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Bulletin No. 1997–7
February 18, 1997

HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be relied
upon as authoritative interpretations.

INCOME TAX
Rev. Rul. 97–8, page 4.
LIFO; price indexes; department stores. The December 1996 Bureau of Labor Statistics price indexes are
accepted for use by department stores employing the
retail inventory and last-in, first-out inventory methods
for valuing inventories for tax years ended on, or with
reference to, December 31, 1996.
T.D. 8700, page 5.
Final regulations under section 475 of the Code provide
guidance to enable taxpayers to comply with the mark-tomarket requirements applicable to dealers in securities.
T.D. 8701, page 23.
Final regulations provide rules for making the deemed
sale and deemed dividend elections under section 1291
of the Code.
T.D. 8707, page 17.
Final regulations under section 731 of the Code provide
rules for partnership distributions of marketable securities and for determining when those distributions are
taxable to the distributee partner.
REG–209040–88, page 34.
Proposed regulations under section 1295 permit certain
shareholders to make a special election, in lieu of the
election currently provided for under that section, for
certain preferred shares of a passive foreign investment
company (PFIC). A public hearing will be held on May 8,
1997.
REG–209817–96, page 41.
Proposed regulations under section 7701 of the Code
relate to the treatment of certain multiple-party financing

Finding Lists begin on page 59.
Announcement of Disbarments and Suspensions begins on page 57.

transactions in which one party realizes income from
leases or similar agreements and another party claims
deductions related to that income. A public hearing will
be held on April 29, 1997.
REG–249819–96, page 50.
Proposed regulations under sections 354, 355, and 356
of the Code relate to exchanges of stock and securities
in certain reorganizations. A public hearing will be held
on March 25, 1997.
REG–252231–96, page 52.
Proposed regulations under section 368 of the Code
provide that the continuity of shareholder interest requirement for corporate reorganizations is satisfied if
the acquiring corporation furnishes consideration which
represents a proprietary interest in the affairs of the
acquiring corporation and such consideration represents
a substantial part of the value of the stock or properties
transferred. A public hearing will be held on May 7,
1997.

EXEMPT ORGANIZATIONS
Announcement 97–12, page 55.
A list is given of organizations now classified as private
foundations.

ADMINISTRATIVE
T.D. 8698, page 29.
Final regulations under section 6231 of the Code
provide guidance necessary for the designation or selection of a tax matters partner for partnerships, including
limited liability companies classified as partnerships.

Mission of the Service
The purpose of the Internal Revenue Service is to
collect the proper amount of tax revenue at the least
cost; serve the public by continually improving the

quality of our products and services; and perform in a
manner warranting the highest degree of public
confidence in our integrity, efficiency and fairness.

Statement of Principles
of Internal Revenue
Tax Administration
The Service also has the responsibility of applying
and administering the law in a reasonable,
practical manner. Issues should only be raised by
examining of ficers when they have merit, never
arbitrarily or for trading purposes. At the same
time, the examining officer should never hesitate
to raise a meritorious issue. It is also important
that care be exercised not to raise an issue or to
ask a court to adopt a position inconsistent with
an established Service position.

The function of the Internal Revenue Service is to
administer the Internal Revenue Code. Tax policy
for raising revenue is determined by Congress.
With this in mind, it is the duty of the Service to
carry out that policy by correctly applying the laws
enacted by Congress; to determine the reasonable
meaning of various Code provisions in light of the
Congressional purpose in enacting them; and to
perform this work in a fair and impartial manner,
with neither a government nor a taxpayer point of view.

Administration should be both reasonable and
vigorous. It should be conducted with as little
delay as possible and with great cour tesy and
considerateness. It should never try to overreach,
and should be reasonable within the bounds of law
and sound administration. It should, however, be
vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax
devices and fraud.

At the heart of administration is interpretation of the
Code. It is the responsibility of each person in the
Service, charged with the duty of interpreting the
law, to try to find the true meaning of the statutory
provision and not to adopt a strained construction in
the belief that he or she is ‘‘protecting the revenue.’’
The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

2

Introduction
The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for
announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation,
court decisions, and other items of general interest. It is
published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin
contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold on a
single-copy basis.

court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are
cautioned against reaching the same conclusions in
other cases unless the facts and circumstances are
substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on
provisions of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all
substantive rulings necessary to promote a uniform
application of the tax laws, including all rulings that
supersede, revoke, modify, or amend any of those
previously published in the Bulletin. All published rulings
apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management
are not published; however, statements of internal
practices and procedures that affect the rights and
duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows:
Subpart A, Tax Conventions, and Subpart B, Legislation
and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and
Subparts. Also included in this part are Bank Secrecy
Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the
Treasury’s Office of the Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts
stated in the revenue ruling. In those based on positions
taken in rulings to taxpayers or technical advice to
Service field offices, identifying details and information
of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory
requirements.

Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in
this part, none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not
have the force and effect of Treasury Department
Regulations, but they may be used as precedents.
Unpublished rulings will not be relied on, used, or cited
as precedents by Service personnel in the disposition of
other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,

The first Bulletin for each month includes an index for
the matters published during the preceding month.
These monthly indexes are cumulated on a quarterly and
semiannual basis, and are published in the first Bulletin
of the succeeding quarterly and semi-annual period,
respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 472.—Last-in, First-out
Inventories
26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department
stores. The December 1996 Bureau of
Labor Statistics price indexes are accepted for use by department stores
employing the retail inventory and lastin, first-out inventory methods for valuing inventories for tax years ended on,
or with reference to, December 31,
1996.

Rev. Rul. 97–8
The following Department Store Inventory Price Indexes for December
1996 were issued by the Bureau of
Labor Statistics on January 14, 1997.
The indexes are accepted by the Internal
Revenue Service, under § 1.472–1(k) of
the Income Tax Regulations and Rev.
Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of
department stores employing the retail
inventory and last-in, first-out inventory

methods for tax years ended on, or with
reference to, December 31, 1996.
The Department Store Inventory Price
Indexes are prepared on a national basis
and include (a) 23 major groups of
departments, (b) three special combinations of the major groups - soft goods,
durable goods, and miscellaneous goods,
and (c) a store total, which covers all
departments, including some not listed
separately, except for the following:
candy, foods, liquor, tobacco, and contract departments.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE
INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS
(January 1941 = 100, unless otherwise noted)

Groups
1. Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2. Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . . .
3. Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . . .
4. Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5. Infants’ Wear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6. Women’s Underwear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7. Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8. Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . . .
9. Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . . .
10. Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11. Men’s Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12. Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . . . .
13. Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14. Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15. Toilet Articles and Drugs. . . . . . . . . . . . . . . . . . . . . . . . . . .
16. Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
17. Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
18. Housewares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19. Major Appliances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20. Radio and Television . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21. Recreation and Education2 . . . . . . . . . . . . . . . . . . . . . . . . . .
22. Home Improvements2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
23. Auto Accessories2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Groups 1 - 15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Groups 16 - 20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . . .
Groups 21 - 23: Misc. Goods2 . . . . . . . . . . . . . . . . . . . . . . . . . .
Store Total3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Dec.
1995

Dec.
1996

Percent Change
from Dec. 1995
to Dec. 19961

532.6
633.5
625.6
891.0
635.6
521.6
290.2
559.9
407.1
602.1
561.6
481.8
978.1
773.6
870.8
669.0
564.5
782.3
246.1
79.1
112.8
123.7
107.5
585.1
462.2
113.3
543.7

538.7
636.6
646.0
894.2
616.8
527.1
287.2
556.4
404.4
610.8
578.6
483.5
965.3
779.4
904.3
664.6
574.8
806.1
245.3
78.1
110.8
132.2
107.3
589.8
466.6
112.9
547.4

1.1
0.5
3.3
0.4
23.0
1.1
21.0
20.6
20.7
1.4
3.0
0.4
21.3
0.7
3.8
20.7
1.8
3.0
20.3
21.3
21.8
6.9
20.2
0.8
1.0
20.4
0.7

1

Absence of a minus sign before percentage change in this column signifies price increase.
Indexes on a January 1986=100 base.
3
The store total index covers all departments, including some not listed separately, except for the following: candy, foods, liquor, tobacco, and contract
departments.
2

DRAFTING INFORMATION
The principal author of this revenue
ruling is Stan Michaels of the Office of

Assistant Chief Counsel (Income Tax
and Accounting). For further information
regarding this revenue ruling, contact

4

Mr. Michaels on (202) 622-4970 (not a
toll-free call).

Section 475.—Mark to Market
Accounting Method for Dealers in
Securities
26 CFR 1.475(c)–1: Definitions—dealers in securities.

T.D. 8700
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Mark to Market for Dealers in
Securities
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regulations.
SUMMARY: This document contains final regulations providing guidance to
enable taxpayers to comply with the
mark-to-market requirements applicable
to dealers in securities. The Revenue
Reconciliation Act of 1993 amended the
applicable tax law. These regulations
provide guidance to dealers in securities.
DATES: These final regulations are effective December 24, 1996, except paragraph (a) of § 1.475(c)–1T is removed
effective December 24, 1996, and the
remainder of § 1.475(c)–1T is removed
effective January 23, 1997.
For dates of applicability, see
§ 1.475(e)–1.
FOR FURTHER INFORMATION
CONTACT: Robert B. Williams at
(202) 622–3960 or Jo Lynn Ricks at
(202) 622–3920 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control number
1545–1496. Responses to this collection
of information are required for a taxpayer to obtain the benefit of an exemption from marking to market under
section 475 for those securities (see
§ 1.475(b)–2) and for a consolidated
group of taxpayers to obtain the benefit
of treating inter-member transactions as
customer transactions for purposes of
the definition of dealer in securities (the
intragroup-customer election, § 1.475(c)–1(a)(3)(iii)).
An agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information
unless the collection of information displays a valid control number.
The estimated annual burden per
recordkeeper regarding § 1.475(b)–2
varies from .25 to 3 hours, depending
on individual circumstances, with an
estimated average of 1 hour. Section
1.475(b)–4 (formerly § 1.475(b)–2T),
which permitted a taxpayer to add or
remove certain identifications on or before January 31, 1994, does not impose
a recordkeeping burden into the future.
The estimated burden per respondent in
making the intragroup-customer election
in §§ 1.475(c)–1(a)(3)(iii) varies from
.25 to 1 hours, depending on individual
circumstances, with an estimated average of .5 hours.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to
the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, T:FP,
Washington, DC 20224, and to the Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503.
Books or records relating to this collection of information must be retained
as long as their contents may become
material in the administration of any
internal revenue law. Generally, tax returns and tax return information are
confidential, as required by 26 U.S.C.
6103.

dealer in securities, and held for investment. Various comments were received
regarding those regulations, and a hearing was held on April 12, 1994.
Additional regulations were proposed
on January 4, 1995 (60 FR 397) (hereinafter sometimes referred to as the 1995
proposed regulations), and on June 20,
1996 (61 FR 31474) (hereinafter sometimes referred to as the 1996 proposed
regulations). The 1995 and 1996 proposed regulations supplemented, and in
a few cases revised, the 1993 proposed
regulations. Hearings on the 1995 and
1996 proposed regulations were held on
May 3, 1995, and October 15, 1996,
respectively.
The final regulations in this document
generally adopt the 1993 proposed regulations, as revised by the 1995 and 1996
proposed regulations, with certain
changes reflecting comments that were
received. These final regulations also
adopt additional portions of the 1995
proposed regulations. The sections that
are not adopted at this time remain
proposed.
The provisions governing mark to
market of debt instruments, which were
proposed in January 1995, attracted substantial comment. The IRS and Treasury
intend to finalize those regulations in a
substantially revised form in response to
those taxpayer comments.

