The Treasury Department and the IRS have issued final regulations that:
- prevent a corporate partner from avoiding corporate-level gain through transactions with a partnership involving equity interests of the partner or certain related entities;
- allow consolidated group members that are partners in the same partnership to aggregate their bases in stock distributed by the partnership for purposes of limiting the application of rules that might otherwise cause basis reduction or gain recognition; and
- require certain corporations that engage in gain elimination transactions to reduce the basis of corporate assets or to recognize gain.
The Treasury Decision adopts as final certain rules set forth in proposed regulations issued in 2015, under Code Sec. 337(d) (with only minor, nonsubstantive clarifications) ( NPRM REG-149518-03), and Code Sec. 732(f) ( NPRM REG-138759-14).
The final regulations affect partnerships and their partners, and apply to transactions occurring on or after June 12, 2015. The regulations are effective on June 8, 2018.
Acquisition of Interest in Stock to Avoid Gain on Appreciated Property
A corporation that distributes appreciated property to its shareholders has to recognize gain under Code Secs. 311(b) and 336(a) as if the property were sold to the shareholders for its fair market value. However, taxpayers have tried to postpone or avoid the recognition of that gain.
For example, if a corporation exchanges appreciated property for its own stock, the corporation would recognize gain on the exchange. However, corporations have tried to avoid recognizing that gain by, for example, taking these steps:
- the corporation enters into a partnership and contributes appreciated property;
- the partnership acquires stock of that corporate partner; then
- the partnership makes a liquidating distribution of the stock to the corporate partner.
The final regulations under Code Sec. 337(d) aim to prevent a corporate partner from avoiding gain recognition when it acquires or increases its interest in stock held by a partnership in exchange for appreciated property. Under the final regulations, a corporate partner may recognize gain when it is treated as acquiring or increasing its interest in stock of the corporate partner held by a partnership in exchange for appreciated property in a manner that avoids gain recognition under Code Sec. 311(b) or Code Sec. 336(a). The final regulations also provide exceptions under which a corporate partner is not required to recognize gain.
Limit on Basis Reduction or Gain Recognition for Consolidated Group Members
The final regulations limit rules that cause basis reduction or gain recognition for consolidated group members that are partners in the same partnership. Code Sec. 732(f) limits the basis of a distributed corporation’s property if—
- a corporate partner receives a distribution from a partnership of stock in another corporation (distributed corporation);
- the corporate partner has control of the distributed corporation, defined as ownership of stock meeting the requirements of Code Sec. 1504(a)(2), immediately after the distribution or at any time thereafter (control requirement); and
- the partnership’s basis in the stock immediately before the distribution exceeded the corporate partner’s basis in the stock immediately after the distribution.
Under these circumstances, the basis of the distributed corporation’s property must be reduced by this excess. Further, the corporate partner must recognize gain to the extent that the basis of the distributed corporation’s property cannot be reduced.
In applying this rule, the final regulations allow the bases of consolidated group members to be aggregated if when two conditions are met:
- two or more of the corporate partners receive a distribution of stock in a distributed corporation from the partnership; and
- the distributed corporation is or becomes a member of the distributee partners’ consolidated group after the distribution.
Final regulations restrict corporate partners from entering into gain elimination transactions. They focus on attempts to eliminate gain in the stock of a distributed corporation while avoiding the effects of a basis step-down in transactions. Under the regulations, in the event of a gain elimination transaction, Code Sec. 732(f) will apply as though the corporate partner acquired control of the distributed corporation immediately before the gain elimination transaction.
Future Proposed Regulations?
The Treasury and IRS are considering publishing a new notice of proposed rulemaking to propose more substantive amendments to the final 337(d) regulations and to allow for additional public comment with respect to proposals in response to certain comments received further reflection by the Treasury IRS, and concerns raised by practitioners.
To learn more or if you have questions about these Final Regulations contact an MCB Tax Advisor at 703-218-3600.