Purchase Price Allocations in Deemed and Actual Asset Acquisitions

Federal RegisterJan 7, 2000

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SUMMARY: This document contains temporary regulations relating to the

allocation of purchase price in deemed and actual asset acquisitions.

The temporary regulations determine the amount realized and the amount

of basis allocated to each asset transferred in a deemed or actual

asset acquisition and affect transactions reported on either Form 8023

or Form 8594. The intended effect of the temporary regulations is to

remove and replace many of the current temporary and final regulations

sections under sections 338 and 1060 and renumber others.

DATES: Effective Date: These regulations are effective January 6, 2000.

Applicability Dates: For dates of applicability of these

regulations, see Sec. 1.338(i)-1T and Sec. 1.1060-1T(a)(2).

FOR FURTHER INFORMATION CONTACT: Richard Starke of the Office of

Assistant Chief Counsel (Corporate), (202) 622-7790 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these temporary

regulations have been reviewed and approved by the Office of Management

and Budget in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)) under the control number 1545-1658.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a valid

control number assigned by the Office of Management and Budget.

The collections of information in these temporary regulations are

in Secs. 1.338-2T(d), 1.338-2T(e)(4), 1.338-5T(d)(3), 1.338-10T(a)(4),

1.338(h)(10)-1T(d)(2), and 1.1060-1T(e)(ii)(A) and (B). The collections

of information are necessary to make an election to treat a sale of

stock as a sale of assets, to calculate and collect the appropriate

amount of tax in a deemed or actual asset acquisition, and to determine

the bases of assets acquired in a deemed or actual asset acquisition.

These collections of information are required to obtain a benefit.

The likely respondents and/or recordkeepers are small businesses or

organizations, businesses, or other for-profit institutions, and farms.

The regulation provides that a section 338 election is made by

filing Form 8023. The burden for this requirement is reflected in the

burden of Form 8023.

The regulation also provides that both a seller and a purchaser

must each file an asset acquisition statement on Form 8594. The burden

for this requirement is reflected in the burden of Form 8594.

The burden for the collection of information in Sec. 1.338-2T(e)(4)

is as follows:

Estimated total annual reporting/recordkeeping burden: 25 hours.

Estimated average annual burden per respondent/recordkeeper: 0.56

hours.

Estimated number of respondents/recordkeepers: 45.

Estimated annual frequency of responses: On occasion.

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, OP:FS: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 a 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.

Background

On August 10, 1999, the IRS and Treasury published in the Federal

proposed rulemaking. The notice contained proposed regulations under

sections 338 and 1060 of the Internal Revenue Code of 1986. The

temporary and final regulations promulgated in this Treasury decision

are substantively the same as the proposed regulations published on

August 10, 1999. The Service and Treasury believe that the comments

received on the proposed regulations warrant further consideration. For

instance, the Service and the Treasury received several comments

requesting reconsideration of (1) the provision in Sec. 1.338-

3(b)(2)(ii) of the proposed regulations stating that a purchase of

target stock occurs only so long as more than a nominal amount is paid

for such share, and (2) the example in Sec. 1.338-1(a)(2) of the

proposed regulations stating that if target is an insurance company for

which a section 338 election is made, then the deemed asset sale will

be characterized and taxed as an assumption-reinsurance transaction.

The temporary regulations reserve the purchase issue addressed in

Sec. 1.338-3(b)(2)(ii) of the proposed regulations pending further

consideration of the comments. The temporary regulations retain the

assumption-reinsurance example because the example properly illustrates

the principles of the proposed and temporary regulations. The Service

and Treasury will give further consideration to the interaction of

section 338 and the assumption-reinsurance rules and the need for

additional guidance on how the assumption-reinsurance rules should work

in the context of a deemed asset sale.

Notwithstanding such comments, the proposed regulations generally

were favorably received, and the Service and Treasury are convinced

that, in general, the proposed regulations provide clearer guidance and

better rules than the current final and temporary regulations under

sections 338 and 1060. Accordingly, pending further review of the

comments received on the proposed regulations, the Service and Treasury

are replacing existing temporary and final regulations with the

proposed rules published on August 10, 1999.

As soon as feasible, final regulations will be promulgated,

replacing these new temporary regulations. All comments received in

response to the requests for comments contained in the notice of August

10, 1999, will be considered in the course of preparing the final

regulations.

Special Analyses

It has been determined that these temporary regulations are not a

significant regulatory action as defined in Executive Order 12866.

Therefore, a regulatory assessment is not required. It has been

determined that a final regulatory flexibility analysis is required for

the collection of information in this Treasury decision under 5 U.S.C.

604. This analysis is set forth below under the heading ``Final

Regulatory Flexibility Act Analysis.'' Pursuant to section 7805(f) of

the Internal Revenue Code, these temporary regulations will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on their impact on small business.

[[Page 1237]]

Final Regulatory Flexibility Act Analysis

This analysis is required under the Regulatory Flexibility Act (5

U.S.C. chapter 6). This regulatory action is intended to simplify and

clarify the current rules relating to both deemed and actual asset

acquisitions. The current rules were developed over a long period of

time and have been repeatedly amended. The IRS and Treasury believe

these temporary regulations will significantly improve the clarity of

the rules relating to both deemed and actual asset acquisitions.

The major objective of these temporary regulations is to modify the

rules for allocating purchase price in both deemed and actual asset

acquisitions. In addition, these temporary regulations replace the

general rules for electing to treat a stock sale as an asset sale.

These collections of information may affect small businesses if the

stock of a corporation which is a small entity is acquired in a

qualified stock purchase or if a trade or business which is also a

small business is transferred in a taxable transaction. Form 8023 (on

which an election to treat a stock sale as an asset sale is filed) has

been submitted to and approved by the Office of Management and Budget.

With respect to Form 8023, the IRS estimated that 201 forms would be

filed each year and that each taxpayer would require 12.98 hours to

comply. Form 8594 (on which a sale or acquisition of assets

constituting a trade or business is reported) has also been submitted

to and approved by the Office of Management and Budget. With respect to

Form 8594, the IRS estimated that 20,000 forms would be filed each year

and that each taxpayer would require 12.25 hours to comply. These

estimates have been made available for public comment and no public

comments have been received. The regulations do not impose new

requirements on small businesses and, in fact, should lessen any

difficulties associated with the existing reporting requirements by

clarifying the rules associated with deemed and actual asset

acquisitions.

The collections of information require taxpayers to file an

election in order to treat a stock sale as an asset sale. In addition,

taxpayers must file a statement regarding the amount of consideration

allocated to each class of assets under the residual method. The

professional skills that would be necessary to make the election or

allocate the consideration would be the same as those required to

prepare a return for the small business.

Consideration was given to limiting the reporting requirements

under section 1060 to trades or businesses meeting a threshold level of

business activity. However, any threshold derived without further

information would be arbitrary. Instead, these regulations authorize

the Commissioner to exclude certain transactions from the reporting

requirements.

Drafting Information: The principal author of these regulations is

Richard Starke, Office of the Assistant Chief Counsel (Corporate).

However, other personnel from the IRS and Treasury Department

participated extensively in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

83 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 1.338(b)-1, 1.338(b)-3T, and 1.1060-1T and by

adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.338-6T also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-7T also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-8 also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-9 also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-10T also issued under 26 U.S.C. 337(d), 338, and

1502. * * *

Section 1.1060-1T also issued under 26 U.S.C. 1060. * * *

Par. 2. In the list below, for each section indicated in the left

column, remove the language in the middle column and add the language

in the right column:

------------------------------------------------------------------------

Section Remove Add

------------------------------------------------------------------------

1.56(g)-1(k)(1)............. of Sec. 1.338(b)- of Sec. 1.338-

2T(b), if otherwise. 6T(b), if

otherwise.

1.56(g)-1(k)(1)............. of Secs. 1.338(b)- of Sec. 1.338-

2T(c)(1) and (2) 6T(c)(1) and (2)

also. also.

1.368-1(a).................. (k) and 1.338- (k) and 1.338-

2(c)(3). 3T(c)(3).

1.368-1(e)(6), Example 4, see Sec. 1.338- see Sec. 1.338-

paragraph (ii). 2(c)(3) (which. 3T(c)(3) (which.

1.597-2(d)(5)(iii)(B)....... (see Sec. 1.338(b)- (see Sec. 1.338-

3T). 7T).

1.597-5(c)(3)(i)............ under Secs. under Sec. 1.338-

1.338(b)-2T(b), 6T(b), (c)(1) and

(c)(1) and (2). (2).

1.597-5(d)(2)(i)............ under Secs. under Sec. 1.338-

1.338(b)-2T(b), 6T(b), (c)(1) and

(c)(1) and (2). (2).

1.921-1T(b)(1), A-1......... and Sec. 1.338-1(d) and Sec. 1.338-

2T(d).

1.1031(d)-1T................ see Sec. 1.1060- see Sec. 1.1060-

1T(b), (d), and (g) 1T(b), (c), and (d)

Example (3). Example 1.

1.1031(j)-1(b)(2)(iii)...... in Sec. 1.1060- in Sec. 1.338-

1T(d). 6T(b), to which

reference is made

by Sec. 1.1060-

1T(c)(2).

1.1502-75(k)................ See Sec. See Sec.

1.338(h)(10)-1(e)(6 1.338(h)(10)-1T(d)(

) for. 7) for

1.1502-76(b)(1)(ii)(A)(1)... See Sec. 1.338- See Sec. 1.338-

1(e)(5) (deemed. 10T(a)(5) (deemed.

------------------------------------------------------------------------

Sec. 1.338-0 through 1.338-3 [Removed]

Par. 3. Sections 1.338-0 through 1.338-3 are removed.

Par. 4. Sections 1.338-0T through 1.338-3T are added to read as

follows:

Sec. 1.338-0T Outline of topics (temporary).

This section lists the captions contained in the regulations under

section 338 as follows:

Sec. 1.338-1T General principles; status of old target and new

target (temporary).

(a) In general.

(1) Deemed transaction.

(2) Application of other rules of law.

(3) Overview.

(b) Treatment of target under other provisions of the Internal

Revenue Code.

(1) General rule for subtitle A.

(2) Exceptions for subtitle A.

(3) General rule for other provisions of the Internal Revenue

Code.

(1) In general.

(2) Examples.

[[Page 1238]]

Sec. 1.338-2T Nomenclature and definitions; mechanics of the

section 338 election (temporary).

(a) Scope.

(b) Nomenclature.

(1) Acquisition date.

(2) Acquisition date assets.

(3) Affiliated group.

(4) Common parent.

(5) Consistency period.

(6) Deemed asset sale.

(7) Deemed sale gain.

(8) Deemed sale return.

(9) Domestic corporation.

(10) Old target's final return.

(11) Purchasing corporation.

(12) Qualified stock purchase.

(13) Related persons.

(14) Section 338 election.

(15) Section 338(h)(10) election.

(16) Selling group.

(17) Target; old target; new target.

(18) Target affiliate.

(19) 12-month acquisition period.

(d) Time and manner of making election.

(e) Special rules for foreign corporations or DISCs.

(1) Elections by certain foreign purchasing corporations.

