inclu- sion in income of excess loss accounts, prevents a group from recognizing any amount (whether loss or gain) on sub- sidiary stock until the subsidiary has taken into account all of its operating income, gain, deduction, and loss. Thus, the rule promotes single entity treatment by en- abling the group to continue treating its investment in subsidiary stock as an in- vestment in the subsidiary’s assets and operations until the subsidiary has either taken all of its items into account or ceased to be a member of the group. Following theRite Aiddecision, practi- tioners have submitted comments suggest- ing that §1.1502–80(c) should be removed from the consolidated return regulations. The suggestion was based on the obser- vation that §1.1502–80(c) prevented inap- propriate disallowance under the LDR and, since the LDR no longer applies to stock dispositions, §1.1502–80(c) is no longer necessary. While it iscorrect that there is no longer an LDR-based justification for the rule in §1.1502–80(c), the LDR was neither the only nor the principal purpose for the rule. The principal purpose of the rule was, and is, to promote single entity treatment. And, with its companion rule governing the inclusion of excess loss ac- counts, this rule continues to do that. In addition, the IRS and Treasury De- partment recognize that, to the extent a subsidiary’s attributes would survive a worthlessness event (for example, when a subsidiary survives and is owned by its creditors following a bankruptcy), §1.1502–80(c) benefits the group by post- poning the time that the subsidiary’s stock is treated as worthless. Because section 382(g)(4)(D) could subject S’s losses to a zero section 382 limitation if P were to treat S’s stock as worthless during bankruptcy, a court might prevent P from treating S’s stock as worthless in an earlier year, effectively denying P any worth- lessness deduction. SeeIn re Prudential Lines, Inc., 928 F.2d 565 (2d Cir. 1991), cert. denied, 112 S.Ct. 82 (1991). Accordingly, the IRS and Treasury De- partment have rejected the suggestion to remove §1.1502–80(c). The proposed reg- ulations do, however, revise the language of the current rule solely for the purpose of clarifying its operation. No substantive change is intended. 9.Effective dates. The proposed regulations described in this section I would be applicable as of the date they are published as final regulations in theFederal Register. J.Request for Comments. As described in this preamble, many ap- proaches and combinations of approaches were considered with respect to both noneconomic and duplicated loss and, al- though the IRS and Treasury Department believe the approach adopted in these pro- posed regulations best responds to and balances the Congressional mandates, comments are requested concerning both the approach adopted in these proposed regulations and other possible approaches. As noted in section D of this preamble, the IRS and Treasury Department are con- tinuing to study, and invite comments on, theissueofgainduplicationbyconsoli- dated groups. Comments are specifically requested concerning the circumstances under which gain duplication should be addressed and the mechanisms that could be adopted to do so. For example, com- ments could address whether a gain du- plication rule could or should parallel the approach to loss duplication suggested in the proposed regulations, or whether some other approach would be more appropri- ate or administrable. Comments are also requested regarding limitations that may be necessary or appropriate to address concerns such as attribute churning and conversion. In addition, comments are requested concerning the noneconomic reduction of stock gain (that is, the appro- priateness of the continued use of a loss disallowance model) and the reduction of noneconomic stock gain (that is, the reduction of basis through the absorption of built-in losses or net built-in losses), and the extent to which it would be appro- priate to address gain duplication without addressing these issues. As noted in section H of this pream- ble, the IRS and Treasury Department are continuing to study the application of sec- tion 362(e)(2) in the consolidated setting. Comments are specifically requested con- cerning the general application of section 362(e)(2) to intercompany transactions, as well as the administrability and appropri- ateness of the proposed rules suspending the application of section 362(e)(2) to intercompany transactions and specially allocating items attributable to intercom- pany section 362(e)(2) transactions. Although these regulations are gener- ally proposed to be applicable when pub- lished as final regulations in theFederal Register, the IRS and Treasury Depart- ment invite comments regarding the extent to which it would be appropriate and de- sirable to allow taxpayers to elect to apply these provisions retroactively. Special Analyses It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory as- sessment is not required. It is hereby cer- tified that these regulations will not have a significant economic impact on a sub- stantial number of small entities. This cer- tification is based on the fact that these regulations primarily will affect affiliated groups of corporations that have elected to file consolidated returns, which tend to be larger entities. Therefore, a Regula- tory Flexibility Analysis under the Regula- tory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f), this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Comments and Requests for Public Hearing Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed origi- nal and eight (8) copies)orelectroniccom- ments that are submitted timely to the IRS. The IRS and Treasury Department request comments on the clarity of the proposed regulations and how they can be made eas- ier to understand. All comments will be available for public inspection and copy- ing. A public hearing will be scheduled ifrequestedinwritingbyanypersonthat timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in theFederal Register. February 20, 20075622007–8 I.R.B. Drafting Information The principal authors of these regulations are Theresa Abell and Phoebe Bennett of the Office of Asso- ciate Chief Counsel (Corporate). How- ever, other personnel from the IRS and Treasury Department participated in their development. ***** Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is proposed to be amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows: Authority: 26 U.S.C. 7805 * * * Section 1.1502–36also issued under 26 U.S.C.1502*** Section 1.1502–36also issued under 26 U.S.C. 337(d). * * * §1.337(d)–1 [Removed] Par. 2. Section 1.337(d)–1 is removed. §1.337(d)–2 [Removed] Par. 3. Section 1.337(d)–2 is removed. Par. 4. Section 1.358–6 is amended by: 1. Revising paragraph (e). 2. Adding new paragraph (f)(3). The revision and addition read as fol- lows: §1.358–6 Stock basis in certain triangular reorganizations. ***** (e)Cross-reference regarding triangu- lar reorganizations involving members of a consolidated group. For rules relating to stock basis adjustments made as a result of a triangular reorganization in which P and S, or P and T, as applicable, are, or be- come, members of a consolidated group, see §1.1502–30. However, if a transac- tion is a group structure change, even if it is also a triangular reorganization, stock basis adjustments are determined under §1.1502–31. ***** (f) * * * (3)Special rule for triangular reorga- nizations involving members of a consoli- dated group. Paragraph (e) of this section shall apply to all transfers on or after the date these regulations are published as fi- nal regulations in theFederal Register. Par. 5. Section 1.1502–13 is amended by: 1.Revising paragraphs (a)(4), (f)(6)(ii), and (j)(5)(i)(A). 2. Adding new paragraph (e)(4). 3. Revising the last sentence of para- graph (f)(6)(iv)(A). 4. Removing the second sentence in paragraph (f)(6)(v). 5. Adding a new last sentence to para- graph (l)(1). The revisions and additions read as fol- lows: §1.1502–13 Intercompany transactions. (a) * * * (4)Application of other rules of law. See §1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. ***** (e) * * * (4)Intercompany section 362(e)(2) transactions—(i)Purpose and scope. This paragraph (e)(4) provides simplifying rules for intercompany transactions that are subject to section 362(e)(2) (intercom- pany section 362(e)(2) transactions). The purpose of this paragraph (e)(4) is to sus- pend the application of section 362(e)(2) during the period of time that the dupli- cation resulting fromthe intercompany section 362(e)(2) transaction (the section 362(e)(2) amount, as defined in paragraph (e)(4)(ii)(A) of this section) can effec- tively be eliminated by the operation of the investment adjustment provisions of §1.1502–32. The amount and location of this duplication is identified and tracked while in the consolidated group. When this duplication can no longer effectively be eliminated by the investment adjust- ment provisions, the principles of section 362(e)(2) apply to the extent necessary to eliminate all or a portion of any remain- ing section 362(e)(2) amount (as defined in paragraph (e)(4)(ii)(B) of this section) reflected in B’s attributes or stock. For purposes of this paragraph (e)(4), any reference to B stock received in an in- tercompany section 362(e)(2) transaction refers to B stock or B securities received (or deemed received) without the recogni- tion of gain or loss. (ii)Identification and elimination of section 362(e)(2) amount—(A)Section 362(e)(2) amount.Thesection 362(e)(2) amountis the amount of duplication re- sulting from an intercompany section 362(e)(2) transaction, and is equal to the amount by which B’s basis in the assets received in an intercompany sec- tion 362(e)(2) transaction would have, but for the application of this paragraph (e)(4), been eliminated under section 362(e)(2)(A) (absent an election under section 362(e)(2)(C)). Such amount is ini- tially reflected in both the basis of the B stock received in the transaction and B’s basis in the assets received. Each share of B stock initially reflects the section 362(e)(2) amount to the extent the basis would have been reduced under section 362(e)(2)(C) if suchan election was made and this paragraph (e)(4) did not apply. B’s basis in each asset received initially reflects the section 362(e)(2) amount to the extent the basis in such asset would have been reduced under section 362(e)(2)(A) if no election was made under section 362(e)(2)(C) and this paragraph (e)(4) did not apply. However, over time the section 362(e)(2) amount may be reflected in B’s basis in assets, deferred items, or other unabsorbed losses (B’s attributes). (B)Remaining section 362(e)(2) amount.Theremaining section 362(e)(2) amountis the portion of the section 362(e)(2) amount that has not been elim- inated. (C)Elimination of section 362(e)(2) amount—(1) Elimination caused by re- duction in B’s attributes. The section 362(e)(2) amount is eliminated as B’s at- tributes that reflectthe section 362(e)(2) amount are taken into account by the group (including as a result of attribute re- duction under paragraph (e)(4)(iv) of this section, or §1.1502–36(d) to the extent it did not reduce the basis in B stock that re- flects the section 362(e)(2) amount). The portions of B’s attributes that reflect a sec- tion 362(e)(2) amount are generally taken into account by the group proportionately. However, because any reduction in B’s attributes under paragraph (e)(4)(iv) of this section is applied to reduce attributes that reflect the section 362(e)(2) amount, the section 362(e)(2) amount is elimi- 2007–8 I.R.B.563February 20, 2007 nated to the extent of the full amount of such reduction. If the section 362(e)(2) amount is eliminated because B’s at- tributes that reflect the section 362(e)(2) amount are taken into account, each share of B stock received in the intercompany section 362(e)(2) transaction that is held by a member is treated as proportionately reflecting the remaining section 362(e)(2) amount (based on the section 362(e)(2) amount reflected before the elimination). (2)Elimination caused by reduction in basis in B stock. The section 362(e)(2) amount is also eliminated to the extent the basis in B stock that reflects the section 362(e)(2) amount is reduced under para- graph (e)(4)(v) of this section, is reduced under §1.1502–36(d), or is otherwise elim- inated (other than under §1.1502–32) with- out the recognition of gain or loss. The portion of the basis in a share of B stock that reflects a section 362(e)(2) amount is so reduced or eliminated before any other portion of the basis in such a share. If the section 362(e)(2) amount is eliminated as provided in this paragraph (e)(4)(ii)(C)(2), each of B’s attributes that reflected the sec- tion 362(e)(2) amount is treated as pro- portionately reflecting the remaining sec- tion 362(e)(2) amount (based on the sec- tion 362(e)(2) amount reflected before the elimination). (iii)Section 362(e)(2) application event. A section 362(e)(2) application event is any transaction or event that re- sults in— (A) A transfer (within the meaning of §1.1502–36(f)(11)) of any of the B stock that was received in the intercompany sec- tion 362(e)(2) transaction; (B) Any satisfaction (actual or deemed) of a security received in an intercompany section 362(e)(2) transaction without the recognition of gain or loss; (C) Any nonmember holding an asset with a substituted basis that reflects all or a portion of the remaining section 362(e)(2) amount or succeeding to an attribute that reflects all or a portion of the remaining section 362(e)(2) amount; or (D) Any other transaction the result of which prevents all or a portion of any remaining section 362(e)(2) amount re- flected in stock basis or attributes from be- ingeffectivelyeliminatedbytheoperation of the investment adjustment provisions of §1.1502–32 when taken into account. (iv)General rule. In the case of an intercompany section 362(e)(2) transac- tion, no adjustment to B’s attributes shall be made under section 362(e)(2) until immediately before a section 362(e)(2) application event (as defined in paragraph (e)(4)(iii) of this section). At that time, unless an election is made under para- graph (e)(4)(v) of this section, B reduces its attributes that reflect the remaining section 362(e)(2) amount as provided in this paragraph (e)(4)(iv). (A)Amount of reduction. If the appli- cation event involves B’s attributes that re- flect all or a portion of the remaining sec- tion 362(e)(2) amount, the amount of the reduction is equal to the remaining sec- tion 362(e)(2) amount reflected in the at- tributes so involved. If the application event involves all or a portion of the B stock received in the intercompany section 362(e)(2) transaction, the amount of the re- duction is equal to the remaining section 362(e)(2) amount reflected in the B stock so involved. (B)Application of reduction.Iftheap- plication event involves B’s attributes that reflect all or a portion of the remaining section 362(e)(2) amount, the reduction is applied to reduce each attribute so involved by the full amount of the remain- ing section 362(e)(2) amount reflected in each such attribute. If the application event involves all or a portion of the B stock received in the intercompany sec- tion 362(e)(2) transaction, the reduction is applied proportionately (based on the remaining section 362(e)(2) amount re- flected in each attribute prior to reduction) to all of B’s attributes that reflect the re- maining section 362(e)(2) amount. (C)Effect of the reduction.Any reduction to B’s attributes under this paragraph (e)(4)(iv) is not a noncapi- tal, nondeductible expense described in §1.1502–32(b)(2)(iii). (v)Election to reduce the basis in B stock. In lieu of reducing B’s attributes as provided in paragraph (e)(4)(iv) of this section, S and B may elect to reduce the basis in the B stock received in the inter- company section 362(e)(2) transaction as provided in this paragraph (e)(4)(v). (A)Amountofreduction. The basis in the B stock is reduced by an amount equal to the amount B would otherwise be re- quired to reduce its attributes under para- graph (e)(4)(iv) of this section. (B)Application of reduction.Ifthe application event involves B’s attributes that reflect all or a portion of the remain- ing section 362(e)(2) amount, the reduc- tion is applied proportionately (based on the remaining section 362(e)(2) amount re- flected in the B stock prior to reduction) to all of the B stock received in the in- tercompany section 362(e)(2) transaction that is held by members immediately be- fore the application event. If the appli- cation event involves all or a portion of the B stock received in the intercompany section 362(e)(2) transaction, the reduc- tion is applied proportionately (based on the remaining section 362(e)(2) amount reflected in the B stock prior to reduc- tion) to the B stock so involved. Any re- duction in the basis of the B stock under this paragraph (e)(4)(v) is applied imme- diately before the section 362(e)(2) appli- cation event. (C)Effect of the reduction.Anyre- duction to the basis of the B stock un- der this paragraph (e)(4)(v) is a nonde- ductible basis recovery item described in §1.1502–32(b)(3)(iii)(B). (D)Election. The election is made in the manner described in regulations imple- menting section 362(e)(2). The election must be made for an intercompany section 362(e)(2) transaction on or with the group return for either the year in which the in- tercompany section 362(e)(2) transaction or the first section 362(e)(2) application event occurs. The election is irrevocable and applicable for all section 362(e)(2) ap- plication events with respect to such in- tercompany section 362(e)(2) transaction (even if the event occurs while S and B are members of another consolidated group). If the election is made on or with the return for the year of the intercompany section 362(e)(2) transaction, it has effect only if and to the extent there is a remaining sec- tion 362(e)(2) amount when there is a sec- tion 362(e)(2) application event. (vi)Examples. The application of this paragraph (e)(4) is illustrated by the fol- lowing examples: Example 1.Section 362(e)(2) amount reflected in asset basis.(i)Facts. P owns the sole outstand- ing share of S stock. S owns Asset 1 with a basis of $100 and a value of $20. On January 1, year 1, S con- tributes Asset 1 to newly formed B in exchange for 10 shares of B stock in a transaction to which section 351 applies. At the end of year 1, B’s only item is a $10 depreciation deduction with respect to Asset 1, which gives rise to a $10 loss that is absorbed by the group. February 20, 20075642007–8 I.R.B. OnJanuary1,year2,Ssellsall10sharesofBstock for $18. After applying and giving effect to all gen- erally applicable rules of law, S’s basis in each share of B stock is $9 (the original $10 basis reduced by $1 loss attributable to the depreciation on Asset 1). No election is made under section 362(e)(2)(C). (ii)Suspension of section 362(e)(2) in year 1.S’s contribution of Asset 1 to B is an intercompany trans- action to which section 362(e)(2) applies. Under the general rules of section 362(e)(2)(A), B’s basis in As- set 1 would be reduced by $80 to its value, $20. How- ever, as described in this paragraph (e)(4), the trans- fer is an intercompany section 362(e)(2) transaction and therefore, under paragraph (e)(4)(iv) of this sec- tion, no adjustment is made under section 362(e)(2) until there is a section 362(e)(2) application event. The $80 reduction that B would have had in its basis in Asset 1 is a section 362(e)(2) amount described in paragraph (e)(4)(ii)(A) of this section. This amount is reflected ratably in S’s basis in the 10 shares of B stock, and in B’s basis in Asset 1. There is no section 362(e)(2) application event in year 1 and so there is no section 362(e)(2) adjustment in year 1. (iii)Application of section 362(e)(2) on sale of Bstock. S’s sale of the B stock is a transfer within the meaning of §1.1502–36(f)(11) and therefore a section 362(e)(2) application event under paragraph (e)(4)(iii)(A) of this section. Accordingly, under paragraphs (e)(4)(iv)(A) and (e)(4)(iv)(B) of this section, because the section 362(e)(2) application event was caused by the transfer of B stock received in the intercompany section 362(e)(2) transaction, B must reduce its basis in Asset 1 that reflects the remaining section 362(e)(2) amount by an amount equal to the remaining section 362(e)(2) amount reflected in the B stock involved in the application event. Because S sold all of the B stock received in the intercompany section 362(e)(2) transaction and this stock reflects all of the section 362(e)(2) amount, B must reduce its basis in Asset 1 by the full amount of the remaining section 362(e)(2) amount immediately before the application event. Although there was originally an $80 section 362(e)(2) amount, $8 of that amount ($80/$100 x $10) was eliminated under paragraph (e)(4)(ii)(C)(1) of this section when the loss attributable to the depreciation deduction on Asset 1 was absorbed in year 1. Thus, at the time of the sale, the remaining section 362(e)(2) amount is only $72 ($80 less $8), and B’s basis in Asset 1 is reduced by such amount, to $18. Under paragraph (e)(4)(iv)(C) of this section, the reduction in the basis of Asset 1 is not a noncapital, nondeductible expense described in §1.1502–32(b)(2)(iii) and so has no effect on S’s basis in its B shares. See §1.1502–36 for additional rules relating to loss on shares of sub- sidiary stock. Example 2.Section 362(e)(2) amount reflected in unabsorbed loss.(i)Facts. The facts are the same as inExample 1, except that during year 1 B sells Asset 1 to an unrelated nonmember for $20, and recognizes an $80 loss that is not absorbed by the group. (ii)Suspension of section 362(e)(2) in year 1.As in paragraph (ii) ofExample 1, S’s contribution of Asset 1 to B is an intercompany section 362(e)(2) transaction, the section 362(e)(2) amount is $80, and there is no section 362(e)(2) adjustment in year 1. This amount is reflected ratably in S’s basis in the 10 shares of B stock, and initially in B’s basis in Asset 1. Further, because the $80 loss recognized on the sale of Asset 1 is not absorbed by the group, at the end of year 1 the remaining section 362(e)(2) amount is $80, reflected ratably in S’s basis in the 10 shares of B stock, and in B’s unabsorbed $80 loss. (iii)Application of section 362(e)(2) on sale of B stock. As in paragraph (iii) ofExample 1,S’ssale of the 10 shares of B stock is a section 362(e)(2) ap- plication event that involves all of the B stock re- ceived in the intercompany section 362(e)(2) trans- action. Accordingly, immediately before the appli- cation event, B must reduce the unabsorbed loss car- ryover that reflects the remaining section 362(e)(2) amount by an amount equal to the remaining section 362(e)(2) amount reflected in the B stock involved in the application event, $80 (all of the remaining sec- tion 362(e)(2) amount). The reduction of the loss car- ryover is not a noncapital, nondeductible expense de- scribed in §1.1502–32(b)(2)(iii) and so has no effect on S’s basis in its B shares. See §1.1502–36 for ad- ditional rules relating to loss on shares of subsidiary stock. Example 3.Section 362(e)(2) amount reflected in unabsorbed loss, partial application.(i)Facts.The facts are the same as inExample 2 , except that on January 1, year 2, S only sells two shares of the B stock to an unrelated nonmember for $4. (ii)Suspension of section 362(e)(2) in year 1. S’s contribution of Asset 1 to B is an intercompany section 362(e)(2) transaction, the section 362(e)(2) amount is $80, and there is no section 362(e)(2) ad- justment in year 1. This amount is reflected ratably in S’s basis in the 10 shares of B stock, and initially in B’s basis in Asset 1. Further, because the $80 loss recognized on the sale of Asset 1 is not absorbed by the group, at the end of year 1 the remaining section 362(e)(2) amount is $80, reflected ratably in S’s basis in the 10 shares of B stock, and in B’s unabsorbed $80 loss. (iii)Application of section 362(e)(2) on sale of B stock. S’s sale of two of the shares of B stock is a section 362(e)(2) application event that involves two shares of the B stock received in the intercompany section 362(e)(2) transaction. Accordingly, immedi- ately before the application event, B must reduce the unabsorbed loss carryover that reflects the remaining section 362(e)(2) amount by an amount equal to the remaining section 362(e)(2) amount reflected in the B stock involved in the application event, $16 ($8 of the remaining section 362(e)(2) amount reflected in each share). The loss carryover is reduced from $80 to $64. This reduction is not a noncapital, nondeductible ex- pense described in §1.1502–32(b)(2)(iii) and so has no effect on S’s basis in its B shares. Additionally, un- der paragraph (e)(4)(ii)(C)(1) of this section, $16 of the remaining section 362(e)(2) amount is eliminated, and, thereafter, the $64 remaining section 362(e)(2) amount is ratably reflected in S’s basis in the re- maining 8 shares of B stock and in B’s $64 loss car- ryover. Because no election is made under section 362(e)(2)(C) in the year of the intercompany sec- tion 362(e)(2) transaction or in the year of the stock sale, the first section 362(e)(2) application event, no such election can be made with respect to the re- maining shares received in the intercompany section 362(e)(2)(C) transaction. See §1.1502–36 for addi- tional rules relating to loss on shares of subsidiary stock. (iv)Application of section 362(e)(2) on sale of B stock, section 362(e)(2)(C) election. If S and B elect under paragraph (e)(4)(v) of this section to reduce S’s basis in the B stock received in the intercom- pany section 362(e)(2) transaction, under paragraph (e)(4)(v)(A) of this section S will reduce its basis in the B stock by $16 (an amount equal to the amount that B would otherwise be required to reduce its loss carryover, or the remaining section 362(e)(2) amount reflected in the two shares of B stock sold). Under paragraph (e)(4)(v)(B) of this section, this $16 reduction is applied proportionately to the two shares of B stock sold immediately before the application event, reducing the basis of each share to $2. The reduction in the basis of the two B shares sold is a nondeductible basis recovery item described in §1.1502–32(b)(3)(iii)(B), and will affect P’s basis in its share of S stock. Additionally, under paragraph (e)(4)(ii)(C)(2) of this section, $16 of the remaining section 362(e)(2) amount is eliminated, and, there- after, the $64 remaining section 362(e)(2) amount is ratably reflected in S’s basis in the remaining 8 shares of B stock and in B’s $80 loss carryover. S recognizes no gain or loss on the sale of these two shares of B stock. Under paragraph (e)(4)(v)(D) of this section, S and B’s election to reduce S’s basis in the B stock is irrevocable and applicable to all future section 362(e)(2) application events with respect to this intercompany section 362(e)(2) transaction, such as subsequent dispositions of B stock to an unrelated nonmember. Example 4.Section 362(e)(2) amount reflected in unabsorbed loss, subgroup exception.(i)Facts. The facts are the same as inExample 3, except that S does not sell any shares of B stock, and on January 1, year 2, P sells the sole share of the S stock to P1, the common parent of another consolidated group. (ii)Suspension of section 362(e)(2) in year 1. S’s contribution of Asset 1 to B is an intercompany section 362(e)(2) transaction, the section 362(e)(2) amount is $80, and there is no section 362(e)(2) ad- justment in year 1. This amount is reflected ratably in S’s basis in the 10 shares of B stock, and initially in B’s basis in Asset 1. Further, because the $80 loss recognized on the sale of Asset 1 is not absorbed by the group, at the end of year 1 the remaining section 362(e)(2) amount is $80, reflected ratably in S’s basis in the 10 shares of B stock, and in B’s unabsorbed $80 loss. (iii)No section 362(e)(2) application event on sale of S stock. P’s sale of the S stock is not an ap- plication event described in paragraph (e)(4)(iii) of this section. Further, because S and B continue to be members of the same consolidated group, there is no transfer (within the meaning of §1.1502–36(f)(11)) of the 10 shares of B stock. Accordingly, there is no application event and, under paragraph (e)(4)(iv) of this section, no section 362(e)(2) adjustment is re- quired. However, adjustments will be required if a section 362(e)(2) application event occurs at a time when there is a remaining section 362(e)(2) amount. ***** (f) * * * (6) * * * (ii)Gain stock. For dispositions of P stock occurring before May 16, 2000, see §1.1502–13(f)(6)(ii) as contained in 26 CFR part 1 in effect on April 1, 2000. For 2007–8 I.R.B.565February 20, 2007 dispositions of P stock occurring on or after May 16, 2000, see §1.1032–3. ***** (iv)***(A)***IfPgrantsMan option to acquire P stock in a transaction meeting the requirements of §1.1032–3, M is treated as having purchased the option from P for fair market value with cash con- tributed to M by P. ***** (j) * * * (5)***(i)*** (A) The acquisition of either the assets of the common parent of the terminating group in a reorganization described in sec- tion 381(a)(2), or the stock of the common parent of the terminating group; or ***** (l)***(1)***Paragraphs(a)(4), (e)(4), (f)(6)(ii), (f)(6)(iv)(A), and (j)(5)(i)(A) of this section apply to all transfers on or after the date these regula- tions are published as final regulations in theFederal Register. ***** Par. 6. Section 1.1502–19 is amended by: 1.Revising paragraphs (a)(3), (c)(1)(iii)(A), and (c)(3)(i)(A). 2. Adding a new last sentence to para- graph (h)(1). The revisions and addition read as fol- lows: §1.1502–19 Excess loss accounts. (a) * * * (3)Application of other rules of law. See §1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. In addition, for purposes of this section, the definitions in §1.1502–32 apply. ***** (c) * * * (1) * * * (iii) * * * (A) All of S’s assets (other than its cor- porate charter and those assets, if any, nec- essary to satisfy state law minimum capi- tal requirements to maintain corporate ex- istence) are treated as disposed of, aban- doned, or destroyed for Federal income tax purposes (for example, under section 165(a) or §1.1502–80(c), or, if S’s asset is stock of a lower-tier member, the stock is treated as disposed of under this paragraph (c)). An asset of S is not considered to be disposed of or abandoned to the extent the disposition is in complete liquidation of S under section 332 or is in exchange for consideration (other than in satisfaction of indebtedness); ***** (3)***(i)*** (A) The acquisition of either the assets of the common parent of the terminating group in a reorganization described in sec- tion 381(a)(2), or the stock of the common parent of the terminating group; or ***** (h)***(1)***Paragraphs(a)(3), (c)(1)(iii)(A), and (c)(3)(i)(A) of this sec- tion apply to all transfers on or after the date these regulations are published as fi- nal regulations in theFederal Register. ***** §1.1502–20 [Removed] Par. 7. Section 1.1502–20 is removed. Par. 8. Section 1.1502–21 is amended by: 1. Removing the last sentence of para- graph (b)(1). 2. Removing paragraph (b)(3)(v). 3. Revising paragraphs (b)(2)(ii)(A), (b)(2)(iv)(B)(2), (h)(6), and (h)(8). 4. Adding new paragraph (h)(1)(iii). The revisions and addition read as fol- lows: §1.1502–21 Net operating losses. ***** (b) * * * (2) * * * (ii)Special rules—(A)Year of depar- ture from group. If a corporation ceases to be a member during a consolidated return year, net operating loss carryovers attributable to the corporation are first carried to the consolidated return year, then are subject to reduction under section 108 and §1.1502–28 (regarding discharge of indebtedness income that is excluded from gross income under section 108(a)), and then are subject to reduction under §1.1502–36 (regarding transfers of loss shares of subsidiary stock). Only the amount that is neither absorbed nor re- duced under section 108 and §1.1502–28 or under §1.1502–36 may be carried to the corporation’s first separate return year. For rules concerning a member departing a subgroup, see paragraph (c)(2)(vii) of this section. ***** (iv)*** (B) * * * (2)Special rules—(i)Carryback to a separate return year. Ifaportionofthe CNOL attributable to a member for a tax- able year is carried back to a separate re- turn year, the percentage of the CNOL at- tributable to each member, as of immedi- ately after such portion of the CNOL is car- ried back, is recomputed pursuant to para- graph (b)(2)(iv)(B)(2)(v)ofthissection. (ii)Excluded discharge of indebtedness income. If during a taxable year a mem- ber realizes discharge of indebtedness in- come that is excluded from gross income under section 108(a) and such amount re- duces any portion of the CNOL attribut- able to any member pursuant to section 108 and §1.1502–28, the percentage of the CNOL attributable to each member as of immediately after the reduction of at- tributes pursuant to sections 108 and 1017, and §1.1502–28, shall be recomputed pur- suant to paragraph (b)(2)(iv)(B)(2)(v)of this section. (iii)Departing member. If during a tax- able year a member that had a separate net operating loss for the year of the CNOL ceases to be a member, the percentage of the CNOL attributable to each member as of the first day of the following consoli- dated return year shall be recomputed pur- suant to paragraph (b)(2)(iv)(B)(2)(v)of this section. (iv)Reduction of attributes for stock loss. If during a taxable year a mem- ber does not cease to be a member of the group and any portion of the CNOL at- tributable to any member is reduced pur- suant to §1.1502–36, the percentage of the CNOL attributable to each member imme- diately after the reduction of attributes pur- suant to §1.1502–36 shall be recomputed pursuant to paragraph (b)(2)(iv)(B)(2)(v) of this section. (v)Recomputed percentage.There- computed percentage of the CNOL at- tributable to each member shall equal the unabsorbed CNOL attributable to the February 20, 20075662007–8 I.R.B. member at the time of the recomputation divided by the sum of the unabsorbed CNOL attributable to all of the members at the time of the recomputation. For pur- poses of the preceding sentence, a CNOL that is reduced pursuant to section 108 and §1.1502–28, or under §1.1502–36, or that is otherwise permanently disallowed or eliminated, shall be treated as absorbed. (vi)Examples. For purposes of the examples in this section, unless otherwise stated, all groups fileconsolidated returns, all corporations have calendar taxable years, the facts set forth the only corporate activity, value means fair market value and the adjusted basis of each asset equals its value, all transactions are with unre- lated persons, and the application of any limitation or threshold under section 382 is disregarded. * * * ***** (h)***(1)*** (iii) Paragraphs (b)(2)(ii)(A) and (b)(2)(iv)(B)(2)ofthissectionapplyto taxable years the original return for which the due date (without regard to extensions) is on or after the date these regulations are published as final regulations in the Federal Register. ***** (6)Certain prior periods. Paragraphs (b)(1), (b)(2)(iv)(A), (b)(2)(iv)(B)(1), and (c)(2)(vii) of this section shall apply to taxable years for which the due date of the original return (without regard to extensions) is after March 21, 2005. Sec- tions 1.1502–21T(b)(1), (b)(2)(iv), and (c)(2)(vii), as contained in 26 CFR part 1 revised as of April 1, 2004, shall ap- ply to taxable years for which the due date of the original return (without re- gard to extensions) is on or before March 21, 2005, and after August 29, 2003. For taxable years for which the due date of the original return (without regard to extensions) is on or before August 29, 2003, see paragraphs (b)(1), (b)(2)(ii)(A), (b)(2)(iv), and (c)(2)(vii) of this section and §1.1502–21T(b)(1) as contained in 26 CFR part 1 revised as of April 1, 2003. ***** (8)Losses treated as expired un- der §1.1502–35(f)(1).Forrulesre- garding losses treated as expired under §1.1502–35(f) on and after March 10, 2006, see §1.1502–21(b)(3)(v) as con- tained in 26 CFR part 1 in effect on April 1, 2006. For rules regarding losses treated as expired before March 10, 2006, see §1.1502–21T(h)(8) as contained in 26 CFR part 1 in effect on April 1, 2005. Par. 9. Section 1.1502–30 is amended by: 1. Revising paragraph (b)(4). 