IRS finalizes regs. addressing limitations on transfers of built-in losses.

• Author: Bakke, Donald W.

The IRS issued final regulations (T.D. 9633) under Sec. 362(e)(2) that provide guidance on the determination of the bases of assets (including stock) transferred in certain nonrecognition transactions to which Sec. 362(e)(2) limitations on built-in losses apply. The final regulations adopt, with a few minor changes, the proposed regulations issued in 2006 (REG-110405-05). The regulations are effective for transactions occurring after Sept. 3, 2013; however, taxpayers may apply the regulations to any transaction occurring after Oct. 22, 2004.

Background

Sec. 362(e)(2), enacted as part of the American Jobs Creation Act of 2004, P.L. 108-357, generally limits taxpayers' ability to duplicate net losses in Sec. 351 contributions and capital contributions. Before Sec. 362(e)(2) was enacted, loss duplication could occur under the normal operation of the subchapter C basis rules--e.g., a transferor that contributes loss property to a transferee would generally take an exchanged basis in the stock of the transferee (which would reflect the loss in the property), and the transferee would take a carryover basis in the property contributed (which would continue to reflect the loss in the property).

Congress enacted Sec. 362(e)(2) because it viewed these transactions as potentially abusive. Sec. 362(e)(2) provides that, in the case of property that is transferred in a Sec. 351 transfer or capital contribution, which is not described in Sec. 362(e)(1) (addressing loss importation transactions), if the transferee's aggregate basis in the property would (but for Sec. 362(e)(2)) exceed the property's fair market value (FMV), then the transferee must reduce its basis in the property so the aggregate basis does not exceed its FMV. This rule has the effect of eliminating the built-in loss at the transferee level.

The aggregate basis reduction required under Sec. 362(e)(2) is allocated among the transferred built-in loss property in proportion to the respective built-in losses. The transferor and transferee may, however, jointly and irrevocably make an election under Sec. 362(e)(2)(C) to reduce the transferor's basis in the stock received. The transferee is permitted to take a carryover basis in the property contributed, thereby eliminating the built-in loss at the transferor level. Until the issuance of final regulations, the primary guidance in this area had been Notice 2005-70, which provided interim guidance for making the Sec. 362(e)(2)(C) election, as...