(i) General rule.

(ii) Qualifying foreign purchasing corporation.

(iii) Qualifying foreign target.

(iv) Triggering event.

(v) Subject to United States tax.

(2) Acquisition period.

(3) Statement of section 338 may be filed by United States

shareholders in certain cases.

(4) Notice requirement for U.S. persons holding stock in foreign

market.

(i) General rule.

(ii) Limitation.

(iii) Form of notice.

(iv) Timing of notice.

(v) Consequence of failure to comply.

(vi) Good faith effort to comply.

Sec. 1.338-3T Qualification for the section 338 election

(temporary).

(a) Scope.

(b) Rules relating to qualified stock purchases.

(1) Purchasing corporation requirement.

(2) Purchase.

(i) Definition.

(ii) Purchase of target. [Reserved]

(iii) Purchase of target affiliate.

(3) Acquisitions of stock from related corporations.

(i) In general.

(ii) Time for testing relationship.

(iii) Cases where section 338(h)(3)(C) applies--acquisitions

treated as purchases.

(iv) Examples.

(4) Acquisition date for tiered targets.

(i) Stock sold in deemed asset sale.

(ii) Examples.

(5) Effect of redemptions.

(i) General rule.

(ii) Redemptions from persons unrelated to the purchasing

corporation.

(iii) Redemptions from the purchasing corporation or related

persons during 12-month acquisition period.

(A) General rule.

(B) Exception for certain redemptions from related corporations.

(iv) Examples.

338 election.

(1) Post-acquisition elimination of target.

(2) Post-acquisition elimination of the purchasing corporation.

(3) Consequences of post-acquisition elimination of target.

(i) Scope.

(ii) Continuity of interest.

(iii) Control requirement.

(iv) Example.

Sec. 1.338-4T Aggregate deemed sale price; various aspects of

taxation of the deemed asset sale (temporary).

(a) Scope.

(b) Determination of ADSP.

(1) General rule.

(2) Time and amount of ADSP.

(i) Original determination.

(ii) Redetermination of ADSP.

(iii) Example.

corporation of the purchasing corporation's recently purchased

target stock.

(1) Determination of amount.

(2) Example.

(d) Liabilities of old target.

(1) In general.

(2) Time and amount of liabilities.

(3) Interaction with deemed sale gain.

(e) Calculation of deemed sale gain.

(f) Other rules apply in determining ADSP.

(g) Examples.

(h) Deemed sale of target affiliate stock.

(1) Scope.

(2) In general.

(3) Deemed sale of foreign target affiliate by a domestic

target.

(4) Deemed sale producing effectively connected income.

(5) Deemed sale of insurance company target affiliate electing

under section 953(d).

(6) Deemed sale of DISC target affiliate.

(7) Anti-stuffing rule.

(8) Examples.

Sec. 1.338-5T Adjusted grossed-up basis (temporary).

(a) Scope.

(b) Determination of AGUB.

(1) General rule.

(2) Time and amount of AGUB.

(i) Original determination.

(ii) Redetermination of AGUB.

(iii) Examples.

(d) Basis of nonrecently purchased stock; gain recognition

election.

(1) No gain recognition election.

(2) Procedure for making gain recognition election.

(3) Effect of gain recognition election.

(i) In general.

(ii) Basis amount.

(iii) Losses not recognized.

(iv) Stock subject to election.

(e) Liabilities of new target.

(1) In general.

(2) Time and amount of liabilities.

(3) Interaction with deemed sale gain.

(f) Adjustments by the Internal Revenue Service.

(g) Examples.

Sec. 1.338-6T Allocation of ADSP and AGUB among target assets

(temporary).

(a) Scope.

(1) In general.

(2) Fair market value.

(i) In general.

(ii) Transaction costs.

(iii) Internal Revenue Service authority.

(b) General rule for allocating ADSP and AGUB.

(1) Reduction in the amount of consideration for Class I assets.

(2) Other assets.

(i) In general.

(ii) Class II assets.

(iii) Class III assets.

(iv) Class IV assets.

(v) Class V assets.

(vi) Class VI assets.

(vii) Class VII assets.

(3) Other items designated by the Internal Revenue Service.

asset.

(1) Allocation not to exceed fair market value.

(2) Allocation subject to other rules.

(3) Special rule for allocating AGUB when purchasing corporation

has nonrecently purchased stock.

(i) Scope.

(ii) Determination of hypothetical purchase price.

(iii) Allocation of AGUB.

(4) Liabilities taken into account in determining amount

realized on subsequent disposition.

(d) Examples.

Sec. 1.338-7T Allocation of redetermined ADSP and AGUB among

target assets (temporary).

(a) Scope.

(b) Allocation of redetermined ADSP and AGUB.

(1) Increases or decreases in deemed sale gain taxable

notwithstanding old target ceases to exist.

(2) Procedure for transactions in which section 338(h)(10) is

not elected.

(i) Deemed sale gain included in new target's return.

(ii) Carryovers and carrybacks.

(A) Loss carryovers to new target taxable years.

(B) Loss carrybacks to taxable years of old target.

(3) Procedure for transactions in which section 338(h)(10) is

elected.

(d) Special rules for AGUB.

(1) Effect of disposition or depreciation of acquisition date

assets.

(2) Section 38 property.

(e) Examples.

Sec. 1.338-8 Asset and stock consistency.

(a) Introduction.

(1) Overview.

(2) General application.

(3) Extension of the general rules.

[[Page 1239]]

(4) Application where certain dividends are paid.

(5) Application to foreign target affiliates.

(6) Stock consistency.

(b) Consistency for direct acquisitions.

(1) General rule.

(2) Section 338(h)(10) elections.

(1) General rule.

(2) Gain not reflected if section 338 election made for target.

(3) Gain reflected by reason of distributions.

(4) Controlled foreign corporations.

(5) Gain recognized outside the consolidated group.

(d) Basis of acquired assets.

(1) Carryover basis rule.

(2) Exceptions to carryover basis rule for certain assets.

(3) Exception to carryover basis rule for de minimis assets.

(4) Mitigation rule.

(i) General rule.

(ii) Time for transfer.

(e) Examples.

(1) In general.

(2) Direct acquisitions.

(f) Extension of consistency to indirect acquisitions.

(1) Introduction.

(2) General rule.

(3) Basis of acquired assets.

(4) Examples.

(g) Extension of consistency if dividends qualifying for 100

percent dividends received deduction are paid.

(1) General rule for direct acquisitions from target.

(2) Other direct acquisitions having same effect.

(3) Indirect acquisitions.

(4) Examples.

(h) Consistency for target affiliates that are controlled

foreign corporations.

(1) In general.

(2) Income or gain resulting from asset dispositions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Operating rule.

(iv) Increase in asset or stock basis.

(3) Stock issued by target affiliate that is a controlled

foreign corporation.

(4) Certain distributions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Increase in asset or stock basis.

(5) Examples.

(i) [Reserved]

(j) Anti-avoidance rules.

(1) Extension of consistency rules.

(2) Qualified stock purchase and 12-month acquisition period.

(3) Acquisitions by conduits.

(i) Asset ownership.

(A) General rule.

(B) Application of carryover basis rule.

(ii) Stock acquisitions.

(A) Purchase by conduit.

(B) Purchase of conduit by corporation.

(4) Conduit.

(5) Existence of arrangement.

(6) Predecessor and successor.

(i) Persons.

(ii) Assets.

(7) Examples.

Sec. 1.338-9 International aspects of section 338.

(a) Scope.

(b) Application of section 338 to foreign targets.

(1) In general.

(2) Ownership of FT stock on the acquisition date.

(3) Carryover FT stock.

(i) Definition.

(ii) Carryover of earnings and profits.

(iii) Cap on carryover of earnings and profits.

(iv) Post-acquisition date distribution of old FT earnings and

profits.

(v) Old FT earnings and profits unaffected by post-acquisition

date deficits.

(vi) Character of FT stock as carryover FT stock eliminated upon

disposition.

(4) Passive foreign investment company stock.

(d) Allocation of foreign taxes.

(e) Operation of section 338(h)(16). [Reserved]

(f) Examples.

Sec. 1.338-10T Filing of returns (temporary).

(a) Returns including tax liability from deemed asset sale.

(1) In general.

(2) Old target's final taxable year otherwise included in

consolidated return of selling group.

(i) General rule.

(ii) Separate taxable year.

(iii) Carryover and carryback of tax attributes.

(iv) Old target is a component member of purchasing

corporation's controlled group.

(3) Old target is an S corporation.

(4) Combined deemed sale return.

(i) General rule.

(ii) Gain and loss offsets.

(iii) Procedure for filing a combined return.

(iv) Consequences of filing a combined return.

(5) Deemed sale excluded from purchasing corporation's

consolidated return.

(6) Due date for old target's final return.

(i) General rule.

(ii) Application of Sec. 1.1502-76(c).

(A) In general.

(B) Deemed extension.

(D) Erroneous filing of return for regular tax year.

(E) Last date for payment of tax.

(7) Examples.

(b) Waiver.

(1) Certain additions to tax.

(2) Notification.

(3) Elections or other actions required to be specified on a

timely filed return.

(i) In general.

(ii) New target in purchasing corporation's consolidated return.

(4) Examples.

Sec. 1.338(h)(10)-1T Deemed asset sale and liquidation

(temporary).

(a) Scope.

(b) Definitions.

(1) Consolidated target.

(2) Selling consolidated group.

(3) Selling affiliate; affiliated target.

(4) S corporation target.

(5) S corporation shareholders.

(6) Liquidation.

(1) In general.

(2) Simultaneous joint election requirement.

(3) Irrevocability.

(4) Effect of invalid election.

(d) Certain consequences of section 338(h)(10) election.

(1) P.

(2) New T.

(3) Old T--deemed sale.

(i) In general.

(ii) Tiered targets.

(4) Old T and selling consolidated group, selling affiliate, or

S corporation shareholders--deemed liquidation; tax

characterization.

(i) In general.

(ii) Tiered targets.

(5) Selling consolidated group, selling affiliate, or S

corporation shareholders.

(i) In general.

(ii) Basis and holding period of T stock not acquired.

(iii) T stock sale.

(6) Nonselling minority shareholders other than nonselling S

corporation shareholders.

(i) In general.

(ii) T stock sale.

(iii) T stock not acquired.

(7) Consolidated return of selling consolidated group.

(8) Availability of the section 453 installment method.

(i) In deemed asset sale.

(ii) In deemed liquidation.

(9) Treatment consistent with an actual asset sale.

(e) Examples.

(f) Inapplicability of provisions.

(g) Required information.

Sec. 1.338(i)-1T Effective dates (temporary).

Sec. 1.338-1T General principles; status of old target and new target

(temporary).

(a) In general--(1) Deemed transaction. Elections are available

under section 338 when a purchasing corporation acquires the stock

of another corporation (the target) in a qualified stock purchase.