Background

The final regulations adopt without
change the provisions in the 1995 proposed regulations that provide rules for
situations where a dealer in securities
receives a security with a basis in its
hands that is determined, in whole or in
part, either by reference to the basis of
the security in the hands of the
transferor or by reference to other property held at any time by the dealer. In
these cases, section 475(a) applies only
to post-acquisition gain and loss with
respect to the security. That is, section
475(a) applies only to changes in value
of the security occurring after its acquisition. See section 475(b)(3). The character of the mark-to-market gain or loss
is determined as provided under section
475(d)(3). The character of preacquisition gain or loss (that is, the
built-in gain or loss at the date the
dealer acquires the security) and the
time for taking that gain or loss into
account are determined without regard
to section 475. The fact that a security

This document contains final regulations under section 475 (relating to
mark-to-market accounting for dealers in
securities). Section 475 was added by
section 13223 of the Revenue Reconciliation Act of 1993, Public Law 103–66,
107 Stat. 481, and is effective for all
taxable years ending on or after December 31, 1993.
On December 29, 1993, temporary
regulations (T.D. 8505, [1994–1 C.B.
152] 58 FR 68747) (hereinafter sometimes referred to as the temporary regulations) and cross-referenced proposed
regulations (FI–72–93, 58 FR 68798)
(hereinafter sometimes referred to as the
1993 proposed regulations) were published to furnish guidance on several
issues, including the scope of exemptions from the mark-to-market requirements, certain transitional issues relating
to the scope of exemptions, and the
meaning of the statutory terms security,

5

Explanation of Provisions
Acquisition by a dealer of a security
with a substituted basis

has a substituted basis in the dealer’s
hands does not affect the security’s date
of acquisition for purposes of determining the timeliness of an identification
under section 475(b).
Scope of Exemptions From Mark-ToMarket Requirement
Section 475(b) exempts certain securities from mark-to-market accounting under section 475(a). Among the exempted
securities are those held for investment
and debt securities not held for sale.
Section 1.475(b)–1(a) of the regulations,
like the temporary rule that preceded it,
provides that held for investment, as
used in section 475(b)(1)(A), and not
held for sale, as used in section
475(b)(1)(B), have the same meaning.
The regulations provide that both terms
refer to a security that is not held by a
taxpayer primarily for sale to customers
in the ordinary course of the taxpayer’s
trade or business. By providing that a
security is held for investment (or not
held for sale) if it is not held primarily
for sale to customers in the ordinary
course of a trade or business, the regulations adopt the concept of held for
investment in section 1236(a). Thus,
under these regulations, a dealer in
securities may identify as held for investment a security that it holds primarily for sale to non-customers (for example, a trading security). The IRS and
the Treasury believe that providing a
single standard for purposes of sections
475 and 1236 is consistent with the
purpose of section 475. These rules
apply to taxable years ending on or after
December 31, 1993.
The final regulations require a taxpayer that identifies a security as exempt from being marked to market to
state (on its books and records) whether
the security is, on the one hand, exempt
as held for investment or not held for
sale or, on the other hand, exempt
because it is a hedge of an item not
subject to mark to market. This regulation applies to identifications made on
or after July 1, 1997.
The temporary and 1993 proposed
regulations provide that stock in a 50percent-controlled subsidiary, and interests in 50-percent-controlled partnerships and trusts, are deemed properly
identified as held for investment and
thus are excluded from mark-to-market
accounting. The 1996 proposed regulations reproposed this rule with two
changes. First, the IRS believed that the
rationale for the rule applies equally to

equity interests in most related persons
and not just to persons controlled by the
taxpayer. Second, after considering various comments received, the IRS proposed that this rule prohibiting marking
a security to market should not apply if
two requirements are met: (1) the security is actively traded on a national
securities exchange or through an
interdealer quotation system; and (2) the
taxpayer who marks owns less than 5
percent of all shares or interests of the
same class. Comments were requested
as to whether it is appropriate to allow
any equity interests in related parties to
be marked to market, and, if so, whether
the proposed limitations are the most
appropriate ones.
After considering the comments received in response, the IRS and the
Treasury have decided to adopt the
provisions in the 1996 proposed regulations with certain modifications. First,
the general threshold above which even
actively traded stock in a related party
may not be marked to market has been
increased from 5% to 15%. The 15%
limit, however, includes shares held both
by the dealer and by certain related
parties. Second, shares that a dealer
acquires from a related party cannot be
marked to market unless, after the time
they were acquired, both one full business day has passed and there has been
significant trading in the security involving persons who are not related to the
taxpayer.
Section 475(b)(3) applies when a security has been exempt from marking to
market and the exemption then ceases to
apply. Thus, changes in a security’s
value that occur while section 475(a)
does not apply are suspended. This rule
has additional significance for certain
members of consolidated groups because
§ 1.1502–13(f)(6) disallows certain
losses recognized by members of consolidated groups on common parent
stock if the loss is not taken into
account pursuant to section 475(a).
The final regulations provide that,
except as determined by the Commissioner, notional principal contracts and
derivative securities described in section
475(c)(2)(D) or (E) that are held by a
dealer in those securities are not eligible
to be exempted from mark-to-market
treatment as held for investment.
Under the temporary and 1993 proposed regulations, however, an analogous barrier to exemption from mark-tomarket treatment did not apply if the
taxpayer established unambiguously that
the security was acquired other than in

6

the taxpayer’s capacity as a dealer in
such securities. It was anticipated that
this exception would apply only in rare
instances. Commenters suggested an
easing of the standard for establishing
that a security was acquired other than
in the taxpayer’s capacity as a dealer in
such securities.
These suggestions are specifically rejected in the final regulations set forth
in § 1.475(b)–1(c). Instead, as described
above, to avoid uncertainty and ambiguity, the rule barring exemption from
mark-to-market treatment for certain notional principal contracts and derivative
securities applies unless the Commissioner explicitly determines otherwise.
For securities acquired or entered into
before January 23, 1997, however, the
final regulations continue the rule found
in the temporary regulations.
Commenters suggested that changes
are needed to allow taxpayers that are
dealers in notional principal contracts
and derivative securities (described in
section 475(c)(2)(D) or (E)) to identify
as exempt from mark-to-market treatment a notional principal contract or
derivative that is held as a hedge of a
position that is not marked to market.
No change was made to the temporary regulations to reflect these comments because none was necessary. Section 1.475(b)–1(c) limits exemptions
only under section 475(b)(1)(A) (concerning securities held for investment).
Section 1.475(b)–1(c) does not limit
exemptions under section 475(b)(1)(C)
(concerning securities that are hedges of
non-mark-to-market positions). Although
the flush language at the end of section
475(b)(1) authorizes analogous regulatory limitations on exemption under section 475(b)(1)(C), as of this time, no
such regulation has been issued or proposed. Accordingly, if a dealer in notional principal contracts or derivatives
enters into a notional principal contract
or derivative as a hedge of a position
that is not marked to market, the dealer
may properly identify it under section
475(b)(1)(C) as exempt from mark-tomarket treatment.
In response to comments, the final
regulations expand the securities that a
taxpayer may identify under section
475(b)(1)(C) as exempt from mark-tomarket accounting. Under the final regulations, a taxpayer can identify as exempt from mark-to-market treatment
under section 475(b)(1)(C) a security
that hedges a position of another member of the taxpayer’s consolidated group
and meets the following three require-

ments: the security is a hedging transaction within the meaning of § 1.1221–
2(b); the security is timely identified as
a hedging transaction under § 1.1221–
2(e) (including satisfaction of the requirement that the hedged item be identified); and the security hedges a
position that is not marked to market
under section 475(a). Although identification of the hedged item is not required
under § 1.1221–2 until some time after
the day the hedging transaction is entered into, the identification of the hedge
under section 475(b)(2) must still be
made no later than the close of the day
on which the hedge is acquired, originated, or entered into.
Permitting taxpayers to identify these
securities as exempt from mark-tomarket accounting is consistent with the
single-entity approach of the consolidated group hedging regulations under
§ 1.1221–2(d)(1). As a result of the
identification, the timing of the gain or
loss on the hedge is matched with the
timing of the gain or loss on the hedged
item without forcing taxpayers to use
back-to-back hedges and the separateentity election under § 1.1221–2(d)(2).
This rule is effective for hedges entered
into on or after January 23, 1997.
Exemptions—Transitional Issues
The final regulations adopt without
substantive change a number of transitional rules relating to various exemption and identification issues. These
transitional rules, now found in
§ 1.475(b)–4, were contained in
§ 1.475(b)–2T of the temporary regulations. A more complete description of
these provisions may be found in the
preamble of T.D. 8505 at 58 FR 68747
(1994–1 C.B. 152).
Dealer in Securities—the
Customer Relationship

Dealer-

The final regulations retain the rules
in the 1995 proposed regulations concerning the dealer-customer relationship.
Thus, the final regulations provide that
determination of whether a transaction is
with a customer is based on all of the
facts and circumstances. Further, under
section 475(c)(1)(B), the term dealer in
securities includes a taxpayer that, in the
ordinary course of its trade or business,
regularly holds itself out as being willing and able to enter into either side of
a transaction enumerated in section
475(c)(1)(B).
The final regulations retain the general rule in the 1996 proposed regula-

tions that transactions with related persons may be transactions with customers
for purposes of section 475. In response
to comments, however, in § 1.475(c)–
1(a)(3) the final regulations provide both
a special rule for members of a consolidated group and an election for the rule
not to apply. If the special rule applies,
then, solely for purposes of determining
whether the taxpayer meets the definition of a dealer in securities, a taxpayer’s transactions with other members of
its consolidated group are not transactions with customers. Thus, a member
whose only customers are other members of its consolidated group generally
is not a dealer in securities. Treating
intragroup transactions as noncustomer
transactions is consistent with the
single-entity approach of §§ 1.1221–
2(d)(1) and 1.1502–13. (The IRS expects to provide additional guidance on
whether there are any circumstances in
which the special rule applies for other
purposes, such as whether a security
may be exempted from mark-to-market
treatment because it is not held for sale
to customers.)
A consolidated group may elect not to
apply the special rule. If a group has
made this intragroup customer election,
a member of a group may be a dealer in
securities even if its only customer
transactions are with other members of
its consolidated group. Once made, the
election continues for all subsequent
taxable years and may be revoked only
with the consent of the Commissioner.
These final regulations significantly
alter the proposed default rule for
intragroup transactions. Under the proposed regulations, a taxpayer’s
intragroup transactions would have been
customer transactions for purposes of
section 475. Because the final regulations reverse this rule (making
noncustomer status the default and requiring an affirmative election to consider intragroup transactions in applying
the dealer definition), the rules for
intragroup transactions are effective for
taxable years beginning on or after
December 24, 1996. (The general rule
for related party transactions other than
intragroup transactions is effective for
taxable years beginning on or after June
20, 1996.) The IRS will soon publish
guidance to assist taxpayers who may
have to change their methods of accounting because their status as a dealer
changes as a result of the application of
§ 1.475(c)–1(a)(3).
For prior years, the Service generally
will not challenge a taxpayer’s treatment

7

of intragroup transactions as customer or
noncustomer transactions, provided the
taxpayer had a reasonable basis for its
treatment of the transactions and consistently applied that basis from year to
year. In this regard, a taxpayer does not
fail this consistency requirement solely
because it changed its treatment of its
intragroup transactions in order: (1) to
avail itself of the separate-entity election
under the consolidated group hedging
regulations, or (2) to coincide with the
expected effective date of either Notice
96–12 (1996–10 I.R.B. 29) or the related party rules in the 1996 proposed
regulations. (If a taxpayer wishes to
change its treatment of prior open years
to be consistent with its status during
the first year that § 1.475(c)–1(a)(3)
applies, see § 301.9100–1T(a).)
Dealer in Securities—Sellers of Nonfinancial Goods and Services
In general, the final regulations exclude from dealer status any taxpayer
that would not be a dealer in securities
but for its purchases and sales of debt
instruments that, at the time of purchase
or sale, are customer debt with respect
to the taxpayer or another member of
the taxpayer’s consolidated group. A
debt instrument is customer debt at a
particular time with respect to a person
if three conditions are met: (1) the
person’s principal activity is selling
nonfinancial goods or providing
nonfinancial services; (2) the debt instrument was issued by a purchaser of
the goods or services at the time of
purchase of those items in order to
finance their purchase; and (3) at all
times after the debt instrument was
issued, it has been owned by the person
who sold the goods or services or by a
member of its consolidated group. If,
however, a taxpayer is a dealer in
securities despite this provision, customer debt remains a security in the
taxpayer’s hands and must be marked to
market unless exempted by another rule.
The temporary regulations contain a
narrower provision—that a seller of
nonfinancial goods or services is not a
dealer in securities for purposes of section 475 solely by virtue of extending
credit to its nonfinancial customers
(even if it sells the debt instruments so
acquired). In response to comments, the
final regulations extend this principle to
accommodate consolidated groups that
include both a seller of nonfinancial
goods or services and a captive finance
subsidiary.