2. Adding a new second sentence to paragraph (c). The revision and addition read as fol- lows: §1.1502–30 Stock basis after certain triangular reorganizations. ***** (b) * * * (4)Application of other rules of law. If a transaction otherwise subject to this section is also a group structure change subject to §1.1502–31, the provisions of §1.1502–31 and not this section apply to determine stock basis. See §1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. See §1.1502–80(d) for the non-application of section 357(c) to P. ***** (c) * * * However, paragraph (b)(4) of this section applies to reorganizations oc- curring on or after the date these regula- tions are published as final regulations in theFederal Register. ***** Par. 10. Section 1.1502–31 is amended by: 1. Revising paragraph (a)(2). 2. Adding a new last sentence to para- graph (h)(1). The revision and addition read as fol- lows: §1.1502–31 Stock basis after a group structure change. (a) * * * (2)Application of other rules of law.If a transaction subject to this section is also a triangular reorganization otherwise subject to §1.1502–30, the provisions of this sec- tion and not those of §1.1502–30 apply to determine stock basis. See §1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. ***** (h) * * * (1) * * * In addition, paragraph (a)(2) of this section applies to group struc- ture changes that occurred on or after the date these regulations are published as fi- nal regulations in theFederal Register. ***** Par. 11. Section 1.1502–32 is amended by: 1. Revising paragraphs (a)(2), (b)(3)(ii)(C)(2),(b)(3)(iii)(C), (b)(3)(iii)(D), (c)(1), (c)(2)(i), the first sentence in paragraph (c)(2)(ii)(A) introductory text, the first sentence in paragraph (c)(3), and the first sentence in paragraph (c)(4)(i) introductory text. 2. Adding new paragraph (h)(9). The revisions and addition read as follows: §1.1502–32 Investment adjustments. (a) * * * (2)Application of other rules of law. See §1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. ***** (b) * * * (3) * * * (ii) * * * (C) * * * (2)Expired loss carryovers.Ifthe amount of the discharge exceeds the amount of the attribute reduction under sections 108 and 1017, and §1.1502–28, the excess nevertheless is treated as ap- plied to reduce tax attributes to the extent a loss carryover attributable to S ex- pired without tax benefit, the expiration was taken into account as a noncapital, nondeductible expense under paragraph (b)(3)(iii) of this section, and the loss car- ryover would have been reduced had it not expired. ***** (iii) * * * (C)Loss suspended under §1.1502– 35(c).For losses suspended by §1.1502–35(c) prior to the date these regulations are published as final reg- ulations in theFederal Register,see §1.1502–32(b)(3)(iii)(C) as contained in 26 CFR part 1 revised as of April 1, 2006. (D)Reimported losses disallowed un- der §1.1502–35. Any loss or deduction the use of which is disallowed pursuant to §1.1502–35(b) (other than duplicating 2007–8 I.R.B.567February 20, 2007 items that are carried back to a consoli- dated return year of the group), and with respect to which no waiver described in paragraph (b)(4) of this section is filed, is treated as a noncapital, nondeductible ex- pense incurred during the taxable year that such loss would otherwise be absorbed. For losses or deductions disallowed un- der §1.1502–35(g)(3)(iii) prior to the date these regulations are published as final regulations in theFederal Register,see §1.1502–32(b)(3)(iii)(D) as contained in 26 CFR part 1 revised as of April 1, 2006. ***** (c)Allocation of adjustments among shares of stock—(1)In general—(i)Dis- tributions. The portion of the adjustment under paragraph (b) of this section that is described in paragraph (b)(2)(iv) of this section (negative adjustments for distribu- tions) is allocated to the shares of S stock to which the distribution relates. (ii)Special allocations in the case of certain loss transfers and reallocations of investment adjustments subject to prior use limitation—(A)Losses attributable to transfers subject to section 362(e)(2)—(1) In general. If a nonmember holds shares of S stock, any amounts that directly or in- directly reflect a section 362(e)(2) amount (as defined in §1.1502–13(e)(4)(ii)(A)) are allocated to members’ shares of S stock under the general principles of this para- graph (c), except that such allocations are made as though the shares of S stock held by nonmembers were not outstanding. (2)Example. The application of this paragraph (c) is illustrated by the follow- ing example: Example.(i)Facts. P owns four of the five out- standing shares of the stock of M. X, a nonmember, owns the remaining outstanding share of M stock. On January 1, year 1, M contributes Asset 1 to S, a newly formed subsidiary, in exchange for five shares of S stock in a transaction to which section 351 applies. At the time of the transfer, M’s basis in Asset 1 is $100 and its value is $20. At the end of year 1, S’s only item is a $10 depreciation deduction with re- spect to Asset 1, which gives rise to a $10 loss that is absorbed by the group. At the beginning of year 2, M sells one of its S shares to X for $3.60, and M and S elect to reduce M’s basis in the S stock under §1.1502–13(e)(4)(v) by the amount of the remaining section 362(e)(2) amount ($72) (computed in para- graph (iii)(C) of thisExample) reflected in the share. See §1.1502–13(e)(4). Accordingly, M’s basis in the S share is reduced by $14.40 (the portion of the $72 remaining section 362(e)(2) amount reflected in the share (computed in paragraph (iii)(C) of thisExam- ple)), to $3.60. M recognizes no gain or loss on the sale of the S share. At the end of year 2, S’s only item is an additional $10 depreciation deduction with respecttoAsset1,whichgivesrisetoanadditional $10 loss that is absorbed by the group. At the end of year 2, M’s only item is a $14.40 nondeductible basis recovery item resulting from the election to reduce its basis in the S share. See, §1.1502–13(e)(4)(v)(C). (ii)Application of section 362(e)(2) and §1.1502–13(e)(4) to the transfer of Asset 1.M’s contribution of Asset 1 to S is a transaction described in section 362(e)(2). Under the general rules of section 362(e)(2)(A), S’s basis in Asset 1 would be limited to its value ($20) and would thus be reduced by $80, from $100 to $20. However, the transfer is an intercompany section 362(e)(2) transaction and therefore, under §1.1502–13(e)(4)(iv), no adjustment is made to S’s basis in Asset 1 under section 362(e)(2) until there is a section 362(e)(2) application event (within the meaning of §1.1502–13(e)(4)(iii)). There is no section 362(e)(2) application event in year 1 and so there is no section 362(e)(2) adjustment in year 1. The $80 reduction that S would have had in its basis in Asset 1 is a section 362(e)(2) amount described in §1.1502–13(e)(4)(ii)(A). This $80 section 362(e)(2) amount is initially reflected ratably ($16 per share) in M’s basis in each of the five shares of S stock received in the transaction, and in S’s basis in Asset 1. Further, under §1.1502–13(e)(4)(ii)(C)(1), the section 362(e)(2) amount reflected in an attribute is generally eliminated proportionately as the attribute is taken into account. Accordingly, $8 ($80/$100 x $10) of the year 1 Asset 1 depreciation deduction is attributable to the section 362(e)(2) amount. (iii)Treatment of year 1 item.(A)Allocation of item among shares of S stock. Although no adjust- ment is made under section 362(e)(2) during year 1, if any shares of S stock are held by nonmembers, any items taken into account that are attributable to the section 362(e)(2) amount must be specially allocated under the rules of this paragraph (c)(1)(ii). Because M owns all the shares of S stock, the special alloca- tion rules of this paragraph (c)(1)(ii) have no appli- cation to the allocation of S’s depreciation deduction to M’s shares. Accordingly, the entire $10 of depre- ciation on Asset 1 is included in the remaining ad- justment to the S shares under the general rules in paragraphs (c)(2) through (c)(4) of this section. As a result, $2 is allocated to, and decreases the basis in, each share of S stock held by M from $20 to $18. (B)Allocation of tiered-up item among shares of M stock. Under paragraph (a)(3)(iii) of this sec- tion, adjustments to M’s basis in S stock tier up and are taken into account in determining adjustments to higher-tier stock. However, because X, a non- member, holds a share of M stock, any portion of the tiering-up adjustment that is attributable to a sec- tion 362(e)(2) amount is specially allocated under this paragraph (c)(1)(ii). In this case, $8 of the adjustment to M’s basis in S stock (80/100 x $10) is attribut- able to a section 362(e)(2) amount and thus $8 of the tiered-up adjustment is indirectly attributable to a sec- tion 362(e)(2) amount. As a result, $8 of the tiered-up adjustment must be allocated as though X’s share of M stock was not outstanding. Accordingly, $2 (1/4) of the $8 of the tiered-up adjustment is allocated to each of P’s four shares of M stock and no portion of that amount is allocated to X’s share of M stock. However, the remaining $2 of the tiered-up adjust- ment not attributable to a section 362(e)(2) amount is included in the remaining adjustment allocated to all outstanding shares under the general rules in para- graphs (c)(2) through (c)(4) of this section. Thus, $.40 (1/5) of the $2 of the tiered-up adjustment is al- located to each outstanding share. (Although $.40 is allocated to X’s share of M stock, that allocation does not affect X’s basis in the share because X is not a member of the group. See paragraph (c)(1)(iv) of this section.) The allocation of the tiered up year 1 item is thus: Allocation Item P’ssharesofMstock (4/5) X’sshareofMstock (1/5) Tiered-up section 362(e)(2) amount ($8ofthe$10depreciationonAsset1) $8.00 ($2.00 per share)N/A Tiered-up non-section 362(e)(2) amount ($2ofthe$10depreciationonAsset1) $1.60 ($.40 per share) $.40 ($.40 per share) Total allocation: $9.60 ($2.40 per share) $.40 ($.40 per share) February 20, 20075682007–8 I.R.B. (C)Remaining section 362(e)(2) amount.After the year 1 items have been taken into account, the re- maining section 362(e)(2) amount with respect to the S shares is $72 ($80 less $8 eliminated due to As- set 1 depreciation being taken into account). Under §1.1502–13(e)(4)(ii)(C)(1), this $72 remaining sec- tion 362(e)(2) amount is reflected proportionately in the five S shares held by M, or $14.40 per share. (iv)Treatment of year 2 items.(A)Elimina- tion of a portion of the section 362(e)(2) amount. Under §1.1502–13(e)(4)(ii)(C)(2), S’s remaining section 362(e)(2) amount is eliminated to the extent of the reduction in M’s basis in the S stock under §1.1502–13(e)(4)(v). Accordingly, S’s remaining section 362(e)(2) amount is reduced by $14.40, to $57.60. This remaining section 362(e)(2) amount is reflected proportionately in the four remaining S shares held by M, or $14.40 per share. (B)Allocation of item among shares of S stock. Because X owns a share of S stock in year 2, the special allocation rule in paragraph (c)(1)(ii) of this section applies to the allocation of the portion of the year 2 depreciation deduction attributable to a section 362(e)(2) amount. Under that rule, $6.40 (57.60/90 x $10) of the item attributable to a section 362(e)(2) amount must be allocated as though only the four shares of S stock held by M were outstanding. Ac- cordingly, $1.60 (1/4) of the $6.40 of the $10 depreci- ation deduction is allocated to each of M’s four shares of S stock and no portion of that amount is allocated to X’s share of S stock. However, the remaining $3.60 of the $10 depreciation deduction not attributable to a section 362(e)(2) amount is included in the remaining adjustment allocated to all outstanding shares under the general rules in paragraphs (c)(2) through (c)(4) of this section. Thus, $.72 (1/5) of the $3.60 of the $10 depreciation deduction is allocated to each out- standing S share. (Although $.72 is allocated to X’s share of S stock, that allocation does not affect X’s basis in the share because X is not a member of the group. See paragraph (c)(1)(iv) of this section.) The allocation of S’s year 2 item is thus: Allocation Item M’s shares of S stock (4/5) X’s share of S stock (1/5) Section 362(e)(2) amount ($6.40 of the $10 depreciation on Asset 1) $6.40 ($1.60 per share)N/A Non-section 362(e)(2) amount ($3.60 of the $10 depreciation on Asset 1) $2.88 ($.72 per share) $.72 ($.72 per share) Total allocation: $9.28 ($2.32 per share) $.72 ($.72 per share) (C)Adjustments to the basis of shares of M stock. The adjustment to the basis of M stock includes two items: M’s $14.40 nondeductible basis recovery item resulting from the reduction in M’s basis in the S stock under §1.1502–13(e)(4)(v); and $9.28 tiered-up adjustment from the adjustment made to its basis in the S stock. The full amount of the $14.40 nondeductible basis recovery item, and $6.40 of the $9.28 tiered-up adjustment is attributable to the section 362(e)(2) amount. Therefore $20.80 ($14.40 plus $6.40) must be allocated entirely to P’s shares of M stock. Accordingly, $5.20 (1/4) of the $20.80 is allocated to each of P’s four shares of M stock. The remaining $2.88 of the tiered-up adjustment not at- tributable to a section 362(e)(2) amount is included in the remaining adjustment allocated to all outstanding shares under the general rules in paragraphs (c)(2) through (c)(4) of this section. Thus, approximately $.58 (1/5) of the $2.88 of the tiered-up adjustment is allocated to each outstanding share. (Although approximately $.58 is allocated to X’s share of M stock, that allocation does not affect X’s basis in the share because X is not a member of the group. See paragraph (c)(1)(iv) of this section.) The allocation of M’s year 2 items is thus: Allocation Item P’ssharesofMstock (4/5) X’sshareofMstock (1/5) Nondeductible basis recovery ($14.40 reduction in S stock basis) $14.40 ($3.60 per share)N/A Tiered-up section 362(e)(2) amount ($6.40 of the $9.28 tiered-up adjustment) $6.40 ($1.60 per share)N/A Tiered-up non-section 362(e)(2) amount ($2.88 of the $9.28 tiered-up adjustment) $2.30 (approx. $.58 per share) $.58 (approx. $.58 per share) Total allocation: $23.10 (approx. $5.78 per share) $.58 (approx. $.58 per share) (D)No duplicative adjustments to the basis of shares of M stock. A portion of the $2.88 of the tiered-up adjustment not attributable to a sec- tion 362(e)(2) amount duplicates a portion of the $14.40 nondeductible basis recovery item result- ing from the reduction in M’s basis in the S stock under §1.1502–13(e)(4)(v). Consequently, under §1.1502–80(a), such portion of the tiered-up adjust- ment is not applied to reduce P’s basis in its shares of M stock. The election to reduce M’s basis in the S stock eliminated $14.40 of the remaining section 362(e)(2) amount. Accordingly, at the S level, $1.60 ($14.40/$90 x $10) of the Asset 1 year 2 depreciation deduction is associated with this amount. This por- tion was allocated to all outstanding shares of S stock under the general rules in paragraphs (c)(2) through (c)(4) of this section ($.32 per share ($1.60/5)). At the M level, $1.28 (4 x $.32) of the tiered-up non-section 362(e)(2) amount reflects depreciation on this $14.40 of Asset 1 basis. So, at the M level, approximately $.26 ($1.28/5) of this tiered-up amount is allocated to each outstanding share.This approximately $.26 per share amount would duplicate a portion of the $14.40 nondeductible basis recovery item if it were applied to reduce P’s basis in the M shares. Accord- ingly, although approximately $5.78 of the items are allocated to each M share held by P, P’s basis in each share of M stock is only reduced by approximately $5.52 ($5.78 less $.26). (B)Losses reattributed pursuant to an election under §1.1502–36(d)(6).If a member transfers (within the mean- ing of §1.1502–36(f)(11)) loss shares of S stock and the common parent elects under §1.1502–36(d)(6) to reattribute S attributes, the resulting noncapital, non- deductible expense is allocated to all loss shares of S stock transferred by mem- bers in the transaction in proportion to the 2007–8 I.R.B.569February 20, 2007 loss in the shares, and such amount tiers up to any higher tiers under the general rules of this section. If lower-tier sub- sidiary attributes that would otherwise be reduced as a result of tier-down attribute reduction under §1.1502–36(d)(5)(ii)(D) are reattributed, theresulting noncapital, nondeductible expense is allocated to the shares of the lower-tier subsidiary (and any tier up of such amount is allocated to the shares of higher tier subsidiaries) that will cause the full amount of this expense to be applied to reduce the basis of the loss shares of S stock transferred by members in the transaction. However, this noncapi- tal, nondeductible expense (and any tier up of such amount) is not allocated to shares (other than S shares) transferred in a trans- fer in which gain or loss was recognized. Further, this noncapital, nondeductible expense (and any tier up of such amount) is allocated among lower-tier shares with positive basis in a manner that reduces the disparity in the basis of the shares to the greatest extent possible. The tier up of this amount is allocated to the loss shares of S stock transferred by members in the transaction in proportion to the loss in the shares, and such amount tiers up to any higher tiers under the general rules of this section. For example, suppose P owns M1,PandM1ownM2,M2ownsS,M1 andSownS1,andM1andS1ownS2.If S sells a portion of the S1 shares at a gain and M2 sells all of the S stock at a net loss (after adjusting thebasis for the gain rec- ognized by S on the sale of the S1 shares), and P elects under §1.1502–36(d)(6) to reattribute attributes of S2, the resulting noncapital, nondeductible expense is allo- cated entirely to the S2 shares held by S1, the tier up of this amount is allocated en- tirely to the S1 shares held by S (excluding the S1 shares sold), and the tier up of this amount is allocated to the loss shares of S stocksoldbyM2. Thisamountthentiers up from M2 to M1 and P, and from M1 to P under the general rules of this section. (C)Reallocations of investment adjust- ments subject to prior use limitation.Ifthe reallocation of an investment adjustment under §1.1502–36(b)(2) is subject to the limitation in §1.1502–36(b)(2)(iii)(B)(2) due to prior use, no amount of such real- location (including as a tiered-up amount) shall be allocated to any share whose prior use resulted in the application of the lim- itation. (iii)Remaining adjustment.There- maining adjustmentis that portion of the adjustment described in paragraphs (b)(2)(i) through (b)(2)(iii) of this section (adjustments for taxable income or loss, tax-exempt income, and noncapital, non- deductible expenses) that is not specially allocated under paragraph (c)(1)(ii) of this section. The remaining adjustment is allocated among the shares of S stock as provided in paragraphs (c)(2) through (c)(4) of this section. If the remaining adjustment is positive, it is allocated first to any preferred stock to the extent pro- vided in paragraph (c)(3) of this section, and then to the common stock as provided in paragraph (c)(2) of this section. If the remaining adjustment is negative, it is al- located only to common stock as provided in paragraph (c)(2) of this section. (iv)Nonmember shares.Noadjustment under this section that is allocated to a share for the period it is owned by a non- member affects the basis of the share. (v)Cross-references. See paragraph (c)(4) of this section for the reallocation of adjustments, and paragraph (d) of this section for definitions. See §1.1502–19(d) for special allocations of basis determined or adjusted under the Code with respect to excess loss accounts. (2)Common stock—(i)Allocation within a class. The remaining adjustment described in paragraph (c)(1)(iii) of this section that is allocable to a class of com- mon stock generally is allocated equally to each share within the class. However, if a member has an excess loss account in shares of a class of common stock at the time of a positive remaining adjustment, the portion of the adjustment allocable to the member with respect to the class is al- located first to equalize and eliminate that member’s excess loss account and then to increase equally its basis in the shares of that class. Similarly, any negative remain- ing adjustment is allocated first to reduce the member’s positive basis in shares of the class before creating or increasing its excess loss account. After positive basis is eliminated, any remaining portion of the negative adjustment is allocated first to equalize, to the greatest extent possible, and then to increase equally, the member’s excess loss accounts in the shares of that class. Distributions and any adjustments or determinations under the Internal Rev- enue Code (for example, under section 358, including any modifications under §1.1502–19(d)) are taken into account before the allocation is made under this paragraph (c)(2)(i). (ii)Allocation among classes—(A) General rule. If S has more than one class of common stock, the extent to which the remaining adjustment described in para- graph (c)(1)(iii) of this section is allocated to each class is determined, based on con- sistently applied assumptions, by taking into account the terms of each class and all other facts and circumstances relating to the overall economic arrangement. * * * ***** (3)Preferred stock. If the remaining ad- justment described in paragraph (c)(1)(iii) of this section is positive, it is allocated to preferred stock to the extent required (when aggregated with prior allocations to the preferred stock during the period that S is a member of the consolidated group) to reflect distributions described in section 301 (and all other distributions treated as dividends) to which the preferred stock be- comes entitled, and arrearages arising, dur- ing the period that S is a member of the consolidated group. * * * ***** (4)Cumulative redetermination—(i) General rule. A member’s basis in each share of S preferred and common stock must be redetermined whenever necessary to determine the tax liability of any person. See paragraph (b)(1) of this section. The redetermination is made by reallocating S’s adjustments described in paragraphs (c)(1)(ii) and (c)(1)(iii) of this section (ad- justments for specially allocated losses and remaining adjustments, respectively) for each consolidated return year (or other applicable period) of the group by taking into account all of the facts and circum- stances affecting allocations under this paragraph (c) as of the redetermination date with respect to all of S shares. * * * ***** (h) * * * (9)Allocations of investment ad- justments, including adjustments at- tributable to certain loss transfers; certainconformingamendments. Paragraphs (a)(2), (b)(3)(ii)(C)(2), (b)(3)(iii)(C), (b)(3)(iii)(D), (c)(1), (c)(2)(i), (c)(2)(ii)(A), (c)(3), and (c)(4)(i) of this section are applicable on or after February 20, 20075702007–8 I.R.B. the date these regulations are published as final regulations in theFederal Register. ***** Par. 12. Section 1.1502–33 is amended by: 1. Revising paragraph (a)(2). 2. Adding a new last sentence to para- graph (j)(1). The revision and addition read as fol- lows: §1.1502–33 Earnings and profits. (a) * * * (2)Application of other rules of law. See §1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. ***** (j)***(1)***However,paragraph (a)(2) of this section applies with respect to determinations of the earnings and profits of a member in consolidated return years beginning on or after the date these regu- lations are published as final regulations in theFederal Register. ***** Par. 13. Section 1.1502–35 is amended by: 1. Revising paragraphs (a), (b) and (h). 2. Removing and reserving paragraphs (f) and (g). 3. Adding new paragraph (l). The revisions and addition read as fol- lows: §1.1502–35 Transfers of subsidiary stock and deconsolidations of subsidiaries. (a)Losses on subsidiary stock trans- ferred or deconsolidated prior to the date that these regulations are published as fi- nal regulations in theFederal Register. If a member disposed of a loss share of stock of a subsidiary (S), or if S ceased to be a member (deconsolidated) when any member held loss shares of S stock, and if the disposition or deconsolidation oc- curred prior to the date that these regula- tions are published as final regulations in theFederal Register, see §1.1502–35, as contained in 26 CFR part 1, revised as of April 1, 2007. For transfers and deconsol- idations on or after the date that these reg- ulations are publishedas final regulations in theFederal Register, see §1.1502–36. (b)Anti-loss reimportation rule appli- cable on or after the date that these regu- lations are published as final regulations in theFederal Register—(1)Conditions for application. This paragraph (b) applies when— (i) A member of a group (the selling group) recognized and was allowed a loss with respect to a share of stock of S, a sub- sidiary or former subsidiary in the selling group; (ii) That stock loss was duplicated (in whole or in part) in S’s attributes (dupli- cating items) at the earlier of the time that the loss was recognized or that S ceased to be a member; and (iii) Within ten years of the date that S ceased to be a member, there is a reimpor- tation event. For this purpose, a reimporta- tion event is any event after which a dupli- cating item becomes directly or indirectly reflected in the attributes of any member of the selling group, including S, or, if not re- flected in the attributes, would be properly taken into account by any member of the selling group (for example, as the result of a carryback) (reimported items). (2)Effect of application. Immediately before the time that a reimported item (or any portion of a reimported item) would be properly taken into account (but for the ap- plication of this paragraph (b)), such item (or such portion of the item) is reduced to zero and no deduction or loss is allowed, directly or indirectly, with respect to that item. (3)Operating rules. For purposes of this paragraph (b)— (i) The terms “member”, “subsidiary”, and “group” include their predecessors and successors to the extent necessary to effec- tuate the purposes of this section; (ii) The determination of whether a loss is duplicative is made under the principles of §1.1502–35, as contained in 26 CFR part 1, revised as of April 1, 2006; and (iii) The reduction of a reimported item (other than duplicating items that are car- ried back to a consolidated return year of the selling group) is a noncapital, non- deductible expense with in the meaning of §1.1502–32(b)(2)(iii). (4)Period of applicability. The pro- visions of this paragraph (b) apply to a reimported item if its related stock loss is recognized on or after the date that these regulations are published as final regula- tions in theFederal Register. The provi- sions of this paragraph (b) (other than para- graph(b)(1)(i))alsoapplytoareimporta- tion event if its related stock loss is recog- nized on or after March 7, 2002, and is rec- ognized in either a disposition (described in paragraph (g)(3)(i)(A) of this section, as contained in 26 CFR part 1, revised as of January 1, 2007) or a disposition other- wise subject to this section. For prior law, see paragraph (g)(3) of this section, as con- tained in 26 CFR part 1, revised as of Jan- uary 1, 2007. ***** (h)Application of other rules of law. See §1.1502–80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. ***** (l)Effective date. Paragraphs (a), (b), and (h) of this section apply with respect to stock transfers, deconsolidations of sub- sidiaries, determinations of worthlessness, and stock dispositions on or after the date these regulations are published as final regulations in theFederal Register.For rules applicable prior to the date these reg- ulations are published as final regulations in theFederal Register, see §1.1502–35 as contained in 26 CFR part 1 in effect on April 1, 2007. §1.1502–35T [Removed] Par. 14. Section 1.1502–35T is re- moved. Par. 15. Section 1.1502–36 is added to read as follows: §1.1502–36 Unified rule for loss on subsidiary stock. (a)In general—(1)Scope. This sec- tion provides rules for adjusting members’ bases in stock of a subsidiary (S) and for reducing S’s attributes when a member (M) transfers a loss share of S stock. See paragraph (f) of this section for definitions of the terms used in this section, including transferandloss share. (2)Purpose. The rules in this section have two principal purposes. The first is to prevent the consolidated return pro- visions from reducing a group’s consoli- dated taxable income through the creation of noneconomic loss on S stock. The sec- ond is to prevent members (including for- mer members) of the group from collec- tively obtaining more than one tax benefit from a single economic loss. Additional purposes are set forth in other paragraphs 2007–8 I.R.B.571February 20, 2007 of this section. The rules of this section must be interpreted and applied in a man- ner that is consistent with and reasonably carries out the purposes of this section. (3)Overview—(i)General application of section. This section applies when M transfers a share of S stock and, after giv- ing effect to all applicable rules of law other than this section, the share is a loss share. Paragraph (b) of this section ap- plies first to require certain redetermina- tions of all members’ bases in shares of S stock. If the transferred share is a loss share after any basis redetermination re- quired by paragraph (b) of this section, paragraph (c) of this section applies to re- quire certain reductions in M’s basis in the transferred loss share. If the transferred share is a loss share after any reduction required by paragraph (c) of this section, paragraph (d) of this section applies to re- quire certain reductions in S’s attributes. Paragraphs (e), (f), and (g) of this section provide general operating rules (predeces- sor/successor rules, effects of prior section 362(e)(2) transactions), definitions, and an anti-abuse rule, respectively. (ii)Stock of multiple subsidiaries trans- ferred in the transaction—(A)Order of ap- plication—(1)Transferred shares in low- est tier.Ifsharesofstockofmorethanone subsidiary are transferred in a transaction and no transferred shares of stock of the lowest-tier subsidiary (S2) are loss shares, any gain recognized with respect to the S2 shares immediately adjusts members’ bases in subsidiary stock under the princi- ples of §1.1502–32. However, if any of the transferred S2 shares are loss shares, first paragraph (b) of this section and then para- graph (c) of this section apply with respect to the S2 shares. After giving effect to any adjustments required under paragraphs (b) and (c) of this section, gain or loss is com- puted on all transferred S2 shares. Any adjustments under paragraphs (b) and (c) of this section, any gain or loss recognized on transferred S2 shares (whether allowed or disallowed), and any other related or resulting adjustments are then applied to adjust members’ bases in subsidiary stock under the principles of §1.1502–32. (2)Application of paragraphs (b) and (c) of this section to higher-tier stock. After giving effect to any lower-tier adjustments described in paragraph (a)(3)(ii)(A)(1) of this section, trans- fers in the next higher tier in which shares are transferred, and then in each next higher tier successively, are subject to the treatment described in paragraph (a)(3)(ii)(A)(1). (3)Application of paragraph (d) of this section. After paragraphs (b) and (c) of this section have been applied with respect to all transferred loss shares and after giving effect to all adjustments (whether required by paragraphs (b) and (c) of this section, by the recognition of gain on a transfer, or otherwise), paragraph (d) of this section applies with respect to the highest-tier shares that are then transferred loss shares. Paragraph (d) then applies with respect to transferred loss shares in each next lower tier successively. (B)Example. The rules of this para- graph (a)(3) are illustrated by the follow- ing example: Example. M owns all the outstanding shares of S stock and one of the two outstanding shares of S2 stock, S owns all the outstanding shares of S1 stock, and S1 owns the other outstanding share of S2 stock. As part of one transaction, M sells all the S shares and its S2 share, and S1 sells its S2 share. The sales are to unrelated individuals, S and S1 do not elect to file a consolidated return after the transaction, the S and S1 shares are loss shares and the S2 shares are gain shares. Each share is transferred within the meaning of this section, the S and S2 shares because S and S2 cease to be owned by M, and M and S1, respectively, as a result of taxable dispositions, and the S1 shares because S and S1 cease to be members of the same group. This section applies to the transfer of the S and S1 (loss) shares, but not to the transfer of the S2 (gain) shares. Accordingly, immediately before the transac- tion, after giving effect to other rules of law, the fol- lowing occurs. First, the gain recognized on the trans- ferred S2 shares tiers up to adjust members’ bases in all upper-tier subsidiary shares under the principles of §1.1502–32. Then, if S’s transferred S1 shares are still loss shares, paragraphs (b) and (c) of this section apply to those shares. The loss on the S1 shares is not recognized in the transfer (because there is no taxable disposition of the shares) and so only the adjustments to the bases of the S1 shares required by paragraphs (b) and (c) of this section tier up to adjust M’s basis in the S stock. Then, if M’s transferred shares of S stock are still loss shares, paragraphs (b) and (c) of this section apply with respect to those shares. If, af- ter giving effect to any adjustments under paragraphs (b) and (c) of this section, any of the S shares are still loss shares, paragraph (d) of this section applies with respect to the transfer of those shares. If any trans- ferred S1 shares are still loss shares after the appli- cation of paragraph (d) of this section with respect to the transfer of S shares, paragraph (d) applies with re- spect to the transfer of the S1 shares. (4)Other rules of law and coordination with deferral and disallowance provisions. This section applies and has effect immedi- ately upon the transfer of a loss share even if the loss is deferred, disallowed, or oth- erwise not taken into account under any other applicable rules of law. For exam- ple, if M sells loss shares of S stock to an- other member in an intercompany transac- tion, every member’s bases in shares of S stock