One type of election, under section 338(g), is available to the

purchasing corporation. Another type of election, under section

338(h)(10), is, in more limited circumstances, available jointly to

the purchasing corporation and the sellers of the stock. (Rules

concerning eligibility for these elections are contained in

Secs. 1.338-2T, 1.338-3T, and 1.338(h)(10)-1T.) Although target is a

single corporation under corporate law, if a section 338 election is

made, then two separate corporations, old target and new target,

generally are considered to exist for purposes of subtitle A of the

Internal Revenue Code. Old target is treated as transferring all of

its assets to an unrelated

[[Page 1240]]

person in exchange for consideration that includes the assumption

of, or taking subject to, liabilities, and new target is treated as

acquiring all of its assets from an unrelated person in exchange for

consideration that includes the assumption of or taking subject to

liabilities. (Such transaction is, without regard to its

characterization for Federal income tax purposes, referred to as the

deemed asset sale and the income tax consequences thereof as the

deemed sale gain.) If a section 338(h)(10) election is made, old

target is also deemed to liquidate following the deemed asset sale.

(2) Application of other rules of law. Other rules of law apply

to determine the tax consequences to the parties as if they had

actually engaged in the transactions deemed to occur under section

338 and Secs. 1.338-0T through 1.338-7T, 1.338-8, 1.338-9, 1.338-

10T, 1.338(h)(10)-1T, and 1.338(i)-1T except to the extent otherwise

provided in Secs. 1.338-0T through 1.338-7T, 1.338-8, 1.338-9,

1.338-10T, 1.338(h)(10)-1T, and 1.338(i)-1T. See also Sec. 1.338-

6T(c)(2). Other rules of law may characterize the transaction as

something other than or in addition to a sale and purchase of

assets; however, it must be a taxable transaction. For example, if

target is an insurance company for which a section 338 election is

made, the deemed asset sale would be characterized and taxed as an

assumption-reinsurance transaction under applicable Federal income

tax law. See Sec. 1.817-4(d).

(3) Overview. Definitions and special nomenclature and rules for

making the section 338 election are provided in Sec. 1.338-2T.

Qualification for the section 338 election is addressed in

Sec. 1.338-3T. The amount for which old target is treated as selling

all of its assets (the aggregate deemed sale price, or ADSP) is

addressed in Sec. 1.338-4T. The amount for which new target is

deemed to have purchased all its assets (the adjusted grossed-up

basis, or AGUB) is addressed in Sec. 1.338-5T. Section 1.338-6T

addresses allocation both of ADSP among the assets old target is

deemed to have sold and of AGUB among the assets new target is

deemed to have purchased. Section 1.338-7T addresses allocation of

ADSP or AGUB when those amounts change after the close of new

target's first taxable year. Asset and stock consistency are

addressed in Sec. 1.338-8. International aspects of section 338 are

covered in Sec. 1.338-9. Rules for the filing of returns are

provided in Sec. 1.338-10T. Eligibility for and treatment of section

338(h)(10) elections is addressed in Sec. 1.338(h)(10)-1T.

(b) Treatment of target under other provisions of the Internal

Revenue Code--(1) General rule for subtitle A. Except as provided in

this section, new target is treated as a new corporation that is

unrelated to old target for purposes of subtitle A of the Internal

Revenue Code. Thus--

(i) New target is not considered related to old target for

purposes of section 168 and may make new elections under section 168

without taking into account the elections made by old target; and

(ii) New target may adopt, without obtaining prior approval from

the Commissioner, any taxable year that meets the requirements of

section 441 and any method of accounting that meets the requirements of

section 446. Notwithstanding Sec. 1.441-1T(b)(2), a new target may

adopt a taxable year on or before the last day for making the election

under section 338 by filing its first return for the desired taxable

year on or before that date.

(2) Exceptions for subtitle A. New target and old target are

treated as the same corporation for purposes of--

(i) The rules applicable to employee benefit plans (including those

plans described in sections 79, 104, 105, 106, 125, 127, 129, 132, 137,

and 220), qualified pension, profit-sharing, stock bonus and annuity

plans (sections 401(a) and 403(a)), simplified employee pensions

(section 408(k)), tax qualified stock option plans (sections 422 and

423), welfare benefit funds (sections 419, 419A, 512(a)(3), and 4976),

voluntary employee benefit associations (section 501(c)(9) and the

regulations thereunder);

(ii) Sections 1311 through 1314 (relating to the mitigation of the

effect of limitations) if a section 338(h)(10) election is not made for

target;

(iii) Section 108(e)(5) (relating to the reduction of purchase

money debt);

(iv) Section 45A (relating to the Indian Employment Credit),

section 51 (relating to the Work Opportunity Credit), section 51A

(relating to the Welfare to Work Credit), and section 1396 (relating to

the Empowerment Zone Act);

(v) Sections 401(h) and 420 (relating to medical benefits for

retirees);

(vi) Section 414 (relating to definitions and special rules); and

(vii) Any other provision designated in the Internal Revenue

Bulletin by the Internal Revenue Service. See Sec. 601.601(d)(2)(ii) of

this chapter (relating to the Internal Revenue Bulletin). See

Sec. 1.1001-3(e)(4)(F) providing that an election under section 338

does not result in the substitution of a new obligor on target's debt.

(3) General rule for other provisions of the Internal Revenue Code.

Except as provided in the regulations under section 338 or in the

Internal Revenue Bulletin by the Internal Revenue Service (see

Sec. 601.601(d)(2)(ii) of this chapter), new target is treated as a

continuation of old target for purposes other than subtitle A of the

Internal Revenue Code. For example--

(i) New target is liable for old target's Federal income tax

liabilities, including the tax liability for the deemed sale gain and

those tax liabilities of the other members of any consolidated group

that included old target that are attributable to taxable years in

which those corporations and old target joined in the same consolidated

return (see Sec. 1.1502-6(a));

(ii) Wages earned by the employees of old target are considered

wages earned by such employees from new target for purposes of sections

3101 and 3111 (Federal Insurance Contributions Act) and section 3301

(Federal Unemployment Tax Act); and

(iii) Old target and new target must use the same employer

identification number.

residual method of Secs. 1.338-0T through 1.338-7T, 1.338-8, 1.338-9,

1.338-10T, 1.338(h)(10)-1T, and 1.338(i)-1T, the Commissioner is

authorized to treat any property (including cash) transferred by old

target in connection with the transactions resulting in the application

of the residual method as, nonetheless, property of target at the close

of the acquisition date if the property so transferred, within 24

months after the deemed asset sale, is owned by new target, or is

owned, directly or indirectly, by a member of the affiliated group of

which new target is a member and continues after the election to be

held or used to more than an insignificant extent in connection with

one or more of the activities of new target. The Commissioner is

authorized to treat any property (including cash) transferred to old

target in connection with the transactions resulting in the application

of the residual method as, nonetheless, not being property of target at

the close of the acquisition date if the property so transferred by the

transferor is, within 24 months after the deemed asset sale, not owned

by new target but owned, directly or indirectly, by a member of the

affiliated group of which new target is a member or owned by new target

but held or used to more than an insignificant extent in connection

with an activity conducted, directly or indirectly, by another member

of the affiliated group of which new target is a member in combination

with other property acquired, directly or indirectly, from the

transferor of the property (or a member of the same affiliated group)

to old target. For purposes of this paragraph (c)(1), an interest in an

entity is considered held or used in connection with an activity if

property of the entity is so held or used. The authority under this

paragraph (c)(1) includes the making of any necessary correlative

adjustments.

(2) Examples. The following examples illustrate this paragraph (c):

Example 1. Prior to a qualified stock purchase under section

338, target transfers

[[Page 1241]]

one of its assets to a related party. The purchasing corporation

then purchases the target stock and also purchases the transferred

asset from the related party. After its purchase of target, the

purchasing corporation and target are members of the same affiliated

group. A section 338 election is made. Under an arrangement with the

purchaser, target continues to use the separately transferred asset

to more than an insignificant extent in connection with its own

activities. Applying the anti-abuse rule of this paragraph (c), the

Commissioner may consider target to own the transferred asset for

purposes of applying section 338 and its allocation rules.

Example 2. Target (T) owns all the stock of T1. T1 leases

intellectual property to T, which T uses in connection with its own

activities. P, a purchasing corporation, wishes to buy the T-T1

chain of corporations. P, in connection with its planned purchase of

the T stock, contracts to consummate a purchase of all the stock of

T1 on March 1 and of all the stock of T on March 2. Section 338

elections are thereafter made for both T and T1. Immediately after

the purchases, P, T and T1 are members of the same affiliated group.

T continues to lease the intellectual property from T1 and to use

the property to more than an insignificant extent in connection with

its own activities. Thus, an asset of T, the T1 stock, was removed

from T's own assets prior to the qualified stock purchase of the T

stock, T1's own assets are used after the deemed asset sale in

connection with T's own activities, and the T1 stock is after the

deemed asset sale owned by P, a member of the same affiliated group

of which T is a member. Applying the anti-abuse rule of this

paragraph (c), the Commissioner may, for purposes of application of

section 338 both to T and to T1, consider P to have bought only the

stock of T, with T at the time of the qualified stock purchases of

both T and T1 (the qualified stock purchase of T1 being triggered by

the deemed sale under section 338 of T's assets) owning T1. The

Commissioner would accordingly apply section 338 first at the T

level and then at the T1 level.

Sec. 1.338-2T Nomenclature and definitions; mechanics of the section

338 election (temporary).

(a) Scope. This section prescribes rules relating to elections

under section 338.

(b) Nomenclature. For purposes of the regulations under section 338

(except as otherwise provided):

(1) T is a domestic target corporation that has only one class of

stock outstanding. Old T refers to T for periods ending on or before

the close of T's acquisition date; new T refers to T for subsequent

periods.

(2) P is the purchasing corporation.

(3) The P group is an affiliated group of which P is a member.

(4) P1, P2, etc., are domestic corporations that are members of the

P group.

(5) T1, T2, etc., are domestic corporations that are target

affiliates of T. These corporations (T1, T2, etc.) have only one class

of stock outstanding and may also be targets.

(6) S is a domestic corporation (unrelated to P and B) that owns T

prior to the purchase of T by P. (S is referred to in cases in which it

is appropriate to consider the effects of having all of the outstanding

stock of T owned by a domestic corporation.)

(7) A, a U.S. citizen or resident, is an individual (unrelated to P

and B) who owns T prior to the purchase of T by P. (A is referred to in

cases in which it is appropriate to consider the effects of having all

of the outstanding stock of T owned by an individual who is a U.S.

citizen or resident. Ownership of T by A and ownership of T by S are

mutually exclusive circumstances.)

(8) B, a U.S. citizen or resident, is an individual (unrelated to

T, S, and A) who owns the stock of P.

(9) F, used as a prefix with the other terms in this paragraph (b),

connotes foreign, rather than domestic, status. For example, FT is a

foreign corporation (as defined in section 7701(a)(5)) and FA is an

individual other than a U.S. citizen or resident.

(10) CFC, used as a prefix with the other terms in this paragraph

(b) referring to a corporation, connotes a controlled foreign

corporation (as defined in section 957, taking into account section

953(c)). A corporation identified with the prefix F may be a controlled

foreign corporation. The prefix CFC is used when the corporation's

status as a controlled foreign corporation is significant.