The rule in the final regulations exempting from dealer status most captive
finance subsidiaries of retailers and
other sellers of nonfinancial goods and
services applies to all taxable years
ending on or after December 31, 1993,
unless the taxpayer elects for the exemption not to apply. If the election is
made, it continues for all subsequent
taxable years and may be revoked only
with the consent of the Commissioner.
Under the final regulations, there are
two additional circumstances in which
this exemption from dealer status does
not apply. The first is when, for purposes of the inventory accounting rules
under section 471, the taxpayer accounts
for any security (as defined in section
475(c)(2)) as inventory. The second circumstance is when the taxpayer is not
itself the seller of nonfinancial goods
and services and the customer debt is
accounted for by the taxpayer or by a
member of its consolidated group under
a method that permits either the recognition of unrealized gains or losses or
deductions for additions to a reserve for
bad debts. This rule does not affect the
seller of nonfinancial goods and services
itself but is designed to prevent groups
from having one captive finance subsidiary that is treated as a nondealer and
another member of the group that is a
dealer or a financial institution that
accounts for customer debt under a
method that takes into account mark-tomarket gains or losses or reserve deductions.
Dealer in Securities—the Negligible
Sales Exemption
Under the final regulations, in general, if a taxpayer purchases securities
from customers (including originating
loans in the ordinary course of the
taxpayer’s trade or business of originating loans) but engages in no more than
negligible sales of the securities so
acquired, the purchases do not cause the
taxpayer to be a dealer in securities.
This negligible sales rule does not apply
if the taxpayer so elects or accounts for
any security as inventory for purposes
of section 471. A taxpayer that would be
a dealer in securities but for the negligible sales rule elects to be a dealer
simply by filing a federal income tax
return reflecting the application of section 475(a) in computing its taxable
income. The final regulations differ
from the proposed regulations by explicitly making the negligible sales rule
elective.

In response to comments, the final
regulations clarify the test for determining negligible sales of debt instruments
acquired from customers. Under this
rule, a taxpayer has engaged in no more
than negligible sales of the debt instruments (or portions of the debt instruments) that it regularly purchases from
customers in the ordinary course of its
business if, and only if, during the year,
either (1) it sells all or part of fewer
than 60 debt instruments (regardless
how acquired), or (2) the total adjusted
basis of the debt instruments or portions
of debt instruments (regardless how acquired) that it sells is less than 5 percent
of the total basis, immediately after
acquisition, of the debt instruments that
it acquires during the year.
This special test replaces the examples in the temporary regulations illustrating the negligible sales provision.
Some
commenters
noted
that
§ 1.475(c)–1T(b)(2) Example 1 of the
temporary regulations is ambiguous because it refers to a taxpayer that both
‘‘retains almost all of the loans that it
acquires’’ and ‘‘sells fewer than 60
loans.’’ The final regulations eliminate
the ambiguity by making no reference to
how many loans are retained.
In response to comments, the final
regulations contain two special rules for
applying the negligible sales test to
members of a consolidated group. Under
the first rule, if a taxpayer is a member
of a consolidated group that has made
the intragroup-customer election, described above, it must apply the negligible sales test for debt instruments by
taking into account all of its sales of
debt instruments to other group members. On the other hand, if the taxpayer
is a member of a consolidated group
that has not made the intragroupcustomer election, the negligible sales
test is satisfied if either of two criteria is
met: first, if the taxpayer satisfies the
negligible sales test, taking into account
all sales of debt instruments including
sales to other group members; or second, if the taxpayer’s consolidated group
would satisfy the test if it were a single
corporation and the members of the
group were divisions of that corporation.
This group-wide approach to the negligible sales test is consistent with the
single-entity approach of §§ 1.1221–
2(d)(1) and 1.1502–13.
Under a new rule in the final regulations, if a debt instrument is qualitatively different from all of the debt
instruments that the taxpayer purchases
from customers, a sale of that debt

8

instrument does not count as one of the
60 instruments sold, and that debt instrument is not included in either the
numerator or the denominator under the
5% test. The regulations contain an
example that illustrates this principle.
The rules regarding the negligible
sales exemption are generally effective
for taxable years ending on or after
December 31, 1993. The special rules
for members of a consolidated group,
however, are effective for taxable years
beginning on or after January 23, 1997.
Further, a taxpayer may rely on the
rules set out in § 1.475(c)–1T(b) (as
contained in 26 CFR part 1 revised
April 1, 1996) for taxable years beginning before January 23, 1997, provided
the taxpayer applies that paragraph reasonably and consistently.
Dealer in Securities—Issuance of Life
Insurance Products
The final regulations adopt without
change a provision in the 1995 proposed
regulations to clarify that a life insurance company does not become a dealer
in securities solely by selling annuity,
endowment, or life insurance contracts
to its customers.
Under the final regulations and the
December 28, 1993, proposed regulations, a contract that is treated for
federal income tax purposes as an annuity, endowment, or life insurance contract is deemed to have been identified
as held for investment, and is therefore
not marked to market by the policy
holder. This rule was necessary because
variable life and annuity products fall
within the literal language of section
475(c)(2)(E). Because many life insurance companies sell these insurance
contracts to their customers, some commenters on the 1993 proposal had asked
whether these life insurance companies
were dealers in securities. There is no
indication that Congress intended for a
life insurance company that was not
otherwise a dealer in securities to be
characterized as a dealer merely because
it sells life insurance policies to its
customers.
Several commenters requested that
certain activities not cause dealer status
under section 475 because those activities, although described by section 475,
traditionally had not been considered
dealer activities. Those comments were
generally rejected. Congress determined
that section 475 would bestow dealer
status on taxpayers who had not been
thought of as dealers prior to the enact-

ment of section 475. Thus, the final
regulations do not adopt proposals that
making and selling policy loans should
not cause an insurance company to be a
dealer in securities and that sales of
student loans or auto loans and sales of
loan participations should not be taken
into account in determining whether a
taxpayer is a dealer in securities. Of
course, if a lead bank never owns a
particular portion of a loan for tax
purposes (because some other participating lender always had the economic
benefits and burdens of that portion),
then the lead bank cannot sell that
portion to that other participating lender.
Thus, the lead bank is not a dealer in
securities by reason of these participations.
Definition of Security
Under the final regulations, certain
items are not securities within the meaning of section 475(c)(2). These items
include both debt issued by the taxpayer
and any security (determined without
regard to this provision) if section 1032
bars recognition of gain or loss by the
taxpayer with respect to that security.
The final regulations adopt without
change the provisions in the 1995 proposed regulations that exclude from the
definition of security all REMIC residual interests acquired on or after
January 4, 1995. This rule was adopted
because applying section 475 to residual
interests would undermine the Congressional design for taxing REMIC income,
including the intended operation of sections 860C and 860E (relating to excess
inclusions).
Unlike the 1995 proposed regulations,
the temporary regulations excluded only
some residual interests from the definition of security. Specifically, the temporary regulations excluded only negative
value residual interests (NVRIs) in a
REMIC and other arrangements that are
determined to have substantially the
same economic effect as NVRIs. Under
the final regulations, this exclusion continues to apply to NVRIs acquired before January 4, 1995.
One commenter acknowledged the
tension between mark-to-market accounting and the excess inclusion rules,
but proposed to address that problem in
another way. Under the commenter’s
proposal, a dealer would be permitted to
mark to market a residual interest, but
any loss resulting from the mark would
be taken into account only to the extent
that the loss exceeded the amount of

excess inclusion with respect to that
residual interest for the taxable year.
The IRS and Treasury believe that
this comment does not address the tension between mark-to-market accounting
and section 860C. Apart from the excess
inclusion rules, the REMIC provisions
contemplate income inclusions (and corresponding basis increases) that are not
necessarily associated with increases in
the value of the residual interest. Under
the commenter’s proposal, a dealer
could claim a loss by marking to market
a residual interest where the increased
basis in the interest resulted from an
allocation of REMIC income that was
unaccompanied by an increase in value.
Thus, the dealer could avoid its allocable share of REMIC income and
thereby frustrate the taxing regime contemplated for residual interests.
Moreover, adopting this comment
would require additional, complex rules,
and the burden of administering those
rules would not be justified by the
potential benefit. For example, under the
proposal, a taxpayer would have one
basis in a residual interest for purposes
of section 475 and a different basis in
the residual interest for purposes of
section 860C(d). Also, adopting the proposal would require rules to coordinate
losses that are limited under section 475
with losses that are limited under section 860C(e)(2).
Some commenters suggested that certain types of assets should not be
marked to market because they may be
difficult to value. Under section 475,
however, ease of valuation is not relevant in determining whether a security
is required to be marked to market.
Character of Gain or Loss
The regulations adopt without change
the proposed provision to clarify that
marking to market a security that is not
held in connection with a taxpayer’s
activities as a dealer in securities does
not affect the character of gain or loss
from that security.
In addition, under a new provision in
the final regulations that responds to
comments from taxpayers, if a dealer in
certain notional principal contracts or
derivative securities (described in section 475(c)(2)(D) or (E)) marks those
securities to market because it is precluded from identifying them as exempt
from mark-to-market treatment on the
grounds that they are held for invest-

9

ment, the dealer recognizes ordinary
gain or loss with respect to those securities.
Effective Dates
These final regulations generally apply to taxable years ending on or after
December 31, 1993, except as otherwise
noted.
Miscellaneous
Some of the 1993 and 1995 proposed
regulations are reordered.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations. The collection of information required by
§ 1.475(b)–2 was contained in a notice
of proposed rulemaking preceding these
regulations that was issued prior to
March 29, 1996. Moreover, it is hereby
certified that the collection of information required by § 1.475(c)–1 of these
regulations (regarding the intragroup
customer election) does not have a significant economic impact on a substantial number of small entities. This certification is based upon the fact that the
election is generally attractive only to an
affiliated group of taxpayers that files a
consolidated return (generally large
businesses), that has elected separate
entity treatment under § 1.1221–2, and
that has an in-house hedge center or
securities dealer which deals solely with
other group members and which uses
mark-to-market accounting for book
purposes. Thus, the election is likely to
be made only by, and the collection of
information applies only to, a very small
number of large taxpayers. Therefore, a
Regulatory Flexibility Analysis under
the Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was submitted to the Small Business Administration
for comment on its impact on small
business.
Drafting Information
The principal authors of these regulations are Robert B. Williams and Jo
Lynn Ricks, Office of Assistant Chief

Counsel (Financial Institutions and
Products), IRS. However, other personnel from the IRS and Treasury Department participated in their development.
*

*

*

*

*

26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by removing the
entries for §§ 1.475(b)–1T, 1.475(b)–2T,
1.475(c)–1T, 1.475(c)–2T, 1.475(d)–1T,
and 1.475(e)–1T and adding entries in
numerical order to read as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.475(a)–3 also issued under
26 U.S.C. 475(e).
Section 1.475(b)–1 also issued under
26 U.S.C. 475(b)(4) and 26 U.S.C.
475(e).
Section 1.475(b)–2 also issued under
26 U.S.C. 475(b)(2) and 26 U.S.C.
475(e).
Section 1.475(b)–4 also issued under
26 U.S.C. 475(b)(2), 26 U.S.C. 475(e),
and 26 U.S.C. 6001.
Section 1.475(c)–1 also issued under
26 U.S.C. 475(e).
Section 1.475(c)–2 also issued under
26 U.S.C. 475(e) and 26 U.S.C.
860G(e).
Section 1.475(d)–1 also issued under
26 U.S.C. 475(e).
Section 1.475(e)–1 also issued under
26 U.S.C. 475(e). * * *
Sections 1.475(b)–1T, 1.475(b)–2T,
1.475(c)–1T, 1.475(c)–2T, 1.475(d)–1T,
and 1.475(e)–1T [Removed]
Par.
2. Sections
1.475(b)–1T,
1.475(b)–2T, 1.475(c)–2T, 1.475(d)–1T,
and 1.475(e)–1T are removed.
Par. 2a. Paragraph (a) of § 1.475(c)–
1T is removed effective December 24,
1996, and the remainder of § 1.475(c)–
1T is removed January 23, 1997.
Par. 3. Sections 1.475–0, 1.475(a)–3,
1.475(b)–1, 1.475(b)–(2), 1.475(b)–4,
1.475(c)–1, 1.475(c)–2, 1.475(d)–1, and
1.475(e)–1 are added to read as follows:
§ 1.475–0 Table of contents.
in

This section lists the major captions
§§ 1.475(a)–3,
1.475(b)–1,

1.475(b)–2, 1.475(b)–4, 1.475(c)–1,
1.475(c)–2, 1.475(d)–1, and 1.475(e)–1.

