The burden of BILs.

• Author: Weck, L. Casey
• Position: Built in losses

The American Jobs Creation Act of 2004, Section 836, enacted Sec. 362(e)(2), to limit the importation of built-in losses (BILs) in Sec. 351 transactions. Specifically, Sec. 362(e)(2)(A) limits the aggregate adjusted bases of the contributed property to the property's fair market value (FMV) immediately after the transaction.

Sec. 362 is silent as to how FMV is determined; to date, the IRS has not addressed the issue. It appears two interpretations of existing authority are possible; they may present drastically different tax consequences, depending on the facts. The difference turns on whether the contributed assets' FMV should be predicated on the (1) combined total of each individual asset's FMV (individual asset method) or (2) consideration received by the transferor (i.e., the assumption of liabilities and the transferee corporation's stock) (gross-up method).

Individual Asset Method

This method is based on concepts similar to those contained in Sec. 704(c) and determines FMV on a property-by-property basis. Thus, the FMV of each asset would be determined immediately after the transaction; the total of those values would be compared to the aggregate basis of the contributed property immediately before the transaction, to determine if a BIL exists.

Example 1: A Corp. contributes, in a joint Sec. 351 transaction, multiple assets worth $100 in total (with a $95 basis) and $35 in liabilities to Newco, in exchange for 20% of Newco's stock. B Corp. contributes $1 to Newco for the remaining 80% of stock ("Additional facts" are discussed below to explain why A would participate in this transaction). Exhibit 1 at right illustrates the BIL analysis using the individual asset method.

The Sec. 351 transaction described in Example 1 does not result in the application of Sec. 362(e)(2), as the total FMV of the contributed assets exceeds their aggregate basis. Thus, Newco would take a carryover basis in the assets A contributed; A would take a $60 basis in Newco's stock.

Gross-up Method

This method is based on concepts similar to those contained in Sec. 382(h)(8) and would determine the effective purchase price received by the transferor as the FMV of the assets contributed in the transaction. As such, the assets' FMV immediately after the transaction would be limited to the assumed liabilities plus the value of the transferee corporation's stock, plus any other consideration received.

Example 2: The facts are the same as in Example 1. Exhibit 2 at...