(except as otherwise provided):

(1) Acquisition date. The term acquisition date has the same

meaning as in section 338(h)(2).

(2) Acquisition date assets. Acquisition date assets are the assets

of the target held at the beginning of the day after the acquisition

date (other than assets that were not assets of old target).

(3) Affiliated group. The term affiliated group has the same

meaning as in section 338(h)(5). Corporations are affiliated on any day

they are members of the same affiliated group.

(4) Common parent. The term common parent has the same meaning as

in section 1504.

(5) Consistency period. The consistency period is the period

described in section 338(h)(4)(A) unless extended pursuant to

Sec. 1.338-8(j)(1).

(6) Deemed asset sale. The deemed asset sale is the transaction

described in Sec. 1.338-1T(a)(1) that is deemed to occur for purposes

of subtitle A of the Internal Revenue Code if a section 338 election is

made.

(7) Deemed sale gain. Deemed sale gain refers to, in the aggregate,

the Federal income tax consequences (generally, the income, gain,

deduction, and loss) of the deemed asset sale. Deemed sale gain also

refers to the Federal income tax consequences of the transfer of a

particular asset in the deemed asset sale.

(8) Deemed sale return. The deemed sale return is the return on

which target's deemed sale gain is reported that does not include any

other items of target. Target files a deemed sale return when a section

338 election (but not a section 338(h)(10) election) is filed for

target and target is a member of a selling group (defined in paragraph

(c)(16) of this section) that files a consolidated return for the

period that includes the acquisition date or is an S corporation. See

Sec. 1.338-10T.

(9) Domestic corporation. A domestic corporation is a corporation--

(i) That is domestic within the meaning of section 7701(a)(4) or

that is treated as domestic for purposes of subtitle A of the Internal

Revenue Code (e.g., to which an election under section 953(d) or

1504(d) applies); and (ii) That is not a DISC, a corporation described

in section 1248(e), or a corporation to which an election under section

936 applies.

(10) Old target's final return. Old target's final return is the

income tax return of old target for the taxable year ending at the

close of the acquisition date that includes the deemed sale gain. If

the disaffiliation rule of Sec. 1.338-10T(a)(2)(i) applies or if target

is an S corporation, target's deemed sale return is considered old

target's final return.

(11) Purchasing corporation. The term purchasing corporation has

the same meaning as in section 338(d)(1). The purchasing corporation

may also be referred to as purchaser. Unless otherwise provided, any

reference to the purchasing corporation is a reference to all members

of the affiliated group of which the purchasing corporation is a

member. See sections 338(h)(5) and (8). Also, unless otherwise

provided, any reference to the purchasing corporation is, with respect

to a deemed purchase of stock under section 338(a)(2), a reference to

new target with respect to its own deemed purchase of stock in another

target.

(12) Qualified stock purchase. The term qualified stock purchase

has the same meaning as in section 338(d)(3).

(13) Related persons. Two persons are related if stock in a

corporation owned by one of the persons would be

[[Page 1242]]

attributed under section 318(a) (other than section 318(a)(4)) to the

other.

(14) Section 338 election. A section 338 election is an election to

apply section 338(a) to target. A section 338 election is made by

filing a statement of section 338 election pursuant to paragraph (d) of

this section. The form on which this statement is filed is referred to

in the regulations under section 338 as the Form 8023 Elections Under

Section 338 for Corporations Making Qualified Stock Purchases.

(15) Section 338(h)(10) election. A section 338(h)(10) election is

an election to apply section 338(h)(10) to target. A section 338(h)(10)

election is made by making a joint election for target under

Sec. 1.338(h)(10)-1T.

(16) Selling group. The selling group is the affiliated group (as

defined in section 1504) eligible to file a consolidated return that

includes target for the taxable period in which the acquisition date

occurs. However, a selling group is not an affiliated group of which

target is the common parent on the acquisition date.

(17) Target; old target; new target. Target is the target

corporation as defined in section 338(d)(2). Old target refers to

target for periods ending on or before the close of target's

acquisition date. New target refers to target for subsequent periods.

(18) Target affiliate. The term target affiliate has the same

meaning as in section 338(h)(6) (applied without section

338(h)(6)(B)(i)). Thus, a corporation described in section

338(h)(6)(B)(i) is considered a target affiliate for all purposes of

section 338. If a target affiliate is acquired in a qualified stock

purchase, it is also a target.

(19) 12-Month acquisition period. The 12-month acquisition period

is the period described in section 338(h)(1), unless extended pursuant

to Sec. 1.338-8(j)(2).

(d) Time and manner of making election. The purchasing corporation

makes a section 338 election for target by filing a statement of

section 338 election on Form 8023 in accordance with the instructions

to the form. The section 338 election must be made not later than the

15th day of the 9th month beginning after the month in which the

acquisition date occurs. A section 338 election is irrevocable. See

Sec. 1.338(h)(10)-1T(c)(2) for section 338(h)(10) elections.

(e) Special rules for foreign corporations or DISCs--(1) Elections

by certain foreign purchasing corporations--(i) General rule. A

qualifying foreign purchasing corporation is not required to file a

statement of section 338 election for a qualifying foreign target

before the earlier of 3 years after the acquisition date and the 180th

day after the close of the purchasing corporation's taxable year within

which a triggering event occurs.

(ii) Qualifying foreign purchasing corporation. A purchasing

corporation is a qualifying foreign purchasing corporation only if,

during the acquisition period of a qualifying foreign target, all the

corporations in the purchasing corporation's affiliated group are

foreign corporations that are not subject to United States tax.

(iii) Qualifying foreign target. A target is a qualifying foreign

target only if target and its target affiliates are foreign

corporations that, during target's acquisition period, are not subject

to United States tax (and will not become subject to United States tax

during such period because of a section 338 election). A target

affiliate is taken into account for purposes of the preceding sentence

only if, during target's 12-month acquisition period, it is or becomes

a member of the affiliated group that includes the purchasing

corporation.

(iv) Triggering event. A triggering event occurs in the taxable

year of the qualifying foreign purchasing corporation in which either

that corporation or any corporation in its affiliated group becomes

subject to United States tax.

(v) Subject to United States tax. For purposes of this paragraph

(e)(1), a foreign corporation is considered subject to United States

tax--

(A) For the taxable year for which that corporation is required

under Sec. 1.6012-2(g) (other than Sec. 1.6012-2(g)(2)(i)(B)(2)) to

file a United States income tax return; or

(B) For the period during which that corporation is a controlled

foreign corporation, a passive foreign investment company for which an

election under section 1295 is in effect, a foreign investment company,

or a foreign corporation the stock ownership of which is described in

section 552(a)(2).

(2) Acquisition period. For purposes of this paragraph (e), the

term acquisition period means the period beginning on the first day of

the 12-month acquisition period and ending on the acquisition date.

(3) Statement of section 338 election may be filed by United States

shareholders in certain cases. The United States shareholders (as

defined in section 951(b)) of a foreign purchasing corporation that is

a controlled foreign corporation (as defined in section 957 (taking

into account section 953(c))) may file a statement of section 338

election on behalf of the purchasing corporation if the purchasing

corporation is not required under Sec. 1.6012-2(g) (other than

Sec. 1.6012-2(g)(2)(i)(B)(2)) to file a United States income tax return

for its taxable year that includes the acquisition date. Form 8023 must

be filed as described in the form and its instructions and also must be

attached to the Form 5471 (information return with respect to a foreign

corporation) filed with respect to the purchasing corporation by each

United States shareholder for the purchasing corporation's taxable year

that includes the acquisition date (or, if paragraph (e)(1)(i) of this

section applies to the election, for the purchasing corporation's

taxable year within which it becomes a controlled foreign corporation).

The provisions of Sec. 1.964-1(c) (including Sec. 1.964-1(c)(7)) do not

apply to an election made by the United States shareholders.

(4) Notice requirement for U.S. persons holding stock in foreign

market--(i) General rule. If a target subject to a section 338 election

was a controlled foreign corporation, a passive foreign investment

company, or a foreign personal holding company at any time during the

portion of its taxable year that ends on its acquisition date, the

purchasing corporation must deliver written notice of the election (and

a copy of Form 8023, its attachments and instructions) to--

(A) Each U.S. person (other than a member of the affiliated group

of which the purchasing corporation is a member (the purchasing group

member)) that, on the acquisition date of the foreign target, holds

stock in the foreign target; and

(B) Each U.S. person (other than a purchasing group member) that

sells stock in the foreign target to a purchasing group member during

the foreign target's 12-month acquisition period.

(ii) Limitation. The notice requirement of this paragraph (e)(4)

applies only where the section 338 election for the foreign target

affects income, gain, loss, deduction, or credit of the U.S. person

described in paragraph (e)(4)(i) of this section under section 551,

951, 1248, or 1293.

(iii) Form of notice. The notice to U.S. persons must be identified

prominently as a notice of section 338 election and must--

(A) Contain the name, address, and employer identification number

(if any) of, and the country (and, if relevant, the lesser political

subdivision) under the laws of which is organized, the purchasing

corporation and the relevant

[[Page 1243]]

target (i.e., target the stock of which the particular U.S. person held

or sold under the circumstances described in paragraph (e)(4)(i) of

this section);

(B) Identify those corporations as the purchasing corporation and

the foreign target, respectively; and

declaration): THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION UNDER

SECTION 338 FOR THE ABOVE CITED FOREIGN TARGET THE STOCK OF WHICH YOU

EITHER HELD OR SOLD UNDER THE CIRCUMSTANCES DESCRIBED IN TREASURY

REGULATIONS SECTION 1.338-2T(e)(4). FOR POSSIBLE UNITED STATES FEDERAL

INCOME TAX CONSEQUENCES UNDER SECTION 551, 951, 1248, OR 1293 OF THE

INTERNAL REVENUE CODE OF 1986 THAT MAY APPLY TO YOU, SEE TREASURY

REGULATIONS SECTION 1.338-9(b). YOU MAY BE REQUIRED TO ATTACH THE

INFORMATION ATTACHED TO THIS NOTICE TO CERTAIN RETURNS.

(iv) Timing of notice. The notice required by this paragraph (e)(4)

must be delivered to the U.S. person on or before the later of the

120th day after the acquisition date of the particular target or the

day on which Form 8023 is filed. The notice is considered delivered on

the date it is mailed to the proper address (or an address similar

enough to complete delivery), unless the date it is mailed cannot be

reasonably determined. The date of mailing will be determined under the

rules of section 7502. For example, the date of mailing is the date of

U.S. postmark or the applicable date recorded or marked by a designated

delivery service.

(v) Consequence of failure to comply. A statement of section 338

election is not valid if timely notice is not given to one or more U.S.

persons described in this paragraph (e)(4). If the form of notice fails

to comply with all requirements of this paragraph (e)(4), the section

338 election is valid, but the waiver rule of Sec. 1.338-10T(b)(1) does

not apply.

(vi) Good faith effort to comply. The purchasing corporation will

be considered to have complied with this paragraph (e)(4), even though

it failed to provide notice or provide timely notice to each person

described in this paragraph (e)(4), if the Commissioner determines that

the purchasing corporation made a good faith effort to identify and

provide timely notice to those U.S. persons.