and all of S’s attributes may be ad- justed under this section even though M’s loss is deferred under §§1.267(f)–1 and 1.1502–13, and S remains a member. See §1.1502–80(a) regarding the general appli- cability of other rules of law and a limita- tion on duplicative adjustments. (5)Nomenclature, factual assumptions adopted in this section. Unless otherwise stated, for purposes of this section, the fol- lowing nomenclature and assumptions are adopted. P is the common parent of a con- solidated group and X is a nonmember of the P group. If a corporation has preferred stock outstanding, it is stock described in section 1504(a)(4). The examples set forth the only facts and activities relevant to the example. All transactions are between unrelated persons and are independent of each other. Tax liabilities and their ef- fect, and the application of any loss disal- lowance or deferral provision of the Code or regulations, including but not limited to section 267, are disregarded. All persons report on a calendar year basis and use the accrual method of accounting. All parties comply with filing and other requirements of this section and all other provisions of the Code and regulations. (b)Basis redetermination to reduce disparity—(1)In general—(i)Purpose and scope. The rules of this paragraph (b) reduce (but do not increase) the extent to which there is disparity in members’ bases in shares of S stock. These rules are intended to prevent the operation of the investment adjustment system from creat- ing noneconomic or duplicated loss when members hold S shares with disparate bases, and they operate by reallocating previously applied investment adjust- ments. The provisions of this paragraph (b) do not alter the aggregate amount of basisinsharesofSstockheldbymembers or the aggregate amount of investment adjustments applied to shares of S stock. (ii)Exemptions from basis redetermi- nation—(A)No potential for redetermi- nation. Notwithstandingthe general rule in paragraph (b)(2) of this section, basis redetermination will not be required if re- determination would not result in a change to any member’s basis in any share of S February 20, 20075722007–8 I.R.B. stock. For example, if S has only one class of stock outstanding and there is no dis- parity in members’ bases in S shares, no member’s basis would be changed by the application of this paragraph (b). Accord- ingly, under this paragraph (b)(1)(ii)(A), no redetermination would be required. Similarly, if S has preferred and common stock outstanding, there is no gain or loss on any member’s preferred shares, and there is no disparity in members’ bases in the common stock, no member’s basis would be changed by the application of this paragraph (b). Accordingly, under this paragraph (b)(1)(ii)(A), no redetermi- nation would be required. (B)Disposition of entire interest. Notwithstanding the general rule in para- graph (b)(2) of this section, basis redeter- mination will not be required if, within the group’s taxable year in which the transfer occurs, every share of S stock held by a member is transferred to a nonmember in one or more fully taxable transactions. (iii)Transfers of stock of subsidiaries at multiple tiers. If stock of subsidiaries at multiple tiers is transferred in a transac- tion, see paragraph (a)(3)(ii) of this section regarding the order of application of this section. (iv)Investment adjustment. For pur- poses of this paragraph (b), the termin- vestment adjustmentmeans the adjustment for items described in §1.1502–32(b)(2), excluding §1.1502–32(b)(2)(iv) (distri- butions). The term includes all such adjustments reflected in the basis of the share, whether originally applied directly by §1.1502–32 or otherwise. The term therefore includes investment adjustments reallocated to the share, and it does not in- clude investment adjustments reallocated from the share, whether pursuant to this section or any other provision of law. It also includes the proportionate amount of investment adjustments reflected in the basis of a share after the basis is appor- tioned among shares, for example in a transaction qualifying under section 355. (2)Basis redetermination rule.IfM transfers a loss share of S stock, all mem- bers’ bases in all their shares of S stock are subject to redetermination under this para- graph (b). The adjustments are made in ac- cordance with the following: (i)Decreasing the bases of transferred loss shares—(A)Removing positive in- vestment adjustments from transferred loss shares. M’s basis in each of its transferred loss shares of S stock is first reduced, but not below value, by removing positive in- vestment adjustments previously applied to the basis of the share. The positive investment adjustments removed from transferred loss shares are reallocated un- der paragraph (b)(2)(ii) of this section after negative investment adjustments are reallocated under paragraph (b)(2)(i)(B) of this section. (B)Reallocating negative investment adjustments. If a transferred share is still a loss share after applying paragraph (b)(2)(i)(A) of this section, M’s basis in the share is reduced, but not below value, by reallocating and applying negative in- vestment adjustments to the transferred loss share from shares held by members that are not transferred loss shares. Re- ductions under this paragraph (b)(2)(i)(B) are made first to M’s bases in transferred loss shares of S preferred stock and then to M’s bases in transferred loss shares of Scommonstock. (ii)Increasing the bases of gain pre- ferred and all common shares—(A)Pre- ferred stock. After the application of para- graph (b)(2)(i) of this section, the posi- tive investment adjustments removed from transferred loss shares are reallocated and applied to increase, but not above value, members’ bases in gain shares of S pre- ferred stock. (B)Common stock. Any positive in- vestment adjustments removed from trans- ferred loss shares and not applied to S pre- ferred shares are then reallocated and ap- plied to increase members’ bases in shares of S common stock. Reallocations are made to shares of common stock without regard to whether a particular share is a loss share or a transferred share, and with- out regard to the share’s value. (iii)Operating rules—(A)In general. All reallocations (both to and from mem- bers’ shares of S stock) are made in a manner that reduces basis disparity among shares of preferred stock and among shares of common stock to the greatest extent possible (that is, causes the ratio of the ba- sis to the value of each member’s share to be as equal as possible). (B)Limits on reallocation—(1)Re- striction to outstanding shares. Invest- ment adjustments can only be reallocated to shares that were held by members in the period to which the adjustment is attribut- able. (2)Limitation by prior use of alloca- tion—(i)In general. In order to prevent the reallocation of investment adjustments from either increasing or decreasing mem- bers’ aggregate bases in subsidiary stock, no investment adjustment (positive or negative) may be reallocated under this paragraph (b)(2) to the extent that it was (or would have been) used prior to the time that it would otherwise be reallo- cated under this paragraph (b)(2). For this purpose, an investment adjustment was used (or would have been used) to the extent that it was reflected in (or would have been reflected in) the basis of a share of subsidiary stock and the basis of that share has already been taken into account, directly or indirectly, in determining in- come, gain, deduction, or loss (including by affecting the application of this section to a prior transfer of subsidiary stock) or in determining the basis of any property that is not subject to §1.1502–32. However, notwithstanding the general rule, if the prior use was in an intercompany trans- action, an investment adjustment may be reallocated to the extent that §1.1502–13 has prevented the gain or loss on the trans- action from being taken into account. (In that case, appropriate adjustments must be made to the prior intercompany transac- tion.) Further, if an investment adjustment was reflected in (or would have been re- flected in) the basis of a share that has been taken into account, but the basis of that share would not change as a result of the reallocation (for example, because the reallocation would be among shares that are all lower-tier to the share with the previously used basis), the invest- ment adjustment may be reallocated. See §1.1502–32(c)(1)(ii)(C) regarding special allocations applicable if the reallocation of an investment adjustment is limited under this paragraph (b)(2)(iii)(B)(2). (ii)Example. The application of this paragraph (b)(2)(iii)(B)(2) is illustrated by the following example: Example.(i)Facts. P owns all 20 shares of M stock, and 10 shares of S stock. M owns the remain- ing 10 shares of S stock. In year 1, S recognizes $200 of income that results in a $10 positive investment ad- justment being allocated to each share of S stock. The group does not recognize any other items. The $100 positive adjustment to M’s basis in the S stock tiers up, and results in a $5 positive adjustment to each share of M stock. In year 2, P sells one share of M 2007–8 I.R.B.573February 20, 2007 stock and recognizes a gain. In year 3, M sells one loss share of S stock, and paragraph (b) of this sec- tion applies and requires a reallocation of the year 1 positive investment adjustment. (ii)Application of limitation by prior use.M’s basis in the transferred loss share of S stock reflects a $10 positive investment adjustment attributable to S’s year 1 income. Under the general rule of this para- graph (b), that $10 would be subject to reallocation to reduce basis disparity. However, that $10 adjust- menthadoriginallytiereduptoadjustP’sbasisin its M shares and, as a result, $.50 of that adjustment was reflected in P’s basis in each share of M stock. When P sold the share of M stock, the basis of that share (including the tiered up $.50) was used in deter- mining the gain on the sale. Accordingly, $.50 of the $10 investment adjustment originally allocated to the S share that tiered-up to the M share was previously used and therefore cannot be reallocated in a manner that would (if it were the original allocation) affect the basis of the sold share. Thus, taking into account the special allocations in §1.1502–32(c)(1)(ii)(C), up to $9.50 of the adjustment to M’s transferred S share could be allocated to P’s shares of S stock (leaving $.50 on M’s transferred S share, all of which would be treated as tiered up to P’s transferred M share). Al- ternatively, all $10 could be reallocated to M’s other S shares (because the tier up to P’s M shares would have been the same regardless which of M’s shares of S stock were adjusted.) (iii)Application of limitation where adjustment wouldhavebeenused. Thefactsarethesameasin paragraph (i) of thisExampleexcept that M does not sellanysharesofSstockand,inyear3,Psellsaloss share of S stock. As in paragraph (i) of thisExam- ple, when P sold the share of M stock, the basis of that share was used in determining the gain on the share. When P sells the loss share of S stock, the $10 positive investment adjustment from S’s year 1 income cannot be reallocated in a manner that, if it were the original adjustment, would have caused any amount to be reflected in the basis of the transferred share. If this $10 positive investment adjustment had originally been allocated to the S shares held by M, $.50 of the $10 investment adjustment would have tiered up to the M share that P sold, would have been reflected in P’s basis, and would have been used in determining the gain or loss on the sale. Accord- ingly, taking into account the special allocations in §1.1502–32(c)(1)(ii)(C), up to $9.50 of the $10 ad- justment to P’s transferred S share could be allocated toM’ssharesofSstock(allofwhichwouldtierup to P’s 19 retained M shares). Alternatively, all $10 could be reallocated to P’s other S shares. (C)Order of reallocation. In general, reallocations are made first with respect to the earliest available adjustments. How- ever, the overall application of this para- graph (b) to a transaction must be made in a manner that reduces basis disparity to the greatest extent possible. (3)Examples. The general application of this paragraph (b) is illustrated by the following examples: Example 1.Transfer of stock received in sec- tion 351 exchange.(i)Redetermination to prevent noneconomic loss.(A)Facts. For many years, P has owned two assets, Asset 1 and Asset 2. On January 1, year 1, P receives four shares of S common stock (the Block 1 shares) in exchange for Asset 1, which has a basis and value of $80. The exchange quali- fies under section 351 and, therefore, under section 358, P’s aggregate basis in the Block 1 shares is $80 ($20 per share). On July 1, year 1, P receives an- other share of S common stock (the Block 2 share) in exchange for Asset 2, which has a basis of $0 and value of $20. This exchange also qualifies as a sec- tion 351 exchange and, undersection 358, P’s basis in the Block 2 share is $0. P’s Block 1 and Block 2 shares are the only outstanding shares of S stock. On October 1, year 1, S sells Asset 2 for $20. On De- cember 31, year 1, P sells one of its Block 1 shares for $20. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in each Block 1 share is $24 (P’s original $20 basis increased under §1.1502–32 by $4 (the share’s allocable portion of the $20 gain recognized on the sale of Asset 2)). In addition, P’s basis in its Block 2 share is $4 (P’s original $0 basis increased under §1.1502–32 by $4 (the share’s allocable portion of the $20 gain recognized on the sale of Asset 2)). P’s sale of the Block 1 share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Basis redetermination under this paragraph (b). Under this paragraph (b), P’s bases in all its shares of S stock are subject to redetermination. First, paragraph (b)(2)(i)(A) of this section applies to re- duce P’s basis in the transferred loss share, but not below value, by removing positive investment adjust- ments applied to the basis of the share. Accordingly, P’s basis in the transferred Block 1 share is reduced by $4 (the amount of the positive investment adjust- ment applied to the share), from $24 to $20. No fur- ther reduction to the basis of the share is required un- der this paragraph (b) because the basis of the share is then equal to value. Under paragraph (b)(2)(ii)(B) of this section, the positive investment adjustment re- moved from the transferred loss share is reallocated and applied to increase P’s bases in its S shares in a manner that reduces basis disparity to the greatest extent possible. Accordingly, the $4 positive invest- ment adjustment removed from the Block 1 share is reallocated and applied to the basis of the Block 2 share, increasing it from $4 to $8. (C)Application of paragraphs (c) and (d) of this section. Because P’s sale of the Block 1 share is no longer a transfer of a loss share after the application of this paragraph (b), paragraphs (c) and (d) of this sectiondonotapply. (ii)Redetermination to prevent duplicated loss. (A)Facts. The facts are the same as in paragraph (i)(A) of thisExample 1, except that, at the time of the second contribution, the value of Asset 1 had de- clined to $20 and so, instead of contributing Asset 2, P contributed Asset 3 to S in exchange for the Block 2 share. At the time of that exchange, Asset 3 had a basis and value of $5. On October 1, year 1, S sells Asset 1 for $20, recognizing a $60 loss that is absorbed by the group. On December 31, year 1, P sells one of its Block 1 shares for $5. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in each Block 1 share is $8 (P’s original $20 basis decreased under §1.1502–32 by $12 (the share’s allocable portion of the $60 loss recognized on the sale of Asset 1)). P’s basis in its Block 2 share is an excess loss account of $7 (its original basis of $5 reduced by $12, the share’s portion of the loss recognized on Asset 1). P’s sale of the Block 1 share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Basis redetermination under this paragraph (b). Under this paragraph (b), P’s bases in all its shares of S stock are subject to redetermination. There are no positive investment adjustments and so there is no adjustment underparagraph (b)(2)(i)(A) of this section. However, under paragraph (b)(2)(i)(B) of this section, P’s basis in the transferred Block 1 share is reduced, but not below value, by reallocating negative investment adjustments from shares that are not transferred loss shares. In total, there were $48 of negative investment adjustments applied to shares that are not transferred loss shares. Accordingly, P’s basis in the Block 1 share is reduced by $3, from $8 to its value of $5. Under paragraph (b)(2)(i)(B) of this section, the negative investment adjustments applied to the transferred share are reallocated from (and therefore cause an increase in the basis of) S shares that are not transferred loss shares in a manner that reduces basis disparity to the greatest extent possible. Accordingly, the $3 negative investment adjustment reallocated and applied to the transferred Block 1 share is reallocated entirely from the Block 2 share, increasing the basis in the Block 2 share from an excess loss account of $7 to an excess loss account of $4. (C) Application of paragraphs (c) and (d) of this section. Because P’s sale of the Block 1 share is no longer a transfer of a loss share after the application of this paragraph (b), paragraphs (c) and (d) of this section do not apply. (iii)Nonapplicability of redetermination rule to sale of entire interest. The facts are the same as in paragraph (ii)(A) of thisExample 1, except that, on December 31, year 1, P sells all its shares of S stock for $25. Under paragraph (b)(1)(ii)(B) of this sec- tion, this paragraph (b) does not apply to redetermine P’s basis in its S shares because every S share held by a member is transferred to a nonmember in a fully taxable transaction. However, the sale of the Block 1 shares is a transfer of loss shares and therefore subject to paragraphs (c) and (d) of this section. Paragraphs (c)(7) and (d)(3)(i)(A) of this section apply netting principles to prevent adjustments under either para- graph (c) or paragraph (d) of this section. Example 2.Redetermination increases basis of transferred loss share.(i)Facts. On January 1, year 1, P owns all 10 outstanding shares of S common stock. Five of the shares have a basis of $20 per share (the Block 1 shares) and five of the shares have a basis of $10 per share (the Block 2 shares). S’s only asset, Asset 1, has a basis of $50. S has no other attributes. On October 1, year 1, S sells Asset 1 for $100. On De- cember 31, year 2, S sells one Block 1 share and one Block 2 share to X for $10 per share. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in each Block 1 share is $25 (P’s original $20 basis increased un- der §1.1502–32 by $5 (the share’s allocable portion of the $50 gain recognized on the sale of Asset 1)), and P’s basis in each Block 2 share is $15 (P’s origi- nal $10 basis increased by $5). P’s sale of the Block 1 and Block 2 shares is a transfer of loss shares and therefore subject to the provisions of this section. (ii)Basis redetermination under this paragraph (b). Under this paragraph (b), P’s bases in all its February 20, 20075742007–8 I.R.B. shares of S stock are subject to redetermination. First, paragraph (b)(2)(i)(A) of this section applies to re- duce P’s basis in the transferred Block 1 and Block 2 shares, but not below value, by removing the pos- itive investment adjustments applied to the bases of the transferred loss shares. Accordingly, the basis of the Block 1 share is reduced by $5, from $25 to $20. The basis of the Block 2 share is also reduced by $5, from $15 to $10. (Although the Block 1 share is still a loss share, there is no reduction to its basis under paragraph (b)(2)(i)(B) of this section because there were no negative investment adjustments to shares that are not transferred loss shares.) Next, paragraph (b)(2)(ii)(B) of this section applies to reallocate and apply the $10 of positive investment adjustments re- moved from the transferred loss shares to increase P’s bases in its S shares in a manner that reduces basis dis- parity to the greatest extent possible. Accordingly, of the $10 positive investment adjustments to be real- located, $6 is reallocated and applied to the basis of the Block 2 share (increasing it from $10 to $16) and $4 is reallocated and applied equally to the basis of each of the four retained Block 2 shares (increasing the basis of each from $15 to $16). After giving ef- fect to the reallocations under this paragraph (b), P’s basis in each retained Block 1 share is $25, P’s basis in the transferred Block 1 share is $20, and P’s basis in each Block 2 share is $16. (iii)Application of paragraph (c) of this section. After the application of this paragraph (b), P’s sale of the Block 1 and Block 2 shares is still a transfer of loss shares and, accordingly, subject to paragraph (c) of this section. No adjustment is required to the basis of the Block 1 share under paragraph (c) of this section because, after its basis is redetermined under this paragraph (b), the net positive adjustment to the basis of the share is $0. See paragraph (c)(3) of this section. However, paragraph (c) of this section re- duces P’s basis in the transferred Block 2 share (by the lesser of its net positive adjustment and its discon- formity amount, or $6, from $16 to $10, its value). (iv)Application of paragraph (d) of this section. After the application of paragraph (c) of this section, P’s sale of the Block 1 share is still a transfer of a loss share and, accordingly, subject to paragraph (d) of this section. No adjustment is required under para- graph (d) of this section because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section. Because P’s sale of the Block 2 share is no longer a transfer of a loss share after the application of para- graph (c) of this section, paragraph (d) of this section does not apply to the transfer of the Block 2 share. Example 3.Application to outstanding common and preferred shares.(i)Facts. P owns all the stock of M and all eight outstanding shares of S common stock. S also has two shares of nonvoting preferred stock outstanding; the preferred shares have a $100 annual, cumulative preference as to dividends (per share). M owns one of the preferred shares (PS1) and P owns the other (PS2). On January 1, year 1, the bases and values of the outstanding S shares are: PreferredCommon PS1 (M) PS2 (P) CS1 (P) CS2 (P) CS3 (P) CS4 (P) CS5 (P) CS6 (P) CS7 (P) CS8 (P) Basis 12509751025 710 550 400 375250215 100 Value10001000 375375375375375375375375 As of January 1, year 1, there are no arrearages on the preferred stock. In year 1, S has a $1100 cap- ital loss and $100 of ordinary income. The loss is absorbed by the group and the resulting negative ad- justment of $1000 is allocable entirely to the common stock. See §1.1502–32(c)(1). In year 2, S has $700 of ordinary income and a $100ordinaryloss.Also,onOctober1,year2,Sde- clares a dividend of $200 ($100 with respect to each of the preferred shares). Thus, there is a net posi- tive investment adjustment for year 2 of $400. See §1.1502–32(b)(2). Under §1.1502–32(c)(1), a neg- ative adjustment of $100 is first allocated to each of the preferred shares to reflect the dividend dec- laration. Then, $400 of the $600 remaining adjust- ment (the adjustment computed without taking distri- butions into account) is allocated $200 to each of the preferred shares to reflect its entitlement to dividends accruing in year 1 and year 2. See §1.1502–32(c)(3). (The year 2 investment adjustment to each preferred share is therefore a positive $100.) Finally, under §1.1502–32(c)(2), the remaining $200 of the invest- ment adjustment is allocated to the common stock, equally to all outstanding shares. After applying and giving effect to all generally applicable rules of law (other than this section), the adjusted bases and the values of the shares as of January 1, year 3, are: PreferredCommon PS1 (M) PS2 (P) CS1 (P) CS2 (P) CS3 (P) CS4 (P) CS5 (P) CS6 (P) CS7 (P) CS8 (P) Basis 12509751025 710 550 400 375250215 100 Year 1 §1.1502–32 adjustments N/AN/A -125-125-125-125-125-125-125-125 Year 2 §1.1502–32 adjustments +100+100 +25+25+25+25+25+25+25+25 Adjusted basis 13501075925 610 450 300 275150115 0 Value11001100 275275275275275275275275 Unrecognized gain/(loss) (250)25(650)(335)(175)(25) 0 125 160 275 On January 1, year 3, M sells PS1 for $1100 and P sells CS2 for $275. The sales of PS1 and CS2 are transfers of loss shares and therefore subject to the provisions of this section. (ii)Basis redetermination under this paragraph (b). Under this paragraph (b), all members’ bases in shares of S stock are subject to redetermination in accordance with the following: (A)Removing positive investment adjustments from transferred loss shares. First, paragraph (b)(2)(i)(A) of this section applies to reduce M’s ba- sisinPS1andP’sbasisinCS2,butnotbelowvalue, by removing the positive investment adjustments applied to the bases of the shares. Accordingly, M‘s basis in PS1 is reduced by $200 (the investment adjustment applied to the share without regard to the distribution), from $1350 to $1150, and P’s basis in CS2 is reduced by $25, from $610 to $585. (B)Reallocating negative investment adjustments from shares that are not transferred loss shares.Be- cause the transferred shares remain loss shares after the removal of positive investment adjustments, their bases are further reduced under paragraph (b)(2)(i)(B) of this section, but not below value, by negative investment adjustments applied to shares that are not transferred loss shares. Reallocations are made first to preferred shares and then to the com- mon shares, in a manner that reduces basis disparity to the greatest extent possible. The remaining loss on PS1 is $50, the remaining loss on CS2 is $310, and the total amount of negative investment adjustments applied to shares that are not transferred loss shares is $875 (the sum of the adjustments made to all com- 2007–8 I.R.B.575February 20, 2007 mon shares other than CS2). Thus, $50 of negative investment adjustments are reallocated to the basis of PS1 and $310 of negative investment adjustments are reallocated to the basis of CS2, reducing each to its value ($1100 and $275, respectively). The neg- ative investment adjustments are reallocated from the shares that are not transferred loss shares in a manner that reduces basis disparity to the greatest extent possible. Accordingly, of the $360 reallocated negative investment adjustments, $125 is reallocated from each of CS7 and CS8, and $110 is reallocated from CS6. As a result, the basis of CS6 increases to $260, the basis of CS7 increases to $240, and the basis of CS8 increases to $125. (C)Increasing basis by reallocated positive in- vestment adjustments. Under paragraph (b)(2)(ii)(A) of this section, the $225 of positive investment adjust- ments removed from the transferred loss shares are then reallocated and applied to increase the basis of preferred shares, but not above value. Accordingly, $25 of that amount is reallocated to PS2, increasing its basis from $1075 to $1100, its value. The remain- ing $200 is allocated among the common shares in a manner that reduces basis disparity to the greatest extent possible. Accordingly, of the $200 positive in- vestment adjustment that is reallocated to common shares, $150 is reallocated to CS8, $35 is reallocated to CS7, and $15 is reallocated to CS6, increasing the basis of each to $275. (D)Summary of reallocation adjustments.The adjustments made under this paragraph (b) are there- fore: PreferredCommon PS1 (M) PS2 (P) CS1 (P) CS2 (P) CS3 (P) CS4 (P) CS5 (P) CS6 (P) CS7 (P) CS8 (P) Adjusted basis before redetermination 13501075925 610 450 300 275150115 0 Removing positive adjustments from transferred loss shares -200 -25 Reallocating negative adjustments -50 -310+110 +125+125 Applying positive adjustments removed from transferred shares +25+15+35+150 Basis after redetermination11001100 925275450 300 275275275275 Value11001100 275275275275275275275275 Gain/(loss)00 (650) 0 (175)(25) 0000 (iii)Application of paragraphs (c) and (d) of this section. Because M’s sale of PS1 and P’s sale of CS 2 are no longer transfers of loss shares after the application of this paragraph (b), paragraphs (c) and (d) of this section do not apply. (i v)Higher-tier effects. The adjustments made to PS1 give rise to a $250 nondeductible basis recov- ery item (a noncapital, nondeductible expense under §1 .1502–32(b)(3)(iii)(B)) that will be included in the year 3 investment adjustment to be applied to reduce P’s basis in its M stock. (c)Stock basis reduction to prevent noneconomic loss—(1)In general.The rules of this paragraph (c) reduce M’s basis in a transferred share of S stock in order to prevent noneconomic stock loss and thereby promote the clear reflection of the group’s income. The effect of these rules is to limit the reduction to M’s basis in the S share to the amount of net unrealized appreciation reflectedin the share’s basis immediately before the transfer. These rules also limit the reduction to M’s basis in the S share to the portion of the share’s basis that is attributable to investment adjustments made pursuant to the consoli- dated return regulations. (2)Basis reduction rule—(i)In general. If M transfers a share of S stock and, after the application of paragraph (b) of this sec- tion, the share is a loss share, M’s basis in the share is reduced, but not below value, by the lesser of— (A) The share’s net positive adjustment (see paragraph (c)(3) of this section); and (B) The share’s disconformity amount (see paragraph (c)(4) of this section). (ii)Transactions that adjusted stock or asset basis. See paragraph (e)(2) of this section for special rules that may apply if a prior transaction, such as an exchange sub- ject to section 362(e)(2), adjusted the basis in any share of S stock or S’s attributes in a manner that altered a share’s disconfor- mity amount. (iii)Transfers of stock of subsidiaries at multiple tiers. If stock of subsidiaries at multiple tiers is transferred in a transac- tion, see paragraph (a)(3)(ii) of this section regarding the order of application of this section. (3)Net positive adjustment. A share’s net positive adjustmentis the greater of— (i) Zero; and (ii) The sum of all investment adjust- ments reflected in the basis of the share. The term investment adjustment has the same meaning as in paragraph (b)(1)(iv) of this section. (4)Disconformity amount. A share’s disconformity amountis the excess, if any, of— (i) M’s basis in the share; over (ii) The share’s allocable portion of S’s net inside attribute amount (as defined in paragraph (c)(5) of this section). (5)Net inside attribute amount.S’snet inside attribute amountis determined as of the time immediately before the trans- fer, taking into account all applicable rules of law other than this section (except as specifically provided otherwise in this sec- tion). S’s net inside attribute amount is the sum of S’s net operating and capital loss carryovers, deferred deductions, money, and basis in assets other than money (for this purpose, S’s basis in any share of lower-tier subsidiary stock is S’s basis in that share, adjusted to reflect any gain or loss recognized in the transaction and any other related or resulting adjustments), re- duced by the amount of S’s liabilities. See paragraph (f) of this section for definitions of the terms “allocable portion”, “deferred deduction”, “liability”, and “loss carry- February 20, 20075762007–8 I.R.B. over”. See paragraph (c)(6) of this section for special rules regarding the computation of S’s net inside attribute amount for pur- posesofthisparagraph(c)ifSholdsstock of a subsidiary. (6)Determination of S’s net inside at- tribute amount if S owns stock of a lower- tier subsidiary—(i)Overview.Ifaloss share of S stock is transferred when S holds a share of stock of another subsidiary (S1) and the S1 share is not transferred in the same transaction, S’s net inside attribute amount is determined by treating S’s basis in its S1 share as tentatively reduced under this paragraph (c)(6). The purpose of this rule is to reduce the extent to which S1’s investment adjustments increase noneco- nomic loss on S stock (as a result of S1’s recognition of items that are indirectly re- flected in members’ bases in S stock). (ii)General rule for nontransferred shares of lower-tier subsidiary.Solely for purposes of determining the discon- formity amount of a share of S stock, S’s basis in a share of S1 stock is treated as reduced by the share’s tentative reduction amount. The tentative reduction amount is the lesser of the S1 share’s net positive ad- justment and the S1 share’s disconformity amount, computed under the principles of paragraphs (c)(3) and (c)(4) of this sec- tion, respectively. (iii)Multiple tiers of nontransferred shares. If S directly or indirectly owns non-transferred shares of stock of sub- sidiaries in multiple tiers, then, subject to the limitations in paragraph (c)(6)(iv) of this section (regarding nontransferred shares that are lower-tier to transferred shares), the rules of this paragraph (c)(6) first apply to determine the tentatively reduced basis of stock of the subsidiary at the lowest tier. These rules then apply successively to determine the tentatively reduced basis of nontransferred shares of stock of subsidiaries at each next higher tier that is lower tier to S. The tenta- tive reductions are treated as noncapital, nondeductible expenses that tier up under the principles of §1.1502–32, tentatively reducing the basis of stock and the net positive adjustments of subsidiaries that are lower tier to S. (iv)Nonapplicability of tentative basis reduction rule to transferred shares.The tentative basis reduction rule in this para- graph (c)(6) does not apply to any share of stock of a lower-tier subsidiary (S1) that is transferred in the same transaction in which the S share is transferred. Fur- ther, for purposes of determining the S share’s disconformity amount, the tenta- tive basis reduction rule in this paragraph (c)(6) does not apply with respect to stock of any other subsidiary (S2) to the extent it is lower tier to the transferred S1 share. However, the tentative basis reduction rule may apply to S2 stock for purposes of com- puting the disconformity amount of the transferred S1 share. The purpose of this rule is to prevent tentative adjustments un- der this paragraph (c)(6) to the extent that this paragraph (c) has already applied to shares of subsidiary stock, without regard to whether the basis of those shares was re- duced under this paragraph (c). (v)Example. The rules of this para- graph (c)(6) are illustrated by the follow- ing example: Example.