(3) Securities held after legging out.
§ 1.475(b)–3 [Reserved]

§ 1.475(a)–1 [Reserved]
§ 1.475(a)–2 [Reserved]
§ 1.475(a)–3 Acquisition by a dealer of
a security with a substituted basis.
(a) Scope.
(b) Rules.
§ 1.475(b)–1 Scope of exemptions from
mark-to-market requirement.
(a) Securities held for investment or
not held for sale.
(b) Securities deemed identified as
held for investment.
(1) In general.
(2) Relationships.
(i) General rule.
(ii) Attribution.
(iii) Trusts treated as partnerships.
(3) Securities traded on certain established financial markets.
(4) Changes in status.
(i) Onset of prohibition against marking.
(ii) Termination of prohibition against
marking.
(iii) Examples.
(c) Securities deemed not held for
investment; dealers in notional principal
contracts and derivatives.
(d) Special rule for hedges of another
member’s risk.
(e) Transitional rules.
(1) Stock, partnership, and beneficial
ownership interests in certain controlled
corporations, partnerships, and trusts before January 23, 1997.
(i) In general.
(ii) Control defined.
(iii) Applicability.
(2) Dealers in notional principal contracts and derivatives acquired before
January 23, 1997.
(i) General rule.
(ii) Exception for securities not acquired in dealer capacity.
(iii) Applicability.
§ 1.475(b)–2 Exemptions—identification requirements.
(a) Identification of the basis for exemption.
(b) Time for identifying a security
with a substituted basis.
(c) Integrated transactions under
§ 1.1275–6.
(1) Definitions.
(2) Synthetic debt held by a taxpayer
as a result of legging in.

10

§ 1.475(b)–4 Exemptions—transitional
issues.
(a) Transitional identification.
(1) Certain securities previously identified under section 1236.
(2) Consistency requirement for other
securities.
(b) Corrections on or before January
31, 1994.
(1) Purpose.
(2) To conform to § 1.475(b)–1(a).
(i) Added identifications.
(ii) Limitations.
(3) To conform to § 1.475(b)–1(c).
(c) Effect of corrections.
§ 1.475(c)–1 Definitions—dealer in securities.
(a) Dealer-customer relationship.
(1) [Reserved].
(2) Transactions described in section
475(c)(1)(B).
(i) In general.
(ii) Examples.
(3) Related parties.
(i) General rule.
(ii) Special rule for members of a
consolidated group.
(iii) The intragroup-customer election.
(A) Effect of election.
(B) Making and revoking the election.
(iv) Examples.
(b) Sellers of nonfinancial goods and
services.
(1) Purchases and sales of customer
paper.
(2) Definition of customer paper.
(3) Exceptions.
(4) Election not to be governed by
the exception for sellers of nonfinancial
goods or services.
(i) Method of making the election.
(A) Taxable years ending after December 24, 1996.
(B) Taxable years ending on or before December 24, 1996.
(ii) Continued applicability of an
election.
(c) Taxpayers that purchase securities
from customers but engage in no more
than negligible sales of the securities.
(1) Exemption from dealer status.
(i) General rule.
(ii) Election to be treated as a dealer.
(2) Negligible sales.
(3) Special rules for members of a
consolidated group.

(i) Intragroup-customer election in effect.
(ii) Intragroup-customer election not
in effect.
(4) Special rules.
(5) Example.
(d) Issuance of life insurance products.
§ 1.475(c)–2 Definitions—security.
(a) Items that are not securities.
(b) Synthetic debt that § 1.1275–6(b)
treats the taxpayer as holding.
(c) Negative value REMIC residuals
acquired before January 4, 1995.
(1) Description.
(2) Special rules applicable to negative value REMIC residuals acquired
before January 4, 1995.
§ 1.475(d)–1 Character of gain or loss.
(a) Securities never held in connection with the taxpayer’s activities as a
dealer in securities.
(b) Ordinary treatment for notional
principal contracts and derivatives held
by dealers in notional principal contracts
and derivatives.
§ 1.475(e)–1 Effective dates.
§ 1.475(a)–3 Acquisition by a dealer of
a security with a substituted basis.
(a) Scope. This section applies if—
(1) A dealer in securities acquires a
security that is subject to section 475(a)
and the dealer’s basis in the security is
determined, in whole or in part, by
reference to the basis of that security in
the hands of the person from whom the
security was acquired; or
(2) A dealer in securities acquires a
security that is subject to section 475(a)
and the dealer’s basis in the security is
determined, in whole or in part, by
reference to other property held at any
time by the dealer.
(b) Rules. If this section applies to a
security—
(1) Section 475(a) applies only to
changes in value of the security occurring after the acquisition; and
(2) Any built-in gain or loss with
respect to the security (based on the
difference between the fair market value
of the security on the date the dealer
acquired it and its basis to the dealer on
that date) is taken into account at the
time, and has the character, provided by
the sections of the Internal Revenue
Code that would apply to the built-in
gain or loss if section 475(a) did not
apply to the security.

§ 1.475(b)–1 Scope of exemptions from
mark-to-market requirement.
(a) Securities held for investment or
not held for sale. Except as otherwise
provided by this section and subject to
the identification requirements of section
475(b)(2), a security is held for investment (within the meaning of section
475(b)(1)(A)) or not held for sale
(within the meaning of section
475(b)(1)(B)) if it is not held by the
taxpayer primarily for sale to customers
in the ordinary course of the taxpayer’s
trade or business.
(b) Securities deemed identified as
held for investment— (1) In general.
The following items held by a dealer in
securities are per se held for investment
within the meaning of section
475(b)(1)(A) and are deemed to be
properly identified as such for purposes
of section 475(b)(2)—
(i) Except as provided in paragraph
(b)(3) of this section, stock in a corporation, or a partnership or beneficial ownership interest in a widely held or
publicly traded partnership or trust, to
which the taxpayer has a relationship
specified in paragraph (b)(2) of this
section; or
(ii) A contract that is treated for
federal income tax purposes as an annuity, endowment, or life insurance contract (see sections 72, 817, and 7702).
(2) Relationships—(i) General rule.
The relationships specified in this paragraph (b)(2) are—
(A) Those described in section
267(b)(2), (3), (10), (11), or (12); or
(B) Those described in section
707(b)(1)(A) or (B).
(ii) Attribution. The relationships described in paragraph (b)(2)(i) of this
section are determined taking into account sections 267(c) and 707(b)(3), as
appropriate.
(iii) Trusts treated as partnerships.
For purposes of this paragraph (b)(2),
the phrase partnership or trust is substituted for the word partnership in sections 707(b)(1) and (3), and a reference
to beneficial ownership interest is added
to each reference to capital interest or
profits interest in those sections.
(3) Securities traded on certain established financial markets. Paragraph
(b)(1)(i) of this section does not apply
to a security if—
(i) The security is actively traded
within the meaning of § 1.1092(d)–1(a)
taking into account only established financial
markets
identified
in
§ 1.1092(d)–1(b)(1)(i) or (ii) (describing

11

national securities exchanges and
interdealer quotation systems);
(ii) Less than 15 percent of all of the
outstanding shares or interests in the
same class are held by the taxpayer and
all persons having a relationship to the
taxpayer that is specified in paragraph
(b)(2) of this section; and
(iii) If the security was acquired (e.g.,
on original issue) from a person having
a relationship to the taxpayer that is
specified in paragraph (b)(2) of this
section, then, after the time the security
was acquired—
(A) At least one full business day has
passed, and
(B) There has been significant trading
involving persons not having a relationship to the taxpayer that is specified in
paragraph (b)(2) of this section.
(4) Changes in status—(i) Onset of
prohibition against marking—(A) Once
paragraph (b)(1) of this section begins
to apply to the security and for so long
as it continues to apply, section 475(a)
does not apply to the security in the
hands of the taxpayer.
(B) If a security has not been timely
identified under section 475(b)(2) and,
after the last day on which such an
identification would have been timely,
paragraph (b)(1) of this section begins
to apply to the security, then the dealer
must recognize gain or loss on the
security as if it were sold for its fair
market value as of the close of business
of the last day before paragraph (b)(1)
of this section begins to apply to the
security, and gain or loss is taken into
account at that time.
(ii) Termination of prohibition against
marking. If a taxpayer did not timely
identify a security under section
475(b)(2), and paragraph (b)(1) of this
section applies to the security on the last
day on which such an identification
would have been timely but thereafter
ceases to apply—
(A) An identification of the security
under section 475(b)(2) is timely if
made on or before the close of the day
paragraph (b)(1) of this section ceases to
apply; and
(B) Unless the taxpayer timely identifies the security under section 475(b)(2)
(taking into account the additional time
for identification that is provided by
paragraph (b)(4)(ii)(A) of this section),
section 475(a) applies to changes in
value of the security after the cessation
in the same manner as under section
475(b)(3).
(iii) Examples. These examples illustrate this paragraph (b)(4):

Example 1. Onset of prohibition against marking—(A) Facts. Corporation H owns 75 percent of
the stock of corporation D, a dealer in securities
within the meaning of section 475(c)(1). On
December 1, 1995, D acquired less than half of
the stock in corporation X. D did not identify the
stock for purposes of section 475(b)(2). On July
17, 1996, H acquired from other persons 70
percent of the stock of X. As a result, D and X
became related within the meaning of paragraph
(b)(2)(i) of this section. The stock of X is not
described in paragraph (b)(3) of this section
(concerning some securities traded on certain
established financial markets).
(B) Holding. Under paragraph (b)(4)(i) of this
section, D recognizes gain or loss on its X stock
as if the stock were sold for its fair market value
at the close of business on July 16, 1996, and the
gain or loss is taken into account at that time. As
with any application of section 475(a), proper
adjustment is made in the amount of any gain or
loss subsequently realized. After July 16, 1996,
section 475(a) does not apply to D’s X stock while
paragraph (b)(1)(i) of this section (concerning the
relationship between X and D) continues to apply.
Example 2. Termination of prohibition against
marking; retained securities identified as held for
investment—(A) Facts. On July 1, 1996, corporation H owned 60 percent of the stock of corporation Y and all of the stock of corporation D, a
dealer in securities within the meaning of section
475(c)(1). Thus, D and Y are related within the
meaning of paragraph (b)(2)(i) of this section.
Also on July 1, 1996, D acquired, as an investment, 10 percent of the stock of Y. The stock of Y
is not described in paragraph (b)(3) of this section
(concerning some securities traded on certain
established financial markets). When D acquired
its shares of Y stock, it did not identify them for
purposes of section 475(b)(2). On December 24,
1996, D identified its shares of Y stock as held for
investment under section 475(b)(2). On December
30, 1996, H sold all of its shares of stock in Y to
an unrelated party. As a result, D and Y ceased to
be related within the meaning of paragraph
(b)(2)(i) of this section.
(B) Holding. Under paragraph (b)(4)(ii)(A) of
this section, identification of the Y shares is timely
if done on or before the close of December 30,
1996. Because D timely identified its Y shares
under section 475(b)(2), it continues after December 30, 1996, to refrain from marking to market its
Y stock.
Example 3. Termination of prohibition against
marking; retained securities not identified as held
for investment— (A) Facts. The facts are the same
as in Example 2 above, except that D did not
identify its stock in Y for purposes of section
475(b)(2) on or before December 30, 1996. Thus,
D did not timely identify these securities under
section 475(b)(2) (taking into account the additional time for identification provided in paragraph
(b)(4)(ii)(A) of this section).
(B) Holding. Under paragraph (b)(4)(ii)(B) of
this section, section 475(a) applies to changes in
value of D’s Y stock after December 30, 1996, in
the same manner as under section 475(b)(3). Thus,
any appreciation or depreciation that occurred
while the securities were prohibited from being
marked to market is suspended. Further, section
475(a) applies only to those changes occurring
after December 30, 1996.
Example 4. Acquisition of actively traded stock
from related party—(A) Facts. Corporation P is
the parent of a consolidated group whose taxable
year is the calendar year, and corporation M, a
member of that group, is a dealer in securities
within the meaning of section 475(c)(1). Corpora-