Sec. 1.338-3T Qualification for the section 338 election (temporary).

(a) Scope. This section provides rules on whether certain

acquisitions of stock are qualified stock purchases and on other

miscellaneous issues under section 338.

(b) Rules relating to qualified stock purchases--(1) Purchasing

corporation requirement. An individual cannot make a qualified stock

purchase of target. Section 338(d)(3) requires, as a condition of a

qualified stock purchase, that a corporation purchase the stock of

target. If an individual forms a corporation (new P) to acquire target

stock, new P can make a qualified stock purchase of target if new P is

considered for tax purposes to purchase the target stock. Facts that

may indicate that new P does not purchase the target stock include new

P's merging downstream into target, liquidating, or otherwise disposing

of the target stock following the purported qualified stock purchase.

(2) Purchase--(i) Definition. The term purchase has the same

meaning as in section 338(h)(3).

(ii) Purchase of target. [Reserved]

(iii) Purchase of target affiliate. Stock in a target affiliate

acquired by new target in the deemed asset sale of target's assets is

considered purchased if, under general principles of tax law, new

target is considered to own stock of the target affiliate meeting the

requirements of section 1504(a)(2), notwithstanding that no amount may

be allocated to target's stock in the target affiliate.

(3) Acquisitions of stock from related corporations--(i) In

general. Stock acquired by a purchasing corporation from a related

corporation (R) is generally not considered acquired by purchase. See

section 338(h)(3)(A)(iii).

(ii) Time for testing relationship. For purposes of section

338(h)(3)(A)(iii), a purchasing corporation is treated as related to

another person if the relationship specified in section

338(h)(3)(A)(iii) exists--

(A) In the case of a single transaction, immediately after the

purchase of Target stock;

(B) In the case of a series of acquisitions otherwise constituting

a qualified stock purchase within the meaning of section 338(d)(3),

immediately after the last acquisition in such series; and

integrated plan to dispose of Target stock, immediately after the last

transaction in such series.

(iii) Cases where section 338(h)(3)(C) applies--acquisitions

treated as purchases. If section 338(h)(3)(C) applies and the

purchasing corporation is treated as acquiring stock by purchase from

R, solely for purposes of determining when the stock is considered

acquired, target stock acquired from R is considered to have been

acquired by the purchasing corporation on the day on which the

purchasing corporation is first considered to own that stock under

section 318(a) (other than section 318(a)(4)).

(iv) Examples. The following examples illustrate this paragraph

(b)(3):

Example 1. (i) S is the parent of a group of corporations that

are engaged in various businesses. Prior to January 1, Year 1, S

decided to discontinue its involvement in one line of business. To

accomplish this, S forms a new corporation, Newco, with a nominal

amount of cash. Shortly thereafter, on January 1, Year 1, S

transfers all the stock of the subsidiary conducting the unwanted

business (Target) to Newco in exchange for 100 shares of Newco

common stock and a Newco promissory note. Prior to January 1, Year

1, S and Underwriter (U) had entered into a binding agreement

pursuant to which U would purchase 60 shares of Newco common stock

from S and then sell those shares in an Initial Public Offering

(IPO). On January 6, Year 1, the IPO closes.

(ii) Newco's acquisition of Target stock is one of a series of

transactions undertaken pursuant to one integrated plan. The series

of transactions ends with the closing of the IPO and the transfer of

all the shares of stock in accordance with the agreements.

Immediately after the last transaction effected pursuant to the

plan, S owns 40 percent of Newco, which does not give rise to a

relationship described in section 338(h)(3)(A)(iii). See Sec. 1.338-

2T(b)(3)(ii)(C). Accordingly, S and Newco are not related for

purposes of section 338(h)(3)(A)(iii).

(iii) Further, because Newco's basis in the Target stock is not

determined by reference to S's basis in the Target stock and because

the transaction is not an exchange to which section 351, 354, 355,

or 356 applies, Newco's acquisition of the Target stock is a

purchase within the meaning of section 338(h)(3).

Example 2. (i) On January 1 of Year 1, P purchases 75 percent in

value of the R stock. On that date, R owns 4 of the 100 shares of T

stock. On June 1 of Year 1, R acquires an additional 16 shares of T

stock. On December 1 of Year 1, P purchases 70 shares of T stock

from an unrelated person and 12 of the 20 shares of T stock held by

(ii) Of the 12 shares of T stock purchased by P from R on

December 1 of Year 1, 3 of those shares are deemed to have been

acquired by P on January 1 of Year 1, the date on which 3 of the 4

shares of T stock held by R on that date were first considered owned

by P under section 318(a)(2)(C) (i.e., 4 x .75). The remaining 9

shares of T stock purchased by P from R on December 1 of Year 1, are

deemed to have been acquired by P on June 1 of Year 1, the date on

which an additional 12 of the 20 shares of T stock owned by R on

that date were first considered owned by P under section

[[Page 1244]]

318(a)(2)(C) (i.e., (20 x .75) -3). Because stock acquisitions by

P sufficient for a qualified stock purchase of T occur within a 12-

month period (i.e., 3 shares constructively on January 1 of Year 1,

9 shares constructively on June 1 of Year 1, and 70 shares actually

on December 1 of Year 1), a qualified stock purchase is made on

December 1 of Year 1.

Example 3. (i) On February 1 of Year 1, P acquires 25 percent in

value of the R stock from B (the sole shareholder of P). That R

stock is not acquired by purchase. See section 338(h)(3)(A)(iii). On

that date, R owns 4 of the 100 shares of T stock. On June 1 of Year

1, P purchases an additional 25 percent in value of the R stock, and

on January 1 of Year 2, P purchases another 25 percent in value of

the R stock. On June 1 of Year 2, R acquires an additional 16 shares

of the T stock. On December 1 of Year 2, P purchases 68 shares of

the T stock from an unrelated person and 12 of the 20 shares of the

T stock held by R.

(ii) Of the 12 shares of the T stock purchased by P from R on

December 1 of Year 2, 2 of those shares are deemed to have been

acquired by P on June 1 of Year 1, the date on which 2 of the 4

shares of the T stock held by R on that date were first considered

owned by P under section 318(a)(2)(C) (i.e., 4 x .5). For purposes

of this attribution, the R stock need not be acquired by P by

purchase. See section 338(h)(1). (By contrast, the acquisition of

the T stock by P from R does not qualify as a purchase unless P has

acquired at least 50 percent in value of the R stock by purchase.

Section 338(h)(3)(C)(i).) Of the remaining 10 shares of the T stock

purchased by P from R on December 1 of Year 2, 1 of those shares is

deemed to have been acquired by P on January 1 of Year 2, the date

on which an additional 1 share of the 4 shares of the T stock held

by R on that date was first considered owned by P under section

318(a)(2)(C) (i.e., (4 x .75) -2). The remaining 9 shares of the T

stock purchased by P from R on December 1 of Year 2, are deemed to

have been acquired by P on June 1 of Year 2, the date on which an

additional 12 shares of the T stock held by R on that date were

first considered owned by P under section 318(a)(2)(C) (i.e., (20

x .75) -3). Because a qualified stock purchase of T by P is made on

December 1 of Year 2, only if all 12 shares of the T stock purchased

by P from R on that date are considered acquired during a 12-month

period ending on that date (so that, in conjunction with the 68

shares of the T stock P purchased on that date from the unrelated

person, 80 of T's 100 shares are acquired by P during a 12-month

period) and because 2 of those 12 shares are considered to have been

acquired by P more than 12 months before December 1 of Year 2 (i.e.,

on June 1 of Year 1), a qualified stock purchase is not made. (Under

Sec. 1.338-8(j)(2), for purposes of applying the consistency rules,

P is treated as making a qualified stock purchase of T if, pursuant

to an arrangement, P purchases T stock satisfying the requirements

of section 1504(a)(2) over a period of more than 12 months.)

Example 4. Assume the same facts as in Example 3, except that on

February 1 of Year 1, P acquires 25 percent in value of the R stock

by purchase. The result is the same as in Example 3.

(4) Acquisition date for tiered targets--(i) Stock sold in deemed

asset sale. If an election under section 338 is made for target, old

target is deemed to sell target's assets and new target is deemed to

acquire those assets. Under section 338(h)(3)(B), new target's deemed

purchase of stock of another corporation is a purchase for purposes of

section 338(d)(3) on the acquisition date of target. If new target's

deemed purchase causes a qualified stock purchase of the other

corporation and if a section 338 election is made for the other

corporation, the acquisition date for the other corporation is the same

as the acquisition date of target. However, the deemed sale and

purchase of the other corporation's assets is considered to take place

after the deemed sale and purchase of target's assets.

(ii) Examples. The following examples illustrate this paragraph

(b)(4):

Example 1. A owns all of the T stock. T owns 50 of the 100

shares of X stock. The other 50 shares of X stock are owned by

corporation Y, which is unrelated to A, T, or P. On January 1 of

Year 1, P makes a qualified stock purchase of T from A and makes a

section 338 election for T. On December 1 of Year 1, P purchases the

50 shares of X stock held by Y. A qualified stock purchase of X is

made on December 1 of Year 1, because the deemed purchase of 50

shares of X stock by new T because of the section 338 election for T

and the actual purchase of 50 shares of X stock by P are treated as

purchases made by one corporation. Section 338(h)(8). For purposes

of determining whether those purchases occur within a 12-month

acquisition period as required by section 338(d)(3), T is deemed to

purchase its X stock on T's acquisition date, i.e., January 1 of

Year 1.

Example 2. On January 1 of Year 1, P makes a qualified stock

purchase of T and makes a section 338 election for T. On that day, T

sells all of the stock of T1 to A. Although T held all of the T1

stock on T's acquisition date, T is not considered to have purchased

the T1 stock because of the section 338 election for T. In order for

T to be treated as purchasing the T1 stock, T must hold the T1 stock

when T's deemed asset sale occurs. The deemed asset sale is

considered the last transaction of old T at the close of T's

acquisition date. Accordingly, the T1 stock actually disposed of by

T on the acquisition date is not included in the deemed asset sale.

Thus, T does not make a qualified stock purchase of T1.

(5) Effect of redemptions--(i) General rule. Except as provided in

this paragraph (b)(5), a qualified stock purchase is made on the first

day on which the percentage ownership requirements of section 338(d)(3)

are satisfied by reference to target stock that is both--

(A) Held on that day by the purchasing corporation; and

(B) Purchased by the purchasing corporation during the 12-month

period ending on that day.

(ii) Redemptions from persons unrelated to the purchasing

corporation. Target stock redemptions from persons unrelated to the

purchasing corporation that occur during the 12-month acquisition

period are taken into account as reductions in target's outstanding

stock for purposes of determining whether target stock purchased by the

purchasing corporation in the 12-month acquisition period satisfies the

percentage ownership requirements of section 338(d)(3).

(iii) Redemptions from the purchasing corporation or related

persons during 12-month acquisition period--(A) General rule. For

purposes of the percentage ownership requirements of section 338(d)(3),

a redemption of target stock during the 12-month acquisition period

from the purchasing corporation or from any person related to the

purchasing corporation is not taken into account as a reduction in

target's outstanding stock.