(i)Facts. P owns the sole outstanding share of S stock, S owns the sole outstanding share of S1 stock, S1 owns the sole outstanding share of S2 stock, S2 owns the sole outstanding share of S3 stock, and S3 owns the sole outstanding share of S4 stock. The S and S1 shares are loss shares, and the S3 share is a gain share. In one transaction, P sells its S share to X, S1 issues new shares in an amount that prevents S and S1 from being members of the same group, and S2 sells the S3 share to an unrelated individual. S1 and S2 elect to file a consolidated return following the transaction, as do S3 and S4. (ii)General applicability of section. The transac- tion is a transfer of the S and S3 shares (by reason of the sales) and of the S1 share (because S and S1 cease to be members of the same group). The transfer of the S3 share is not a transfer of a loss share and so this section does not apply to that transfer. This sec- tion does, however, apply to the transfer of the S and S1 loss shares. Under paragraph (a)(3)(ii)(A) of this section, the application of this section begins with the application of paragraph (b) to the transfer of the loss share of S1 stock, the lowest-tier subsidiary the stock of which is transferred in the transaction. (iii)Application of paragraphs (b) and (c) to transfer of S1 stock. First, the gain recognized on the transfer of S3 stock tiers up to adjust the basis of each upper-tier share. Then, because the transferred S1 share is still a loss share under these facts, paragraph (b) of this section applies to S’s transfer of S1 stock. However, no adjustment is required under paragraph (b) of this section because redetermination would change no member’s basis in a share (members hold only one share of S1 stock). See paragraph (b)(1)(ii)(A) of this section. The S1 share is still a loss share and so it is then subject to the provisions of this paragraph (c). In determining basis reduction under this paragraph (c), the disconformity amount of the S1 share is computed by treating S1’s basis in S2 stock as tentatively reduced under this paragraph (c)(6). In determining the disconformity amount of the S1 share, this tentative reduction rule has no application with respect to S2’s basis in the S3 share (because the S3 share is transferred in the transac- tion) or with respect to S3’s basis in the S4 share (because the S4 stock is lower tier to the transferred S3 share). After the application of this paragraph (c) to the transfer of the S1 share, paragraph (b) of this section applies to P’s transfer of the S share if the share is still a loss share. (iv)Application of section to transfer of S stock. First, assuming the S share has remained a loss share, paragraph (b) of this section applies to P’s transfer of S stock. However, no adjustment is required un- der paragraph (b) of this section, either because there is no potential for redetermination (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, para- graphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. The transferred share is still a loss share and there- fore subject to the provisions of this paragraph (c). In determining the disconformity amount of the S share, S’s net inside attributes are determined by taking into account S’s actual basis in the S1 stock. The tenta- tive reduction rule of this paragraph (c)(6) does not applytoS’sbasisintheS1sharebecausetheS1share is transferred in the transaction. All other shares are lowertiertothetransferredS1shareandarethere- fore not subject to tentative reduction for purposes of determining the disconformity amount of the S share. (7)Netting of gains and losses taken into account—(i)General rule. Solely for purposes of computing the basis reduction required under this paragraph (c), the basis of each transferred loss share of S stock is treated as reduced proportionately (as to loss) by the amount of gain taken into account by members with respect to all transferred gain shares of S stock, provided that— (A) The gain and loss shares are trans- ferred in the same transaction; and (B) The gain is taken into account in the year of the transaction. (ii)Example. The netting rule of this paragraph (c)(7) is illustrated by the fol- lowing example: Example.Disposition of gain and loss shares.(i) Facts. P owns the only two outstanding shares of S common stock. Share A has a basis of $54 and Share B has a basis of $100. In the same transaction, P sells the two S shares to X for $60 each. P realizes a gain of $6 on Share A and a loss of $40 on Share B. P’s sale of Share B is a transfer of a loss share and there- fore subject to the provisions of this section. (No ad- justment is required under paragraph (b) of this sec- tion because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See paragraph (b)(1)(ii)(B) of this section.) The transfer is then subject to the provisions of this paragraph (c). However, for this purpose, P treats its basis in Share B as reduced by the $6 gain taken into account with respect to Share A. Thus, solely for purposes of com- puting the basis reduction required with respect to P’s basis in Share B, P’s basis in Share B is treated as $94 ($100 less $6). If, after the application of this para- graph (c), the sale of Share B is still a transfer of a loss share, then the transfer is subject to paragraph (d) of this section. (Although the basis of Share B 2007–8 I.R.B.577February 20, 2007 is not reduced by gain for purposes of paragraph (d) of this section, paragraph (d)(3)(i)(A) of this section applies netting principles to limit adjustments under paragraph (d) of this section.) (ii)Allocation of gain amount to determine net loss. The facts are the same as in paragraph (i) of thisExample, except that, in addition to Share A and Share B, a third share of S stock, Share C, is outstand- ing. P’s basis in Share C is $80. P sells all three shares of S stock to X for $60 each. P’s sales of Share B andShareCaretransfersoflosssharesandtherefore subject to the provisions of this section. (No adjust- ment is required under paragraph (b) of this section because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See paragraph (b)(1)(ii)(B) of this section.) The transfer is then subject to the provisions of this paragraph (c). However, for this purpose, P treats its bases in Share B and Share C as reduced by the $6 gain taken into account on Share A. The gain is allocated to Share B and Share C proportionately based on the amount of loss in each share. Thus, $4 of gain ($40/$60 x $6) is treated as allocated to Share B and $2 of gain ($20/$60 x $6) is treated as allocated to Share C. Ac- cordingly, P computes the basis reduction required under this paragraph (c) by treating its basis in Share B as $96 ($100 less $4) and its basis in Share C as $78 ($80 less $2). If, after the application of this para- graph (c), the sales of Share B and Share C are still transfers of loss shares, then the transfers are subject to paragraph (d) of this section. (Although the bases of Share B and Share C are not reduced by gain for purposes of paragraph (d) of this section, paragraph (d)(3)(i)(A) of this section applies netting principles to limit adjustments under paragraph (d) of this sec- tion.) (iii)Disposition of stock with deferred gain.The facts are the same as in paragraph (i) of thisExample, except that P sells the gain share to a member. Under §1.1502–13, P’s gain recognized on Share A is not taken into account in the taxable year of the transfer and therefore cannot be treated as reducing P’s loss recognized on Share B. (8)Examples. The application of this paragraph (c) is illustrated by the follow- ing examples. Example 1.Appreciation reflected in stock basis at acquisition.(i)Appreciation recognized as gain. (A)Facts. On January 1, year 1, P purchases the sole outstanding share of S stock for $100. At that time, S owns two assets, Asset 1 with a basis of $0 and a value of $40, and Asset 2 with a basis and value of $60. In year 1, S sells Asset 1 for $40. On De- cember 31, year 1, P sells its S share for $100. After applying and giving effect toall generally applicable rules of law (other than this section), P’s basis in the S share is $140 (P’s original $100 basis increased under §1.1502–32 to reflect the $40 gain recognized on the sale of Asset 1). P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph(b)ofthissection,P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share is reduced, but not below value, by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is the greater of zero and the sum of all investment adjust- ments applied to the basis of the share, computed without taking distributions into account. There are no distributions. The only investment adjustment to the share is the $40 adjustment attributable to the gain recognized on the sale of Asset 1. Thus, the share’s net positive adjustment is $40. The share’s disconformity amount is the excess, if any, of its ba- sis ($140) over its allocable portion of S’s net inside attribute amount. S’s net inside attribute amount is the sum of S’s money ($40 from the sale of Asset 1) and S’s basis in Asset 2 ($60), or $100. The share is the only outstanding S share and so its allocable portion of the $100 net inside attribute amount is the entire $100. Thus, the share’s disconformity amount is $40, the excess of $140 over $100. The lesser of the net positive adjustment ($40) and the share’s disconformity amount ($40) is $40. Accordingly, the basis in the share is reduced by $40, from $140 to $100, immediately before the sale. (D)Application of paragraph (d) of this section. Because P’s sale of the S share is no longer a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply. (ii)Appreciation recognized as income (instead of gain). The facts are the same as in paragraph (i)(A) of thisExample 1, except that, instead of selling Asset 1, the value of Asset 1 is consumed in the production of $40 of income in year 1 (reducing the value of Asset 1 to $0). Because the net positive adjustment includes items of income as well as items of gain, the results are the same as those described in paragraph (i) of this Example 1. (iii)Post-acquisition appreciation eliminates stock loss. The facts are the same as in paragraph (i)(A) of thisExample 1except that, in addition, the value of Asset 2 increases to $100 before the stock is sold. As a result, P sells the S share for $140. BecauseP’ssaleoftheSshareisnotatransferofa loss share, this section does not apply to the transfer, notwithstanding that P’s basis in the S share was increased by the gain recognized on Asset 1. (iv)Distributions.(A)Facts. The facts are the same as in paragraph (i)(A) of thisExample 1except that, in addition, S distributes a $10 dividend before the end of year 1. As a result, the value of the share decreases and P sells the share for $90. After apply- ing and giving effect to all generally applicable rules of law (other than this section), P’s basis in the S share is $130 (P’s original $100 basis increased by $30 un- der §1.1502–32 (the net of the $40 gain recognized onthesaleofAsset1andthe$10 dividend declared and distributed)). P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph (b) of this section, P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share is reduced, but not below value, by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is $40 (the sum of all investment adjustments applied to the basis of the share, computed without taking dis- tributions into account). The share’s disconformity amount is the excess of its basis ($130) over its allo- cable portion of S’s net inside attribute amount. S’s net inside attribute amount is the sum of S’s money ($30, the $40 sale proceeds minus the $10 distribu- tion) and S’s basis in Asset 2 ($60), or $90. The share is the only outstanding S share and so its allocable portion of the $90 net inside attribute amount is the entire $90. The lesser of the share’s net positive adjustment ($40) and its disconformity amount ($40) is $40. Accordingly, the basis in the share is reduced by $40, from $130 to $90, immediately before the sale. (D)Application of paragraph (d) of this section. Because P’s sale of the S share is no longer a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply. Example 2.Loss of appreciation reflected in ba- sis.(i)Facts. On January 1, year 1, P purchases the sole outstanding share of S stock for $100. At that time, S owns two assets, Asset 1 with a basis of $0 andavalueof$40,andAsset2withabasisandvalue of $60. The value of Asset 1 declines to $0 and P sells its S share for $60. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in the S share remains $100. P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (ii)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph (b) of this section, P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (iii)Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in the S share ($100) is reduced immediately before the sale, but not below value ($60), by the lesser of the share’s net positive adjustment and disconformity amount. There were no adjustments to P’s basis in the share and so the share’s net positive adjustment is $0. Thus, although the share’s disconformity amount is $40 (the excess of P’s basis in the share ($100) over the share’s allocable portion of S’s net inside at- tribute amount ($60)), no basis reduction is required under this paragraph (c). (iv)Application of paragraph (d) of this section. After the application of this paragraph (c), P’s sale of the S share is still a transfer of a loss share, and, accordingly, subject to paragraph (d) of this section. No adjustment is required under paragraph (d) of this February 20, 20075782007–8 I.R.B. section because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section. Example 3.ItemsaccruingafterSbecomesa member.(i)Recognition of loss accruing after S be- comes a member.(A)Facts. On January 1, year 1, P purchases the sole outstanding share of S stock for $100. At that time, S owns two assets, Asset 1, with a basis of $0 and a value of $40, and Asset 2, with a basis and value of $60. In year 1, S sells Asset 1 for $40. Also in year 1, the value of Asset 2 declines and S sells Asset 2 for $20. On December 31, year 1, P sells its S share for $60. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in the S share is $100 (P’s original $100 basis, unadjusted under §1.1502–32 be- cause the $40 gain recognized on the sale of Asset 1 offsets the $40 loss on the sale of Asset 2). P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph (b) of this section, P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c).Un- der this paragraph (c), P’s basis in the S share ($100) is reduced immediately before the sale, but not below value ($60), by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is $0. Thus, although the share has a disconformity amount of $40 (the ex- cess of P’s basis in the share ($100) over the share’s allocable portion of S’s net inside attribute amount ($60)),nobasisreductionisrequiredunderthispara- graph (c). (D)Application of paragraph (d) of this section. After the application of this paragraph (c), P’s sale of the S share is still a transfer of a loss share, and, accordingly, subject to paragraph (d) of this section. No adjustment is required under paragraph (d) of this section because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section. (ii)Recognition of gain accruing after S becomes amember.(A)Facts. The facts are the same as in paragraph (i)(A) of thisExample 3, except that nei- ther P nor S sells anything in year 1. In addition, in year 2, the value of Asset 1 declines to $0, the value of Asset 2 returns to $60, and S creates Asset 3 (with a basis of $0). In year 3, S sells Asset 3 for $40. On De- cember 31, year 3, P sells its S share for $100. After applying and giving effect toall generally applicable rules of law (other than this section), P’s basis in the S share is $140 (P’s original $100 basis increased un- der §1.1502–32 to reflect the $40 gain recognized on the sale of Asset 3 in year 3). (B)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph(b)ofthissection,P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c).Un- der this paragraph (c), P’s basis in the S share ($140) is reduced immediately before the sale, but not below value ($100), by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is $40 (the year 3 investment adjustment). The share’s disconformity amount is the excess of its basis ($140) over its allocable portion of S’s net inside attribute amount. S’s net inside at- tribute amount is $100, the sum of S’s money ($40 from the sale of Asset 3) and its basis in its assets ($60 (the sum of Asset 1’s basis of $0 and Asset 2’s basis of $60)). S’s $100 net inside attribute amount is allocable entirely to the sole outstanding S share. Thus, the share’s disconformity amount is the excess of $140 over $100, or $40. The lesser of the share’s net positive adjustment ($40) and its disconformity amount ($40) is $40. Accordingly, the basis in the share is reduced by $40, from $140 to $100, immedi- ately before the sale. (D)Application of paragraph (d) of this section. Because P’s sale of the S share is no longer a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply. (iii)Recognition of income earned after S be- comes a member. The facts are the same as in paragraph (ii)(A) of thisExample 3, except that in- stead of creating Asset 3, S earns $40 of income from services provided in year3. Because the net positive adjustment includes items of income as well as items of gain, the results are the same as those described in paragraph (ii) of thisExample 3. Example 4.Computing the disconformity amount.(i)Unrecognized loss reflected in stock basis.(A)Facts. P owns the sole outstanding share of S stock with a basis of $100. S owns two assets, Asset 1 with a basis of $20 and a value of $60, and Asset 2 with a basis of $60 and a value of $40. In year 1, S sells Asset 1 for $60. On December 31, year 1, P sells the S share for $100. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in the S share is $140 (P’s original $100 basis increased under §1.1502–32 to reflect the $40 gain recognized on the sale of Asset 1). P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph(b)ofthissection,P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c).Un- der this paragraph (c), P’s basis in the S share ($140) is reduced immediately before the sale, but not below value ($100), by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is $40 (the year 1 investment adjustment). The share’s disconformity amount is the excess of its basis ($140) over its allocable portion of S’s net inside attribute amount. S’s net inside at- tribute amount is the sum of S’s money ($60 from the sale of Asset 1) and S’s basis in Asset 2 ($60), or $120. S’s net inside attribute amount is allocable entirely to the sole outstanding S share. Thus, the share’s disconformity amount is the excess of $140 over $120, or $20. The lesser of the share’s net pos- itive adjustment ($40) and its disconformity amount ($20) is $20. Accordingly, the basis in the share is reduced by $20, from $140 to $120, immediately be- fore the sale. (D)Application of paragraph (d) of this section. After the application of this paragraph (c), P’s sale of the S share is still a transfer of a loss share, and, accordingly, subject to paragraph (d) of this section. Paragraph (d) of this section reduces the basis of As- set 2 by $20 because the loss is duplicated. (ii)Loss carryover. The facts are the same as in paragraph (i)(A) of thisExample 4,exceptthatAsset 2 has a basis of $0 (rather than $60) and S has a $60 loss carryover (as defined in paragraph (f)(6) of this section). The analysis of the application of this para- graph (c) is the same here as in paragraph (i)(C) of this Example 4. Furthermore, the analysis of the applica- tion of this paragraph (c) would also be the same if the $60 loss carryover were subject to a section 382 lim- itation from a prior ownership change, or if, instead, it were subject to the limitation in §1.1502–21(c) on losses carried from separate return limitation years. However, under each alternative fact pattern, para- graph (d) of this section reduces the loss carryover by $20 because the loss is duplicated. (iii)Liabilities. The facts are the same as in para- graph(i)(A)ofthisExample 4, except that S borrows $100 before P sells the S share. S’s net inside attribute amount remains $120, computed as the sum of S’s money ($160 ($60 from the sale of Asset 1 plus the $100 borrowed cash)) plus S’s basis in Asset 2 ($60), minus its liabilities ($100). Thus, the S share’s dis- conformity amount remains the excess of $140 over $120, or $20. The results are the same as in paragraph (i) of thisExample 4. Example 5.Computing the allocable portion of the net inside attribute amount.(i) Facts.OnJan- uary 1, year 1, P owns all five outstanding shares of S stock with a basis of $20 per share. S owns Asset with a basis of $0. In year 1, S sells Asset for $100. On December 31, year 1, P sells one of its S shares, Share 1, for $20. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in Share 1 is $40 (P’s original $20 basis increased by $20 under §1.1502–32 to reflect the share’s allocable portion of the $100 gain recog- nized on the sale of Asset). P’s sale of Share 1 is a transfer of a loss share and therefore subject to the provisions of this section. (ii)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section because redetermination would change no member’s basis in a share (S has only one class of stock outstanding and there is no disparity in the basis of the shares). See paragraph (b)(1)(ii)(A) of this section. After the application of paragraph (b) of this section, P’s sale of Share 1 is still a transfer of a loss share and therefore subject to this paragraph (c). (iii)Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in Share 1 ($40) is reduced immediately before the sale, but not below value ($20), by the lesser of the share’s net positive 2007–8 I.R.B.579February 20, 2007 adjustment and disconformity amount. Share 1’s net positive adjustment is $20 (the year 1 investment adjustment). Share 1’s disconformity amount is the excess of its basis ($40) over its allocable portion of S’s net inside attribute amount. S’s net inside attribute amount is the sum of S’s money ($100 from the sale of Asset), and Share 1’s allocable portion of S’s net inside attribute amount is $20 (1/5 x $100). Thus, Share 1’s disconformity amount is the excess of $40 over $20, or $20. The lesser of the share’s net positive adjustment ($20) and its disconformity amount ($20) is $20. Accordingly, the basis in the share is reduced by $20, from $40 to $20, immedi- ately before the sale. (iv)Application of paragraph (d) of this section. Because P’s sale of Share 1 is no longer a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply. Example 6.Liabilities.(i)In general.(A)Facts. On January 1, year 1, P purchases the sole outstanding share of S stock for $100. At that time, S owns Asset, with a basis of $0 and value of $100, and $100 cash. S also has a $100 liability. In year 1, S distributes $60 to P and earns $20. The value of Asset declines to $60 and, on December 31, year 1, P sells the S share for $20. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in the S share is $60 (P’s original $100 basis decreased under §1.1502–32 by $40 (the net of the $60 distribution and the $20 income earned)). P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph (b) of this section, P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c).Un- der this paragraph (c), P’s basis in the S share ($60) is reduced immediately before the sale, but not below value ($20), by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is $20 (the year 1 investment adjustment computed without taking the distribution into account). The share’s disconformity amount is the excess of its basis ($60) over its allocable por- tion of S’s net inside attribute amount. S’s net in- side attribute amount is negative $40, computed as the sum of S’s money ($60 ($100 minus the $60 dis- tribution plus the $20 income earned)) plus S’s basis in Asset ($0), minus S’s liability ($100). S’s net in- side attribute amount is allocable entirely to the sole outstanding S share. Thus, the share’s disconformity amount is the excess of $60 over negative $40, or $100. The lesser of the share’s net positive adjust- ment ($20) and its disconformity amount ($100) is $20. Accordingly, the basis in the share is reduced by $20, from $60 to $40, immediately before the sale. (D)Application of paragraph (d) of this section. After the application of this paragraph (c), the S share is still a loss share and, accordingly, S’s attributes are subject to reduction under paragraph (d) of this sec- tion. No adjustment is required under paragraph (d) of this section, however, because there is no aggre- gate inside loss. See paragraph (d)(3)(iii) of this sec- tion. (ii)Excluded cancellation of indebtedness in- come—insufficient attributes available for reduction required by sections 108 and 1017, and §1.1502–28. (A)Facts. The facts are the same as in paragraph (i)(A) of thisExample 6, except that P does not sell the S share. Instead, in year 4, Asset is destroyed in a fire and S spends its $60 on deductible expenses that are not absorbed by the group. S’s loss becomes part of the consolidated net operating loss (CNOL). In year 5, S becomes insolvent and S’s debt is dis- charged. Because of S’s insolvency, S’s discharge of indebtedness income is excluded under section 108 and, as a result, S’s attributes are subject to reduction under sections 108 and 1017, and §1.1502–28. S’s only attribute is the portion of the CNOL attributable to S ($60) and it is reduced to $0. There are no other consolidated attributes. In year 5, the S stock becomes worthless under section 165(g), taking into account the provisions of §1.1502–80(c). After ap- plying and giving effect toall generally applicable rules of law (other than this section), P’s basis in the S share is $60 (P’s original $100 basis decreased un- der §1.1502–32 by the year 1 investment adjustment of $40 (the net of the $60 distribution and the $20 income earned). The investment adjustment for year 5 is $0 ($60 tax exempt income from the excluded COD applied to reduce attributes minus $60 noncap- ital, nondeductible expense from the reduction of S’s portion of the CNOL). Under paragraph (f)(11)(i)(D) of this section, a share is transferred on the last day of the taxable year during which it becomes worthless under section 165(g), taking into account the provi- sions of §1.1502–80(c). Accordingly, P transfers a loss share of S stock on December 31, year 5, and the transfer is therefore subject to the provisions of this section. (B) Application of paragraph (b) of this sec- tion. No adjustment is required under paragraph (b) of this section because redetermination would change no member’s basis in a share. See paragraph (b)(1)(ii)(A) of this section. After the application of paragraph (b) of this section, P’s transfer of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c). Under this paragraph (c), P’s basis in its S share ($60) is reduced immediately before the sale, but not below value ($0), by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is $20 (the year 1 investment adjustment computed without taking the distribution into account). The share’s disconformity amount is the excess of its basis ($60) over its allo- cable portion of S’s net inside attribute amount. S’s net inside attribute amount is $0 (S’s basis in Asset). (The attribute reduction required under sections 108 and 1017 and §1.1502–28 is given effect before the application of this section; therefore, S’s portion of the CNOL was eliminated under section 108 and §1.1502–28.) S’s net inside attribute amount is allo- cable entirely to the sole outstanding S share. Thus, the share’s disconformity amount is the excess of $60 over $0, or $60. The lesser of the share’s net positive adjustment ($20) and its disconformity amount ($60) is $20. Accordingly, the basis in the share is reduced by $20, from $60 to $40, immediately before the transfer. (D)Application of paragraph (d) of this section. After the application of this paragraph (c), the S share is still a loss share, and, accordingly, S’s attributes are subject to reduction under paragraph (d) of this sec- tion. No adjustment is required under paragraph (d) of this section, however, because there is no aggre- gate inside loss. See paragraph (d)(3)(iii) of this sec- tion. (iii)Excluded cancellation of indebtedness in- come—full attribute reduction under sections 108 and 1017, and §1.1502–28 (using attributes attrib- utable to another member).(A)Facts. The facts are the same as in paragraph (ii)(A) of thisExample 6except that P loses the $60 distributed in year 1 and the loss is not absorbed by the group. Thus, as of December 31, year 5, the CNOL is $120, at- tributable $60 to S and $60 to P. As a result, under §1.1502–28(a)(4), after the portion of the CNOL attributable to S is reduced to $0, the remaining $40 of excluded COD applies to the portion of the CNOL attributable to P, reducing it from $60 to $20. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in the S share at the end of year 5 is $100 (P’s original $100 basis decreased under §1.1502–32 by $40 at the end of year 1 and then increased under §1.1502–32 by $40 at the end of year 5 ($100 tax exempt income from the excluded COD applied to reduce attributes minus $60 noncapital, nondeductible expense from the reduction of S’s portion of the CNOL). Under paragraph (f)(11)(i)(D) of this section, a share is transferred on the last day of the taxable year during which it becomes worthless under section 165(g), taking into account the provisions of §1.1502–80(c). Accordingly, P transfers a loss share of S stock on December 31, year 5, and thetransfer istherefore subject to the provisions of this section. (B)Application of paragraph (b) of this sec- tion. No adjustment is required under paragraph (b) of this section because redetermination would change no member’s basis in a share. See paragraph (b)(1)(ii)(A) of this section. After the application of paragraph (b) of this section, P’s transfer of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (C)Basis reduction under this paragraph (c).Un- der this paragraph (c), P’s basis in the S share ($100) is reduced immediately before the sale, but not below value ($0), by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is $60 (the sum of the year 1 investment adjustment computed without taking the distribution into account ($20) and the year 5 invest- ment adjustment ($40)). The share’s disconformity amount is the excess of its basis ($100) over its allo- cable portion of S’s net inside attribute amount. S’s net inside attribute amount is $0 (S’s basis in Asset). S’s net inside attribute amount is allocable entirely to the sole outstanding S share. The share’s discon- formity amount is therefore $100. The lesser of the share’s net positive adjustment ($60) and its discon- formity amount ($100) is $60. Accordingly, P’s basis in the share is reduced by $60, from $100 to $40, im- mediately before the transfer. (D)Application of paragraph (d) of this section. After the application of this paragraph (c), the S share is still a loss share, and, accordingly, S’s attributes are February 20, 20075802007–8 I.R.B. subject to reduction under paragraph (d) of this sec- tion. No adjustment is required under paragraph (d) of this section, however,because there is no aggre- gate inside loss. See paragraph (d)(3)(iii) of this sec- tion. Example 7.Lower-tier subsidiary (no transfer of lower-tier stock).(i)Facts. P owns the sole outstand- ing share of S stock with a basis of $160. S owns two assets, Asset A with a basis and value of $100, and the sole outstanding share of S1 stock with a basis of $60. S1 owns one asset, Asset 1, with a basis of $20 and value of $60. In year 1, S1 sells Asset 1 to X for $60, recognizing $40 of gain. On December 31, year 1, P sells its S share to Y, a member of another consol- idated group, for $160. After applying and giving ef- fect to all generally applicable rules of law (other than this section), P’s basis in the S share is $200 (P’s orig- inal $160 basis increased under §1.1502–32 by $40 (to reflect the tiering up of the increase to S’s basis in the S1 share under §1.1502–32 by $40 (to reflect the gain recognized on S1’s sale of Asset 1)). P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (S does not transfer the S1 share because S and S1 are members of the same group following the transfer. See para- graph(f)(11)ofthissection.) (ii)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph (b) of this section, P’s sale of the S share is still a transfer of a loss share and therefore subject to this paragraph (c). (iii)Basis reduction under this paragraph (c).