tion M regularly acts as a market maker with
respect to common and preferred stock of corporation P. Corporation P has outstanding 2,000,000
shares of series X preferred stock, which are
traded on a national securities exchange. During
the business day on December 29, 1997, corporation P sold 100,000 shares of series X preferred
stock to corporation M for $100 per share. Subsequently, also on December 29, 1997, persons not
related to corporation M engaged in significant
trading of the series X preferred stock. At the
close of business on December 30, 1997, the fair
market value of series X stock was $99 per share.
At the close of business on December 31, 1997,
the fair market value of series X stock was $98.50
per share. Corporation M sold the series X stock
on the exchange on January 2, 1998. At all
relevant times, corporation M and all persons
related to M owned less than 15% of the outstanding series X preferred stock.
(B) Holding. The 100,000 shares of series X
preferred stock held by corporation M are not
subject to mark-to-market treatment under section
475(a) on December 29, 1997, because at that
time the stock was held for less than one full
business day and is therefore treated as properly
identified as held for investment. At the close of
business on December 30, 1997, that prohibition
on marking ceases to apply, and section 475(b)(3)
begins to apply. The built-in loss is suspended,
and subsequent appreciation and depreciation are
subject to section 475(a). Accordingly, when corporation M marks the series X stock to market at
the close of business on December 31, 1997,
under section 475(a) it recognizes and takes into
account a loss of $.50 per share. Under section
475(b)(3), when corporation M sells the series X
stock on January 2, 1998, it takes into account the
suspended loss, that is, the difference between the
$100 per share it paid corporation P for that stock
and the $99-per-share fair market value when
section 475(b)(1) ceased to be apply to the stock.
No deduction, however, is allowed for that loss.
(See § 1.1502–13(f)(6), under which no deduction
is allowed to a member of a consolidated group
for a loss with respect to a share of stock of the
parent of that consolidated group, if the member
does not take the gain or loss into account
pursuant to section 475(a).)

(c) Securities deemed not held for
investment; dealers in notional principal
contracts and derivatives—(1) Except as
otherwise determined by the Commissioner in a revenue ruling, revenue procedure, or letter ruling, section
475(b)(1)(A) (exempting from mark-tomarket accounting certain securities that
are held for investment) does not apply
to a security if—
(i) The security is described in section 475(c)(2)(D) or (E) (describing certain notional principal contracts and derivative securities); and
(ii) The taxpayer is a dealer in such
securities.
(2) See § 1.475(d)–1(b) for a rule
concerning the character of gain or loss
on securities described in this paragraph
(c).
(d) Special rule for hedges of another
member’s risk. A taxpayer may identify
under section 475(b)(1)(C) (exempting

12

certain hedges from mark-to-market accounting) a security that hedges a position of another member of the taxpayer’s consolidated group if the security
meets the following requirements—
(1) The security is a hedging transaction within the meaning of § 1.1221–
2(b);
(2) The security is timely identified
as a hedging transaction under
§ 1.1221–2(e) (including identification
of the hedged item); and
(3) The security hedges a position
that is not marked to market under
section 475(a).
(e) Transitional rules—(1) Stock,
partnership, and beneficial ownership
interests in certain controlled corporations, partnerships, and trusts before
January 23, 1997— (i) In general. The
following items held by a dealer in
securities are per se held for investment
within the meaning of section
475(b)(1)(A) and are deemed to be
properly identified as such for purposes
of section 475(b)(2)—
(A) Stock in a corporation that the
taxpayer controls (within the meaning of
paragraph (e)(1)(ii) of this section); or
(B) A partnership or beneficial ownership interest in a widely held or
publicly traded partnership or trust that
the taxpayer controls (within the meaning of paragraph (e)(1)(ii) of this section).
(ii) Control defined. Control means
the ownership, directly or indirectly
through persons described in section
267(b) (taking into account section
267(c)), of—
(A) 50 percent or more of the total
combined voting power of all classes of
stock entitled to vote; or
(B) 50 percent or more of the capital
interest, the profits interest, or the beneficial ownership interest in the widely
held or publicly traded partnership or
trust.
(iii) Applicability. The rules of this
paragraph (e)(1) apply only before January 23, 1997.
(2) Dealers in notional principal contracts and derivatives acquired before
January 23, 1997—(i) General rule.
Section 475(b)(1)(A) (exempting certain
securities from mark-to-market accounting) does not apply to a security if—
(A) The security is described in section 475(c)(2)(D) or (E) (describing certain notional principal contracts and derivative securities); and
(B) The taxpayer is a dealer in such
securities.

(ii) Exception for securities not acquired in dealer capacity. This paragraph (e)(2) does not apply if the taxpayer establishes unambiguously that the
security was not acquired in the taxpayer’s capacity as a dealer in such securities.
(iii) Applicability. The rules of paragraph (e)(2) apply only to securities
acquired before January 23, 1997.
§ 1.475(b)–2 Exemptions—identification requirements.
(a) Identification of the basis for exemption. An identification of a security
as exempt from mark to market does not
satisfy section 475(b)(2) if it fails to
state whether the security is described
in—
(1) Either of the first two subparagraphs of section 475(b)(1) (identifying
a security as held for investment or not
held for sale); or
(2) The third subparagraph thereof
(identifying a security as a hedge).
(b) Time for identifying a security
with a substituted basis. For purposes of
determining the timeliness of an identification under section 475(b)(2), the date
that a dealer acquires a security is not
affected by whether the dealer’s basis in
the security is determined, in whole or
in part, either by reference to the basis
of the security in the hands of the
person from whom the security was
acquired or by reference to other property held at any time by the dealer. See
§ 1.475(a)–3 for rules governing how
the dealer accounts for such a security if
this identification is not made.
(c) Integrated transactions under
§ 1.1275–6— (1) Definitions. The following terms are used in this paragraph
(c) with the meanings that are given to
them by § 1.1275–6: integrated transaction, legging into, legging out, qualifying debt instrument, § 1.1275–6 hedge,
and synthetic debt instrument.
(2) Synthetic debt held by a taxpayer
as a result of legging in. If a taxpayer is
treated as the holder of a synthetic debt
instrument as the result of legging into
an integrated transaction, then, for purposes of the timeliness of an identification under section 475(b)(2), the synthetic debt instrument is treated as
having the same acquisition date as the
qualifying debt instrument. A pre-leg-in
identification of the qualifying debt instrument under section 475(b)(2) applies
to the integrated transaction as well.
(3) Securities held after legging out.
If a taxpayer legs out of an integrated

transaction, then, for purposes of the
timeliness of an identification under section 475(b)(2), the qualifying debt instrument, or the § 1.1275–6 hedge, that
remains in the taxpayer’s hands is generally treated as having been acquired,
originated, or entered into, as the case
may be, immediately after the leg-out. If
any loss or deduction determined under
§ 1.1275–6(d)(2)(ii)(B) is disallowed by
§ 1.1275–6(d)(2)(ii)(D) (which disallows deductions when a taxpayer legs
out of an integrated transaction within
30 days of legging in), then, for purposes of this section and section
475(b)(2), the qualifying debt instrument
that remains in the taxpayer’s hands is
treated as having been acquired on the
same date that the synthetic debt instrument was treated as having been acquired.
§ 1.475(b)–4 Exemptions—transitional
issues.
(a) Transitional identification—(1)
Certain securities previously identified
under section 1236. If, as of the close of
the last taxable year ending before December 31, 1993, a security was identified under section 1236 as a security
held for investment, the security is
treated as being identified as held for
investment for purposes of section
475(b).
(2) Consistency requirement for other
securities. In the case of a security
(including a security described in section 475(c)(2)(F)) that is not described
in paragraph (a)(1) of this section and
that was held by the taxpayer as of the
close of the last taxable year ending
before December 31, 1993, the security
is treated as having been properly identified under section 475(b)(2) or
475(c)(2)(F)(iii) if the information contained in the dealer’s books and records
as of the close of that year supports the
identification. If there is any ambiguity
in those records, the taxpayer must, no
later than January 31, 1994, place in its
records a statement resolving this ambiguity and indicating unambiguously
which securities are to be treated as
properly identified. Any information that
supports treating a security as having
been properly identified under section
475(b)(2) or (c)(2)(F)(iii) must be applied consistently from one security to
another.
(b) Corrections on or before January
31, 1994—(1) Purpose. This paragraph

13

(b) allows a taxpayer to add or remove
certain identifications covered by
§ 1.475(b)–1.
(2) To conform to § 1.475(b)–1(a)—
(i) Added identifications. To the extent
permitted by paragraph (b)(2)(ii) of this
section, a taxpayer may identify as being described in section 475(b)(1)(A) or
(B)—
(A) A security that was held for
immediate sale but was not held primarily for sale to customers in the ordinary
course of the taxpayer’s trade or business (for example, a trading security); or
(B) An evidence of indebtedness that
was not held for sale to customers in the
ordinary course of the taxpayer’s trade
or business and that the taxpayer intended to hold for less than one year.
(ii) Limitations. An identification described in paragraph (b)(2)(i) of this
section is permitted only if—
(A) Prior to December 28, 1993, the
taxpayer did not identify as being described in section 475(b)(1)(A) or (B)
any of the securities described in paragraph (b)(2)(i) of this section;
(B) The taxpayer identifies every security described in paragraph (b)(2)(i) of
this section for which a timely identification of the security under section
475(b)(2) cannot be made after the date
on which the taxpayer makes these
added identifications; and
(C) The identification is made on or
before January 31, 1994.
(3) To conform to § 1.475(b)–1(c).
On or before January 31, 1994, a taxpayer described in § 1.475(b)–
1(e)(2)(i)(B) may remove an identification under section 475(b)(1)(A) of a
security described in § 1.475(b)–
1(e)(2)(i)(A).
(c) Effect of corrections. An identification added under paragraph (a)(2) or
(b)(2) of this section is timely for
purposes of section 475(b)(2) or
(c)(2)(F)(iii). An identification removed
under paragraph (a)(2) or (b)(3) of this
section does not subject the taxpayer to
the provisions of section 475(d)(2).
§ 1.475(c)–1 Definitions—dealer in securities.
(a) Dealer-customer relationship.
Whether a taxpayer is transacting business with customers is determined on
the basis of all of the facts and circumstances.
(1) [Reserved].
(2) Transactions described in section
475(c)(1)(B)—(i) In general. For purposes of section 475(c)(1)(B), the term

dealer in securities includes, but is not
limited to, a taxpayer that, in the ordinary course of the taxpayer’s trade or
business, regularly holds itself out as
being willing and able to enter into
either side of a transaction enumerated
in section 475(c)(1)(B).
(ii) Examples. The following examples illustrate the rules of this paragraph (a)(2). In the following examples,
B is a bank and is not a member of a
consolidated group:
Example 1. B regularly offers to enter into
interest rate swaps with other persons in the
ordinary course of its trade or business. B is
willing to enter into interest rate swaps under
which it either pays a fixed interest rate and
receives a floating rate or pays a floating rate and
receives a fixed rate. B is a dealer in securities
under section 475(c)(1)(B), and the counterparties
are its customers.
Example 2. B, in the ordinary course of its
trade or business, regularly holds itself out as
being willing and able to enter into either side of
positions in a foreign currency with other banks in
the interbank market. B’s activities in the foreign
currency make it a dealer in securities under
section 475(c)(1)(B), and the other banks in the
interbank market are its customers.
Example 3. B engages in frequent transactions
in a foreign currency in the interbank market.
Unlike the facts in Example 2, however, B does
not regularly hold itself out as being willing and
able to enter into either side of positions in the
foreign currency, and all of B’s transactions are
driven by its internal need to adjust its position in
the currency. No other circumstances are present
to suggest that B is a dealer in securities for
purposes of section 475(c)(1)(B). B’s activity in
the foreign currency does not qualify it as a dealer
in securities for purposes of section 475(c)(1)(B),
and its transactions in the interbank market are not
transactions with customers.