(B) Exception for certain redemptions from related corporations. A

redemption of target stock during the 12-month acquisition period from

a corporation related to the purchasing corporation is taken into

account as a reduction in target's outstanding stock to the extent that

the redeemed stock would have been considered purchased by the

purchasing corporation (because of section 338(h)(3)(C)) during the 12-

month acquisition period if the redeemed stock had been acquired by the

purchasing corporation from the related corporation on the day of the

redemption. See paragraph (b)(3) of this section.

(iv) Examples. The following examples illustrate this paragraph

(b)(5):

Example 1. QSP on stock purchase date; redemption from unrelated

person during 12-month period. A owns all 100 shares of T stock. On

January 1 of Year 1, P purchases 40 shares of the T stock from A. On

July 1 of Year 1, T redeems 25 shares from A. On December 1 of Year

1, P purchases 20 shares of the T stock from A. P makes a qualified

stock purchase of T on December 1 of Year 1, because the 60 shares

of T stock purchased by P within the 12-month period ending on that

date satisfy the 80-percent ownership requirements of section

338(d)(3) (i.e., 60/75 shares), determined by taking into account

the redemption of 25 shares.

Example 2. QSP on stock redemption date; redemption from

unrelated person during 12-month period. The facts are the same as

in Example 1, except that P purchases 60 shares of T stock on

January 1 of Year 1 and none

[[Page 1245]]

on December 1 of Year 1. P makes a qualified stock purchase of T on

July 1 of Year 1, because that is the first day on which the T stock

purchased by P within the preceding 12-month period satisfies the

80-percent ownership requirements of section 338(d)(3) (i.e., 60/75

shares), determined by taking into account the redemption of 25

shares.

Example 3. Redemption from purchasing corporation not taken into

account. On December 15 of Year 1, T redeems 30 percent of its stock

from P. The redeemed stock was held by P for several years and

constituted P's total interest in T. On December 1 of Year 2, P

purchases the remaining T stock from A. P does not make a qualified

stock purchase of T on December 1 of Year 2. For purposes of the 80-

percent ownership requirements of section 338(d)(3), the redemption

of P's T stock on December 15 of Year 1 is not taken into account as

a reduction in T's outstanding stock.

Example 4. Redemption from related person taken into account. On

January 1 of Year 1, P purchases 60 of the 100 shares of X stock. On

that date, X owns 40 of the 100 shares of T stock. On April 1 of

Year 1, T redeems X's T stock and P purchases the remaining 60

shares of T stock from an unrelated person. For purposes of the 80-

percent ownership requirements of section 338(d)(3), the redemption

of the T stock from X (a person related to P) is taken into account

as a reduction in T's outstanding stock. If P had purchased the 40

redeemed shares from X on April 1 of Year 1, all 40 of the shares

would have been considered purchased (because of section

338(h)(3)(C)(i)) during the 12-month period ending on April 1 of

Year 1 (24 of the 40 shares would have been considered purchased by

P on January 1 of Year 1 and the remaining 16 shares would have been

considered purchased by P on April 1 of Year 1). See paragraph

(b)(3) of this section. Accordingly, P makes a qualified stock

purchase of T on April 1 of Year 1, because the 60 shares of T stock

purchased by P on that date satisfy the 80-percent ownership

requirements of section 338(d)(3) (i.e., 60/60 shares), determined

by taking into account the redemption of 40 shares.

338 election--(1) Post-acquisition elimination of target. (i) The

purchasing corporation may make an election under section 338 for

target even though target is liquidated on or after the acquisition

date. If target liquidates on the acquisition date, the liquidation is

considered to occur on the following day and immediately after new

target's deemed purchase of assets. The purchasing corporation may also

make an election under section 338 for target even though target is

merged into another corporation, or otherwise disposed of by the

purchasing corporation provided that, under the facts and

circumstances, the purchasing corporation is considered for tax

purposes as the purchaser of the target stock.

(ii) The following examples illustrate this paragraph (c)(1):

Example 1. On January 1 of Year 1, P purchases 100 percent of

the outstanding common stock of T. On June 1 of Year 1, P sells the

T stock to an unrelated person. Assuming that P is considered for

tax purposes as the purchaser of the T stock, P remains eligible,

after June 1 of Year 1, to make a section 338 election for T that

results in a deemed asset sale of T's assets on January 1 of Year 1.

Example 2. On January 1 of Year 1, P makes a qualified stock

purchase of T. On that date, T owns the stock of T1. On March 1 of

Year 1, T sells the T1 stock to an unrelated person. On April 1 of

Year 1, P makes a section 338 election for T. Notwithstanding that

the T1 stock was sold on March 1 of Year 1, the section 338 election

for T on April 1 of Year 1 results in a qualified stock purchase by

T of T1 on January 1 of Year 1. See paragraph (b)(4)(i) of this

section.

(2) Post-acquisition elimination of the purchasing corporation. An

election under section 338 may be made for target after the acquisition

of assets of the purchasing corporation by another corporation in a

transaction described in section 381(a), provided that the purchasing

corporation is considered for tax purposes as the purchaser of the

target stock. The acquiring corporation in the section 381(a)

transaction may make an election under section 338 for target.

(3) Consequences of post-acquisition elimination of target--(i)

Scope. The rules of this paragraph (c)(3) apply to the transfer of

target assets to the purchasing corporation (or another member of the

same affiliated group as the purchasing corporation) (the transferee)

following a qualified stock purchase of target stock, if the purchasing

corporation does not make a section 338 election for target.

Notwithstanding the rules of this paragraph (c)(3), section 354(a) (and

so much of section 356 as relates to section 354) cannot apply to any

person other than the purchasing corporation or another member of the

same affiliated group as the purchasing corporation unless the transfer

of target assets is pursuant to a reorganization as determined without

regard to this paragraph (c)(3).

(ii) Continuity of interest. By virtue of section 338, in

determining whether the continuity of interest requirement of

Sec. 1.368-1(b) is satisfied on the transfer of assets from target to

the transferee, the purchasing corporation's target stock acquired in

the qualified stock purchase represents an interest on the part of a

person who was an owner of the target's business enterprise prior to

the transfer that can be continued in a reorganization.

(iii) Control requirement. By virtue of section 338, the

acquisition of target stock in the qualified stock purchase will not

prevent the purchasing corporation from qualifying as a shareholder of

the target transferor for the purpose of determining whether,

immediately after the transfer of target assets, a shareholder of the

transferor is in control of the corporation to which the assets are

transferred within the meaning of section 368(a)(1)(D).

(iv) Example. The following example illustrates this paragraph

(c)(3):

Example. (i) Facts. P, T, and X are domestic corporations. T and

X each operate a trade or business. A and K, individuals unrelated

to P, own 85 and 15 percent, respectively, of the stock of T. P owns

all of the stock of X. The total adjusted basis of T's property

exceeds the sum of T's liabilities plus the amount of liabilities to

which T's property is subject. P purchases all of A's T stock for

cash in a qualified stock purchase. P does not make an election

under section 338(g) with respect to its acquisition of T stock.

Shortly after the acquisition date, and as part of the same plan, T

merges under applicable state law into X in a transaction that, but

for the question of continuity of interest, satisfies all the

requirements of section 368(a)(1)(A). In the merger, all of T's

assets are transferred to X. P and K receive X stock in exchange for

their T stock. P intends to retain the stock of X indefinitely.

(ii) Status of transfer as a reorganization. By virtue of

section 338, for the purpose of determining whether the continuity

of interest requirement of Sec. 1.368-1(b) is satisfied, P's T stock

acquired in the qualified stock purchase represents an interest on

the part of a person who was an owner of T's business enterprise

prior to the transfer that can be continued in a reorganization

through P's continuing ownership of X. Thus, the continuity of

interest requirement is satisfied and the merger of T into X is a

reorganization within the meaning of section 368(a)(1)(A). Moreover,

by virtue of section 338, the requirement of section 368(a)(1)(D)

that a target shareholder control the transferee immediately after

the transfer is satisfied because P controls X immediately after the

transfer. In addition, all of T's assets are transferred to X in the

merger and P and K receive the X stock exchanged therefor in

pursuance of the plan of reorganization. Thus, the merger of T into

X is also a reorganization within the meaning of section

368(a)(1)(D).

(iii) Treatment of T and X. Under section 361(a), T recognizes

no gain or loss in the merger. Under section 362(b), X's basis in

the assets received in the merger is the same as the basis of the

assets in T's hands. X succeeds to and takes into account the items

of T as provided in section 381.

(iv) Treatment of P. By virtue of section 338, the transfer of T

assets to X is a reorganization. Pursuant to that reorganization, P

exchanges its T stock solely for stock of X, a party to the

reorganization. Because P is the purchasing corporation, section 354

applies to P's exchange of T stock for X stock in the merger of T

into X. Thus, P recognizes no gain or loss on the exchange.

[[Page 1246]]

Under section 358, P's basis in the X stock received in the exchange

is the same as the basis of P's T stock exchanged therefor.

(v) Treatment of K. Because K is not the purchasing corporation

(or an affiliate thereof), section 354 cannot apply to K's exchange

of T stock for X stock in the merger of T into X unless the transfer

of T's assets is pursuant to a reorganization as determined without

regard to this paragraph (c)(3). Under general principles of tax law

applicable to reorganizations, the continuity of interest

requirement is not satisfied because P's stock purchase and the

merger of T into X are pursuant to an integrated transaction in

which A, the owner of 85 percent of the stock of T, received solely

cash in exchange for A's T stock. See, e.g., Yoc Heating v.

Commissioner, 61 T.C. 168 (1973); Kass v. Commissioner, 60 T.C. 218

(1973), aff'd, 491 F.2d 749 (3d Cir. 1974). Thus, the requisite

continuity of interest under Sec. 1.368-1(b) is lacking and section

354 does not apply to K's exchange of T stock for X stock. K

recognizes gain or loss, if any, pursuant to section 1001(c) with

respect to its T stock.

Secs. 1.338-4 and 1.338-5 [Redesignated as Secs. 1.338-8 and 1.338-9]

Par. 5. Sections 1.338-4 and 1.338-5 are redesignated as

Secs. 1.338-8 and 1.338-9, respectively.

Par. 6. New Secs. 1.338-4T and 1.338-5T are added to read as

follows:

Sec. 1.338-4T Aggregate deemed sale price; various aspects of taxation

of the deemed asset sale (temporary).

(a) Scope. This section provides rules under section 338(a)(1) to

determine the aggregate deemed sale price (ADSP) for target. ADSP is

the amount for which old target is deemed to have sold all of its

assets in the deemed asset sale. ADSP is allocated among target's

assets in accordance with Sec. 1.338-6T to determine the amount for

which each asset is deemed to have been sold. When an increase or

decrease with respect to an element of ADSP is required, under general

principles of tax law, after the close of new target's first taxable

year, redetermined ADSP is allocated among target's assets in

accordance with Sec. 1.338-7T. This section also provides rules

regarding the recognition of gain or loss on the deemed sale of target

affiliate stock. Notwithstanding section 338(h)(6)(B)(ii), stock held

by a target affiliate in a foreign corporation or in a corporation that

is a DISC or that is described in section 1248(e) is not excluded from

the operation of section 338.