(A) In general. Under this paragraph (c), P’s basis in the S share ($200) is reduced immediately before the sale, but not below value ($160), by the lesser of the share’s net positive adjustment and disconformity amount. The S share’s net positive adjustment is $40. The share’s disconformity amount is the excess, if any, of the basis of the share ($200) over the share’s allocable portion of S’s net inside attribute amount. S’s net inside attribute amount is the sum of S’s basis in Asset A ($100) plus S’s basis in the S1 share. (B)S’s basis in the S1 share. Although S’s actual basis in the S1 share is $100 (S’s original $60 basis increased by S1’s year 1 positive $40 investment ad- justment), for purposes of computing the S share’s disconformity amount, S’s basis in the S1 share is tentatively reduced by the lesser of the S1 share’s net positive adjustment and its disconformity amount. The S1 share’s net positive adjustment is $40 (the year 1 investment adjustment). The S1 share’s dis- conformity amount is the excess, if any, of its basis ($100) over its allocable portion of S1’s net inside at- tribute amount. S1’s net inside attribute amount is $60 (its cash received on the sale of Asset 1) and it is entirely attributable to S’s S1 share. The S1 share’s disconformity amount is therefore the excess of $100 over $60, or $40. The lesser of the S1 share’s net pos- itive adjustment ($40) and its disconformity amount ($40) is $40. Accordingly, for purposes of computing the disconformity amount of the S share, S’s basis in its S1 share is tentatively reduced by $40, from $100 to $60. (C)The disconformity amount of P’s S share.S’s net inside attribute amount is treated as the sum of its basis in Asset A ($100) and its (tentatively reduced) basis in its S1 share ($60), or $160. S’s net inside attribute amount is allocable entirely to P’s S share. Thus, the S share’s disconformity amount is the ex- cess of $200 over $160, or $40. (D)Amount of reduction. P’s basis in its S share is reduced by the lesser of the S share’s net positive adjustment ($40) and disconformity amount ($40), or $40. Accordingly, P’s basis in the S share is reduced by $40, from $200 to $160, immediately before the sale. (E)Effect on S’s basis in its S1 share.Thetrans- action has no effect on S’s basis in the S1 share. Thus, S owns the S1 share with a basis of $100, S’s original $60 basis in the share plus the $40 adjustment for the gain recognized on the sale of Asset 1 in year 1. (iv)Application of paragraph (d) of this section. Because P’s sale of the S share is no longer a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply. (d)Attribute reduction to prevent dupli- cation of loss—(1)In general.Therules of this paragraph (d) reduce S’s attributes to the extent they duplicate a net loss on shares of S stock transferred by members in a single transaction. This rule furthers single entity principles by preventing S from using deductions and losses to the extent that the group or its members (in- cluding former members) have either used, or preserved for later use, a corresponding loss in S shares. This rule applies without regard to whether S ceases to be a member after the transfer of its shares. (2)Attribute reduction rule—(i)Gen- eral. If a transferred share is a loss share after the application of paragraph (c) of this section, S’s attributes are reduced by S’s attribute reduction amount. S’s at- tribute reduction amount is determined un- der paragraph (d)(3) ofthis section and ap- plied in accordance with the provisions of paragraphs (d)(4), (d)(5), and (d)(6) of this section. (ii)Transfers of stock of subsidiaries at multiple tiers. If stock of subsidiaries at multiple tiers is transferred in a trans- action, this paragraph (d) (other than paragraph (d)(6) to the extent necessary to make the election to reattribute attributes) applies only after paragraphs (b) and (c) of this section have applied with respect to all transfers of loss shares. See paragraph (a)(3)(ii) of this section regarding the or- der of application of this section. (3)Attribute reduction amount—(i) General.S’sattribute reduction amount is the lesser of— (A) The net stock loss (see paragraph (d)(3)(ii) of this section); and (B) S’s aggregate inside loss (see para- graph (d)(3)(iii) of this section). (ii)Net stock loss.Thenet stock lossis the excess, if any, of— (A) The aggregate basis of all shares of S stock transferred by members in the transaction (taking into account any ad- justments required under paragraphs (b) and (c) of this section, any gain or loss rec- ognized at lower tiers, and any other re- lated or resulting adjustments); over (B) The aggregate value of those shares. (iii)Aggregate inside loss—(A)Gen- eral.S’saggregate inside lossis the ex- cess, if any, of— (1) S’s net inside attribute amount; over (2) The value of all outstanding shares of S stock. (B)Net inside attribute amount.S’s net inside attribute amountgenerally has the same meaning as in paragraph (c)(5) of this section. However, if S holds stock of a lower-tier subsidiary, the provisions of paragraph (d)(5) of this section (and not the provisions of paragraph (c)(6) of this section) modify the computation of S’s net inside attribute amount for purposes of this paragraph (d). (iv)Transactions that adjusted stock or asset basis. See paragraph (e)(2) of this section for special rules that may apply if a prior transaction, such as an exchange sub- ject to section 362(e)(2), adjusted the basis in any share of S stock or S’s attributes in a manner that altered the potential for loss duplication. (v)Lower-tier subsidiaries.Seepara- graph (d)(5) of this section for special rules relating to the application of this paragraph (d) if S owns shares of stock of a sub- sidiary. (4)Application of attribute reduc- tion—(i)Attributes available for reduc- tion. S’s attributes available for reduction under this paragraph (d) are— (A)Category A. Net operating loss car- ryovers; (B)Category B. Capital loss carryovers; (C)Category C. Deferred deductions; (D)Category D. Basis in publicly traded property (other than stock of a subsidiary), but only to the extent of the amount, if any, that each such property’s basis exceeds its value; and (E)Category E. Basis of assets exclud- ing— 2007–8 I.R.B.581February 20, 2007 (1) Money and cash equivalents, and (2) The basis of publicly traded prop- erty (other than stock of a subsidiary). (ii)Rules of application—(A)In gen- eral. S’s attribute reduction amount is al- located and applied to reduce the attributes in each category in the order that the cat- egories are set forth in paragraph (d)(4)(i) of this section. If the amount to be allo- cated and applied to any category equals or exceeds the amount of attributes in the category, the attributes in that category are reduced to zero and any excess is then al- located and applied to the attributes in the next category. If the amount to be allo- cated and applied is less than the amount of attributes in any category other than Cate- gory A or Category B, it is allocated and applied proportionately to all attributes in the category based on the amount of each attribute. If the amount to be allocated and applied to attributes in Category E exceeds the amount of attributes in that category, then— (1) To the extent of any liabilities of S (or a lower-tier subsidiary) that are not taken into account for tax purposes be- fore the transfer, such excess is suspended and allocated and applied proportionately to reduce any amounts that would be de- ductible or capitalizable as a result of such liabilities later being taken into account by S or another person; solely for pur- poses of this paragraph (d)(4)(ii)(A)(1),li- abilitymeans any liability or obligation that would be required to be capitalized as an assumed liability by a person that pur- chased all of S’s assets and assumed all of S’s liabilities in a single transaction; and (2) To the extent such excess is greater than any amount suspended by paragraph (d)(4)(ii)(A)(1) of this section, it is disre- garded and has no further effect. (B)Order of reduction of loss carry- overs. With respect to attributes in Cate- gory A and Category B, the attribute reduc- tion amount is applied first to reduce losses carried from the first taxable year in which a loss carryover arose, and then to reduce loss carryovers that arose in each next suc- cessive year. (C)Time and effect of attribute reduc- tion. In general, the reduction of attributes is effective immediately before the trans- action in which there is a transfer of a loss share of S stock. If the reduction to a member’s basis in a share of S stock exceeds the basis of that share, the ex- cess is an excess loss account to which the member owning the share succeeds (and such excess loss account is not taken into account under §1.1502–19 or other- wise as a result of the transaction). The reductions to attributes required under this paragraph (d)(4), including by reason of paragraph (d)(5)(ii)(D) of this section (tier down of attribute reduction amounts to lower-tier subsidiaries), are not noncapi- tal, nondeductible expenses described in §1.1502–32(b)(2)(iii). Accordingly, such reductions have no effect on the basis of stock of upper-tier subsidiaries. (5)Special rules applicable if S holds stock of a lower-tier subsidiary (S1) imme- diately before a transfer of loss shares of Sstock—(i)Computation of S’s attribute reduction amount. For purposes of deter- mining S’s attribute reduction amount un- der paragraph (d)(3) of this section— (A)Single share. All of S’s shares of S1 stock held immediately before the transac- tion (whether or not transferred in, or held by S immediately after, the transaction) are treated as a single share (generally referred to as the S1 stock); and (B)Deemed basis.S’sbasisinitsS1 stock is treated as itsdeemed basisin the stock, which is equal to the greater of— (1) The sum of S’s basis in each share of S1 stock (adjusted to reflect any gain or loss recognized on the transfer of any S1 shares in the transaction, whether allowed or disallowed); and (2) The portion of S1’s net inside at- tribute amount allocable to S’s shares of S1 stock. (C)Multiple tiers. If S owns (directly or indirectly) stock of subsidiaries in mul- tiple tiers (whether or not transferred in, or held by S, directly or indirectly, imme- diately after, the transaction), S’s deemed basis in such stock is determined first with respect to shares of stock of the lowest-tier subsidiary or subsidiaries. Deemed basis is then determined with respect to the basis of stock of subsidiaries in each next higher tier. (ii)Allocation and application of S’s at- tribute reduction amount—(A)Allocation of attribute reduction amount between S1 stock and other assets. For purposes of allocating S’s attribute reduction amount, S’s basis in S1 stock is treated as equal to its deemed basis in the S1 stock (deter- mined under paragraph (d)(5)(i)(B) of this section), reduced by— (1)ThevalueofS’stransferredshares of S1 stock, (2) The excess of the sum of S1’s money, S1’s cash equivalents, the value of S1’s publicly traded property (other than stock of a subsidiary) and S1’s transferred shares of lower-tier subsidiary (S2) stock, and all corresponding S2 amounts (net of S2’s liabilities) that are allocable to S1’s nontransferred shares of S2 stock, over the total amount of S1’s liabilities, to the extent that such excess is allocable to S’s nontransferred shares of S1 stock, and (3) The corresponding amounts with re- spect to shares of stock of all lower tier subsidiaries. (B)Application of attribute reduction amount to S’s S1 stock. The attribute re- duction amount allocated to S’s S1 stock (the allocated amount) is apportioned among, and applied to reduce S’s bases in, S’s individual S1shares in accordance with the following— (1) No allocated amount is apportioned to a share of transferred S1 stock if gain or loss is recognized on its transfer; (2) The allocated amount is apportioned among all of S’s other shares of S1 stock in a manner that, when applied to those shares, reduces the disparity in S’s bases in the S1 shares to the greatest extent pos- sible; (3) The allocated amount that is ap- portioned to any S1 share transferred in a transfer in which no gain or loss was rec- ognized is applied only to the extent nec- essary to reduce the basis of that share to, but not below, the value of the share; and (4) The allocated amount that is appor- tionedtoS1sharesnottransferredinthe transaction is applied to reduce the bases of such shares without limitation. (C)Further effects of allocated amount. Any portion of the allocated amount that isnotappliedtoreduceS’sbasisina share of S1 stock has no effect on any other attributes of S, it is not a noncap- ital, nondeductible expense of S, and it does not cause S to recognize income or gain. However, as provided in paragraph (d)(5)(ii)(D) of this section, such amounts continue to be part of the allocated amount for purposes of the tier down rule in para- graph (d)(5)(ii)(D) of this section. (D)Tier down of attribute reduction amount—(1)General rule. The portion of S’s attribute reduction amount that is al- located to S1 stock (the allocated amount) February 20, 20075822007–8 I.R.B. is an attribute reduction amount of S1. Thus, subject to the basis conforming limitation in paragraph (d)(5)(ii)(D)(2)of this section, the allocated amount applies to reduce S1’s attributes under the provi- sions of this paragraph (d). The allocated amount is an attribute reduction amount of S1 that must be allocated to S1’s as- sets even if its application to S’s basis in S1 stock is limited under paragraph (d)(5)(ii)(B) of this section and even if its application to S1’s attributes is limited under paragraph (d)(5)(ii)(D)(2)ofthis section. (2)Conforming limitation on reduc- tion of lower-tier subsidiary’s attributes. Notwithstanding the general rule in para- graph (d)(5)(ii)(D)(1)ofthissection,and subject to any modification in paragraph (e)(2) of this section, the application of S’s attribute reduction amount to S1’s attributes (the tier down amount) is lim- ited such that, when combined with any attribute reduction amount computed with respect to a transfer of S1 stock, the total amount of reduction to S1’s attributes does not exceed the excess of— (i) The portion of S1’s net inside at- tributes that is allocable to all S1 shares held by members immediately before the transaction; over (ii) The sum of the value of all S1 shares transferred by members in the transaction and the sum of all members’ bases in any other shares of S1 stock held immediately before the transaction (after any reduction under this section, including this paragraph (d)). (iii)Stock basis restoration.Afterthis paragraph (d) has applied with respect to all shares of subsidiary stock transferred in the transaction, basis is restored un- der this paragraph (d)(5)(iii). In general, under this paragraph (d)(5)(iii), reduc- tions otherwise required under paragraph (d)(5)(ii)(B) of this section are reversed to the extent necessary to restore members’ bases in subsidiary stock to conform the basis of each member’s share of subsidiary stock to the share’s allocable portion of the subsidiary’s net inside attribute amount as defined in paragraph (c)(5) of this sec- tion, without regard to paragraph (c)(6) of this section. The restoration adjust- ments are first made at the lowest tier and then at each next higher tier successively. Restoration adjustments do not tier up to affect the bases of higher-tier shares. Rather, restoration is computed and ap- plied separately at each tier. For purposes of this rule– (A) A subsidiary’s net inside attribute amount is determined by treating the basis in stock of a lower-tier subsidiary as the actual basis of the stock, as adjusted under this section; (B) The net inside attribute amount is treated as decreased by any attribute reduc- tion amount suspended under paragraph (d)(4)(ii)(A)(1) of this section (liabilities not taken into account); and (C) If a subsidiary received property in a prior intercompany section 362(e)(2) transaction and the stock of such sub- sidiary was reduced as the result of an election under section 362(e)(2)(C) (taking into account the provisions of §1.1502–13(e)(4)), the net inside attribute amount must be reduced as provided in paragraph (e)(2) of this section. (6)Elections to reduce the potential for loss duplication—(i)In general. Notwith- standing the general operation of this paragraph (d), the common parent of the group of which S is a member immedi- ately before the transaction (P) may make an irrevocable election to reduce the po- tential for loss duplication, and thereby avoid or reduce attribute reduction. Un- der this paragraph (d)(6), P may elect to reduce members’ bases in transferred loss shares of S stock, or reattribute S’s at- tributes (including attributes of lower-tier subsidiaries) to the extent such attributes would otherwise be subject to reduction under this paragraph (d), or both. The combined amount ofstock basis reduc- tion and reattribution of attributes may not exceed S’s attribute reduction amount, tentatively computed without regard to any election under this paragraph (d)(6). (ii)Order of application—(A)Stock of one subsidiary transferred in the trans- action. If shares of stock of only one subsidiary are transferred in the trans- action, any stock basis reduction and reattribution of attributes (including from lower-tier subsidiaries) is deemed to occur immediately before the application of this paragraph (d), based on the tentatively computed attribute reduction amount. If a transferred share is still a loss share after giving effect to this election, the provi- sions of this paragraph (d) then apply with respect to that share. (B)Stock of multiple subsidiaries trans- ferred in the transaction.Ifsharesofstock of more than one subsidiary are transferred in the transaction and elections under this paragraph (d)(6) are made with respect to transfers of stock of subsidiaries in mul- tiple tiers, effect is given to the elections from the lowest tier to the highest tier in the manner provided in this paragraph (d)(6)(ii)(B). The scope of the election for the transfer at the lowest tier is determined by tentatively applying paragraph (d) with respect to the transferred loss shares of this lowest-tier subsidiary immediately af- ter applying paragraphs (b) and (c) of this sectiontothestockofsuchsubsidiary. The effect of any stock basis reduction or reattribution of losses immediately tiers up (under the principles of §1.1502–32) to adjust members’ bases in all higher-tier shares. The process is repeated for elec- tions for each next higher-tier transfer. (iii)Special rules for reattribution elections—(A)In general. Because the reattribution election is intended to pro- vide the group a means to retain certain S attributes, and not to change the loca- tion of attributes where S continues to be a member, the election to reattribute attributes may only be made if S becomes a nonmember (within the meaning of §1.1502–19(c)(2)) as a result of the trans- action. The election to reattribute S’s attributes can only be made for attributes in Category A, Category B, and Category C. Attributes subject to the election will be reattributed to P in the same order, manner, and amount that they would otherwise be reduced under paragraph (d)(4) of this sec- tion. P succeeds to reattributed attributes as if such attributes were succeeded to in a transaction described in section 381(a). Any owner shift of the subsidiary (includ- ing any deemed owner shift resulting from section 382(g)(4)(D) or section 382(l)(3)) in connection with the transaction is not taken into account under section 382 with respect to the reattributed attributes. The reattribution of S’s attributes is a noncapital, nondeductible expense de- scribed in §1.1502–32(b)(2)(iii). See §1.1502–32(c)(1)(ii)(B) regarding special allocations applicable to such noncapital, nondeductible expense. If P elects to reat- tribute S attributes (including attributes of a lower-tier subsidiary) and reduce S stock basis, the reattribution is given effect before the stock basis reduction. 2007–8 I.R.B.583February 20, 2007 (B)Insolvency limitation.IfS,orany higher-tier subsidiary, is insolvent within the meaning of section 108(d)(3) at the time of the transfer, S’s losses may be reattributed only to the extent they exceed the sum of the separate insolvencies of any subsidiaries (taking into account only S and its higher-tier subsidiaries) that are insolvent. For purposes of determining insolvency, liabilities owed to higher-tier members are not taken into account, and stock of a subsidiary that is limited and preferred as to dividends and that is not owned by higher-tier members is treated as a liability to the extent of the amount of preferred distributions to which the stock would be entitled if the subsidiary were liquidated on the date of the disposition. (C)Limitation on reattribution from lower-tier subsidiaries. P’s ability to reattribute attributes of lower-tier sub- sidiaries is limited under this paragraph (d)(6)(iii)(C) in order to prevent circu- lar computations of the attribute reduc- tion amount. Accordingly, attributes that would otherwise be reduced as a result of tier down attribute reduction under para- graph (d)(5)(ii)(D) of this section may only be reattributed to the extent that the reduction in the basis of any lower-tier subsidiary stock resulting from the non- capital, nondeductible expense (as allo- cated under §1.1502–32(c)(1)(ii)(B)) will not create an excess loss account in any such stock. (iv)Special rules for stock basis reduc- tion elections. Anelectiontoreduceba- sis in S stock is effective for all members’ bases in loss shares of S stock that are transferred in the transaction. The reduc- tion is allocated among all such shares in proportion to the amount of loss on each share. This reduction in S stock basis is a noncapital, nondeductible expense of the transferring member. The attribute reduc- tion amount (determined under paragraph (d)(3)(i) of this section) is treated as re- duced by the amount of any reduction in the basis of the S stock under this para- graph (d)(6). Accordingly, the election to reduce stock basis under this paragraph (d)(6) is treated as reducing or eliminat- ing the duplication even if the shares of S stock are loss shares after giving effect to the election. (v)Form and manner of election.An election under this paragraph (d)(6) is made in the form of a statement titled “Section 1.1502–36 Election to Reat- tribute Attributes,” “Section 1.1502–36 Election to Reduce Stock Basis,” or “Sec- tion 1.1502–36 Election to Reattribute Attributes and Reduce Stock Basis,” as ap- plicable. The statement must include the name and employer identification number of the subsidiary the stock of which is transferred, the name and employer iden- tification number of any lower-tier sub- sidiary whose attributes are reattributed, and the amount by which the group is electing to reattribute attributes and/or reduce stock basis. The statement must be included on or with the group’s timely filed original return for the taxable year of the transfer of the subsidiary stock to which the election relates. (7)Examples. The application of this paragraph (d) is illustrated by the follow- ing examples: Example 1.Computation of attribute reduction amount.(i)Transfer of all S shares.(A)Facts.P owns all 100 of the outstanding shares of S stock with a basis of $2 per share. S owns land with a basis of $100, has a $120 loss carryover, and has no liabilities. Each share has a value of $1. P sells 30 of the S shares to X for $30. As a result of the sale, P and S cease to be members of the same group. Accordingly, P trans- fers all 100 S shares. See paragraphs (f)(11)(i)(A) and (f)(11)(i)(B) of this section. P’s transfer of the S shares is a transfer of loss shares and therefore sub- ject to the provisions of this section. (B)Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) of this section because redetermination would not change any member’s basis in an S share (there is only one class of stock outstanding and there is no disparity in the bases of the shares). See paragraph (b)(1)(ii)(A) of this section. No adjustment is re- quired under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, P’s transfer of the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). Under this paragraph (d), S’s attributes are reduced by S’s attribute reduction amount. Paragraph (d)(3) of this section provides that S’s attribute reduction amount is the lesser of the net stock loss and S’s aggregate inside loss. The net stock loss is the ex- cess of the aggregate bases of the transferred shares ($200) over the aggregate value of the transferred shares ($100), or $100. S’s aggregate inside loss is the excess of its net inside attribute amount ($220, the sum of the $100 basis of the land and the $120 loss carryover) over the value of all outstanding S shares ($100), or $120. The attribute reduction amount is therefore the lesser of the net stock loss ($100) and the aggregate inside loss ($120), or $100. Under paragraph (d)(4) of this section, S’s $100 attribute reduction amount is allocated and applied to reduce S’s $120 loss carryover to $20. Under paragraph (d)(4)(ii)(C) of this section, the reduction of the loss carryover is not a noncapital, nondeductible expense and has no effect on P’s basis in the S stock. (ii)Transfer of less than all S shares.(A)Facts. Thefactsarethesameasinparagraph(i)(A)ofthis Example 1, except that P only sells 20 S shares to X. P’s sale of the 20 S shares is a transfer of loss shares and therefore subject to the provisions of this section. (B)Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of thisExample 1. Thus, after the application of paragraph (c) of this section, P’s transfer of the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). Under this paragraph (d),S’s attributes are reduced by S’s attribute reduction amount. Paragraph (d)(3) of this section provides that S’s attribute reduction amount is the lesser of the net stock loss and S’s aggregate inside loss. The net stock loss is the ex- cess of the aggregate bases of the transferred shares ($40) over the aggregate value of the transferred shares ($20), or $20. S’s aggregate inside loss is the excess of its net inside attribute amount ($220) over the value of all outstanding S shares ($100), or $120. The attribute reduction amount is therefore the lesser of the net stock loss ($20) and the aggregate inside loss ($120), or $20. Under paragraph (d)(4) of this section, S’s $20 attribute reduction amount is allocated and applied to reduce S’s $120 loss carry- over to $100. Under paragraph (d)(4)(ii)(C) of this section, the reduction of the loss carryover is not a noncapital, nondeductible expense and has no effect on P’s basis in the S stock. Example 2.Proportionate allocation of attribute reduction amount.(i)Facts. P owns the sole out- standing share of S stock with a basis of $150. S owns land with a basis of $100, a factory with a basis of $20, and rental property with a basis of $30. P sells its S share for $90. P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (ii)Application of paragraphs (b) and (c) of this section . No adjustment is required under paragraph (b) of this section, either because redetermination would not change any member’s basis in a share (members hold only one share of S stock) or be- cause P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, re- spectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. No adjustment is required under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, P’s sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (iii)Attribute reduction under this paragraph (d). Under paragraph (d)(3) of this section, S’s attribute reductionamountisdeterminedtobe$60,thelesser of the net stock loss ($60) and S’s aggregate inside loss ($60, the excess of S’s $150 net inside attribute amount (the $100 basis of the land plus the $20 basis of the factory plus the $30 basis of the rental prop- erty) over the $90 value of the S share). Under para- graph (d)(4) of this section, the $60 attribute reduc- tion amount is allocated and applied proportionately to reduce S’s attributes as follows: February 20, 20075842007–8 I.R.B. Available attributesAttribute amountAllocable portion of attribute reduction amount Adjusted attribute amount Category E Basis of land $100(100/150 x $60) $40$60 Basis of factory $20(20/150 x $60) $8$12 Basis of rental property $30(30/150 x $60) $12$18 Total attributes $150$60$90 Example 3.Publicly traded property.(i)Facts. The facts are the same as in paragraph (i) ofExam- ple 2, except that, instead of the factory and rental property, S holds two sharesof publicly traded stock, Share X (basis and value of $20) and Share Y (basis of $30 and value of $5). P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (ii)Application of paragraphs (b) and (c) of this section. No adjustment is made under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (ii) of Example 2. Thus, after the application of paragraph (c) of this section, P’s sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (iii)Attribute reduction under this paragraph (d). Under paragraph (d)(3) of this section, S’s attribute reductionamountisdeterminedtobe$60,thelesser of the net stock loss ($60) and S’s aggregate inside loss ($60, the excess of S’s $150 net inside attribute amount (the $20 basis of Share X plus the $30 basis of Share Y plus the $100 basis of the land) over the $90 value of the S share). Although S has $150 of at- tributes, S’s attributes available for reduction include the basis of publicly traded property only to the ex- tent it exceeds the value of the property. That loss on publicly traded property is a Category D attribute. S’s attribute reduction amount is allocated and applied to reduce S’s attributes as follows: Available attributesAttribute amountApplication of attribute reduction amountAdjusted attribute amount Category D Loss in Share Y $25$25$0 Category E Basis of land $100$35$65 Total attributes $125$60$65 Attributes after application of paragraph (d) AttributeAmount Basis of Share X $20 Basis of Share Y $5 Basis of land $65 Example 4.Attributes attributable to liability not taken into account.(i)S operates one business.(A) Facts. On January 1, year 1, P forms S by exchang- ing $100 and land with a basis of $50 for the sole outstanding share of S stock. In year 1, S earns $500, spends $100 to build a factory on its land, and pur- chases $450 of publicly traded property. S also earns a section 38 general business credit of $50. How- ever, pollution generated by S’s business gives rise to a substantial environmental remediation liability un- der Federal law. Before any amounts have been taken into account with respect to the environmental reme- diation liability, P sells its S share to X for $150. At the time of the sale, the value of the publicly traded property was $450. If X had purchased S’s assets and assumed S’s liabilities directly, X would have been required to capitalize any expenses related to environ- mental remediation. After giving effect to all other provisions of law, P’s basis in the S share is $650 (the original basis of $150 increased by the $500 of in- come earned). The sale is therefore a transfer of a loss share of subsidiary stock and subject to this sec- tion. (B)Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would not change any member’s basis in a share (P holds only one share of S stock) or because P trans- fers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, para- graphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. No adjustment to basis is made under paragraph (c) of this section because, although the net positive adjustment is $500, the disconformity amount is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, P’s sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of the net stock loss ($500) and the aggregate inside loss. The aggregate inside loss is $500, computed as the excess of S’s net inside attribute amount ($650, the sum of $100 (basis in factory), $50 (basis in land), $450 (basis in publicly traded property), and $50 (cash remaining after pur- chases)) over the value of the S share ($150). Thus, S’s attribute reduction amount is $500, the lesser of the net stock loss ($500) and the aggregate inside loss ($500). Under paragraph (d)(4) of this section, S’s $500 attribute reduction amount is allocated and ap- plied to reduce S’s attributes as follows: 2007–8 I.R.B.585February 20, 2007 Available attributesAttribute amountAllocable portion of attribute reduction amount Adjusted attribute amount Category D Loss on publicly traded property $0$0$0 Category E Basis of factory $100$100$0 Basis of land $50$50$0 Under the general rule of this paragraph (d), the re- maining $350 attribute reduction amount would have no further effect (and would not be applied to re- duce S’s general business tax credit). However, S has a liability that has not been taken into account, and, therefore, under paragraph (d)(4)(ii)(A)(1)of this section, the remaining $350 attribute reduction amount is suspended and allocated and applied to re- duce any amounts that would be deductible or capital- izable as a result of the liability later being taken into account. If the liability is satisfied for an amount that is less than $350, under paragraph (d)(4)(ii)(A)(2)the remaining portion of that $350 is disregarded and has no further effect. (ii)S operates more than one business.(A)Facts. The facts are the same as in paragraph (i)(A) ofEx- ample 4, except that S operates a business providing environmental remediation services. Prior to P’s sale of the S share, S transfers its environmental remedi- ationservicesbusinessandits$50ofcashtoS1in exchange for the sole outstanding share of S1 stock. (S’s basis in the assets transferred in connection with the environmental remediation business is $0.) (B)Application of paragraphs (b) and (c) of this section. No adjustment is made under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of thisExample 4.Thus, after the application of paragraph (c) of this section, P’s sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). (1)Computation of attribute reduction amount.Un- der paragraph (d)(3) of this section, S’s attribute re- duction amount is the lesser of the net stock loss ($500) and the aggregate inside loss. The aggregate inside loss is the excess of S’s net inside attribute amount over the value of the S share. Under para- graph (d)(5)(i)(B) of this section, S’s net inside at- tribute amount is determined by using S’s deemed ba- sis in the S1 share ($50, the greater of its basis ($50) and S1’s net inside attribute amount ($50)). Accord- ingly, S’s net inside attribute amount is $650 (the sum of $100 (basis in factory), $50 (basis in land), $450 (basis in publicly traded property), and $50 (deemed basis in S1 stock). The aggregate inside loss is $500, computed as the excess of S’s net inside attribute amount ($650) over the value of the S share ($150). Thus, S’s attribute reduction amount is $500, com- puted as the lesser of the net stock loss ($500) and the aggregate inside loss ($500). (2)Allocation, apportionment, and application of attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S’s $500 attribute reduc- tion amount is allocated proportionately (by basis) between its assets and the S1 share. Under paragraph (d)(5)(ii)(A) of this section, for this purpose, S’s ba- sis in its S1 share is its deemed basis ($50) reduced by S1’s cash ($50), or, $0. As a result, no portion of S’s attribute reduction amount is allocated to the S1 share and the entire attribute reduction amount is allo- cated as set forth in paragraph (i)(C) of thisExample 4. In addition, as in paragraph (i)(C) of thisExample 4, under paragraph (d)(4)(ii)(A)(1) of this section, the remaining $350 excess attribute reduction amount is suspended and applied to the extent of S’s environ- mental remediation liability to reduce any amounts that would be deductible or capitalizable as a result of such liability later being taken into account. Alter- natively, assume that S1 had liabilities for employee medical expenses that had not been taken into account for tax purposes, the $350excess attribute reduction amount would be suspended and then allocated and applied as S’s and S1’s liabilities are taken into ac- count. In either case, under paragraph (d)(4)(ii)(A)(2) of this section, to the extent the suspended amount ex- ceeds the liabilities taken into account, that excess is disregarded and has no further effect. Example 5.Wholly owned lower-tier subsidiary (no lower-tier transfer).(i)Application of conform- ing limitation.(A) Facts. P owns the sole outstand- ing share of S stock with a basis of $250. S owns Asset with a basis of $100 and the only two outstand- ing shares of S1 stock (Share A has a basis of $40 and Share B has a basis of $60). S1 owns Asset 1 with a basis of $50. P sells its S share to P1, the common parent of another consolidated group, for $50. The sale is a transfer of a loss share and therefore subject to this section. (B)Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would not change any member’s basis in a share (members hold only one share of S stock) or be- cause P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, re- spectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. No adjustment is required under paragraph (c) of this section because, although there is a $50 disconformity amount, the net positive ad- justment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, P’s sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). (1)Computation of attribute reduction amount.Un- der paragraph (d)(3) of this section, S’s attribute re- duction amount is the lesser of P’s net stock loss and S’s aggregate inside loss. P’s net stock loss is $200 ($250 basis minus $50 value). S’s aggregate inside loss is the excess of S’s net inside attribute amount over the value ofthe S share. Under para- graphs (d)(3)(iii)(B) and (d)(5)(i) of this section, S’s net inside attribute amount is $200, computed as the sum of S’s basis in Asset ($100) and its deemed basis in the S1 stock (treated as a single share) ($100, com- puted as the greater of S’s $100 total basis in the S1 shares and S1’s $50 basis in Asset 1). S’s aggregate inside loss is therefore $150 ($200 net inside attribute amount minus $50 value of the S share). Accordingly, S’s attribute reduction amount is $150, the lesser of the net stock loss ($200) and the aggregate inside loss ($150). (2)Allocation, apportionment, and application of S’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S’s $150 attribute reduction amount is allocated proportionately (by basis) between Asset (basis $100) and the S1 stock (treated as a single share) (deemed basis $100). Accordingly, $75 of the attribute reduction amount ($100/$200 x $150) is allocated to Asset and $75 of the attribute reduction amount ($100/$200 x $150) is allocated to the S1 stock. The $75 allocated to Asset is applied to reduce S’s basis in Asset to $25. The $75 allocated to the S1 stock is first apportioned between the shares in a manner that reduces disparity to the greatest extent possible. Thus, of the total $75 allocated to the S1 stock, $27.50 is apportioned to Share A and $47.50 is apportioned to Share B. The application of the apportioned amounts reduces the basis of each share to $12.50. As a result, im- mediately after the allocation, apportionment, and application of S’s attribute reduction amount, S’s basis in Asset is $25 and S’s basis in each of the S1 shares is $12.50. (3)Tier down of S’s attribute reduction amount, application of conforming limitation. Under para- graph (d)(5)(ii)(D) of this section, any portion of S’s attribute reduction amount allocated to S1 stock is an attribute reduction amount of S1 (regardless of the ex- tent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Under the general rules of this paragraph (d), the $75 allo- catedtotheS1stockwouldbeappliedtoreduceS1’s basis in Asset 1 to $0. However, under paragraph (d)(5)(ii)(D)(2) of this section, S1’s attributes can be reduced by only $25 as a result of tier down attribute reduction, the excess of the portion of S1’s net in- side attribute amount that is allocable to all S1 shares held by members immediately before the transaction ($50) over the sum of the aggregate value of S1 shares transferred by members in the transaction (none) and the aggregate amount of members’ bases in nontrans- ferred S1 shares, after reduction under this paragraph ($25). Thus, of S1’s $75 tier down attribute reduc- February 20, 20075862007–8 I.R.B. tion amount, only $25 is applied to reduce S1’s basis in Asset 1, from $50 to $25. The remaining $50 of allocated amount has no further effect. (4)Basis restoration. Under paragraph (d)(5)(iii) of this section, after this paragraph (d) has been ap- plied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of sub- sidiary stock under paragraph (d)(5)(ii)(B) of this sec- tion is reversed to the extent necessary to conform the basis of that share to the share’s allocable por- tion of the subsidiary’s net inside attribute amount. S1’s net inside attribute amount after the application of this paragraph (d) is $25 and thus each of the two S1 share’s allocable portion of S1’s net inside at- tribute amount is $12.50. Accordingly, the basis of each share (as reduced by this paragraph (d)) is al- ready conformed with its allocable portion of S1’s net inside attribute amount and no restoration will be re- quired or permitted under paragraph (d)(5)(iii) of this section. (ii)Application of basis restoration rule.