(3) Related parties—(i) General rule.
Except as provided in paragraph
(a)(3)(ii) of this section (concerning
transactions between members of a consolidated group, as defined in § 1.1502–
1(h)), a taxpayer’s transactions with related persons may be transactions with
customers for purposes of section 475.
For example, if a taxpayer, in the ordinary course of the taxpayer’s trade or
business, regularly holds itself out to its
foreign subsidiaries or other related persons as being willing and able to enter
into either side of transactions enumerated in section 475(c)(1)(B), the taxpayer is a dealer in securities within the
meaning of section 475(c)(1), even if it
engages in no other transactions with
customers.
(ii) Special rule for members of a
consolidated group. Solely for purposes
of paragraph (c)(1) of section 475 (concerning the definition of dealer in securities) and except as provided in paragraph (a)(3)(iii) of this section, a
taxpayer’s transactions with other mem-

bers of its consolidated group are not
with customers. Accordingly, notwithstanding paragraph (a)(2) of this section,
the fact that a taxpayer regularly holds
itself out to other members of its consolidated group as being willing and
able to enter into either side of a
transaction enumerated in section
475(c)(1)(B) does not cause the taxpayer
to be a dealer in securities within the
meaning of section 475(c)(1)(B).
(iii) The intragroup-customer election—(A) Effect of election. If a consolidated group makes the intragroupcustomer election, paragraph (a)(3)(ii) of
this section (special rule for members of
a consolidated group) does not apply to
the members of the group. Thus, a
member of a group that has made this
election may be a dealer in securities
within the meaning of section 475(c)(1)
even if its only customer transactions
are with other members of its consolidated group.
(B) Making and revoking the election. Unless the Commissioner otherwise
prescribes, the intragroup-customer election is made by filing a statement that
says, ‘‘[Insert name and employer identification number of common parent]
hereby makes the Intragroup-Customer
Election (as described in § 1.475(c)–
1(a)(3)(iii) of the income tax regulations) for the taxable year ending [describe the last day of the year] and for
subsequent taxable years.’’ The statement must be signed by the common
parent and attached to the timely filed
federal income tax return for the consolidated group for that taxable year.
The election applies for that year and
continues in effect for subsequent years
until revoked. The election may be
revoked only with the consent of the
Commissioner.
(iv) Examples. The following examples illustrate this paragraph (a)(3):
General Facts. HC, a hedging center, provides
interest rate hedges to all of the members of its
affiliated group (as defined in section 1504(a)(1)).
Because of the efficiencies created by having a
centralized risk manager, group policy prohibits
members other than HC from entering into derivative interest rate positions with outside parties. HC
regularly holds itself out as being willing and able
to, and in fact does, enter into either side of
interest rate swaps with its fellow members. HC
periodically computes its aggregate position and
hedges the net risk with an unrelated party. HC
does not otherwise enter into interest rate positions
with persons that are not members of the affiliated
group. HC attempts to operate at cost, and the
terms of its swaps do not factor in any risk of
default by the affiliate. Thus, HC’s affiliates
receive somewhat more favorable terms then they
would receive from an unrelated swaps dealer (a
fact that may subject HC and its fellow members

14

to reallocation of income under section 482). No
other circumstances are present to suggest that HC
is a dealer in securities for purposes of section
475(c)(1)(B).
Example 1. General rule for related persons. In
addition to the General Facts stated above, assume that HC’s affiliated group has not elected
under section 1501 to file a consolidated return.
Under paragraph (a)(3)(i) of this section, HC’s
transactions with its affiliates can be transactions
with customers for purposes of section 475(c)(1).
Thus, under paragraph (a)(2)(i) of this section, HC
is a dealer in securities within the meaning of
section 475(c)(1)(B), and the members of the
group with which it does business are its customers.
Example 2. Special rule for members of a
consolidated group. In addition to the General
Facts stated above, assume that HC’s affiliated
group has elected to file consolidated returns and
has not made the intragroup-customer election.
Under paragraph (a)(3)(ii) of this section, HC’s
interest rate swap transactions with the members
of its consolidated group are not transactions with
customers for purposes of determining whether
HC is a dealer in securities within the meaning of
section 475(c)(1). Further, the fact that HC regularly holds itself out to members of its consolidated group as being willing and able to enter into
either side of a transaction enumerated in section
475(c)(1)(B) does not cause HC to be a dealer in
securities within the meaning of section
475(c)(1)(B). Because no other circumstances are
present to suggest that HC is a dealer in securities
for purposes of section 475(c)(1)(B), HC is not a
dealer in securities.
Example 3. Intragroup-customer election. In
addition to the General Facts stated above, assume that HC’s affiliated group has elected to file
a consolidated return but has also made the
intragroup-customer election under paragraph
(a)(3)(iii) of this section. Thus, the analysis and
result are the same as in Example 1.

(b) Sellers of nonfinancial goods and
services— (1) Purchases and sales of
customer paper. Except as provided in
paragraph (b)(3) of this section, if a
taxpayer would not be a dealer in
securities within the meaning of section
475(c)(1) but for its purchases and sales
of debt instruments that, at the time of
purchase or sale, are customer paper
with respect to either the taxpayer or a
corporation that is a member of the
same consolidated group (as defined in
§ 1.1502–1(h)) as the taxpayer, then for
purposes of section 475 the taxpayer is
not a dealer in securities.
(2) Definition of customer paper. A
debt instrument is customer paper with
respect to a person at a point in time
if—
(i) The person’s principal activity is
selling nonfinancial goods or providing
nonfinancial services;
(ii) The debt instrument was issued
by a purchaser of the goods or services
at the time of the purchase of those
goods or services in order to finance the
purchase; and

(iii) At all times since the debt instrument was issued, it has been held either
by the person selling those goods or
services or by a corporation that is a
member of the same consolidated group
as that person.
(3) Exceptions. Paragraph (b)(1) of
this section does not apply if—
(i) For purposes of section 471, the
taxpayer accounts for any security (as
defined in section 475(c)(2)) as inventory;
(ii) The taxpayer is subject to an
election under paragraph (b)(4) of this
section; or
(iii) The taxpayer is not described in
paragraph (b)(2)(i) of this section and
one or more debt instruments that are
customer paper with respect to a corporation that is a member of the same
consolidated group as the taxpayer are
accounted for by the taxpayer, or by a
corporation that is a member of the
same consolidated group as the taxpayer, in a manner that allows recognition of unrealized gains or losses or
deductions for additions to a reserve for
bad debts.
(4) Election not to be governed by
the exception for sellers of nonfinancial
goods or services—(i) Method of making the election. Unless the Commissioner otherwise prescribes, an election
under this paragraph (b)(4) must be
made in the manner, and at the time,
prescribed in this paragraph (b)(4)(i).
The taxpayer must file with the Internal
Revenue Service a statement that says,
‘‘[Insert name and taxpayer identification number of the taxpayer] hereby
elects not to be governed by
§ 1.475(c)–1(b)(1) of the income tax
regulations for the taxable year ending
[describe the last day of the year] and
for subsequent taxable years.’’
(A) Taxable years ending after December 24, 1996. If the first taxable
year subject to an election under this
paragraph (b)(4) ends after December
24, 1996, the statement must be attached
to a timely filed federal income tax
return for that taxable year.
(B) Taxable years ending on or before December 24, 1996. If the first
taxable year subject to an election under
this paragraph (b)(4) ends on or before
December 24, 1996, and the election
changes the taxpayer’s taxable income
for any taxable year the federal income
tax return for which was filed before
February 24, 1997, the statement must
be attached to an amended return for the
earliest such year that is so affected, and
that amended return (and an amended

return for any other such year that is so
affected) must be filed not later than
June 23, 1997. If the first taxable year
subject to an election under this paragraph (b)(4) ends on or before December 24, 1996, but the taxpayer is not
described in the preceding sentence, the
statement must be attached to the first
federal income tax return that is for a
taxable year subject to the election and
that is filed on or after February 24,
1997.
(ii) Continued applicability of an
election. An election under this paragraph (b)(4) continues in effect for
subsequent taxable years until revoked.
The election may be revoked only with
the consent of the Commissioner.
(c) Taxpayers that purchase securities
from customers but engage in no more
than negligible sales of the securities—
(1) Exemption from dealer status—(i)
General rule. A taxpayer that regularly
purchases securities from customers in
the ordinary course of a trade or business (including regularly making loans
to customers in the ordinary course of a
trade or business of making loans) but
engages in no more than negligible sales
of the securities so acquired is not a
dealer in securities within the meaning
of section 475(c)(1) unless the taxpayer
elects to be so treated or, for purposes
of section 471, the taxpayer accounts for
any security (as defined in section
475(c)(2)) as inventory.
(ii) Election to be treated as a dealer.
A taxpayer described in paragraph
(c)(1)(i) of this section elects to be
treated as a dealer in securities by filing
a federal income tax return reflecting
the application of section 475(a) in
computing its taxable income.
(2) Negligible sales. Solely for purposes of paragraph (c)(1) of this section,
a taxpayer engages in negligible sales of
debt instruments that it regularly purchases from customers in the ordinary
course of its business if, and only if,
during the taxable year, either—
(i) The taxpayer sells all or part of
fewer than 60 debt instruments, regardless how acquired; or
(ii) The total adjusted basis of the
debt instruments (or parts of debt instruments), regardless how acquired, that
the taxpayer sells is less than 5 percent
of the total basis, immediately after
acquisition, of the debt instruments that
it acquires in that year.
(3) Special rules for members of a
consolidated group— (i) Intragroupcustomer election in effect. If a taxpayer
is a member of a consolidated group

15

that has made the intragroup-customer
election (described in paragraph
(a)(3)(iii) of this section), the negligible
sales test in paragraph (c)(2) of this
section takes into account all of the
taxpayer’s sales of debt instruments to
other group members.
(ii) Intragroup-customer election not
in effect. If a taxpayer is a member of a
consolidated group that has not made
the intragroup-customer election (described in paragraph (a)(3)(iii) of this
section), the taxpayer satisfies the negligible sales test in paragraph (c)(2) of
this section if either—
(A) The test is satisfied by the taxpayer, taking into account sales of debt
instruments to other group members (as
in paragraph (c)(3)(i) of this section); or
(B) The test is satisfied by the group,
treating the members of the group as if
they were divisions of a single corporation.
(4) Special rules. Whether sales of
securities are negligible is determined
without regard to—
(i) Sales of securities that are necessitated by exceptional circumstances and
that are not undertaken as recurring
business activities;
(ii) Sales of debt instruments that
decline in quality while in the taxpayer’s hands and that are sold pursuant to
an established policy of the taxpayer to
dispose of debt instruments below a
certain quality; or
(iii) Acquisitions and sales of debt
instruments that are qualitatively different from all debt instruments that the
taxpayer purchases from customers in
the ordinary course of its business.
(5) Example. The following example
illustrates paragraph (c)(4)(iii) of this
section:
Example. I, an insurance company, regularly
makes policy loans to its customers but does not
sell them. I, however, actively trades Treasury
securities. No other circumstances are present to
suggest that I is a dealer in securities for purposes
of section 475(c)(1). Since the Treasuries are
qualitatively different from the policy loans that I
originates, under paragraph (c)(4)(iii) of this section, I disregards the purchases and sales of
Treasuries in applying the negligible sales test in
paragraph (c)(2) of this section.

