IRS clarifies Section 351 for contributions to publicly traded partnership subsidiaries

The IRS has issued a private letter ruling (PLR 201547003) clarifying a perceived contradiction between Section 351 and Treasury regulations regarding a taxpayer’s contribution to a controlled publicly traded partnership (PTP).

Section 7704(a) generally provides that a PTP is treated as a corporation for U.S. federal income tax purposes. Section 351(a) generally states that no gain or loss is recognized if property is transferred to a corporation solely in exchange for stock in the corporation and the corporation is controlled by the transferors immediately after the exchange. An exception to the general rule is provided under Section 351(e), where the transferee corporation is an “investment company.” The exception was designed to prevent investors from achieving the diversification of investment portfolios by contributing highly appreciated stock tax-free under Section 351 rather than selling the stock and reinvesting the proceeds in other assets.  

The determination of whether a transferee corporation is an investment company should be made by taking into account, among other various assets, the stock and securities held by the corporation in a regulated investment company (RIC), a real estate investment trust (REIT), or a PTP (as defined in Sec. 7704(b)). Thus, the securities held in these entities were considered by Congress to be investment assets under this section.

Treas. Reg. Sec. 1.351-1(c)(1) provides that a transfer is made to an investment company under Section 351(e) when both of the following apply:

  • The transfer results in a diversification (defined under Treas. Reg. Sec. 1.351-1(c)(5) and (6)).
  • The transferee is a RIC, a REIT or a corporation more than 80% of the value of whose assets are held for investment and are readily marketable stock or securities, or interests in RICs or REITs.
In making the determination under the 80% test described above, Treas. Reg. Sec. 1.351-1(c)(4) provides a look-through rule where any stock or securities in a subsidiary corporation should be disregarded and the parent corporation should be deemed to own its ratable share of such subsidiaries’ assets when the parent corporation owns 50% or more of the combined voting power or total value of all classes of stock.

This is where the statutory language and regulations potentially conflict: Should the stock or securities in a RIC, a REIT or a PTP subsidiary that is owned 50% or more by a transferee parent corporation be disregarded in applying the 80% test under the Treasury regulations despite the fact that these were deemed investment assets by Congress in the statute?

In the letter ruling, the taxpayer’s contribution was to a PTP (the parent PTP), which was immediately controlled within the meaning of Section 351 by the taxpayer after the exchange. The parent PTP owned more than 50% of the stock or securities of another PTP (the subsidiary PTP). The IRS ruled that in applying the 80% test for determination of whether the parent PTP was an investment company under Section 351(e), the stock and securities of the subsidiary PTP should be disregarded and the parent PTP would be deemed to own its ratable share of the subsidiary PTP’s assets. This ruling is arguably applicable where the subsidiary is a RIC or a REIT rather than a PTP.

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