(A) Facts. The facts are the same as in paragraph (i)(A) of thisExample 5, except that S’s basis in Share A is $15 and S’s basis in Share B is $35, and S1’s basis in Asset 1 is $100. (B)Basis redetermination and basis reduction un- der paragraphs (b) and (c) of this section.Noadjust- ment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of thisExample 5. Thus, after the application of paragraph (c) of this section, P’s transfer of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). (1)Computation of attribute reduction amount.Un- der paragraph (d)(3) of this section, S’s attribute re- duction amount is the lesser of P’s net stock loss and S’s aggregate inside loss. P’s net stock loss is $200 ($250 basis minus $50 value). S’s aggregate inside loss is the excess of S’s net inside attribute amount over the value of the S share. Under para- graphs (d)(3)(iii)(B) and (d)(5)(i) of this section, S’s net inside attribute amount is $200, computed as the sum of S’s basis in Asset ($100) and its deemed ba- sis in the S1 stock (treated as a single share) ($100, computed as the greater of S’s $50 total basis in the S1 shares and S1’s $100 basis in Asset 1). S’s ag- gregate inside loss is therefore $150 ($200 net inside attribute amount minus $50 value of the S share). Ac- cordingly, S’s attribute reduction amount is $150, the lesser of the net stock loss ($200) and the aggregate inside loss ($150). (2)Allocation, apportionment, and application of S’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S’s $150 attribute reduction amount is allocated proportionately (by basis) between Asset (basis $100) and the S1 stock (treated as a single share) (deemed basis $100). Accordingly, $75 of the attribute reduction amount ($100/$200 x $150) is allocated to Asset and $75 of the attribute reduction amount ($100/$200 x $150) is allocated to the S1 stock. The $75 allocated to AssetisappliedtoreduceS’sbasisinAssetto$25. The $75 allocated to the S1 stock is first apportioned between the shares in a manner that reduces disparity to the greatest extent possible. Thus, of the total $75 allocated to the S1 stock, $27.50 is apportioned to Share A and $47.50 is apportioned to Share B. The application of the apportioned amounts reduces the basis of each share to an excess loss account of $12.50. As a result, immediately after the alloca- tion, apportionment, and application of S’s attribute reduction amount, S’s basis in Asset is $25 and S’s basis in each of the S1 shares is an excess loss account of $12.50. (3)Tier down of S’s attribute reduction amount, application of limitation. Under para- graph (d)(5)(ii)(D) of this section, any portion of S’s attribute reduction amount allocated to S1 stock is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Ac- cordingly, under the general rules of this paragraph (d), the $75 allocated to the S1 stock is applied to reduce S1’s basis in Asset 1 from $100 to $25. (4)Basis restoration. Under paragraph (d)(5)(iii) of this section, after this paragraph (d) has been ap- plied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of sub- sidiary stock under paragraph (d)(5)(ii)(B) of this sec- tion is reversed to the extent necessary to conform the basis of that share to the share’s allocable por- tion of the subsidiary’s net inside attribute amount. S1’s net inside attribute amount after the application of this paragraph (d) is $25 and thus each of the two S1 share’s allocable portion of S1’s net inside at- tribute amount is $12.50. Accordingly, the reductions to Share A and to Share B under this paragraph (d) are reversed to restore the basis of each share to $12.50. Thus, $25 of the $27.50 attribute reduction applied to reduce the basis of Share A and $25 of the $47.50 at- tribute reduction applied to reduce the basis of Share B are reversed, restoring the basis of each share to $12.50. Example 6.Multiple blocks of lower-tier subsidiary stock outstanding.(i)Excess loss ac- count taken into account (transfer of upper-tier share causes disposition within the meaning of §1.1502–19(c)(1)(ii)(B)).(A)Facts. P owns the sole outstanding share of S stock with a basis of $200. S holds all five outstanding shares of S1 common stock (shares A, B, C, D, and E). S has an excess loss account of $20 in share A and a positive basis of $20 in each of the other shares. The only investment adjustment applied to any S1 share was a negative $20 investment adjustment applied to share A when it was the only outstanding share, and this amount tiered up and adjusted P’s basis in the S share. S1 owns one asset with a basis of $250. P sells its S share to P1, the common parent of a consolidated group, for $20. The sale of the S share is a disposition of share A under §1.1502–19(c)(1)(ii)(B) (after the transaction, S1 will no longer be a member of the P group). Under paragraph (a)(3)(i) of this section, before the application of this section, S’s excess loss account in share A is takeninto account, increasing S’s basis in share A to $0 and P’s basis in its S share to $220. After giving effect to the recognition of the excess loss account, P’s sale of the S share is a transfer of a loss share and therefore subject to the provisions of this section. (B)Basis redetermination and basis reduction un- der paragraphs (b) and (c) of this section. No adjust- ment is made under paragraph (b) of this section, ei- ther because redetermination would change no mem- ber’s basis in a share (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable trans- action. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. No adjustment is made under paragraph (c) of this section because, even though there is a disconformity amount of $120, the net positive adjustment is zero. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, P’s sale of the S share remains a transfer of a loss share and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). (1)Computation of attribute reduction amount.Un- der paragraph (d)(3) of this section, S’s attribute re- duction amount is the lesser of P’s net stock loss and S’s aggregate inside loss. P’s net stock loss is $200 (the S share’s $220 basis minus its $20 value). S’s aggregate inside loss is the excess of S’s net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this section, S’s net inside attribute amount is $250, S’s deemed basis in the S1 stock (treated as a single share) ($250, computed as the greater of S’s $80 total basis in the S1 shares ($0 basis of share A plus $20 of basis in each of the four other shares) and S1’s $250 basis in its as- set). S’s aggregate inside loss is therefore $230 ($250 net inside attribute amount minus $20 value of the S share). Accordingly, S’s attribute reduction amount is $200, the lesser of the net stock loss ($200) and the aggregate inside loss ($230). (2)Allocation, apportionment, and application of S’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S’s $200 attribute reduction amount is allocated entirely to the S1 stock (treated as a single share) and then apportioned among the shares in a manner that reduces disparity to the greatest extent possible. Thus, $24 is appor- tioned to share A and $44 is apportioned to each of the other shares. Because there is no transfer of the S1 shares, the apportioned amounts are applied fully to reduce the basis of each share to an excess loss account of $24. (3)Tier down of S’s attribute reduction amount. Under paragraph (d)(5)(ii)(D) of this section, the $200 of S’s attribute reduction amount allocated to the S1 shares is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is appor- tioned and applied to reduce the basis of any shares of S1 stock). Accordingly, under the general rules of this paragraph (d), S1’s $200 attribute reduction amount is allocated and applied to reduce S1’s basis in its asset from $250 to $50. (4 )Basis restoration. Under paragraph (d)(5)(iii) of this section, after this paragraph (d) has been ap- plied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of sub- sidiary stock under paragraph(d)(5)(ii)(B) of this sec- tion is reversed to the extent necessary to conform the basis of that share to the share’s allocable por- tion of the subsidiary’s net inside attribute amount. S1’s net inside attribute amount after the application of this paragraph (d) is $50 and thus each of the five S1 share’s allocable portion of S1’s net inside at- tribute amount is $10. Accordingly, the reductions to the bases of S1 stock under this paragraph (d) are reversed to restore (to the extent possible) the basis of each share to $10. Thus, $24 of the $24 attribute reduction applied to reduce the basis of share A is re- versed, restoring the basis of share A to $0, and $34 of the $44 attribute reduction applied to reduce the basis 2007–8 I.R.B.587February 20, 2007 of each other share is reversed, restoring the basis of each of those shares to $10. (ii)Sale of gain share to member.(A)Facts.The facts are the same as in paragraph (i)(A) of thisEx- ample 6, except that P owns shares A, B, C, and D, S owns share E, S has a liability of $20, and S1’s ba- sis in its asset is $500. Also, as part of the trans- action, S sells share E to P for $40. Unlike under the facts of paragraph (i)(A) of thisExample 6,there is no disposition of share A within the meaning of §1.1502–19(c)(1)(ii)(B) (because the share continues to be held by P, and S1 continues to be a member of the P group). As a result, the share A excess loss ac- count is not taken into account. Although S’s sale of share E is a transfer of that share, the share is not a loss share and thus the transfer is not subject to this section. P’s sale of the S share, however, is a transfer of a loss share and therefore subject to the provisions of this section. (B)Transfer in lowest tier (gain share).S’ssale of share E is the lowest tier transfer in the transac- tion. Under paragraph (a)(3)(ii)(A)(1) of this section, because there are no transfers of loss shares at that tier, no adjustments are required under paragraphs (b) and (c) of this section. However, S’s gain recognized on the transfer of share E is computed and immedi- ately adjusts members’ bases in subsidiary stock un- der the principles of §1.1502–32 (because P and S are not members of the same group immediately after the transaction, the sale is not subject to §1.1502–13). Accordingly, P’s basis in its S share is increased by $20, from $200 to $220. (C)Transfers in next higher (the highest) tier (ap- plication of paragraphs (b) and (c) of this section). The next higher tier transfer is P’s sale of the S stock. Because the sale is a transfer of a loss share, first paragraph (b) of this section and then paragraph (c) of this section apply to the transfer. No adjustments are required under paragraph (b), either because there is no potential for redetermination (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, para- graphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. Under paragraph (c) of this section, P’s basis in its S share is decreased by $20, the lesser of the disconfor- mity amount ($200, computed as the excess of stock basis ($220) over S’s net inside attribute amount ($20, the $40 value of the transferred share E minus the $20 liability)) and the net positive adjustment ($20). Thus, after the application of paragraph (c) of this sec- tion, P’s basis in the S share is $200, and the sale re- mains a transfer of a loss share. There are no higher tier transfers and, therefore, P’s transfer of the S share is then subject to this paragraph (d). (D)Attribute reduction under this paragraph (d). (1)Computation of attribute reduction amount.Un- der paragraph (d)(3) of this section, S’s attribute re- duction amount is the lesser of P’s net stock loss and S’s aggregate inside loss. After the application of paragraph (c) of this section, P’s net stock loss is $180 (the S share’s $200 basis minus its $20 value). S’s aggregate inside loss is the excess of S’s net inside attribute amount over the value of the S share. Un- der paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this sec- tion, S’s net inside attribute amount is $80, computed as $100 (S’s deemed basis in share E (the greater of S’s basis in share E, adjusted for the gain recognized, ($40) and share E’s allocable portion of S1’s net in- side attribute amount ($100, representing 1/5 of S1’s $500 basis in its asset))) minus S’s liability ($20). Ac- cordingly, S’s net aggregate inside loss is $60 ($80 net inside attribute amount minus $20 value of the S stock). S’s attribute reduction amount is therefore the lesser of $180 and $60, or $60. (2)Allocation, apportionment, and application of S’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S’s $60 attribute reduction amount is allocated entirely to its S1 stock, share E. However, under paragraph (d)(5)(ii)(B)(1) of this section, none of the allocated amount is ap- portioned to, or applied to reduce the basis of share E, because share E was transferred in a transfer in which gain or loss was recognized. Under paragraph (d)(5)(ii)(C) of this section, the $60 allocated amount not apportioned to share E has no effect on S or S’s attributes. (3)Tier down of S’s attribute reduction amount. Notwithstanding the fact that no portion of the allo- catedamountwasapportionedtoorappliedtoreduce the basis of share E, the entire $60 allocated amount tiers down and is an attribute reduction amount of S1. See paragraphs (d)(5)(ii)(C) and (d)(5)(ii)(D) of this section. Under the general rules of this paragraph (d), S1’s $60 attribute reduction amount is allocated and applied to reduce S1’s basis in its asset from $500 to $440. (4)Basis restoration. Under paragraph (d)(5)(iii) of this section, after this paragraph (d) has been ap- plied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of sub- sidiary stock under paragraph (d)(5)(ii)(B) of this sec- tion is reversed to the extent necessary to conform the basis of that share to the share’s allocable por- tion of the subsidiary’s net inside attribute amount. No reduction was made to the basis of any share of subsidiary stock under paragraph (d)(5)(ii)(B) of this section. Therefore, no stock basis is increased under the basis restoration rule in paragraph (d)(5)(iii) of this section. Example 7.Allocation of attribute reduction if lower-tier subsidiary has nonloss assets or liabilities. (i)S1 holds cash.(A)Facts. P owns the sole out- standing share of S stock with a basis of $800. S owns Asset 1 with a basis of $400 and the sole outstanding share of S1 stock with a basis of $300. S1 holds As- set 2 with a basis of $50, and $100 cash. P sells its S share to P1, the common parent of a consolidated group, for $100. (B)Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (mem- bers hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmem- ber in a fully taxable transaction. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this sec- tion. No adjustment is required under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, P’s sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). (1)Computation of attribute reduction amount.Un- der paragraph (d)(3) of this section, S’s attribute re- duction amount is the lesser of P’s net stock loss and S’s aggregate inside loss. P’s net stock loss is $700 (the S share’s $800 basis minus its $100 value). S’s aggregate inside loss is the excess of S’s net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i) of this section, S’s net inside attribute amount is the sum of its ba- sis in Asset 1 of $400 and its deemed basis in the S1 share. S’s deemed basis in the S1 share is $300, the greater of S’s basis in the S1 share ($300) and S1’s net inside attribute amount ($150, S1’s $50 basis in Asset 2 plus S1’s $100 cash). Therefore, S’s net inside at- tribute amount is $700 and S’s aggregate inside loss is $600 ($700 net inside attribute amount less $100 value). S’s attribute reduction amount is $600, the lesser of the net stock loss($700) and the aggregate inside loss ($600). (2)Allocation, apportionment, and application of S’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii)(A) of this section, S’s $600 at- tribute reduction amount is allocated proportionately (by basis) between S’s basis in Asset 1 ($400) and its deemed basis in the S1 share. For purposes of allocat- ing the attribute reduction amount, S’s deemed basis in the S1 share is reduced by S1’s $100 cash (from $300 to $200). Thus, the $600 is allocated $400 to Asset 1 ($400/$600 x $600) and $200 to the S1 share ($200/$600 x $600). The $400 allocated to Asset 1 is applied to reduce S’s basis in Asset 1 to $0. The $200 allocated to the S1 share is apportioned and applied to reduce S’s basis in the S1 share to $100. (3)Tier down of S’s attribute reduction amount. Under paragraph (d)(5)(ii)(D) of this section, any por- tion of S’s attribute reduction amount allocated to the S1 stock is an attribute reduction amount of S1 (re- gardless of the extent, if any, to which it is appor- tioned and applied to reduce the basis of any shares of S1 stock). Accordingly, underthe general rules of this paragraph (d), the $200 allocated to the S1 share is an attribute reduction amount of S1 that is allocated and applied entirely to reduce S1’s basis in Asset 2 from $50 to $0. The remaining $150 S1 attribute reduction amount is disregarded and has no further effect. (4 )Basis restoration. Under paragraph (d)(5)(iii) of this section, after this paragraph (d) has been ap- plied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of sub- sidiary stock under paragraph(d)(5)(ii)(B) of this sec- tion is reversed to the extent necessary to conform the basis of that share to the share’s allocable portion of the subsidiary’s net inside attribute amount. S1’s net inside attribute amount after the application of this paragraph (d) is $100 and thus the S1 share’s allo- cable portion of S1’s net inside attribute amount is $100. Accordingly, the basis of the share (as reduced by this paragraph (d)) is already conformed with its allocable portion of S1’s net inside attribute amount and no restoration will be required or permitted under paragraph (d)(5)(iii) of this section. (ii)S1 borrows cash. The facts are the same as in paragraph (i)(A) of thisExample 7except that S1 borrows $50 from X, an unrelated person, immedi- ately before P sells the S share. The computation of the attribute reduction amount is the same as in para- graph(i)(C)ofthisExample 7(because the $50 cash from the loan proceeds and the $50 liability offset in the computation of S’s net inside attribute amount). However, under paragraph (d)(5)(ii)(A) of this sec- tion, for purposes of allocating the attribute reduction amount, deemed basis is reduced by the amount of S1’s cash, but only to the extent it exceeds S1’s liabil- February 20, 20075882007–8 I.R.B. ities. S1’s cash ($150, the original $100 plus the $50 loan proceeds) exceeds itsliability ($50) by $100, so S’s deemed basis in the S1 share is reduced by $100 (from $300 to $200) for allocation purposes. The re- sults are the same as in paragraph (i) of thisExample 7. (iii)S1 borrows cash and invests in non-publicly traded property.(A)Facts. The facts are the same as in paragraph (ii) of thisExample 7except that S1 uses its $150 (the original $100 plus the $50 loan proceeds) to purchase Asset 3, an asset that is not publicly traded. (B)Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of thisExample 7.Thus, after the application of paragraph (c) of this section, P’s sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d). (1)Computation of attribute reduction amount.The attribute reduction amount is the same as computed in paragraph (i)(C)(1)ofthisExample 7(because $50 of the basis in S1’s assets and the $50 liability offset in the computation of S1’s net inside attribute amount of $150). (2)Allocation, apportionment, and application of S’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii)(A) of this section, S’s $600 at- tribute reduction amount is allocated proportionately (by basis) between S’s basis in Asset 1 ($400) and its deemed basis in the S1 share. For purposes of allo- cating the attribute reduction amount, deemed basis is only reduced for allocation purposes by cash, cash equivalents, and the value of publicly traded prop- erty (reduced by liabilities). Thus, there is no reduc- tion to the basis of the S1 share for purposes of allo- cating the attribute reduction amount. Accordingly, S’s $600 attribute reduction amount is allocated $343 ($400/$700 x $600) to Asset 1 and $257 ($300/$700 x $600) to the S1 share. (3)Tier down of S’s attribute reduction amount, application of conforming limitation. Under para- graph (d)(5)(ii)(D) of this section, any portion of S’s attribute reduction amount allocated to the S1 stock is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Thus, the entire $257 of S’s attribute reduction amount allo- cated to the S1 share is an attribute reduction amount of S1. Under the general rules of this paragraph (d), the entire amount is allocated to, and would be ap- pliedtoreduce,S1’sbasesinAsset2andAsset3,re- ducing the basis of each asset to $0. However, under paragraph (d)(5)(ii)(D)(2) of this section, the reduc- tion is limited to the excess of S1’s net inside attribute amount ($150) over S’s basis in the S1 share after re- duction under this paragraph (d) ($43). Thus, of the $257 attribute reduction amount allocated to the S1 share, only $107 is applied proportionately to reduce S1’s bases in Asset 2 by $26.75 ($50/$200 x $107), to $23.25, and Asset 3 by $80.25 ($150/$200 x $107), to $69.75. The remaining $150 S1 attribute reduction amount is disregarded and has no further effect. (4)Basis restoration. Under paragraph (d)(5)(iii) of this section, after this paragraph (d) has been ap- plied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of sub- sidiary stock under paragraph(d)(5)(ii)(B) of this sec- tion is reversed to the extent necessary to conform the basis of that share to the share’s allocable por- tion of the subsidiary’s net inside attribute amount. S1’s net inside attribute amount after the application of this paragraph (d) is $43 ($23.25 basis in Asset 2 plus $69.75 basis in Asset 3 minus $50 liability) and thus the S1 share’s allocable portion of S1’s net in- side attribute amount is $43. Accordingly, the basis of the share (as reduced by this paragraph (d)) is al- ready conformed with its allocable portion of S1’s net inside attribute amount and no restoration will be re- quired or permitted under paragraph (d)(5)(iii) of this section. Example 8.Election to reduce stock basis or reat- tribute attributes under paragraph (d)(6) of this sec- tion.(i)Deconsolidating sale.(A)Facts.Powns the sole outstanding share of M stock with a basis of $1,000. M owns all 100 outstanding shares of S stock with a basis of $2.10 per share ($210 total). M sells all its S shares to X for $1 per share (total $100) and makes no election under paragraph (d)(6) of this sec- tion. At the time of the sale, S has no liabilities and the following: CategoryAttributeAttribute amount Category ANOL $10 Category EBasis of Asset 1 $20 Basis of Asset 2 $180 Total Category E $200 (B)Application of paragraphs (b) and (c) of this section. No adjustment is made under paragraph (b) of this section, either because redetermination would change no member’s basis in a share (S has only one class of stock outstanding and there is no dispar- ity in the basis of the shares) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, para- graphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. No adjustment is required under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the appli- cationofparagraph(c)ofthissection,M’stransferof the S shares is still a transfer of loss shares and, ac- cordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d).(1)Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of the net stock loss ($110, P’s aggregate basis in the transferred S shares ($210) less the aggregate value of the transferred shares ($100)) and S’s aggregate inside loss. S’s aggregate inside loss is $110 (S’s $210 net inside attribute amount (the $10 NOL plus the $20 basis of Asset 1 plus the $180 basis of Asset 2) less the $100 value of all outstanding S shares). Thus, the attribute reduction amount is $110. (2)Application of attribute reduction amount.S’s $110 attribute reduction amount is applied as follows: CategoryAttributeAttribute amountAllocation of attribute reduction amountAdjusted attribute amount Category ANOL $10$10$0 Category EBasis of Asset 1 $20(20/200 x $100) $10$10 Basis of Asset 2 $180(180/200 x $100) $90$90 Total Category E $200$100$100 (D)Results. The P group realizes a $110 loss on M’s sale of the S shares, which reduces P’s basis in the M share from $1,000 to $890. The reduction of S’s attributes is not a noncapital, nondeductible expense of S and does not tier up to reduce the basis of the S shares or M share. Immediately after the transaction, the entities own the following: 2007–8 I.R.B.589February 20, 2007 EntityAssetBasis PMshare $890 X100 S shares $100 Asset 1 $10 S Asset 2 $90 (E)Election to reduce stock basis. The facts are thesameasinparagraph(i)(A)ofthisExample 8ex- cept that P elects under paragraph (d)(6) of this sec- tion to reduce M’s bases in the S shares by the full attribute reduction amount of $110, in lieu of S re- ducing its attributes. The election is effective for all transferred loss shares and is allocated to such shares in proportion to the loss in each share. Accord- ingly, the basis of each of the 100 transferred shares is reduced from $2.10 to $1.00. After giving effect to the election, the S shares are not loss shares and this section has no further application to the trans- fer. The reduction of M’s bases in the S shares pur- suant to the election underparagraph (d)(6) of this section is a noncapital, nondeductible expense of M that will reduce P’s basis in the M share. See para- graph (d)(6)(iv) of this section. Immediately after the transaction, the entities own the following: EntityBasis/Attribute PMshare $890 X100 S shares $100 NOL $10 Asset 1 $20 S Asset 2 $180 (F)Election to reattribute losses. The facts are thesameasinparagraph(i)(A)ofthisExample 8ex- cept that P elects under paragraph (d)(6) of this sec- tion to reattribute S’s attributes. Although S’s at- tribute reduction amount is $110, P can only reat- tributeattributesinCategoryA,CategoryB,andCat- egory C. P can therefore electto reattribute $10 of at- tributes (the NOL), and, as a result, will reduce S’s NOL to $0. The reattribution of the $10 NOL is a noncapital, nondeductibleexpense of S, and under §1.1502–32(c)(1)(ii)(B) this expense is allocated to thelosssharesofSstocksoldinproportiontothe loss in the shares, or $.10 per share. Further, this ex- pense tiers up under the general rules of §1.1502–32 and reduces P’s basis in the M stock by $10. After giving effect to the election, the P group would real- ize a $100 loss on M’s sale of the S shares. M could recognize the $100 stock loss (in which case S’s basis in Asset 1 and Asset 2 would be reduced to $10 and $90, respectively, asin paragraph (i)(C)(2)ofthisEx- ample 8) or P could elect to reduce M’s basis in the S shares by all or any portion of the $100 stock loss (in which case S’s attribute reduction amount would be reduced by the amount of the reduction in the basis of the S stock, and S’s basis in Asset 1 and Asset 2 would be reduced proportionately). (ii)Nondeconsolidating sale.(A)Facts.The facts are the same as in paragraph (i)(A) of thisEx- ample 8, except that M only sells 20 S shares (for a total of $20). (B)Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of thisExample 8. Thus, after the application of paragraph (c) of this section, M’s sale of the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d). (C)Attribute reduction under this paragraph (d).(1)Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of the net stock loss ($22, P’s aggregate basis in the transferred S shares ($42) less the aggregate value of the transferred shares ($20)) and S’s $110 aggregate inside loss (as calculated in paragraph (i)(C)(1)ofthisExample 8). Thus, the attribute reduction amount is $22. (2)Application of attribute reduction amount.S’s $22 attribute reduction amount is applied as follows: CategoryAttributeAttribute amountAllocation of attribute reduction amountAdjusted attribute amount Category ANOL $10$10$0 Category EBasis of Asset 1 $20(20/200 x $12) $1.20$18.80 Basis of Asset 2 $180(180/200 x $12) $10.80$169.20 Total Category E $200$12$188 (D)Results. The P group realizes a $22 loss on M’s sale of the S shares, which reduces P’s basis in the M share from $1,000 to $978. The reduction of S’s attributes is not a noncapital, nondeductible ex- pense of S and does not tier up to reduce the bases of the S shares or M share. Immediately after the trans- action, the entities have the following: February 20, 20075902007–8 I.R.B. EntityAssetBasis PMshare $978 X20 S shares $20 Asset 1 $18.80 S Asset 2 $169.20 (E)Election to reduce stock basis. The facts are the same as in paragraph (ii)(A) of thisExample 8, except that P elects under paragraph (d)(6) of this sec- tion to reduce M’s bases in the S shares by the full at- tribute reduction amount of $22, in lieu of S reducing its attributes. The election is effective for all trans- ferred loss shares and is allocated to such shares in proportion to the loss in eachshare. Accordingly, the basis of each of the 20 transferred shares is reduced from $2.10 to $1.00. The P group realizes no loss on M’s sale of the S shares. The reduction of M’s basis in the S shares pursuant to the election under paragraph (d)(6) of this section is a noncapital, non- deductible expense of M that will reduce P’s basis in the M share. Immediately after the transaction, the entities have the following: EntityBasis/Attribute PMshare $978 X20 S shares $20 NOL $10 Asset 1 $20 S Asset 2 $180 (F)E lection to reattribute attributes. The facts are the same as in paragraph (ii)(A) of thisExample 8. Because S remains a member of the P group fol- low ing M’s sale of S stock, P cannot elect under para- graph (d)(6) of this section to reattribute any portion of S’s attributes in lieu of attribute reduction. Exa mple 9.Transfers at multiple tiers, gain and loss shares.