(d) Issuance of life insurance products. A life insurance company that is
not otherwise a dealer in securities
within the meaning of section 475(c)(1)
does not become a dealer in securities
solely because it regularly issues life
insurance products to its customers in
the ordinary course of a trade or business. For purposes of the preceding
sentence, the term life insurance product

means a contract that is treated for
federal income tax purposes as an annuity, endowment, or life insurance contract. See sections 72, 817, and 7702.
§ 1.475(c)–2 Definitions—security.
(a) Items that are not securities. The
following items are not securities within
the meaning of section 475(c)(2) with
respect to a taxpayer and, therefore, are
not subject to section 475—
(1) A security (determined without
regard to this paragraph (a)) if section
1032 prevents the taxpayer from recognizing gain or loss with respect to that
security;
(2) A debt instrument issued by the
taxpayer (including a synthetic debt instrument, within the meaning of
§ 1.1275–6(b)(4), that § 1.1275–6(b)
treats the taxpayer as having issued); or
(3) A REMIC residual interest, or an
interest or arrangement that is determined by the Commissioner to have
substantially the same economic effect,
if the residual interest or the interest or
arrangement is acquired on or after
January 4, 1995.
(b) Synthetic debt that § 1.1275–6(b)
treats the taxpayer as holding. If
§ 1.1275–6 treats a taxpayer as the
holder of a synthetic debt instrument
(within the meaning of § 1.1275–
6(b)(4)), the synthetic debt instrument is
a security held by the taxpayer within
the meaning of section 475(c)(2)(C).
(c) Negative value REMIC residuals
acquired before January 4, 1995. A
REMIC residual interest that is described in paragraph (c)(1) of this section or an interest or arrangement that is
determined by the Commissioner to
have substantially the same economic
effect is not a security within the meaning of section 475(c)(2).
(1) Description. A residual interest in
a REMIC is described in this paragraph
(c)(1) if, on the date the taxpayer acquires the residual interest, the present
value of the anticipated tax liabilities
associated with holding the interest exceeds the sum of—
(i) The present value of the expected
future distributions on the interest; and
(ii) The present value of the anticipated tax savings associated with holding the interest as the REMIC generates
losses.
(2) Special rules applicable to negative value REMIC residuals acquired
before January 4, 1995. Solely for purposes of this paragraph (c)—

(i) If a transferee taxpayer acquires a
residual interest with a basis determined
by reference to the transferor’s basis,
then the transferee is deemed to acquire
the interest on the date the transferor
acquired it (or is deemed to acquire it
under this paragraph (c)(2)(i)).
(ii) Anticipated tax liabilities, expected future distributions, and anticipated tax savings are determined under
the rules in § 1.860E–2(a)(3) and without regard to the operation of section
475.
(iii) Present values are determined
under the rules in § 1.860E–2(a)(4).
§ 1.475(d)–1 Character of gain or loss.
(a) Securities never held in connection with the taxpayer’s activities as a
dealer in securities. If a security is
never held in connection with the taxpayer’s activities as a dealer in securities, section 475(d)(3)(A) does not affect
the character of gain or loss from the
security, even if the taxpayer fails to
identify the security under section
475(b)(2).
(b) Ordinary treatment for notional
principal contracts and derivatives held
by dealers in notional principal contracts and derivatives. Section
475(d)(3)(B)(ii) (concerning the character of gain or loss with respect to a
security held by a person other than in
connection with its activities as a dealer
in securities) does not apply to a security if § 1.475(b)–1(c) and the absence
of a determination by the Commissioner
prevent section 475(b)(1)(A) from applying to the security.
§ 1.475(e)–1 Effective dates.
(a) and (b) [Reserved].
(c) Section 1.475(a)–3 (concerning
acquisition by a dealer of a security
with a substituted basis) applies to securities acquired, originated, or entered
into on or after January 4, 1995.
(d) Except as provided elsewhere in
this paragraph (d), § 1.475(b)‘‘1 (concerning the scope of exemptions from
the mark-to-market requirement) applies
to taxable years ending on or after
December 31, 1993.
(1) Section 1.475(b)’’1(b) applies as
follows:
(i) Section 1.475(b)‘‘1(b)(1)(i) (concerning equity interests issued by a
related person) applies beginning June
19, 1996. If, on June 18, 1996, a
security is subject to mark-to-market
accounting and, on June 19, 1996,
§ 1.475(b)–1(b)(1) begins to apply to

16

the security solely because of the effective dates in this paragraph (d) (rather
than because of a change in facts), then
the rules of § 1.475(b)–1(b)(4)(i)(A)
(concerning the prohibition against
marking) apply, but § 1.475(b)–
1(b)(4)(i)(B) (imposing a mark to market on the day before the onset of the
prohibition) does not apply.
(ii) Section 1.475(b)–1(b)(2) (concerning relevant relationships for purposes of determining whether equity
interests in related persons are prohibited from being marked to market) applies beginning June 19, 1996.
(iii) Section 1.475(b)’’1(b)(3) (concerning certain actively traded securities) applies beginning June 19, 1996, to
securities held on or after that date,
except for securities described in
§ 1.475(b)‘‘1(e)(1)(i) (concerning equity
interests issued by controlled entities). If
a
security
is
described
in
§ 1.475(b)’’1(e)(1)(i),
§ 1.475(b)‘‘1(b)(3) applies only on or after January 23, 1997, if the security is held on
or after that date. If § 1.475(b)’’1(b)(1)
ceases to apply to a security by virtue of
the operation of this paragraph
(d)(1)(iii), the rules of § 1.475(b)‘‘1(b)(4)(ii) apply to the cessation.
(iv) Except to the extent provided in
paragraph (d)(1) of this section,
§ 1.475(b)’’1(b)(4) (concerning changes
in status) applies beginning June 19,
1996.
(2) Section 1.475(b)‘‘1(c) (concerning
securities deemed not held for investment by dealers in notional principal
contracts and derivatives) applies to securities acquired on or after January 23,
1997.
(3) Section 1.475(b)–1(d) (concerning
the special rule for hedges of another
member’s risk) is effective for securities
acquired, originated, or entered into on
or after January 23, 1997.
(e) Section 1.475(b)–2 (concerning
identification of securities that are exempt from mark to market treatment)
applies as follows:
(1) Section 1.475(b)–2(a) (concerning
the general rules for identification of
basis for exemption from mark to market treatment) applies to identifications
made on or after July 1, 1997.
(2) Section 1.475(b)–2(b) (concerning
time for identifying a security with a
substituted basis) applies to securities
acquired, originated, or entered into on
or after January 4, 1995.
(3) Section 1.475(b)–2(c) (concerning
identification in the context of integrated
transactions under § 1.1275–6) applies

on and after August 13, 1996 (the
effective date of § 1.1275–6).
(f) [Reserved].
(g) Section 1.475(b)–4 (concerning
transitional issues relating to exemptions) applies to taxable years ending on
or after December 31, 1993.
(h) Section 1.475(c)–1 applies as follows:
(1) Except as otherwise provided in
this paragraph (h)(1), § 1.475(c)–1(a)
(concerning the dealer-customer relationship) applies to taxable years beginning on or after January 1, 1995.
(i) [Reserved].
(ii) Section 1.475(c)–1(a)(2)(ii) (illustrating rules concerning the dealercustomer relationship) applies to taxable
years beginning on or after June 20,
1996.
(iii) (A) Section 1.475(c)–1(a)(3) applies to taxable years beginning on or
after June 20, 1996, except for transactions between members of the same
consolidated group.
(B) For transactions between members of the same consolidated group,
paragraph § 1.475(c)–1(a)(3) applies to
taxable years beginning on or after
December 24, 1996.
(2) Section 1.475(c)–1(b) (concerning
sellers of nonfinancial goods and services) applies to taxable years ending on
or after December 31, 1993.
(3) Except as otherwise provided in
this paragraph (h)(3), § 1.475(c)–1(c)
(concerning taxpayers that purchase securities but engage in no more than
negligible sales of the securities) applies
to taxable years ending on or after
December 31, 1993.
(i) Section 1.475(c)–1(c)(3) (special
rules for members of a consolidated
group) is effective for taxable years
beginning on or after December 24,
1996.
(ii) A taxpayer may rely on the rules
set out in § 1.475(c)–1T(b) (as contained in 26 CFR part 1 revised April 1,
1996) for taxable years beginning before
January 23, 1997, provided the taxpayer
applies that paragraph reasonably and
consistently.
(4) Section 1.475(c)–1(d) (concerning
the issuance of life insurance products)
applies to taxable years beginning on or
after January 1, 1995.
(i) Section 1.475(c)–2 (concerning the
definition of security) applies to taxable
years ending on or after December 31,
1993. By its terms, however,
§ 1.475(c)–2(a)(3) applies only to residual interests or to interests or arrangements that are acquired on or after

January 4, 1995; and the integrated
transactions that are referred to in
§§ 1.475(c)–2(a)(2) and 1.475(c)–2(b)
exist only after August 13, 1996 (the
effective date of § 1.1275–6).
(j) Section 1.475(d)–1 (concerning
the character of gain or loss) applies to
taxable years ending on or after December 31, 1993.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 4. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 5. In § 602.101 paragraph (c) is
amended by:
1. Removing the following entry
from the table:
§ 602.101 OMB Control numbers.
*

*

*

*

*

(c) * * *
CFR part or section where

Current OMB

identified and described

control No.

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1.475(b)–2T . . . . . . . . . . . . . . . 1545–1422
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Section 731.—Extent of
Recognition of Gain or Loss on
Distribution
26 CFR 1.731–2: Partnership distribution of marketable securities.

T.D. 8707
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Distribution of Marketable
Securities by a Partnership
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations providing rules for
partnership distributions of marketable
securities under section 731(c) of the
Internal Revenue Code of 1986, as
amended, and for determining when
those distributions are taxable to the
distributee partner. The regulations reflect changes to the law made by the
Uruguay Round Agreements Act enacted
on December 8, 1994.
DATES: These regulations are effective
on December 26, 1996.

2. Adding an entry in numerical order
to the table to read as follows:

FOR FURTHER INFORMATION CONTACT: Terri A. Belanger or William M.
Kostak at (202) 622–3080 (not a tollfree number).

§ 602.101 OMB Control numbers.

SUPPLEMENTARY INFORMATION:

*

*

*

*

*

(c) * * *
CFR part or section where

Current OMB

identified and described

control No.

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1.475(b)–4. . . . . . . . . . . . . . . . . 1545–1496
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Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved December 6, 1996.
Donald C. Lubick,
Acting Assistant Secretary of the
Treasury.
(Filed by the Office of the Federal Register on
December 23, 1996, 8:45 a.m., and published in
the issue of the Federal Register for December 24,
1996, 61 F.R. 67715)

