Final Regulations Address Limits on Transfer of Built‐in Losses

• DOI: http://doi.org/10.1002/jcaf.22025
• Published date: 01 January 2015
• Date: 01 January 2015

83

© 2015 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22025

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Shirley Dennis-Escoffier

Final Regulations Address Limits on

Transfer of Built-in Losses

The Internal Revenue Service

(IRS) issued final regulations

providing guidance on the deter-

mination of basis in nonrecog-

nition transactions involving

built-in losses. This primarily

involves tax-free transfers of

property to corporations, such

as incorporating a business that

was previously organized as a

sole proprietorship or partner-

ship or transfers to existing

corporations. The purpose of

these rules is to prevent taxpay-

ers from generating multiple tax

losses from one economic loss. It

is important for taxpayers to be

aware of the need for valuation

of individual assets to determine

how to apportion the aggregate

built-in losses in these transfers.

Alternatively, they can make the

election to reduce their stock

basis instead of reducing the

basis of corporate assets.

BACKGROUND

The transfer of property to

a corporation in exchange for

stock is usually not currently

taxable if it meets the require-

ments under Internal Revenue

Code (IRC) Section 351.

• The shareholders transfer

qualified property to the

corporation in exchange

for the corporation’s stock.

Qualified property includes

almost any type of asset

other than services.

• Immediately after the

exchange, the shareholders

transferring property are in

control of the corporation.

Control is generally defined

as owning at least 80% of

the stock entitled to vote

and at least 80% of the

total number of shares of

all other classes of stock of

the corporation.

Assuming these require-

ments are met, the shareholder

does not recognize gain or

loss as long as the shareholder

receives only corporate stock.

The shareholder’s basis in the

stock acquired equals the tax

basis in the property transferred.

The corporation does not rec-

ognize any gain or loss and will

use a carryover tax basis equal

to the shareholder’s tax basis in

the property immediately prior

to the transfer. When property

with a built-in gain is trans-

ferred, IRC Section 351 shields

the shareholder from recogniz-

ing current gain, postponing

gain recognition until the share-

holder subsequently disposes of

the stock in a taxable transac-

tion.

Example 1: Ed trans-

fers property with a

tax basis of $100,000

and a fair market

value of $130,000 to

Alpha Corporation in

exchange for all of its

stock. Neither Ed nor

Alpha recognizes any

gain at the time of the

transfer. Ed’s basis for

the Alpha stock will be

$100,000 and Alpha’s

basis for the property

will be $100,000. If Ed

later sells his Alpha

stock for $130,000, he

will recognize a capital

gain on the date of sale

of $30,000. If Alpha

Corporation sells the

property for $130,000,

it would recognize a

$30,000 gain on the

date of sale.

If the shareholder receives

something other than just cor-

porate stock (such as cash or

other property), it is referred to

as “boot” and can trigger gain to

the extent of the lesser of real-

ized gain or boot received. In

this situation, the corporation