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IRS issues final regulations on importation of built-in-loss property

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Tax Hot Topics: Importation of built-in-loss propertyTreasury and the IRS recently issued final regulations (T.D. 9759) that provide guidance on preventing the importation of property with net built-in losses into the U.S. as a result of certain nonrecognition transactions related to corporations. The final regulations generally adopt, with some modifications and clarifications, proposed regulations (REG-161948-05), issued in September 2013.

Most notably, the final regulations instruct taxpayers on applying Sections 362(e)(1) and 334(b)(1)(B).  

Sections 362(a) and (b) state that a corporation has a basis in property acquired in certain specified transactions that is the same as the transferor’s basis, but increased by the amount of any gain recognized by the transferor. Section 362(a) applies such treatment to property acquired by a corporation in a Section 351 transaction or a contribution to capital, and Section 362(b) applies such treatment to property acquired by a corporation in a reorganization defined under Section 368.

Notwithstanding Sections 362(a) and (b), Section 362(e)(1) generally provides that if certain built-in loss property is transferred to a corporation, the property’s basis in the corporation’s hands is its fair market value. Section 362(e)(1) applies to “importation property,” which includes property that satisfies the following two conditions:

  1. The gain or loss related to such property isn’t subject to U.S. federal income tax to the transferor immediately before the transfer.
  2. The gain or loss related to such property is subject to U.S. federal income tax to the transferee immediately after such transfer.

Section 334(b)(1)(A) generally provides that a corporation’s basis of property received in a Section 332 liquidation is the same as the transferor’s basis. However, Section 334(b)(1)(B) states that the acquiring corporation’s basis in importation property received in a Section 332 transaction equals the property’s fair market value if Section 334(b)(1)(A) would otherwise provide that the aggregate adjusted basis of such importation property would exceed its fair market value immediately after the liquidation.

The final regulations generally adopt the proposed regulations, which provided specific rules to implement the statutory framework of the previously mentioned anti-loss importation provisions. For example, the regulations provide rules for identifying importation property and for determining whether the transfer of such importation property occurs in a transaction subject to the anti-loss importation provisions.

Based on comments received, Treasury and the IRS clarified in the preamble and the final regulations several issues involving partnerships. For example, the final regulations clarify that the partnership agreement, as well as any applicable rules of law are taken into account in determining which partner an item would be allocated in a hypothetical sale. The final regulations also clarify that generally accepted conventions in determining allocable income will be respected in determining whether there is an importation of loss for publicly traded partnerships. Finally, the preamble also clarifies the application of the aggregate and entity principles in certain examples adopted in the final regulations.

Commenters noted there was a “cliff effect” and resulting potential to avoid the anti-loss importation provisions related to certain transactions involving tax-exempt entities. Accordingly, the final regulations adopt an approach that treats debt-financed property as subject to federal income tax in proportion to the amount of such gain or loss that could be included in the tax-exempt transferor’s unrelated business taxable income on a sale under Sections 511-514. The final regulations provide that portions of property determined under this rule are generally treated under the anti-loss importation provisions in the same way as portions of property tentatively divided to reflect multiple owners of gain or loss on the property.    

The regulations also adopt, in part and without change, proposed regulations (REG-163314-03) issued in March 2005 regarding amendments that reflect statutory changes to Sections 332 and 351.

The final regulations generally apply to transactions occurring on or after March 28, 2016, unless completed according to a binding agreement already in effect. The final regulations also apply to certain transactions occurring before March 28, 2016, resulting from a retroactive entity classification election filed after March 28, 2016.

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