(i)Facts. P owns the sole outstanding share of S stock with a basis of $700. S owns Asset 1(b asis of $170) and all ten outstanding shares of S1 common stock ($170 basis in share 1, $10 basis in share 2, and $15 basis in each of share 3 through share 10 ). S1 owns the sole outstanding share of S2 ($0 basis), the sole outstanding share of S3 ($60 basis), and the sole outstanding share of S4 ($100 basis). S2 ’s sole asset is Asset 2 ($75basis). S3’s sole asset is Asset 3 ($75 basis). S4’s sole asset is Asset 4 ($80 basis). In one transaction, P sells its S share to P1 (the c ommon parent of a different consolidated group) for $240, S sells S1 share 1 to X for $20, S transfers S1 share 2 to a partnership in a section 721 transaction, a nd S1 sells its S2 share to Y for $50. No election is made under paragraph (d)(6) to reduce stock basis or reattribute attributes. ( ii)Transfer in lowest tier (only gain share).S1’s saleoftheS2shareisatransferoftheS2shareand that is the lowest tier in which there is a transfer. There is no transfer of a loss share at that tier, and thus this section does not apply to that transfer. The gain recognized on the transfer of the S2 share is computed and is applied to adjust the bases of mem- bers’ shares of subsidiary stock under the principles of §1.1502–32. Accordingly, $5 is allocated to each of S1 shares, increasing the basis of share 1 to $175, the basis of share 2 to $15, and the basis of each other share to $20. The $50 applied to S’s bases in S1 shares then tiers up to increase P’s basis in the S share from $700 to $750. (iii)Transfers in next higher tier (loss share).S’s sale of the S1 share 1 and S’s transfer of the S1 share 2 to a partnership are both transfers of stock in the next high er tier. However, only the S1 share 1 is a loss share and so this section only applies with respect to the transfer of that share. (A)B asis redetermination under paragraph (b) of this section. Under paragraph (b)(2)(i)(A) of this sec- tion, members’ bases in S1 shares are redetermined by f irst removing the positive investment adjustments applied to the bases of transferred loss shares. Ac- cordingly, the $5 positive investment adjustment ap- pli ed to the basis of S1 share 1 is removed, reduc- ing the basis of S1 share 1 from $175 to $170. Be- cause there were no negative adjustments made to the ba ses of S1 shares, there are no negative adjustments that can be reallocated to further reduce the basis of S1 share 1. Finally, under paragraph (b)(2)(ii)(B), th e positive investment adjustment removed from S1 share 1 is reallocated and applied to increase the bases of other S1 shares in a manner that reduces disparity t o the greatest extent possible. Accordingly, the en- tire $5 is reallocated and applied to increase the basis of S1 share 2, from $15 to $20. After basis is redeter- m ined under paragraph (b) of this section, S1 share 1 is still a loss share and therefore subject to basis re- duction under paragraph (c) of this section. ( B)Basis reduction under paragraph (c) of this section.NoadjustmentisrequiredtothebasisofS1 share 1 under paragraph (c) of this section because, al- though the disconformity amount is $149 (the excess of the $170 stock basis over the share’s $21 alloca- ble portion of S1’s net inside attribute amount ($210, determined under paragraph (c)(5) of this section as S1’s basis in the stock of S2 (adjusted for the gain rec- ognized) ($50), S3 ($60), and S4 ($100))), the share’s net positive adjustment is $0 (because the $5 posi- tive investment adjustment originally allocated to S1 share 1 was reallocated to S1 share 2 under paragraph (b)ofthissection).Seeparagraph (c)(3) of this sec- tion. (C)Computation of loss, adjustments to stock ba- sis. S recognizes a loss of $150 on the sale of the S1 share 1 ($170 adjusted basis minus $20 amount real- ized ). P’s basis in its S share is therefore decreased by the $150 loss recognized by S (on the sale of the S1 share) and increased by the $50 gain that tiered up fro m S1 (as a result of S1’s sale of the S2 share). Fol- lowing these adjustments, P’s basis in the S share is $600 and the sale of the S share is still a transfer of a los sshare. (iv)Transfer in highest tier (loss share).Thesale of the S share is a transfer in the next higher tier, whi ch is the highest tier in this transaction. Because the sale is a transfer of a loss share, it is subject to this section. (A )Basis redetermination and basis reduction under paragraphs (b) and (c) of this section.No adjustment is required under paragraph (b) of this se ction, either because there is no potential for redetermination (members hold only one share of S stock) or because P transfers the group’s entire in terest in S to a nonmember in a fully taxable trans- action. See, respectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. In addition, no a djustment is required under paragraph (c) of this section because, although the disconformity amount is $230 (the excess of the $600 stock basis over the $ 370 allocable portion of S’s net inside attribute amount ($370, determined under paragraph (c)(5) of this section as S’s basis in the stock of S1 (adjusted for the loss recognized) ($200) and Asset 1 ($170))), the share’s net positive adjustment is $0. See para- graph (c)(3) of this section.Accordingly, the sale of the S share is still a transfer of a loss share. Because there are no higher-tier loss shares transferred in the transaction, this paragraph (d) then applies with respect to the transfer of the S share. (B)Attribute reduction under this paragraph (d). (1)Computation of S’s attribute reduction amount. Under paragraph (d)(3) of this section, S’s attribute reduction amount is the lesser of P’s net stock loss and S’s aggregate inside loss. P’s net stock loss is $360 (the S share’s $600 adjusted basis minus $240 amount realized). S’s aggregate inside loss is the ex- 2007–8 I.R.B.591February 20, 2007 cess of S’s net inside attribute amount over the value of the S share. S’s net inside attribute amount is the sum of its bases in its assets, treating its S1 shares as a single share (the S1 stock) and treating S’s deemed basis in the S1 stock as its basis in that stock. Un- der paragraph (d)(5)(i)(C) of this section, when sub- sidiaries are owned in multiple tiers, deemed basis is first determined for shares at the lowest tier, and then for stock in each next higher tier. S1’s deemed basis in the S2 stock is $75 (the greater of $50 (S1’s basis in the S2 share ($0) increased by the $50 gain recog- nized) and $75 (S2’s basis in Asset 2)). S1’s deemed basis in the S3 stock is $75 (computed as the greater of $60 (S1’s basis in the S3 share) and $75 (S3’s ba- sis in Asset 3)). S1’s deemed basis in the S4 stock is $100 (computed as the greater of $100 (S1’s ba- sis in the S4 share) and $80 (S4’s basis in Asset 4)). Accordingly, S1’s net inside attribute amount is $250 ($75 deemed basis in the S2 stock plus $75 deemed basis in the S3 stock plus $100 deemed basis in the S4 stock). S’s deemed basis in the S1 stock is the greater of the sum of S’s actual basis in each share of S1 stock (adjusted for any gain or loss recognized) and S1’s net inside attribute amount. S’s actual basis in the S1 stock, adjusted for the loss recognized, is $200 (the sum of S’s $170 basis in the S1 share 1 and S’s $20 basis in each other S1 share, reduced by the $150 loss recognized). Thus, S’s deemed basis in the S1 stock is $250, the greater of $200 (aggregate basis in S1 shares, adjusted for loss recognized) and $250 (S1’s net inside attribute amount). As a result, S’s net inside attribute amount is $420, the sum of $250 (S’s deemedbasisinS1stock)and$170(S’sbasisinAs- set 1). Accordingly, the aggregate inside loss is $180, the excess of S’s net inside attribute amount ($420) over the value of all of the S stock ($240). S’s at- tribute reduction amount is therefore $180, the lesser of the net stock loss ($360) and the aggregate inside loss ($180). (2)Allocation, apportionment, and application of S’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S’s $180 attribute reduction amount is allocated proportionately (by ba- sis) between Asset 1 and its S1 stock. Under para- graph (d)(5)(ii)(A) of this section, for purposes of allocating S’s $180 attribute reduction amount, S’s deemed basis in the S1 stock is reduced by the value of any transferred S1 shares (and other items that are not relevant here). Additionally, for this purpose, S’s deemed basis in S1 stock is reduced by S’s nontrans- ferred S1 shares’ allocable portion of the value of S1’s transferred shares of each lower-tier subsidiary’s stock (and other items that are not relevant here). Ac- cordingly, for purposes of allocating S’s attribute re- duction amount, S’s deemed basis in the S1 stock must be reduced by $80 (the $40 value of the two transferred S1 shares, and S’s eight nontransferred S1 shares’ $40 allocable portion of the $50 value of the transferred S2 share), to $170. Thus, $90 of the at- tribute reduction amount ($170/$340 x $180) is al- located to Asset 1 and $90 of the attribute reduction amount ($170/$340 x $180) is allocated to the S1 stock. Under paragraph (d)(5)(ii)(B)(1) of this sec- tion, none of the $90 allocated to the S1 stock is ap- portioned to share 1 because loss is recognized on the transfer of share 1. Under paragraph (d)(5)(ii)(B)(2) of this section, the $90 allocated amount is appor- tioned among the other nine shares of S1 stock in a manner that reduces disparity to the greatest ex- tent possible. Accordingly, of the total $90 allocated amount, $10 is apportioned to each of the remaining shares of S1 stock. Under paragraph (d)(5)(ii)(B)(3) of this section, however, an apportioned amount can- not be applied to reduce the basis of a transferred share below its value. Because the basis of share 2 is already equal to its value, none of the $10 apportioned to share 2 is applied to reduce its basis. The amounts apportioned to the remaining S1 shares, however, are applied to reduce the bases of those shares without limitation, reducing the basis of each from $20 to $10. As a result, immediately after the allocation and ap- plication of S’s attribute reduction amount, S’s basis in Asset 1 is $80 ($170 minus $90), its basis in share 1 is $170, its basis in share 2 is $20, and its basis in each other share of S1 stock is $10. Under paragraph (d)(5)(ii)(D) of this section, the entire $90 of S’s at- tribute reduction amount that was allocated to the S1 stock is an attribute reduction amount of S1, regard- less of the fact that none of the allocated amount was apportioned to share 1 and none of the amount appor- tioned to share 2 was applied to reduce the basis of share 2. (v)Attribute reduction under this paragraph (d) in next lower tier.(A)Computation of S1’s attribute reduction amount. S’s sale of share 1 is a transfer of a loss share and is in the next lower tier. Thus, this para- graph (d) next applies with respect to S’s transfer of share 1. S1’s attribute reduction amount will include both the $90 attribute reduction amount that tiered down from S and any attribute reduction amount re- sulting from the application of this paragraph (d) with respect to S’s transfer of the S1 share 1 (S1’s direct at- tribute reduction amount). Under paragraph (d)(3) of this section, S1’s direct attribute reduction amount is the lesser of the net stock loss on transferred S1 shares and S1’s aggregate inside loss. The net stock loss on transferred S1 shares is $150, computed as the ex- cess of S’s $190 adjusted bases in transferred shares of S1 stock ($170 in share 1 plus $20 in share 2) over the value of those shares ($40). S1’s aggregate inside loss is $50, the excess of S1’s $250 net inside attribute amount (as calculated in paragraph (iv)(B)(1) of this Example 10) over the $200 value of all outstanding S1 shares (extrapolated from the amount realized on the sale of share 1). Therefore, S1’s direct attribute reduction amount is $50, the lesser of the $150 net stock loss and S1’s $50 aggregate inside loss. S1’s total attribute reduction amount is thus $140, the sum of the $90 attribute reduction amount that tiered down from S and the $50 direct attribute reduction amount computed with respect to the transfer of share 1. (B)Allocation, apportionment, and application of S1’s attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S1’s $140 at- tribute reduction amount is allocated proportionately (by basis) among the S2 stock, the S3 stock, and the S4 stock. As described in paragraph (iv)(B)(2) of thisExample 10, under paragraph (d)(5)(ii)(A) of this section, for purposes of allocating S1’s $140 at- tribute reduction amount, S1’s deemed basis in the S2 stock is reduced by the value of the transferred S2 share. Accordingly, for purposes of allocating S1’s attribute reduction amount, S1’s deemed basis in the S2 stock must be reduced by $50 (the value of the transferred S2 share), to $25. Thus, $17.50 of S1’s attribute reduction amount ($25/$200 x $140) is al- located to the S2 stock, $52.50 of S1’s attribute re- duction amount ($75/$200 x $140) is allocated to the S3 stock, and $70 of S1’s attribute reduction amount ($100/$200 x $140) is allocated to the S4 stock. Un- der paragraph (d)(5)(ii)(B)(1) of this section, none of the amount allocated to S2 stock is apportioned to the S2 share because gain was recognized on the trans- fer of the S2 share. However, the $52.50 allocated to the S3 stock is apportioned and applied to reduce the basis in the S3 share, from $60 to $7.50, and the $70 allocated to the S4 stock is apportioned and ap- plied to reduce the basis of the S4 share, from $100 to $30. (Note: Although the conforming limitation in paragraph (d)(5)(ii)(D)(2) of this section limits the application of tier down attribute reduction such that the total amount of attribute reduction applied to re- duce S1’s attributes does not exceed $130 (the excess of S1’s $250 net inside attribute amount over $120, the value of the transferred S1 shares ($40) plus the basis of the nontransferred S1 shares after reduction ($80)), this limitation does not apply because only $122.50 ($52.50 plus $70) of attribute reduction is applied to reduce S1’s attributes.) Under paragraph (d)(5)(ii)(D) of this section, the attribute reduction amount allocated to the S2 stock, the S3 stock, and the S4 stock becomes an attribute reduction amount of S2, S3, and S4, respectively (even though the amount allocated to S2 stock was not apportioned or applied to reduce the basis of the S2 share). (vi)Attribute reduction under this paragraph (d) in lowest tier. Although the sale of the S2 share is a transfer of subsidiary stock at the next lower tier, the S2 share is not a loss share. Thus, this paragraph (d) does not apply with respect to that transfer. However, S2, S3, and S4 have attribute reduction amounts that tiered down from S1 and that are applied to reduce attributes under the provisions of this paragraph (d). (A)Tier down of S1’s attribute reduction amount to S2. Under the general rules of this paragraph (d), S2’s $17.50 attribute reduction amount is allocated and applied to reduce S2’s basis in Asset 2 from $75 to $57.50. (B)Tier down of S1’s attribute reduction amount to S3. Under the general rules of this paragraph (d), S3’s $52.50 of attribute reduction amount is allocated and applied to reduce S3’s basis in Asset 3 from $75 to $22.50. (C)Tier down of S1’s attribute reduction amount to S4, application of conforming limitation.Under the general rules of this paragraph (d), S4’s $70 at- tribute reduction amount is allocated to, and would beappliedtoreduce,S4’sbasisinAsset4. How- ever, under paragraph (d)(5)(ii)(D)(2)ofthissection, the reduction is limited to the excess of S4’s net in- side attribute amount ($80) over the basis of the S4 share ($30, after reduction under this paragraph (d)). As a result, only $50 (the excess of $80 over $30) of S4’s $70 attribute reduction amount is applied to S4’s basis in Asset 4, reducing it from $80 to $30. The remaining $20 of S4’s attribute reduction amount is disregarded and has no further effect. (vii)Application of basis restoration rule.Af- ter all adjustments required under this paragraph (d) have been given effect, reductions made to the ba- sis of subsidiary stock under this paragraph (d) are subject to reversal under the basis restoration rule in paragraph (d)(5)(iii) of this section. Under this rule, adjustments are reversed (and basis is restored) only to the extent necessary to conform the basis of each share with its allocable portion of the subsidiary’s net inside attribute amount. The restoration adjustments February 20, 20075922007–8 I.R.B. are first made at the lowest tier and then at each next higher tier successively. (A)Basis restoration at lowest tier.Norestora- tion is permitted with respect to the S2 share because the basis of the S2 share was not reduced under para- graph (d)(5)(ii)(B) of this section. S3’s net inside attribute amount ($22.50, after reduction under this paragraph (d)) exceeds S1’s basis in the S3 share ($7.50, after reduction under this paragraph (d)) by $15. To conform S1’s basis in the S3 share to S3’s net inside attribute amount, the $52.50 reduction to the basis of the S3 share under paragraph (d)(5)(ii)(B) of this section is reversed by $15 (restoring basis to $22.50). The restoration of S1’s basis in the S3 share does not tier up to affect the basis in stock of any other subsidiary. S1’s basis in the S4 share ($30, af- ter reduction under this paragraph (d)) is already con- formed with S4’s net inside attribute amount ($30, af- ter reduction under this paragraph (d)) and no restora- tion will be required or permitted under paragraph (d)(5)(iii) of this section. (B)Basis restoration at next higher tier. Each share of S1 stock has an allocable portion of S1’s net inside attribute amount equal to $10.25 (1/10 x $102.50, the sum of S1’s adjusted bases in its S2 stock ($50, $0 plus $50 gain recognized), S3 stock ($22.50 after restoration), and S4 stock ($30)). Neither S’s basis in S1 share 1 nor S’s basis in S1 share 2 was reduced under this paragraph (d). Accordingly, the basis of neither share is subject to restoration under paragraph (d)(5)(iii) of this section. However, S’s ba- sis in each of its other shares of S1 stock was reduced by $10, from $20 to $10. Accordingly, the reduction to the basis of each of those shares is reversed to the extent of $.25, to restore the basis of each such share to $10.25 (its allocable portion of S1’s net inside at- tribute amount). (vii)Results. After the application of this section, P recognizes a loss of $360 on the sale of the S share, S recognizes a loss of $150 on the sale of S1 share 1, and S1 recognizes a $50 gain on the sale of the S2 share. Immediately after the transaction, the entities each directly own the following: EntityAssetBasisValue P1S share $240$240 PProceeds of the sale of S share $240$240 Proceeds of sale of Share 1 of S1 stock $20$20 Partnership interest received for Share 2 $20$20 S Shares 3 through 10 of S1 stock $82 ($10.25 per share) Proceeds of sale of S2 share $50$50 The S3 share $22.50 S1 The S4 share $30 S2Asset 2 $57.50 S3Asset 3 $22.50 S4Asset 4 $30 XShare1ofS1stock $20$20 YTheS2share $50$50 PartnershipShare 2 of S1 stock $20$20 (e)Operating rules—(1)Predecessors, successors. This section applies to prede- cessor or successor persons, groups, and assets to the extent necessary to effectuate the purposes of this section. (2)Adjustments for prior transactions that altered stock basis or other attributes. In certain situations, M’s basis in S stock or S’s attributes are adjusted in a manner that alters the relationship between stock basis and inside attributes. Such adjust- ments affect the extent to which this rela- tionship identifies unrecognized asset gain reflected in stock basis and the extent to which loss is duplicated. The provisions of this paragraph (e)(2) modify the com- putations in paragraphs (c) and (d) of this section to adjust for the effects of such ad- justments. (i)Reductions to S’s basis in assets or other attributes pursuant to sec- tion 362(e)(2)(A). If S’s attributes have been reduced under section 362(e)(2) (taking into account the provisions of §1.1502–13(e)(4)), then the disconfor- mity amount of the S shares received (or deemed received) in the transaction to which section 362(e)(2) applied is re- duced by the amount that the basis in such shares would have been reduced under section 362(e)(2)(C) (taking into account the provisions of §1.1502–13(e)(4)) had such an election been made. In addition, for purposes of determining the attribute reduction amount under paragraph (d) of this section resulting from the transfer of any S shares received (or deemed re- ceived) in a transaction to which section 362(e)(2) applied, and for purposes of applying paragraph (d)(5)(ii)(D)(2)ofthis section (conforming limitation) to S, the basis in such shares is treated as reduced by the amount the basis in such shares would have been reduced under section 362(e)(2)(C) (taking into account the pro- visions of §1.1502–13(e)(4)) had such an election been made. (ii)Reductions to the basis of any share of S stock pursuant to an election un- der section 362(e)(2)(C).Ifthebasisof any share of S stock has been reduced as the result of an election under sec- tion 362(e)(2)(C) (taking into account the provisions of §1.1502–13(e)(4)), then, for purposes of computing either any S share’s disconformity amount or S’s ag- gregate inside loss, and for purposes of applying paragraph (d)(5)(iii) of this sec- tion (stock basis restoration) to S, S’s net inside attribute amount is reduced by the amount that S’s attributes would have been reduced under section 362(e)(2)(A) (taking into account the provisions of §1.1502–13(e)(4)) in the absence of an election under section 362(e)(2)(C) 2007–8 I.R.B.593February 20, 2007 (taking into account the provisions of §1.1502–13(e)(4)). (iii)Other adjustments. The Commis- sioner shall make such adjustments as appropriate if the relationship between a member’s basis in a share of S stock and the share’s allocable portion of S’s net inside attributes has been altered, other than by the operation of §1.1502–32 or this section, provided that such change is not otherwise addressed in this sec- tion. Taxpayers may request a written determination from the Commissioner de- termining that other adjustments to M’s basis in S stock or S’s attributes are to be adjusted in a manner consistent with the principles of this paragraph (e)(2) for pur- poses of making the computations under paragraphs (c) and (d) of this section. (iv)Example. The application of this paragraph (e)(2) is illustrated by the fol- lowing example: Example.Adjustments for intercompany section 362(e)(2) transaction.(i)Adjustments for reduction of S’s basis in assets.(A)Facts. In an intercompany section 362(e)(2) transaction (within the meaning of §1.1502–13(e)(4)(i)), P contributes Asset 1 to newly formed S in exchange for the sole outstanding share of S stock. At the time of the contribution, P’s basis in Asset 1 was $100 and its value was $20. Accordingly, S’s basis in Asset 1 would have been reduced by $80 under section 362(e)(2) and that $80 is a section 362(e)(2) amount within the meaning of §1.1502–13(e)(4)(ii)(A). P sells the S share for $20 in year 3. As of the time of the sale, no por- tion of the section 362(e)(2) amount has been taken into account and thus the entire $80 is a remaining section 362(e)(2) amount reflected in S’s basis in Asset 1 and P’s basis in the share of S stock. P’s sale of the S share is a section 362(e)(2) application event within the meaning of §1.1502–13(e)(4)(iii) and therefore, immediately before the sale, S’s basis in Asset 1 is reduced by $80 pursuant to section 362(e)(2) and §1.1502–13(e)(4)(iv). Un- der §1.1502–13(e)(4)(iv)(C), this reduction is not a noncapital, nondeductible expense described in §1.1502–32(b)(2)(iii), and does not affect P’s basis in the S share. The sale is also a transfer of a loss share and therefore subjectto the provisions of this section. (B)Application of paragraph (b) of this section. No adjustment is required under paragraph (b) of this section, either because there is no potential for rede- termination (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, re- spectively, paragraphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. After the application of paragraph (b) of this section, P’s sale of the S share is still a transfer of a loss share and therefore subject to paragraph (c) of this section. (C)Basis reduction under paragraph (c) of this section. In determining the reduction of basis under paragraph (c) of this section, the share’s disconfor- mity amount is reduced by $80, the amount that the basis in the S share would have been reduced under §1.1502–13(e)(4)(v) had such an election been made. The disconformity amount (and the net positive ad- justment) are $0 and so no basis adjustment will be made under paragraph (c) of this section. The trans- ferred share is still a loss share and so is therefore subject to paragraph (d) of this section. (D)Attribute reduction under paragraph (d) of this section. In determining the attribute reduction amount under paragraph (d)(3) of this section, P’s basis in the transferred share is treated as reduced by $80, the amount that the basis in the S share would have been reduced under §1.1502–13(e)(4)(v) had such an election been made. As a result, P recognizes an $80 loss on the sale of the S stock, but, for pur- poses of applying paragraph (d) of this section, the net stock loss and, therefore, the attribute reduction amount are $0. (ii)Adjustments for election to reduce stock basis under section 362(e)(2)(C). The facts are the same as in paragraph (i) of thisExample,exceptthatPandS elect to reduce P’s basis in the S share by $80 under §1.1502–13(e)(4)(v). As a result, the basis of Asset 1 remains $100 and, immediately before the sale of the S stock, P’s basis in the S share is reduced to $20. Because the share is then not a loss share, this sec- tion does not apply to the transfer. If, instead, the share were sold for less than $20, it would be a loss share and the transfer would be subject to this section. In that case, for purposes of computing the S share’s disconformity amount, S’s aggregate inside loss, and applying paragraph (d)(5)(iii) of this section, S’s net inside attributes would be treated as reduced by $80, the amount that S’s attributes would have been re- duced under §1.1502–13(e)(4)(iv) had the election under §1.1502–13(e)(4)(v) not been made. (3)Plural, singular. All terms used in this section include both the plural and singular as the context may require. (f)Definitions. In addition to the def- initions in other paragraphs of this sec- tion and in §1.1502–1, the following defi- nitions apply for purposes of this section. (1)Allocable portionhas the same meaning as in §1.1502–32(b)(4)(iii)(B). Thus, for example, within a class of stock, each share has the same allocable portion of the net inside attribute amount and, if there is more than one class of stock, the net inside attribute amount is allocated to each class by taking into account the terms of each class and all other facts and circumstances relating to the overall eco- nomic arrangement. (2)Deferred deductionmeans any de- duction for expenses or loss that would be taken into account under general tax accounting principles as of the time of the transfer of the share, but that is neverthe- less not taken into account immediately af- ter the transfer by reason of the application of a deferral provision. Such provisions include, for example, sections 267(f) and 469, and §1.1502–13.Deferred deduction also includes equivalent amounts, such as negative adjustments under section 475 (mark to market accounting method for dealers in securities) and section 481 (ad- justments required by changes in method of accounting). (3)Distributionhas the same meaning as in §1.1502–32(b)(3)(v). (4)Higher tier, lower tier. A subsidiary (S1) (and its shares of stock) ishigher tierwith respect to another subsidiary (S2) (and its shares of stock) if investment ad- justments made to the bases of shares of S2 stock under §1.1502–32 affect the in- vestment adjustments made to the bases of shares of S1 stock. A subsidiary (S1) (and its shares of stock) islower tierwith respect to another subsidiary (S) (and its shares of stock) if investment adjustments made to the bases of shares of S1 stock affect the investment adjustments made to the bases of shares of S stock. The term lowest-tier subsidiary generally refers to a subsidiary that owns no stock of an- other subsidiary. The term highest-tier subsidiary generally refers to a subsidiary the stock of which is not lower tier to any shares transferred in the transaction. (5)Liabilitymeans a liability that has been incurred within the meaning of sec- tion 461(h), except to the extent otherwise provided in paragraph (d)(4)(ii)(A)(1)of this section. (6)Loss carryovermeans any net op- erating or capital loss carryover attribut- able to S that is or, under the principles of §1.1502–21, would be carried to S’s first taxable year, if any, following the year of the transfer. (7)Loss share, gain share.Aloss share is a share of stock with a basis that exceeds its value. Again shareis a share of stock with a value that exceeds its basis. (8)Preferred stock, common stock.Pre- ferred stockandcommon stockhave the same meanings as in §1.1502–32(d)(2) and (3), respectively. (9)Publicly traded property. Property ispublicly traded propertyif it is traded on an established market within the meaning of §1.1273–2(f). (10)Transactionincludes all the steps taken pursuant to the same plan or arrange- ment. (11)Transfer—(i)Definition. Except as provided in paragraph (f)(11)(ii) of this section, for purposes of this section, M February 20, 20075942007–8 I.R.B. transfers a share of Sstock on the earliest of— (A) The date that M ceases to own the share as a result of a transaction in which, but for the application of this section, M would recognize gain or loss with respect to the share; (B) The date that M and S cease to be members of the same group; (C) The date that a nonmember acquires the share from M; and (D) The last day of the taxable year dur- ing which the share becomes worthless un- der section 165(g), taking into account the provisions of §1.1502–80(c). (ii)Excluded transactions. Notwith- standing paragraph (f)(11)(i) of this sec- tion, M does not transfer a share of S stock if— (A) M ceases to own the share as a result of a section 381(a) transaction in which any member acquires assets from S or in which S acquires assets from M, provided that, in either case, M recognizes no gain or loss with respect to the share; or (B) M ceases to own the share as a re- sult of a distribution of the share to a non- member in a transaction to which section 355 applies, provided M does not recog- nize any gain or loss with respect to the share as a result of the distribution of the share. (12)Valuemeans the amount realized, if any, or otherwise the fair market value. (g)Anti-abuse rule—(1)General rule. If a taxpayer acts with a view to avoid the purposes of this section or to apply the rules of this section to avoid the purposes of any other rule of law,appropriate adjust- ments will be made to carry out the pur- poses of this section or such other rule of law. (2)Examples. The following examples illustrate the principles of the anti-abuse rule in this paragraph (g). No implication is intended regarding the potential applica- bility of any other anti-abuse rules: Example 1.Stuffing gain asset to eliminate loss. (i)Facts. On January 1, year 1, P owns Asset 1 with a basis of $0 and a value of $100. On that same date, P purchases the sole outstanding share of S stock for $100. At that time, S owns Asset 2 with a basis of $0 and a value of $100. In year 1, S sells Asset 2 for $100. In year 2, with a view to avoiding the basis reduction rule in paragraph (c) of this section upon the sale of the S share, P contributes Asset 1 to S in a transaction to which section 351 applies and receives an additional share of S stock with a basis of $0 under section 358. On December 31, year 2, P sells its two S shares for $200. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in the original share of S stock is $200 (P’s original $100 basis, increased by $100 under §1.1502–32 to reflect the $100 gain recognized on the sale of Asset 2), and P’s basis in the other share of S stock is $0. (ii)Analysis. Absent the application of this para- graph (g), P would not recognize any net gain or loss on the sale of the two S shares. Under paragraph (c)(7) of this section, for purposes of computing the basis reduction required by paragraph (c) of this sec- tion, P’s basis in the original share of S stock would be treated as reduced by the gain recognized on the other share of S stock. Further, P would not recog- nize any net stock loss within the meaning of para- graph (d)(3)(ii) of this section. Accordingly, this sec- tion would not apply to the transfer of the S shares. However, because P contributed Asset 1 to S with a view to avoiding the basis reduction rule in paragraph (c) of this section, the contribution of Asset 1 is disre- garded for purpose of applying this section. Accord- ingly, this section applies to the sale of the S share without regard to the contribution of Asset 1, and the basis of the original S share is reduced by $100 under paragraph (c) of this section. P recognizes no gain or loss on the sale of the original S share, and $100 of gain on the sale of the other S share. Example 2.Loss Trafficking.(i)Facts.OnJan- uary 1, year 1, P purchases the sole outstanding share of S stock for $100. At that time, S owns one as- set, Asset 1, with a basis of $0 and a value of $100. In year 1, S sells Asset 1 for $100 and, with a view to eliminating the disconformity amount, S purchases the sole outstanding share of X stock, a corporation with a $100 NOL and an asset with a basis and value of $1, from an unrelated party for $1. In year 2, X is liquidated into S in a transaction to which section 332 applies. On December 31, year 2, P sells its S share for $100. After applying and giving effect to all generally applicable rules of law (other than this section), P’s basis in the S share is $200 (P’s original $100 basis, increased under §1.1502–32 to reflect the $100 gain recognized on the sale of Asset 1). P’s sale of the S share is a transfer of a loss share and there- fore subject to the provisions of this section. (ii)Analysis. No adjustment is required under paragraph (b) of this section, either because there is no potential for redetermination (members hold only one share of S stock) or because P transfers the group’s entire interest in S to a nonmember in a fully taxable transaction. See, respectively, para- graphs (b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. Under paragraph (c) of this section, P’s basis in the S share ($200) is reduced, but not below the share’s value ($100), by the lesser of the share’s net positive adjustment and disconformity amount. The share’s net positive adjustment is the greater of zero and the sum of all investment adjustments applied to the basis of the share, computed without taking distributions into account. There are no distributions. The only in- vestment adjustment to the S share is the $100 pos- itive adjustment attributable to the gain recognized on the sale of Asset 1. The share’s net positive ad- justment is therefore $100. The share’s disconfor- mity amount is the excess, if any, of its basis ($200) over its allocable portion of S’s net inside attribute amount. Because S purchased the X stock and liqui- dated X with a view to avoiding the purposes of this section (to utilize X’s attributes to minimize the dis- conformity amount of the S loss share), the attributes acquired from X are disregarded for purposes of ap- plying this section. Accordingly, S’s net inside at- tribute amount is limited to S’s money ($100 from thesaleofAsset1,less$1forthepurchaseofthe X stock), or $99. The loss share’s allocable portion of the $99 net inside attribute amount is $99. The loss share’s disconformity amount is therefore the ex- cess of $200 over $99, or $101. The lesser of the share’s net positive adjustment ($100) and disconfor- mity amount ($101) is $100. As a result, the basis in the loss share is reduced by $100, and P recognizes no gain or loss on the sale of the S share. Example 3.Use of a partnership to prevent cur- rent attribute reduction.(i)Facts. P owns 100 shares of S stock with a basis of $10 each. S owns Asset 1 with a basis of $1000 and a value of $100. In year 1, with a view to preventing a current reduction in the basis of Asset 1, S and M form a partnership. S contributes Asset 1 and M contributes Asset 2. On December 31, year 1, P sells 20 S shares for $1 each. After applying paragraph (c) of this section, P’s ba- sis in each transferred S share is still $10, and P rec- ognizes a $180 loss (a $9 loss on each transferred S share). (ii)Analysis. No adjustment is required under paragraph (b) of this section because S has only one class of stock outstanding and there is no disparity in the bases of the shares. See paragraph (b)(1)(ii)(A) of this section. No adjustment is required under para- graph (c) of this section because the net positive ad- justment is $0. See paragraph (c)(3) of this section. Absent the application of this paragraph (g), under paragraph (d) of this section S’s attribute reduction amount of $180 would be applied to reduce S’s ba- sis in the partnership interest. Because S acted with a view to avoiding a current reduction in the basis of Asset 1 under paragraph (d)of this section, this sec- tion is applied by treating S as if it held Asset 1 at the time of the stock sale. Example 4.Creation of an intercompany receiv- able to mitigate attribute reduction.