(b) Determination of ADSP--(1) General rule. ADSP is the sum of--

(i) The grossed-up amount realized on the sale to the purchasing

corporation of the purchasing corporation's recently purchased target

stock (as defined in section 338(b)(6)(A)); and

(ii) The liabilities of old target.

(2) Time and amount of ADSP--(i) Original determination. ADSP is

initially determined at the beginning of the day after the acquisition

date of target. General principles of tax law apply in determining the

timing and amount of the elements of ADSP.

(ii) Redetermination of ADSP. ADSP is redetermined at such time and

in such amount as an increase or decrease would be required, under

general principles of tax law, for the elements of ADSP. For example,

ADSP is redetermined because of an increase or decrease in the amount

realized for recently purchased stock or because liabilities not

originally taken into account in determining ADSP are subsequently

taken into account. An increase or decrease to one element of ADSP may

cause an increase or decrease to the other element of ADSP. For

example, if an increase in the amount realized for recently purchased

stock of target is taken into account after the acquisition date, any

increase in the tax liability of target for the deemed sale gain is

also taken into account when ADSP is redetermined. Increases or

decreases with respect to the elements of ADSP that are taken into

account before the close of new target's first taxable year are taken

into account for purposes of determining ADSP and the deemed sale gain

as if they had been taken into account at the beginning of the day

after the acquisition date. Increases or decreases with respect to the

elements of ADSP that are taken into account after the close of new

target's first taxable year result in the reallocation of ADSP among

target's assets under Sec. 1.338-7T.

(iii) Example. The following example illustrates this paragraph

(b)(2):

Example. In Year 1, T, a manufacturer, purchases a customized

delivery truck from X with purchase money indebtedness having a

stated principal amount of $100,000. P acquires all of the stock of

T in Year 3 for $700,000 and makes a section 338 election for T.

Assume T has no liabilities other than its purchase money

indebtedness to X. In Year 4, when T is neither insolvent nor in a

title 11 case, T and X agree to reduce the amount of the purchase

money indebtedness to $80,000. Assume further that the reduction

would be a purchase price reduction under section 108(e)(5). T and

X's agreement to reduce the amount of the purchase money

indebtedness would not, under general principles of tax law that

would apply if the deemed asset sale had actually occurred, change

the amount of liabilities of old target taken into account in

determining its amount realized. Accordingly, ADSP is not

redetermined at the time of the reduction. See Sec. 1.338-

5T(b)(2)(iii) Example 1 for the effect on AGUB.

corporation of the purchasing corporation's recently purchased target

stock--(1) Determination of amount. The grossed-up amount realized on

the sale to the purchasing corporation of the purchasing corporation's

recently purchased target stock is an amount equal to--

(i) The amount realized on the sale to the purchasing corporation

of the purchasing corporation's recently purchased target stock

determined as if old target were the selling shareholder and the

installment method were not available and determined without regard to

the selling costs taken into account in paragraph (c)(1)(iii) of this

section;

(ii) Divided by the percentage of target stock (by value,

determined on the acquisition date) attributable to that recently

purchased target stock;

(iii) Less the selling costs incurred by the selling shareholders

in connection with the sale to the purchasing corporation of the

purchasing corporation's recently purchased target stock that reduce

their amount realized on the sale of the stock (e.g., brokerage

commissions and any similar costs to sell the stock).

(2) Example. The following example illustrates this paragraph (c):

Example. T has two classes of stock outstanding, voting common

stock and preferred stock not taken into account for purposes of

section 1504(a)(2). On March 1 of Year 1, P purchases 40 percent of

the outstanding T stock from S1 for $500, 20 percent of the

outstanding T stock from S2 for $225, and 20 percent of the

outstanding T stock from S3 for $275. On that date, the fair market

value of all the T voting common stock is $1,250 and the preferred

stock $750. S1, S2, and S3 respectively incur $40, $35, and $25 of

selling costs. S1 continues to own the remaining 20 percent of the

outstanding T stock. The grossed-up amount realized on the sale to P

of P's recently purchased T stock is calculated as follows: The

total amount realized (without regard to selling costs) is $1,000

(500 + 225 + 275). The percentage of T stock by value on the

acquisition date attributable to the recently purchased T stock is

50% (1,000/(1,250 + 750)). The selling costs are $100 (40 + 35 +

25). The grossed-up amount realized is $1,900 (1,000/.5 - 100).

(d) Liabilities of old target--(1) In general. The liabilities of

old target are the liabilities of target (and the liabilities to which

target's assets are subject) as of the beginning of the day after the

acquisition date (other than liabilities that were neither liabilities

of old target nor liabilities to which old target's assets were

subject). In order to be taken into account in ADSP, a

[[Page 1247]]

liability must be a liability of target that is properly taken into

account in amount realized under general principles of tax law that

would apply if old target had sold its assets to an unrelated person

for consideration that included that person's assumption of, or taking

subject to, the liability. Thus, ADSP takes into account both tax

credit recapture liability arising because of the deemed asset sale and

the tax liability for the deemed sale gain unless the tax liability is

borne by some person other than the target. For example, ADSP would not

take into account the tax liability for the deemed sale gain when a

section 338(h)(10) election is made for a target S corporation because

the S corporation shareholders bear that liability. However, if a

target S corporation is subject to a tax under section 1374 or 1375,

the liability for tax imposed by those sections is a liability of

target taken into account in ADSP (unless the S corporation

shareholders expressly assume that liability).

(2) Time and amount of liabilities. The time for taking into

account liabilities of old target in determining ADSP and the amount of

the liabilities taken into account is determined as if old target had

sold its assets to an unrelated person for consideration that included

the unrelated person's assumption of or taking subject to the

liabilities. For example, if no amount of a target liability is

properly taken into account in amount realized as of the beginning of

the day after the acquisition date, the liability is not initially

taken into account in determining ADSP (although it may be taken into

account at some later date). As a further example, an increase or

decrease in a liability that does not affect the amount of old target's

basis, deductions, or noncapital nondeductible items arising from the

incurrence of the liability is not taken into account in redetermining

ADSP.

(3) Interaction with deemed sale gain. Though deemed sale gain

increases or decreases ADSP by creating or reducing a tax liability,

the amount of the tax liability itself is a function of the size of the

deemed sale gain. Thus, the determination of ADSP may require trial and

error computations.

(e) Calculation of deemed sale gain. Deemed sale gain on each asset

is computed by reference to the ADSP allocated to that asset.

(f) Other rules apply in determining ADSP. ADSP may not be applied

in such a way as to contravene other applicable rules. For example, a

capital loss cannot be applied to reduce ordinary income in calculating

the tax liability on the deemed sale for purposes of determining ADSP.

(g) Examples. The following examples illustrate this section. For

purposes of the examples in this paragraph (g), unless otherwise

stated, T is a calendar year taxpayer that files separate returns and

that has no loss, tax credit, or other carryovers to Year 1.

Depreciation for Year 1 is not taken into account. T has no liabilities

other than the Federal income tax liability resulting from the deemed

asset sale, and the T shareholders have no selling costs. Assume that

T's tax rate for any ordinary income or net capital gain resulting from

the deemed sale of assets is 34 percent and that any capital loss is

offset by capital gain. On July 1 of Year 1, P purchases all of the

stock of T and makes a section 338 election for T. The examples are as

follows:

Example 1. One class. (i) On July 1 of Year 1, T's only asset is

an item of section 1245 property with an adjusted basis to T of

$50,400, a recomputed basis of $80,000, and a fair market value of

$100,000. P purchases all of the T stock for $75,000, which also

equals the amount realized for the stock determined as if old target

were the selling shareholder.

(ii) ADSP is determined as follows (In the following formula, G

is the grossed-up amount realized on the sale to P of P's recently

purchased T stock, L is T's liabilities other than T's tax liability

for the deemed sale gain, TR is the applicable tax rate,

and B is the adjusted basis of the asset deemed sold):

ADSP = G + L + TR (ADSP - B)

ADSP = ($75,000/1) + $0 + .34 (ADSP - $50,400)

ADSP = $75,000 + .34ADSP - $17,136

.66ADSP = $57,864

ADSP = $87,672.72

(iii) Because ADSP for T ($87,672.72) does not exceed the fair

market value of T's asset ($100,000), a Class V asset, T's entire

ADSP is allocated to that asset. Thus, T has deemed sale gain of

$37,272.72 (consisting of $29,600 of ordinary income and $7,672.72

of capital gain).

(iv) The facts are the same as in paragraph (i) of this Example

1, except that on July 1 of Year 1, P purchases only 80 of the 100

shares of T stock for $60,000. The grossed-up amount realized on the

sale to P of P's recently purchased T stock (G) is $75,000

($60,000/.8). Consequently, ADSP and deemed sale gain are the same

as in paragraphs (ii) and (iii) of this Example 1.

(v) The facts are the same as in paragraph (i) of this Example

1, except that T also has goodwill (a Class VII asset) with an

appraised value of $10,000. The results are the same as in

paragraphs (ii) and (iii) of this Example 1. Because ADSP does not

exceed the fair market value of the Class V asset, no amount is

allocated to the Class VII asset (goodwill).

Example 2. More than one class. (i) P purchases all of the T

stock for $140,000, which also equals the amount realized for the

stock determined as if old target were the selling shareholder. On

July 1 of Year 1, T has liabilities (not including the tax liability

for the deemed sale gain) of $50,000, cash (a Class I asset) of

$10,000, actively traded securities (a Class II asset) with a basis

of $4,000 and a fair market value of $10,000, goodwill (a Class VII

asset) with a basis of $3,000, and the following Class V assets:

------------------------------------------------------------------------

Ratio of

asset fmv

Asset Basis FMV to total

Class V fmv

------------------------------------------------------------------------

Land............................. $5,000 $35,000 .14

Building......................... 10,000 50,000 .20

Equipment A (Recomputed basis 5,000 90,000 .36

$80,000)........................

Equipment B (Recomputed basis 10,000 75,000 .30

$20,000)........................

--------------------------------------

Totals....................... $30,000 $250,000 1.00

------------------------------------------------------------------------

(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to

the cash and $10,000 to the actively traded securities. The amount

allocated to an asset (other than a Class VII asset) cannot exceed

its fair market value (however, the fair market value of any

property subject to nonrecourse indebtedness is treated as being not

less than the amount of such indebtedness; see Sec. 1.338-6T(a)(2)).

See Sec. 1.338-6T(c)(1) (relating to fair market value limitation).