17

Background
This document amends 26 CFR part 1
to provide rules relating to the treatment
of partnership distributions of marketable securities under section 731(c). Under section 731(a), in the case of a
distribution by a partnership to a partner, gain is recognized to the partner
only to the extent that any money
distributed exceeds the adjusted basis of
the partner’s interest in the partnership.
Prior to the enactment of section 731(c),
marketable securities were not considered money and, therefore, the distribution of marketable securities by a partnership to a partner was not a taxable
event. Section 731(c) now treats a partnership distribution of marketable securities as a distribution of money and as
a taxable event if the value of the
distributed securities exceeds the adjusted basis of the partner’s interest in
the partnership. Section 731(c) also provides several exceptions to the general

rule that a distribution of marketable
securities will be treated as a distribution of money.
On January 2, 1996, the IRS published in the Federal Register (61 FR
28) a notice of proposed rulemaking
(PS–2–95) to provide guidance regarding section 731(c). A number of public
comments were received concerning the
proposed regulations. However, the public hearing scheduled for April 3, 1996,
was cancelled because no one requested
to speak. After consideration of the
written comments received, the proposed
regulations are adopted as revised by
this Treasury decision.
Explanation of Provisions
I. General background
The proposed regulations provide
rules for determining when and the
extent to which a distribution of marketable securities by a partnership to a
partner will be treated as a distribution
of money for purposes of section 731(a).
Although modified in response to comments, the final regulations generally
adopt the rules contained in the proposed regulations.
II. Public comments
Several comments requested that the
IRS reconsider the requirement in
§ 1.731–2(d)(2)(ii) of the proposed
regulations that a marketable security
must be actively traded on the date of
distribution to qualify for the ‘‘nonrecognition transaction’’ exception to section 731(c). Because of this rule, financial instruments (securities) that are
treated as marketable securities under
section 731(c)(2)(B) on the date of
distribution, but that are not actively
traded, would not qualify for this exception. Commentators suggested that the
final regulations should not include this
requirement or should include a more
narrowly drafted provision. In response
to these comments, the final regulations
provide that a security that falls within
the definition of marketable security
may qualify for the exceptions under
§ 1.731–2(d) of the final regulations
even if the security is not actively
traded on the date of distribution. An
anti-stuffing rule has been added to
address the concern to which the
actively-traded requirement of the proposed regulations was directed.
Several comments also suggested that
§ 1.731–2(d)(2) of the proposed regulations should allow a de minimis amount
of cash and marketable securities to be

transferred in a nonrecognition transaction. The final regulations provide that if
the value of money and marketable
securities transferred in a nonrecognition
transaction is less than 20 percent of the
total amount of all property transferred
in exchange for the distributed security,
the entire value of the distributed security will qualify for the nonrecognition
transaction exception under § 1.731–
2(d)(1)(ii) of the final regulations.
Several commentators also suggested
that the five-year rules of § 1.731–
2(d)(2) and (3) of the proposed regulations be eliminated. Section 1.731–
2(d)(2) of the proposed regulations
provided that a marketable security that
was acquired in a nonrecognition transaction in exchange for other property
and distributed within five years by the
partnership would not be subject to
section 731(c). Section 1.731–2(d)(3) of
the proposed regulations provided that a
marketable security that was acquired by
the partnership before it became actively
traded would also not be subject to
section 731(c) if it was distributed by
the partnership within five years of
becoming actively traded. One commentator, for example, argued that a security
is no less a substitute for the underlying
assets in a nonrecognition transaction
after five years than before five years.
These five- year rules were included in
the proposed regulations because of administrative concerns. For example, it
may be difficult, after the passage of
many years, for taxpayers or the IRS to
determine the circumstances in which a
partnership acquired a particular security. Moreover, it is not clear whether
certain exceptions should apply to a
distribution of securities if those securities were acquired by a partnership
many years ago and are now distributed
to a partner who was not a partner at
the time the securities were acquired.
These administrative concerns remain
valid, and a five year time limitation
provides a reasonable and simple solution to such problems. Therefore, the
final regulations retain both five-year
rules.
One comment requested clarification
regarding whether a section 708(b)(1)(B) termination affects a partnership’s
qualification for the exceptions under
§ 1.731–2(d) and (e) of the regulations.
Another commentator suggested that the
regulations be modified to provide that
marketable securities will not be treated
as money when there is a deemed
distribution of marketable securities by
the terminating partnership as the result

18

of a section 708(b)(1)(B) termination. In
response to these comments, the final
regulations provide that a section
708(b)(1)(B) termination does not have
any effect on a partnership’s qualification for the exceptions under section
731(c). In addition, a deemed distribution occurring as a result of a section
708(b)(1)(B) termination will not be
subject to section 731(c).
Several comments suggested that the
10-percent test in the investment partnership look-through rule under
§ 1.731–2(e)(4) of the proposed regulations should be modified or eliminated.
A partnership can qualify for the investment partnership exception only if it has
never been engaged in a trade or business and substantially all of its assets
are investment assets. Under the proposed regulations, a partnership is
treated as engaged in a trade or business
engaged in by, or as holding a proportionate share of the assets of, a lowertier partnership in which the partnership
holds a partnership interest unless the
upper-tier partnership does not participate in the management of the lowertier partnership and the interest held by
the upper-tier partnership is less than 10
percent of the total profits and capital
interests in the lower-tier partnership.
According to the comments, the requirement that the upper-tier partnership not
participate in the management of the
lower-tier partnership should be sufficient to ensure passive ownership of the
interest in the lower-tier partnership.
The commentators further argued that
ownership of more than 10 percent of
the capital and profits interest in a
lower-tier partnership may still be consistent with passive ownership. After
consideration of these comments, the
final regulations modify the rule in the
proposed regulations to increase the
threshold ownership percentage amount
from 10 to 20 percent.
In response to a comment, the final
regulations clarify that an interest in a
lower-tier partnership that qualifies for
the exception to the investment partnership ‘‘look-through’’ rule is treated as
eligible property for purposes of determining whether the partner who contributed the lower-tier partnership interest is
an eligible partner of the upper-tier
investment partnership.
One commentator recommended that
the regulations include an example that
illustrates the section 732(a)(2) ordering
rules for distributions that include
money, marketable securities and other
property, and to clarify whether market-

able securities are treated as money for
purposes of section 732(a)(2). Because
the statute and the regulations provide
that marketable securities are treated as
money only for purposes of sections
731(a)(1) and 737, no additional examples are necessary.
One comment suggested that the effective date of the regulations should be
the same as the effective date of section
731(c) because the regulations contain
guidance for the various exceptions provided for by the Internal Revenue Code.
In response to this comment, the final
regulations provide that, for the period
between the effective date of the statutory provision and the effective date of
these regulations, taxpayers may apply
the rules contained in these regulations.
Another comment suggested that the
final regulations should make clear that
the rules in the investment partnership
exception apply with respect to all property contributed to, or held by, a partnership at any time (including any period
prior to the enactment of section
731(c)). The IRS and Treasury believe
that this is sufficiently clear from the
statutory language, and an explicit statement to this effect in these regulations is
not necessary and may be confusing.
One comment requested that the regulations provide several examples illustrating abusive transactions intended to
be covered by the anti-abuse rules of
§ 1.731–2(h), and that these rules be
coordinated with the general anti-abuse
rules of § 1.701–2. After consideration
of this comment, it has been determined
that the text of the regulations adequately describes several situations that
would be considered abusive under
these rules, and that additional examples
are unnecessary.
In response to several comments, the
final regulations clarify that the 90 percent test of § 1.731–2(c)(2)(i) and the
20 percent test of § 1.731–2(c)(2)(ii) are
determined using the gross value of the
entity’s assets, disregarding any debt
that may encumber or otherwise be
allocable to those assets, other than debt
that is incurred to acquire property with
a principal purpose of avoiding or reducing the effect of section 731(c).
Finally, the regulations clarify the
interaction of the limitation on gain rule
in section 731(c)(3)(B) and the various
exceptions listed in paragraph (d). The
regulations provide that any gain or loss
on a distributed security that qualifies
for an exception is not taken into account in determining the distributee
partner’s limitation on gain.

III. Effective dates
In general, section 731(c) applies to
distributions made after December 8,
1994. These regulations are effective for
distributions made on or after December
26, 1996. However, taxpayers may apply the rules of this section to distributions made after December 8, 1994, and
before December 26, 1996.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations, and because the notice of proposed rulemaking
preceding the regulations was issued
prior to March 29, 1996, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Pursuant to section 7805(f) of
the Internal Revenue Code, the notice of
proposed rulemaking preceding these
regulations was submitted to the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal authors of these regulations are Terri A. Belanger and William
M. Kostak, Office of Assistant Chief
Counsel (Passthroughs and Special Industries), IRS. However, other personnel
from the IRS and Treasury Department
participated in their development.
*

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Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.731–2 also issued under 26
U.S.C. 731(c). * * *
Par. 2. Section 1.731–2 is added to
read as follows:
§ 1.731–2 Partnership distributions of
marketable securities.
(a) Marketable securities treated as
money. Except as otherwise provided in
section 731(c) and this section, for purposes of sections 731(a)(1) and 737, the
term money includes marketable securi-

19

ties and such securities are taken into
account at their fair market value as of
the date of the distribution.
(b) Reduction of amount treated as
money—(1) Aggregation of securities.
For purposes of section 731(c)(3)(B)
and this paragraph (b), all marketable
securities held by a partnership are
treated as marketable securities of the
same class and issuer as the distributed
security.
(2) Amount of reduction. The amount
of the distribution of marketable securities that is treated as a distribution of
money under section 731(c) and paragraph (a) of this section is reduced (but
not below zero) by the excess, if any,
of—
(i) The distributee partner’s distributive share of the net gain, if any, which
would be recognized if all the marketable securities held by the partnership
were sold (immediately before the transaction to which the distribution relates)
by the partnership for fair market value;
over
(ii) The distributee partner’s distributive share of the net gain, if any, which
is attributable to the marketable securities held by the partnership immediately
after the transaction, determined by using the same fair market value as used
under paragraph (b)(2)(i) of this section.
(3) Distributee partner’s share of net
gain. For purposes of section
731(c)(3)(B) and paragraph (b)(2) of
this section, a partner’s distributive
share of net gain is determined—
(i) By taking into account any basis
adjustments under section 743(b) with
respect to that partner;
(ii) Without taking into account any
special allocations adopted with a principal purpose of avoiding the effect of
section 731(c) and this section; and
(iii) Without taking into account any
gain or loss attributable to a distributed
security to which paragraph (d)(1) of
this section applies.
(c) Marketable securities—(1) In
general. For purposes of section 731(c)
and this section, the term marketable
securities is defined in section 731(c)(2).
(2) Actively traded. For purposes of
section 731(c) and this section, a financial instrument is actively traded (and
thus is a marketable security) if it is of
a type that is, as of the date of distribution, actively traded within the meaning
of section 1092(d)(1). Thus, for example, if XYZ common stock is listed on
a national securities exchange, particular
shares of XYZ common stock that are
distributed by a partnership are market-

able securities even if those particular
shares cannot be resold by the
distributee partner for a designated period of time.
(3) Interests
in
an
entity—
(i) Substantially all. For purposes of
section 731(c)(2)(B)(v) and this section,
substantially all of the assets of an
entity consist (directly or indirectly) of
marketable securities, money, or both
only if 90 percent or more of the assets
of the entity (by value) at the time of
the distribution of an interest in the
entity consist (directly or indirectly) of
marketable securities, money, or both.
(ii) Less than substantially all. For
purposes of section 731(c)(2)(B)(vi) and
this section, an interest in an entity is a
marketable security to the extent that the
value of the interest is attributable (directly or indirectly) to marketable securities, money, or both, if less than 90
percent but 20 percent or more of the
assets of the entity (by value) at the
time of the distribution of an interest in
the entity consist (directly or indirectly)
of marketable securities, money, or both.
(4) Value of assets. For purposes of
section 731(c) and this section, the value
of the assets of an entity is determined
without regard to any debt that may
encumber or otherwise be allocable to
those assets, other than debt that is
incurred to acquire an asset with a
principal purpose of avoiding or reducing the effect of section 731(c) and this
section.
(d) Exceptions—(1) In general. Except as otherwise provided in paragraph
(d)(2) of this section, section 731(c) and
this section do not apply to the distribution of a marketable security if—
(i) The security was contributed to
the partnership by the distributee partner;
(ii) The security was acquired by the
partnership in a nonrecognition transaction, and the following conditions are
satisfied—
(A) The value of any marketable securities and money exchanged by the
partnership in the nonrecognition transaction is less than 20 percent of the
value of all the assets exchanged by the
partnership in the nonrecognition transaction; and
(B) The partnership distributed the
security within five years of either the
date the security was acquired by the
partnership or, if later, the date the
security became marketable; or

(iii) The security was not a marketable security on the date acquired by the
partnership, and the following conditions
are satisfied—
(A) The entity that issued the security
had no outstanding marketable securities
at the time the security was acquired by
the partnership;
(B) The security was held by the
partnership for at least six months before the date the security became marketable; and
(C) The partnership distributed the
security within five years of the date the
security became marketable.
(2) Anti-stuffing rule. Paragraph
(d)(1) of this section does not apply to
the extent that 20 percent or more of the
value of the distributed security is attributable to marketable securities or money
contributed (directly or indirectly) by
the partnership to the entity to which the
distributed security relates after the security was acquired by the partnership
(other than marketable securities contributed by the partnership that were
originally contributed to the partnership
by the distributee partner). For purposes
of this paragraph (d)(2), money contributed by

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A60fa57ae038bd318. Public record. Not legal advice.