(i)Facts.Powns 100 shares of S stock each with equal basis that ex- ceeds value. S owns cash and Asset 1 with a basis that exceeds value. In year 1, with a view to mitigating a reduction in the basis of Asset 1, S lends the cash to M. On December 31, year 1, P sells 20 S shares and recognizes a loss. (ii)Analysis. No adjustment is required under paragraph (b) of this section because S has only one class of stock outstanding and there is no disparity in the bases of the shares. See paragraph (b)(1)(ii)(A) of this section. No adjustment is required under para- graph (c) of this section because the net positive ad- justment is $0. See paragraph (c)(3) of this section. Absent the application of this paragraph (g), under paragraph (d) of this section S’s attribute reduction amount would be applied to proportionately reduce the basis in S’s assets. Accordingly, S’s basis in both its intercompany receivable and Asset 1 would be re- duced. Because S acted with a view to mitigating the reduction in the basis of Asset 1 under paragraph (d) of this section, this section is applied without regard to the intercompany receivable. Accordingly, S’s ba- sis in Asset 1 is reduced by the full attribute reduction amount. (h)Effective date. This section ap- plies to all transfers on or after the date 2007–8 I.R.B.595February 20, 2007 these regulations are published as final regulations in theFederal Register.For rules applicable on and after March 10, 2006, and before the date these regulations are published as final regulations in the Federal Register, see §§1.1502–35 and 1.337(d)–2 as contained in 26 CFR part 1 in effect on January 1, 2007. For rules ap- plicable on and after March 3, 2005 and be- fore March 10, 2006, see §§1.337(d)–2T, 1.1502–20 and 1.1502–35T as contained in 26 CFR part 1 in effect on April 1, 2005. For rules applicable before March 3, 2005, see §§1.337(d)–2T, 1.1502–20, and 1.1502–35T as contained in 26 CFR part 1 in effect on April 1, 2004. Par. 16. Section 1.1502–80 is amended by: 1. Revising paragraphs (a) and (c). 2. Adding new paragraph (g). The revisions and addition read as fol- lows: §1.1502–80 Applicability of other provisions of law. (a)In general. The Internal Revenue Code, or other law, shall be applicable to the group to the extent the regulations do not exclude its application. To the extent not excluded, other rules operate in addi- tion to, and may be modified by, these reg- ulations. Thus, for example, in a transac- tion to which section 381(a) applies, the acquiring corporation will succeed to the tax attributes described in section 381(c). Furthermore, sections 269 and 482 apply for any consolidated year. However, in a recognition transaction otherwise subject to section 1001, for example, the rules of section 1001 continue to apply, but may be modified by the intercompany transaction regulations under §1.1502–13. Nothing in these regulations shall be interpreted or ap- plied to require an adjustment to a mem- ber’s basis in subsidiary stock or other at- tributes to the extent the adjustment would have the effect of duplicating another ad- justment required under the Code or other rule of law, including other provisions of these regulations. ***** (c)Deferral of section 165—(1)Gen- eral rule. Subsidiary stock is not treated as worthless under section 165 until immedi- ately before the earlier of the time— (i) The stock is worthless within the meaning of §1.1502–19(c)(1)(iii); and (ii) The subsidiary for any reason ceases to be a member of the group. (2)Cross reference. See §1.1502–36 for additional rules relating to stock loss. ***** (g)Effective dates. Paragraphs (a) and (c) of this section are applicable on or after the date these regulations are published as final regulations in theFederal Register. Par. 17. Section 1.1502–91 is amended by revising paragraph (h)(2) to read as fol- lows: §1.1502–91 Application of section 382 with respect to a consolidated group. ***** (h) * * * (2)Disposition of stock or an intercom- pany obligation of a member.Gainorloss recognized by a member on the disposition ofstock(includingstockdescribedinsec- tion 1504(a)(4) and §1.382–2T(f)(18)(ii) and (iii)) of another member is treated as a recognized gain or loss for purposes of section 382(h)(2) (unless disallowed) even though gain or loss on such stock was not included in the determination of a net un- realized built-in gain or loss under para- graph (g)(1) of this section. Gain or loss recognized by a member with respect to an intercompany obligation is treated as recognized gain or loss only to the extent (if any) the transaction gives rise to ag- gregate income or loss within the consol- idated group. The first sentence of this paragraph (h)(2) is applicable on or after the date these regulations are published as final regulations in theFederal Register. ***** Par. 18. For each section listed in the ta- ble, remove the language in the “Remove” column and add in its place the language in the “Add” column as set forth below: SectionRemoveAdd §1.267(f)–1(k)§1.337(d)–2; §1.1502–35§1.1502–36 §1.597–4(g)(2)(v)§§1.337(d)–2 and 1.1502–35(f)§1.1502–36 §1.1502–11(b)(3)(ii)(c)§§1.337(d)–2 and 1.1502–35§1.1502–36 §1.1502–12(r)§§1.337(d)–2 and 1.1502–35§1.1502–36 §1.1502–15(b)(2)(iii)§§1.337(d)–2, 1.1502–35, or§1.1502–36 §1.1502–32(b)(3)(iii)(B)§1.1502–35(b) or (f)(2) Mark E. Matthews, Deputy Commissioner for Services and Enforcement. (Filed by the Office of the Federal Register on January 16, 2007, 10:51 a.m., and published in the issue of the Federal Register for January 23, 2007, 72 F.R. 2963) Update to Revenue Procedure 2001–31, Filing Summary of Archer MSAs, Electronically Announcement 2007–15 The Tax Relief and Healthcare Act of 2006 (P.L. 109–432) requires trustee/cus- todians to file Form 8851,Summary of Archer MSAs. Revenue Procedure 2001–31 contains procedures for filing Form 8851. Currently, this revenue pro- cedure is being revised but will not be available by March 20, 2007, the due date of Form 8851. Numerous changes are be- ing made to the revenue procedure. This announcement detailsthe major changes so filers can use this announcement along with Revenue Procedure 2001–31 to file February 20, 20075962007–8 I.R.B. Form 8851 electronically. The changes are: •The name of the Martinsburg Com- puting Center was changed to Enter- prise Computing Center – Martinsburg (ECC-MTB). •The due date for filing Forms 8851 was changed to March 20, 2007. This date is effective for both filing periods, Jan- uary 1, 2005 through June 20, 2005 and January 1, 2006 through June 20, 2006. A separate transmission is required for each filing period. •ECC-MTB no longer accepts mag- netic media for the filing of Forms 8851. The only acceptable method for those with over 250 forms is electronic filing via the Filing In- formation Returns System (FIRE) at http://fire.irs.gov. For more informa- tion regarding the FIRE system, refer to Publication 3609,Filing Informa- tion Returns Electronically, which can be downloaded fromwww.irs.gov.Fil- ers of Form 8851 must call ECC-MTB toll-free at 1–866–455–7438, ext. 3 for log-on instructions. If you have questions concerning the filing of Form 8851,Summary of Archer MSAs, please contact the Internal Revenue Service ECC-MTB toll-free at 866–455–7438. Emancipation Day Holiday Filing and Payment Extension Announcement 2007–16 Taxpayers across the nation have until Tuesday, April 17, 2007, to file their 2006 returns and pay any taxes due. Taxpay- ers have extra time to file and pay because April 15 falls on a Sunday in 2007, and the following day, Monday, April 16, is Eman- cipation Day, a legal holiday in the Dis- trict of Columbia. This means the entire country has an April 17 deadline. Previ- ously, the April 17 deadline applied just to individuals in the District of Columbia and six eastern states who are served by an IRS processing facility in Massachusetts, where Patriots Day will be observed on April 16, 2007. By law, filing and payment deadlines that fall on a Saturday, Sunday or legal holiday are timely satisfied if met on the next business day. Under I.R.C. § 7503, holidays observed in the District of Co- lumbia have impact nationwide on tax is- sues, not just in the District of Colum- bia. Under city legislation, April 16 is a holiday in the District of Columbia. See § 301.7503–1(b), Proc. & Admin. Regs.; D.C. Code § 28–2701; D.C. LEGIS 16–91. Among the tax-filing and payment re- quirements affected by this change, the April 17, 2007 deadline will apply to any of the following: 2006 federal individual income tax re- turns, whether filedelectronically or on paper; Requests for an automatic six-month tax-filing extension, whether submitted electronically or on Form 4868; Tax year 2006 balance due payments, whether made electronically (direct debit or credit card) or by check; Tax-year 2006 contributions to a Roth or traditional IRA; Individual estimated tax payments for the first quarter of 2007, whether made electronically or by check; and Individual refund claims for tax year 2003, where the regular three-year statute of limitations is expiring. Other tax-filing and payment require- ments affected by this change are de- scribed in IRS Publication 509,Tax Cal- endars for 2007, available at the IRS web site athttp://www.irs.gov/publica- tions/p509/index.html. Exclusion From Gross Income of Previously Taxed Earnings and Profits and Adjustments to Basis of Stock in Controlled Foreign Corporations and of Other Property; Correction Announcement 2007–17 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Correction to notice of pro- posed rulemaking. SUMMARY: This document cor- rects notice of proposed rulemaking (REG–121509–00, 2006–40 I.R.B. 602) that was published in theFederal Regis- teron Tuesday, August 29, 2006 (71 FR 51155). The document contains proposed regulations that provide guidance relat- ing to the exclusion from gross income of previously taxed earnings and profits under section 959 of the Internal Revenue Code (Code) and related basis adjustments under section 961 of the Code. FOR FURTHER INFORMATION CONTACT: Ethan Atticks, (202) 622–3840 (not a toll-free number). SUPPLEMENTARY INFORMATION: Background The notice of proposed rulemaking (REG–121509–00) that is the subject of these corrections is under sections 959 and 961 of the Internal Revenue Code. Need for Correction As published, REG–121509–00 con- tains errors that may prove to be mislead- ing and are in need of clarification. Correction of Publication Accordingly, the notice of proposed rulemaking (REG–121509–00), that was the subject of FR Doc. 06–7195, is cor- rected as follows: 1. On page 51155, column 1, in the preamble, under the paragraph heading “Background”, the last paragraph of the column, third line, the language, “sec- tions 959 and 961. Section 959(a)(1)” is 2007–8 I.R.B.597February 20, 2007 corrected to read “sections 959, 961, and 1502. Section 959(a)(1)”. 2. On page 51156, column 1, in the preamble, the last paragraph of the col- umn, fifth line from bottom, the language “109–222), which provides for look-” is corrected to read “109–222), which gener- ally provides for look-”. 3. On page 51156, column 3, in the preamble, under paragraph heading “2. Shareholder PTI Accounts”, sixth line, the language “directly, or indirectly under section” is corrected to read “directly or indirectly under section”. 4. On page 51157, column 1, in the pre- amble, under paragraph heading “3. Suc- cessors in Interest”, second paragraph, six- teenth line, the language “corporation from a person that is not a” is corrected to read “corporation from any person, including a person that is not a”. 5. On page 51157, column 1, in the pre- amble, under paragraph heading “B. CFC- Level Exclusion Under Section 959(b)”, first line of first paragraph, the language “The earnings and profits of a CFC” is cor- rected to read “Section 959(b) provides an exclusion pursuant to which the earnings and profits of a CFC”. 6. On page 51157, column 1, in the preamble, under paragraph heading “B. CFC-Level Exclusion Under Section 959(b)”, first paragraph, third line from the bottom of the paragraph, the language “rules regarding cross-chain sales of” is corrected to read “to provide guidance regarding cross-chain sales of”. 7. On page 51157, column 2, in the preamble, first paragraph of the column, ninth line, the language “section 951(a)) and a $100 of non-” is corrected to read “section 951(a)) and $100x of non-”. 8. On page 51157, column 2, in the pre- amble, first paragraph of the column, last line, the language “$91x ((70% x $30) + (70% x $100)).” is corrected to read “$91x ((70% x $30x) + (70% x $100x)).”. 9. On page 51157, column 2, in the pre- amble, second paragraph of the column, third line, the language “accordingly, pro- vides that, the amount” is corrected to read “accordingly, provides that the amount”. 10. On page 51157, column 2, in the preamble, second paragraph of the col- umn, eleventh line, the language “of sec- tion 958(a)) in the lower-tier and” is cor- rected to read “of section 958(a)) in the lower- and”. 11. On page 51157, column 2, in the preamble, fourth paragraph of the column, seventh line, the language “CFC from a person who was not taxed” is corrected to read “CFC from a person that was not taxed”. 12. On page 51157, column 3, in the preamble, first paragraph of the column, eighth line, the language “inclusion is still $100. In contrast, Prop.” is corrected to read “inclusion is still $100x. In contrast, Prop.”. 13. On page 51157, column 3, in the preamble, under the paragraph heading “1. Shareholder-Level Accounting of PTI”, last line of the column, the language “shareholder who owns the stock or by” is corrected to read “shareholder that owns the stock or by”. 14. On page 51158, column 2, in the preamble, under the paragraph heading “a. Dollar Basis Pooling Election”, first paragraph of the column, ninth to fifteenth lines, the language “to a distribution of PTI. Notice 88–71, 1988–2 C.B. 374, makes this pooled approach available to taxpayers for purposes of section 986(c) at the taxpayer’s election, but it does not provide guidance as to how this election is made. The proposed regulations” is cor- rected to read “to a distribution of PTI. The proposed regulations make this pooled ap- proach available to taxpayers for purposes of section 986(c) at the taxpayer’s elec- tion. The proposed regulations”. 15. On page 51158, column 3, in the preamble, under paragraph heading “4. Adjustment of Shareholder PTI Ac- counts”, second paragraph, tenth line, the language “corporation. Next, a share- holder’s PTI” is corrected to read “corpo- ration. Second, a shareholder’s PTI”. 16. On page 51160, column 1, in the preamble, under paragraph heading “b. Shareholder That Is a Member of a Con- solidated Group”, first paragraph, seventh line from the bottom of the first paragraph, the language “consolidated group who own stock in” is corrected to read “consol- idated group that own stock in”. 17. On page 51160, column 1, in the preamble, second paragraph, eleventh line, the language “taxable year who own stock in the” is corrected to read “taxable year that own stock in the”. 18. On page 51161, column 3, in the preamble, under paragraph heading “A. Coordination of Shareholder-Level and Corporate-Level Accounts”, ninth line, the language “PTI information is to be shared between” is corrected to read “PTI information is to be shared among”. 19. On page 51161, column 3, in the preamble, thirteenth line, the language “are necessary, and if so, how they” is corrected to read “are necessary and, if so, how they”. 20. On page 51162, column 3, in the preamble, underparagraph heading “F. Section 961(c) Basis Adjustments”, first line of the paragraph, the language “Section 961(c) is by its terms only” is corrected to read “Section 961(c) is only”. § 1.959–1 [Corrected] 21. On page 51163, column 3, § 1.959–1(a), second line of the column, the language “except that such distribu- tions shall” is corrected to read “except that such distribution shall”. 22. On page 51164, column 1, § 1.959–1(b)(2), first paragraph of the column, fifth and sixth lines, the language “any) that are attributable to section 951(a) inclusions.” is corrected to read “any).”. 23. On page 51164, column 1, § 1.959–1(b)(3), second paragraph of the column, third line, the language “income with respect to the previously” is corrected to read “a United States shareholder’s in- come with respect to the previously”. 24. On page 51164, column 1, § 1.959–1(b)(4)(iii), second line from the bottom of the paragraph, the lan- guage “corporations are members of the same” is corrected to read “if both the first mentioned corporation and the covered shareholder are members of the same”. 25. On page 51165, column 1, § 1.959–1(d)(3), second paragraph of the column, first line, the language “The application of this paragraph” is corrected to read “Examples. The application of this paragraph”. 26. On page 51165, column 1, § 1.959–1(d)(3),Example 1., paragraph heading, the language “Shareholder previ- ously taxed earnings and profits account.” is corrected to read “Shareholder’s previ- ously taxed earnings and profits account.”. 27. On page 51165, column 1, § 1.959–1(d)(3)(i), eighth and ninth lines, the language “currency. FC earns $100x of subpart F income in year 1 and $100x of non-subpart” is corrected to read “cur- February 20, 20075982007–8 I.R.B. rency. In year 1, FC earns $100x of subpart F income and $100x of non-subpart F”. § 1.959–2 [Corrected] 28. On page 51165, column 2, § 1.959–2(a)(1), fourth line from the bottom of the paragraph, the language “income of such distributee CFC also” is corrected to read “income of such up- per-tier CFC also”. 29. On page 51165, column 3, § 1.959–2(a)(2), paragraph (i) ofExample 2., second line from the bottom of the paragraph, the language “2, and FC had no earnings for year 2 other” is corrected to read “2, and FC had no earnings and profits for year 2 other”. 30. On page 51165, column 3, § 1.959–2(a)(2), paragraph (ii) ofExam- ple 3., eighth and ninth lines, the language “DP’spro ratashare of the remaining $50, or $35 ($50 x 70%), is included in DP’s gross” is corrected to read “DP’spro ratashare of the remaining $50x, or $35x ($50xx70%),isincludedinDP’sgross”. 31. On page 51166, column 1, § 1.959–2(a)(2), paragraph (ii) ofEx- ample 3., first paragraph of the column, first line, the language “reduced to $0, however, as a result of the” is corrected to read “reduced to $0, as a result of the”. 32. On page 51166, column 1, § 1.959–2(b)(2), third paragraph of the column, first line, the language “The ap- plication of this paragraph” is corrected to read “Example. The application of this paragraph”. § 1.959–3 [Corrected] 33. On page 51166, column 3, § 1.959–3(b)(3)(i), third paragraph of the column, fifth through twelfth lines, the language “earnings and profits in the year in which such amounts are included in gross income of a United States share- holder under section 951(a) and are reclas- sified as to category of earnings and profits in the year in which such amounts would be so included but for the provisions of” is corrected to read “earnings and profits in the taxable year of the foreign corpora- tion in which such amounts are included in the gross income of a United States shareholder under section 951(a) and are reclassified as to category of earnings and profits in the taxable year of the foreign corporation in whichsuch amounts would be so included in the gross income of a United States shareholder under section 951(a) but for the provisions of”. 34. On page 51167, column 2, § 1.959–3(c)(1), third paragraph of the column, fourth line,the language “are distributed by a foreign corporation” is corrected to read “are distributed by a foreign corporation to another foreign cor- poration”. 35. On page 51167, column 2, § 1.959–3(c)(1), fourteenth line, the lan- guage “included in the foreign corpora- tion’s” is corrected to read “included in the distributee foreign corporation’s”. 36. On page 51167, column 2, § 1.959–3(c)(2), fourth paragraph of the column, first line, the language “The ap- plication of this paragraph” is corrected to read “Example. The application of this paragraph”. 37. On page 51172, column 3, § 1.959–3(g)(4), paragraph (i) ofExample 1., first paragraph of the column, fourth line from the bottom of the paragraph, the language “earnings andprofits on its stock Class A” is corrected to read “earnings and profits on its Class A”. 38. On page 51173, column 3, § 1.959–3(g)(4), paragraph (i) ofExample 5., third line, the language “on its stock Class A stock consisting of a” is corrected to read “ on its Class A stock consisting of a”. 39. On page 51174, column 3, § 1.959–3(h)(3)(i), third paragraph of the column, fourth line from the bottom of the paragraph, the language “§§ 1.959–1 and this section shall apply” is corrected to read “§ 1.959–1 and this section shall apply”. 40. On page 51175, column 1, § 1.959–3(h)(4)(i), fourth paragraph of the column, fifth line from the bottom of the paragraph, the language “§§ 1.959–1 and this section shall” is corrected to read “§ 1.959–1 and this section shall”. 41. On page 51175, column 1, § 1.959–3(h)(4)(ii), fifth paragraph of the column, first line, the language “The application of this paragraph” is corrected to read “Example. The application of this paragraph”. § 1.961–2 [Corrected] 42. On page 51177, column 1, § 1.961–2(d), paragraph (i) ofExample 3., third paragraph of the column, third line from the bottom of the paragraph, the language “December 31, of year 1. In year 2, DP has a” is corrected to read “Decem- ber 31 of year 1. In year 2, DP has a”. § 1.961–3 [Corrected] 43. On page 51177, column 2, § 1.961–3(a)(1), first paragraph of the column, second line from the bottom of the paragraph, the language “shareholders gross income under” is corrected to read “shareholder’s gross income under”. 44. On page 51177, column 3, § 1.961–3(b)(1), third paragraph of the column, twelfth line, the language “than wholly owned by a single United” is cor- rected to read “than wholly indirectly owned by a single United”. LaNita Van Dyke, Chief, Publications and Regulations Branch, Legal Processing Division, Associate Chief Counsel (Procedure and Administration). (Filed by the Office of the Federal Register on December 7, 2006, 8:45 a.m., and published in the issue of the Federal Register for December 8, 2006, 71 F.R. 71116) Flat Rate Supplemental Wage Withholding; Correction Announcement 2007–20 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Correcting amendment. SUMMARY: This document contains cor- rection to final regulations (T.D. 9276, 2006–37 I.R.B. 423) that were published in theFederal Registeron Tuesday, July 25, 2006 (71 FR 42049), amending the regulations that provide for determining the amount of income tax withholding on supplemental wages. These regulations apply to all employers and others making supplemental wage payments to employ- ees. DATES: The correction is effective Jan- uary 1, 2007. FOR FURTHER INFORMATION CONTACT: A. G. Kelley, (202) 622–6040 (not a toll-free number). 2007–8 I.R.B.599February 20, 2007 SUPPLEMENTARY INFORMATION: Background The final regulationsthat are the subject of this correction are under sections 3401 and 3402 of the Internal Revenue Code. Need for Correction As published, final regulations (T.D. 9276) contain an error that may prove to be misleading and is in need of clarifica- tion. ***** Correction of Publication Accordingly, 26 CFR part 31 is cor- rected by making the following correcting amendment: PART 31—EMPLOYMENT TAXES ANDCOLLECTIONOFINCOME TAX AT SOURCE Paragraph 1. The authority citation for part 31 continues to read, in part, as fol- lows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section 31.3402(g)–1(a)(8) is amended by revising the last sentence of Example 3paragraph (iv). The revision readsasfollows: § 31.3402(g)–1 Supplemental wage payments. (a) * * * (8) * * * Example 3.*** (iv)***IfRelectstouseoptional flat rate withholding provided under para- graph(a)(7)(iii)(F) of this section, with- holding would be calculated at 25 percent of the $1,000,000 portion of the payment and would be $250,000. ***** LaNita Van Dyke, Chief, Publications and Regulations Branch, Legal Processing Division, Associate Chief Counsel (Procedure and Administration). (Filed by the Office of the Federal Register on January 25, 2007, 8:45 a.m., and published in the issue of the Federal Register for January 26, 2007, 72 F.R. 3734) February 20, 20076002007–8 I.R.B. Definition of Terms Revenue rulings and revenue procedures (hereinafter referred to as “rulings”) that have an effect on previous rulings use the following defined terms to describe the ef- fect: Amplifieddescribes a situation where no change is being made in a prior pub- lished position, but the prior position is be- ingextendedtoapplytoavariationofthe fact situation set forth therein. Thus, if an earlier ruling held that a principle ap- plied to A, and the new ruling holds that the same principle also applies to B, the earlier ruling is amplified. (Compare withmodi- fied,below). Clarifiedis used in those instances where the language in a prior ruling is be- ing made clear because the language has caused, or may cause, some confusion. It is not used where a position in a prior ruling is being changed. Distinguisheddescribes a situation where a ruling mentions a previously pub- lished ruling and points out an essential difference between them. Modifiedis used where the substance of a previously published position is being changed. Thus, if a prior ruling held that a principle applied to A but not to B, and the new ruling holds that it applies to both A and B, the prior ruling is modified because it corrects a published position. (Compare withamplifiedandclarified, above). Obsoleteddescribes a previously pub- lished ruling that is not considered deter- minative with respect to future transac- tions. This term is most commonly used in a ruling that lists previously published rul- ings that are obsoleted because of changes in laws or regulations. A ruling may also be obsoleted because the substance has been included in regulations subsequently adopted. Revokeddescribes situations where the position in the previously published ruling is not correct and the correct position is beingstatedinanewruling. Supersededdescribes a situation where the new ruling does nothing more than re- state the substance and situation of a previ- ously published ruling (or rulings). Thus, the term is used to republish under the 1986 Code and regulations the same po- sition published under the 1939 Code and regulations. The term is also used when it is desired to republish in a single rul- ing a series of situations, names, etc., that were previously published over a period of time in separate rulings. If the new rul- ing does more than restate the substance of a prior ruling, a combination of terms is used. For example,modifiedandsu- persededdescribes a situation where the substance of a previously published ruling is being changed in part and is continued without change in part and it is desired to restate the valid portion of the previously published ruling in a new ruling that is self contained. In this case, the previously pub- lished ruling is first modified and then, as modified, is superseded. Supplementedis used in situations in which a list, such as a list of the names of countries, is published in a ruling and that list is expanded by adding further names in subsequent rulings. After the original rul- ing has been supplemented several times, a new ruling may be published that includes the list in the original ruling and the ad- ditions, and supersedes all prior rulings in the series. Suspendedis used in rare situations to show that the previous published rul- ings will not be applied pending some future action such as the issuance of new or amended regulations, the outcome of cases in litigation, or the outcome of a Service study. Abbreviations The fol lowing abbreviations in current use and for merly used will appear in material publis hedintheBulletin. A—Individual. Acq.—A cquiescence. B—Individual. BE—Beneficiary. BK—Bank . B.T.A.—Board of Tax Appeals. C—Individual. C.B.—Cu mulative Bulletin. CFR—Code of Federal Regulations. CI—City. COOP—Coo perative. Ct.D.—Court Decision. CY—County. D—Decede nt. DC—Dummy Corporation. DE—Donee. Del. Order —Delegation Order. DISC—Domestic International Sales Corporation. DR—Donor. E—Estate. EE—Employee. E.O.—Executive Order. ER—Emp loyer. ERISA—Employee Retirement Income Security Act. EX—Executor. F—Fiduc iary. FC—Foreign Country. FICA—Federal Insurance Contributions Act. FISC—Fo reign International Sales Company. FPH—Foreign Personal Holding Company. F.R.—Federal Register. FUTA—Fed eral Unemployment Tax Act. FX—Foreign corporation. G.C.M.—Chief Counsel’s Memorandum. GE—Grante e. GP—General Partner. GR—Grantor. IC—Insura nce Company. I.R.B.—Internal Revenue Bulletin. LE—Lessee. LP—Limited Partner. LR—Lessor. M—Minor. Nonacq.—No nacquiescence. O—Organization. P—Parent Corporation. PHC—Persona l Holding Company. PO—Possession of the U.S. PR—Partner. PRS—Pa rtnership. PTE—Prohibited Transaction Exemption. Pub. L.—Public Law. REIT—Re al Estate Investment Trust. Rev. Proc.—Revenue Procedure. Rev. Rul.—Revenue Ruling. S—Subsi diary. S.P.R.—Statement of Procedural Rules. Stat.—Statutes at Large. T—Target Corporation. T.C.—Tax Court. T.D.—Treasury Decision. TFE—Trans feree. TFR—Transferor. T.I.R.—Technical Information Release. TP—Taxpay er. TR—Trust. TT—Trustee. U.S.C.—Uni ted States Code. X—Corporation. Y—Corporation. Z—Corporat ion. 2007–8 I.R.B.iFebruary 20, 2007 Numerical Finding List 1 Bulletins 2007–1 through 2007–8 Announcements: 2007-1, 2007-1 I.R.B.243 2007-2, 2007-2 I.R.B.263 2007-3, 2007-4 I.R.B.376 2007-4, 2007-7 I.R.B.518 2007-5, 2007-4 I.R.B.376 2007-6, 2007-4 I.R.B.376 2007-7, 2007-4 I.R.B.377 2007-8, 2007-5 I.R.B.416 2007-9, 2007-5 I.R.B.417 2007-10, 2007-6 I.R.B.464 2007-11, 2007-6 I.R.B.464 2007-12, 2007-6 I.R.B.465 2007-13, 2007-7 I.R.B.519 2007-14, 2007-7 I.R.B.519 2007-15, 2007-8 I.R.B.596 2007-16, 2007-8 I.R.B.597 2007-17, 2007-8 I.R.B.597 2007-19, 2007-7 I.R.B.521 2007-20, 2007-8 I.R.B.599 Notices: 2007-1, 2007-2 I.R.B.254 2007-2, 2007-2 I.R.B.254 2007-3, 2007-2 I.R.B.255 2007-4, 2007-2 I.R.B.260 2007-5, 2007-3 I.R.B.269 2007-6, 2007-3 I.R.B.272 2007-7, 2007-5 I.R.B.395 2007-8, 2007-3 I.R.B.276 2007-9, 2007-5 I.R.B.401 2007-10, 2007-4 I.R.B.354 2007-11, 2007-5 I.R.B.405 2007-12, 2007-5 I.R.B.409 2007-13, 2007-5 I.R.B.410 2007-14, 2007-7 I.R.B.501 2007-15, 2007-7 I.R.B.503 2007-16, 2007-8 I.R.B.536 Proposed Regulations: REG-157711-02, 2007-8 I.R.B.537 REG-152043-05, 2007-2 I.R.B.263 REG-161919-05, 2007-6 I.R.B.463 REG-125632-06, 2007-5 I.R.B.415 Revenue Procedures: 2007-1, 2007-1 I.R.B.1 2007-2, 2007-1 I.R.B.88 2007-3, 2007-1 I.R.B.108 2007-4, 2007-1 I.R.B.118 2007-5, 2007-1 I.R.B.161 2007-6, 2007-1 I.R.B.189 Revenue Procedures— Continued: 2007-7, 2007-1 I.R.B.227 2007-8, 2007-1 I.R.B.230 2007-9, 2007-3 I.R.B.278 2007-10, 2007-3 I.R.B.289 2007-11, 2007-2 I.R.B.261 2007-12, 2007-4 I.R.B.354 2007-13, 2007-3 I.R.B.295 2007-14, 2007-4 I.R.B.357 2007-15, 2007-3 I.R.B.300 2007-16, 2007-4 I.R.B.358 2007-17, 2007-4 I.R.B.368 2007-18, 2007-5 I.R.B.413 2007-19, 2007-7 I.R.B.515 2007-20, 2007-7 I.R.B.517 Revenue Rulings: 2007-1, 2007-3 I.R.B.265 2007-2, 2007-3 I.R.B.266 2007-3, 2007-4 I.R.B.350 2007-4, 2007-4 I.R.B.351 2007-5, 2007-5 I.R.B.378 2007-6, 2007-5 I.R.B.393 2007-7, 2007-7 I.R.B.468 2007-8, 2007-7 I.R.B.469 2007-9, 2007-6 I.R.B.422 Treasury Decisions: 9298, 2007-6 I.R.B.434 9299, 2007-6 I.R.B.460 9300, 2007-2 I.R.B.246 9301, 2007-2 I.R.B.244 9302, 2007-5 I.R.B.382 9303, 2007-5 I.R.B.379 9304, 2007-6 I.R.B.423 9305, 2007-7 I.R.B.479 9306, 2007-6 I.R.B.420 9307, 2007-7 I.R.B.470 9308, 2007-8 I.R.B.523 9309, 2007-7 I.R.B.497 1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin 2006–52, dated December 26, 2006. February 20, 2007ii2007–8 I.R.B. Finding List of Current Actions on Previously Published Items 1 Bulletins 2007–1 through 2007–8 Notices: 2005-29 Modified and superseded by Notice 2007-4, 2007-2 I.R.B.260 2006-2 Modified and superseded by Notice 2007-4, 2007-2 I.R.B.260 2006-50 Amplified, clarified, and modified by Notice 2007-11, 2007-5 I.R.B.405 Proposed Regulations: REG-208270-86 Corrected by Ann. 2007-4, 2007-7 I.R.B.518 REG-121509-00 Corrected by Ann. 2007-17, 2007-8 I.R.B.597 REG-141901-05 Corrected by Ann. 2007-7, 2007-4 I.R.B.377 REG-142270-05 Corrected by Ann. 2007-2, 2007-2 I.R.B.263 REG-127819-06 Corrected by Ann. 2007-5, 2007-4 I.R.B.376 REG-136806-06 Corrected by Ann. 2007-6, 2007-4 I.R.B.376 Hearing cancelled by Ann. 2007-19, 2007-7 I.R.B.521 Revenue Procedures: 98-20 Superseded by Rev. Proc. 2007-12, 2007-4 I.R.B.354 2000-38 Modified by Rev. Proc. 2007-16, 2007-4 I.R.B.358 2000-50 Modified by Rev. Proc. 2007-16, 2007-4 I.R.B.358 2001-42 Modified and amplified by Rev. Proc. 2007-19, 2007-7 I.R.B.515 Revenue Procedures— Continued: 2002-9 Modified and amplified by Rev. Proc. 2007-14, 2007-4 I.R.B.357 Modified by Rev. Proc. 2007-16, 2007-4 I.R.B.358 2004-11 Superseded by Rev. Proc. 2007-16, 2007-4 I.R.B.358 2004-65 Modified and superseded by Rev. Proc. 2007-20, 2007-7 I.R.B.517 2005-12 Superseded by Rev. Proc. 2007-17, 2007-4 I.R.B.368 2005-69 Superseded by Rev. Proc. 2007-15, 2007-3 I.R.B.300 2006-1 Superseded by Rev. Proc. 2007-1, 2007-1 I.R.B.1 2006-2 Superseded by Rev. Proc. 2007-2, 2007-1 I.R.B.88 2006-3 Superseded by Rev. Proc. 2007-3, 2007-1 I.R.B.108 2006-4 Superseded by Rev. Proc. 2007-4, 2007-1 I.R.B.118 2006-5 Superseded by Rev. Proc. 2007-5, 2007-1 I.R.B.161 2006-6 Superseded by Rev. Proc. 2007-6, 2007-1 I.R.B.189 2006-7 Superseded by Rev. Proc. 2007-7, 2007-1 I.R.B.227 2006-8 Superseded by Rev. Proc. 2007-8, 2007-1 I.R.B.230 Revenue Rulings: 75-161 Obsoleted by Rev. Rul. 2007-8, 2007-7 I.R.B.469 76-188 Obsoleted by Rev. Rul. 2007-8, 2007-7 I.R.B.469 Revenue Rulings— Continued: 78-330 Modified by Rev. Rul. 2007-8, 2007-7 I.R.B.469 81-225 Clarified and amplified by Rev. Rul. 2007-7, 2007-7 I.R.B.468 2003-43 Modified by Notice 2007-2, 2007-2 I.R.B.254 2003-92 Clarified and amplified by Rev. Rul. 2007-7, 2007-7 I.R.B.468 2005-76 Supplemented and superseded by Rev. Rul. 2007-4, 2007-4 I.R.B.351 Treasury Decisions: 9276 Corrected by Ann. 2007-20, 2007-8 I.R.B.599 9278 Corrected by Ann. 2007-9, 2007-5 I.R.B.417 Ann. 2007-10, 2007-6 I.R.B.464 9286 Corrected by Ann. 2007-8, 2007-5 I.R.B.416 1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin 2006–52, dated December 26, 2006. 2007–8 I.R.B.iiiFebruary 20, 2007 February 20, 20072007–8 I.R.B. 2007–8 I.R.B.February 20, 2007 February 20, 20072007–8 I.R.B. INTERNAL REVENUE BULLETIN The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superin- tendent of Documents when their subscriptions must be renewed. CUMULATIVE BULLETINS The contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are sold on a single copy basis andare notincluded as part of the subscription to the Internal Revenue Bulletin. Subscribers to the weekly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of print and are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from the Superintendent of Documents. ACCESS THE INTERNAL REVENUE BULLETIN ON THE INTERNET You may view the Internal Revenue Bulletin on the Internet at www.irs.gov. Under information for: select Businesses. Under related topics, select More Topics. Then select Internal Revenue Bulletins. INTERNAL REVENUE BULLETINS ON CD-ROM Internal Revenue Bulletins are available annually as part ofPublication 1796 (Tax Products CD-ROM). The CD-ROM can be purchased from National Technical Information Service (NTIS) on the Internet at www.irs.gov/cdorders (discount for online orders) or by calling 1-877-233-6767. The first release is available in mid-December and the final release is available in late January. HOW TO ORDER Check the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance, detach entire page, and mail to the Superintendent of Documents, P.O. Box 371954, Pittsburgh PA, 15250–7954. Please allow two to six weeks, plus mailing time, for delivery. WE WELCOME COMMENTS ABOUT THE INTERNAL REVENUE BUL LETIN If you have c omments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we would be p leased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page (www.irs.g ov) or write to the IRS Bulletin Unit, SE:W:CAR:MP:T:T:SP, Washington, DC 20224 Internal Revenue Service W ashington,DC20224 Official B usiness Penalty for Private Use, $300
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