Prop. Regs. bar use of basis shifting to create artificial losses.

• Author: Kautter, David J.
• Position: Stock redemptions

The Service issued proposed regulations (REG-150313-01) on how to treat the basis of redeemed stock when a stock redemption is treated as a distribution under Sec. 301.

For such distributions, current regulations preserve and protect the redeemed stock's basis from elimination, by allowing "proper adjustments" to be made to the redeeming corporation's remaining stock. The basis is also preserved in transactions subject to Sec. 304, in which immediately after the transaction, the seller owns acquiring corporation stock. In certain transactions, however, taxpayers sometimes take the position that certain adjustments are proper, even if the adjustments shift basis from a person not subject to U.S. tax to one who is, or to stock other than that of the redeeming corporation; see, e.g., Notice 2001-45.

Proposed Changes

The proposed regulations remove the Regs. Sec. 1.302-2(c) proper-adjustment method, and add new Prop. Regs. Sec. 1.302-5, for redemptions taxable as dividends. In general, under Prop. Regs. Sec. 1.302-5, if an amount received in a stock redemption is treated as a dividend distribution, an amount equal to the redeemed stock's basis (after adjusting for certain provisions, including Sec. 301(c)(2)), will be treated, on the redemption date, as a loss recognized on a stock disposition. The proposed regulations provide guidance on when to take the loss into account; generally, this is a date later than the redemption date. The loss's attributes (e.g., the character and source) are determined on the redemption date.

Generally, under the proposed regulations, a taxpayer can take a loss attributable to the redeemed stock's basis (not previously considered) into account when, and to the extent that, the shareholder must take into account gain from an actual or deemed stock sale or exchange of redeeming corporation stock (the "accelerated inclusion date") and the balance when the facts and circumstances causing the redemption to be treated as a dividend distribution no longer exist (the "final inclusion date"). Specifically, the proposed regulations define the "final inclusion date" as:

1. The first date on which the redeemed shareholder would satisfy Sec. 302(b)(1), (2) or (3) criteria if the facts and circumstances that exist on such date had existed immediately after the redemption (subject to certain exceptions for acquisitive and divisive transactions, and whether the redeemed shareholder is a partnership, S corporation, estate or...