(iii) The portion of ADSP allocable to the Class V assets is

preliminarily determined as follows (in the formula, the amount

allocated to the Class I assets is referred to as I and the amount

allocated to the Class II assets as II):

ADSPV = (G - (I + II)) + L + TR x [(II -

BII) + (ADSPV - BV)]

ADSPV = ($140,000 - ($10,000 + $10,000)) + $50,000 + .34

x [($10,000 - $4,000) + (ADSPV - ($5,000 + $10,000 +

$5,000 + $10,000))]

[[Page 1248]]

ADSPV = $161,840 + .34 ADSPV

.66 ADSPV = $161,840

ADSPV = $245,212.12

(iv) Because, under the preliminary calculations of ADSP, the

amount to be allocated to the Class I, II, III, IV, V, and VI assets

does not exceed their aggregate fair market value, no ADSP amount is

allocated to goodwill. Accordingly, the deemed sale of the goodwill

results in a capital loss of $3,000. The portion of ADSP allocable

to the Class V assets is finally determined by taking into account

this loss as follows:

ADSPV = (G - (I + II)) + L + TR x [(II -

BII) + (ADSPV - BV) +

(ADSPVII - BVII)]

ADSPV = ($140,000 - ($10,000 + $10,000)) + $50,000 + .34

x [($10,000 - $4,000) + (ADSPV - $30,000) + ($0-$3,000)]

ADSPV = $160,820 + .34 ADSPV

.66 ADSPV = $160,820

ADSPV = $243,666.67

(v) The allocation of ADSPV among the Class V assets

is in proportion to their fair market values, as follows:

------------------------------------------------------------------------

Asset ADSP Gain

------------------------------------------------------------------------

Land............................ $34,113.33 $29,113.33

(capital gain).

Building........................ 48,733.34 38,733.34 (capital

gain).

Equipment A..................... 87,720.00 82,720.00 (75,000

ordinary income

7,720 capital

gain).

Equipment B..................... 73,100.00 63,100.00 (10,000

ordinary income

53,100 capital

gain).

---------------------------------------

Totals...................... $243,666.67 $213,666.67.

------------------------------------------------------------------------

Example 3. More than one class. (i) The facts are the same as in

Example 2, except that P purchases the T stock for $150,000, rather

than $140,000. The amount realized for the stock determined as if

old target were the selling shareholder is also $150,000.

(ii) As in Example 2, ADSP exceeds $20,000. Thus, $10,000 of

ADSP is allocated to the cash and $10,000 to the actively traded

securities.

(iii) The portion of ADSP allocable to the Class V assets as

preliminarily determined under the formula set forth in paragraph

(iii) of Example 2 is $260,363.64. The amount allocated to the Class

V assets cannot exceed their aggregate fair market value ($250,000).

Thus, preliminarily, the ADSP amount allocated to Class V assets is

$250,000.

(iv) Based on the preliminary allocation, the ADSP is determined

as follows (in the formula, the amount allocated to the Class I

assets is referred to as I, the amount allocated to the Class II

assets as II, and the amount allocated to the Class V assets as V):

ADSP = G + L + TR x [(II - BII) + (V -

BV) + (ADSP - (I + II + V+ BVII))]

ADSP = $150,000 + $50,000 + .34 x [($10,000 - $4,000) + ($250,000

-$30,000) + (ADSP - ($10,000 + $10,000 + $250,000 + $3,000))]

ADSP = $200,000 + .34ADSP - $15,980

.66ADSP = $184,020

ADSP = $278,818.18

(v) Because ADSP as determined exceeds the aggregate fair market

value of the Class I, II, III, IV, V, and VI assets, the $250,000

amount preliminarily allocated to the Class V assets is appropriate.

Thus, the amount of ADSP allocated to Class V assets equals their

aggregate fair market value ($250,000), and the allocated ADSP

amount for each Class V asset is its fair market value. Further,

because there are no Class VI assets, the allocable ADSP amount for

the Class VII asset (goodwill) is $8,818.18 (the excess of ADSP over

the aggregate ADSP amounts for the Class I, II, III, IV, V and VI

assets).

Example 4. Amount allocated to T1 stock. (i) The facts are the

same as in Example 2, except that T owns all of the T1 stock

(instead of the building), and T1's only asset is the building. The

T1 stock and the building each have a fair market value of $50,000,

and the building has a basis of $10,000. A section 338 election is

made for T1 (as well as T), and T1 has no liabilities other than the

tax liability for the deemed sale gain. T is the common parent of a

consolidated group filing a final consolidated return described in

Sec. 1.338-10T(a)(1).

(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to

the cash and $10,000 to the actively traded securities.

(iii) Because T does not recognize any gain on the deemed sale

of the T1 stock under paragraph (h)(2) of this section, appropriate

adjustments must be made to reflect accurately the fair market value

of the T and T1 assets in determining the allocation of ADSP among

T's Class V assets (including the T1 stock). In preliminarily

calculating ADSPV in this case, the T1 stock can be

disregarded and, because T owns all of the T1 stock, the T1 asset

can be treated as a T asset. Under this assumption, ADSPV

is $243,666.67. See paragraph (iv) of Example 2.

(iv) Because the portion of the preliminary ADSP allocable to

Class V assets ($243,666.67) does not exceed their fair market value

($250,000), no amount is allocated to Class VII assets for T.

Further, this amount ($243,666.67) is allocated among T's Class V

assets in proportion to their fair market values. See paragraph (v)

of Example 2. Tentatively, $48,733.34 of this amount is allocated to

the T1 stock.

(v) The amount tentatively allocated to the T1 stock, however,

reflects the tax incurred on the deemed sale of the T1 asset equal

to $13,169.34 (.34 - ($48,733.34 - $10,000)). Thus, the ADSP

allocable to the Class V assets of T, and the ADSP allocable to the

T1 stock, as preliminarily calculated, each must be reduced by

$13,169.34. Consequently, these amounts, respectively, are

$230,497.33 and $35,564.00. In determining ADSP for T1, the grossed-

up amount realized on the deemed sale to new T of new T's recently

purchased T1 stock is $35,564.00.

(vi) The facts are the same as in paragraph (i) of this Example

4, except that the T1 building has a $12,500 basis and a $62,500

value, all of the outstanding T1 stock has a $62,500 value, and T

owns 80 percent of the T1 stock. In preliminarily calculating

ADSPV, the T1 stock can be disregarded but, because T

owns only 80 percent of the T1 stock, only 80 percent of T1 asset

basis and value should be taken into account in calculating T's

ADSP. By taking into account 80 percent of these amounts, the

remaining calculations and results are the same as in paragraphs

(ii), (iii), (iv), and (v) of this Example 4, except that the

grossed-up amount realized on the sale of the recently purchased T1

stock is $44,455.00 ($35,564.00/0.8).

(h) Deemed sale of target affiliate stock--(1) Scope. This

paragraph (h) prescribes rules relating to the treatment of gain or

loss realized on the deemed sale of stock of a target affiliate when a

section 338 election (but not a section 338(h)(10) election) is made

for the target affiliate. For purposes of this paragraph (h), the

definition of domestic corporation in Sec. 1.338-2T(c)(9) is applied

without the exclusion therein for DISCs, corporations described in

section 1248(e), and corporations to which an election under section

936 applies.

(2) In general. Except as otherwise provided in this paragraph (h),

if a section 338 election is made for target, target recognizes no gain

or loss on the deemed sale of stock of a target affiliate having the

same acquisition date and for which a section 338 election is made if--

(i) Target directly owns stock in the target affiliate satisfying

the requirements of section 1504(a)(2);

(ii) Target and the target affiliate are members of a consolidated

group filing a final consolidated return described in Sec. 1.338-

10T(a)(1); or

(iii) Target and the target affiliate file a combined return under

Sec. 1.338-10T(a)(4).

(3) Deemed sale of foreign target affiliate by a domestic target. A

domestic target recognizes gain or loss on the deemed sale of stock of

a foreign target affiliate. For the proper treatment of such gain or

loss, see, e.g., sections 1246, 1248, 1291 et seq., and 338(h)(16) and

Sec. 1.338-9.

(4) Deemed sale producing effectively connected income. A foreign

target recognizes gain or loss on the deemed

[[Page 1249]]

sale of stock of a foreign target affiliate to the extent that such

gain or loss is effectively connected (or treated as effectively

connected) with the conduct of a trade or business in the United

States.

(5) Deemed sale of insurance company target affiliate electing

under section 953(d). A domestic target recognizes gain (but not loss)

on the deemed sale of stock of a target affiliate that has in effect an

election under section 953(d) in an amount equal to the lesser of the

gain realized or the earnings and profits described in section

953(d)(4)(B).

(6) Deemed sale of DISC target affiliate. A foreign or domestic

target recognizes gain (but not loss) on the deemed sale of stock of a

target affiliate that is a DISC or a former DISC (as defined in section

992(a)) in an amount equal to the lesser of the gain realized or the

amount of accumulated DISC income determined with respect to such stock

under section 995(c). Such gain is included in gross income as a

dividend as provided in sections 995(c)(2) and 996(g).

(7) Anti-stuffing rule. If an asset the adjusted basis of which

exceeds its fair market value is contributed or transferred to a target

affiliate as transferred basis property (within the meaning of section

7701(a)(43)) and a purpose of such transaction is to reduce the gain

(or increase the loss) recognized on the deemed sale of such target

affiliate's stock, the gain or loss recognized by target on the deemed

sale of stock of the target affiliate is determined as if such asset

had not been contributed or transferred.

(8) Examples. The following examples illustrate this paragraph (h):

Example 1. (i) P makes a qualified stock purchase of T and makes

a section 338 election for T. T's sole asset, all of the T1 stock,

has a basis of $50 and a fair market value of $150. T's deemed

purchase of the T1 stock results in a qualified stock purchase of T1

and a section 338 election is made for T1. T1's assets have a basis

of $50 and a fair market value of $150.

(ii) T realizes $100 of gain on the deemed sale of the T1 stock,

but the gain is not recognized because T directly owns stock in T1

satisfying the requirements of section 1504(a)(2) and a section 338

election is made for T1.

(iii) T1 recognizes gain of $100 on the deemed sale of its

assets.

Example 2. The facts are the same as in Example 1, except that P

does not make a section 338 election for T1. Because a section 338

election is not made for T1, the $100 gain realized by T on the

deemed sale of the T1 stock is recognized.

Example 3. (i) P makes a qualified stock purchase of T and makes

a section 338 election for T. T owns all of the stock of T1 and T2.

T's deemed purchase of the T1 and T2 stock results in a qualified

stock purchase of T1 and T2 and section 338 elections are made for

T1 and T2. T1 and T2 each own 50 percent of the vote and value of T3

stock. The deemed purchases by T1 and T2 of the T3 stock result in a

qualified stock purchase of T3 and a section 338 election is made

for T3. T is the common parent of a consolidated group and all of

the deemed asset sales are reported on the T group's final

consolidated return. See Sec. 1.338-10T(a)(1).

(ii) Because T, T1, T2 and T3 are members of a consolidated

group filing a final consolidated return, no gain or loss is

recognized by T, T1 or T2 on their respective deemed sales of target

affiliate stock.

Example 4. (i) T's sole asset, all of the FT1 stock, has a basis

of $25 and a fair market value of $150. FT1's sole asset, all of the

FT2 stock, has a basis of $75 and a fair market value of $150. FT1

and FT2 each have $50 of accumulated earnings and profits for

purposes of section 1248(c) and (d). FT2's assets have a basis of

$125 and a fair market value of $150, and their sale would not

generate subpart F income under section 951. The sale of the FT2

stock or assets would not generate income effectively connected with

the conduct of a trade or business within the United States. FT1

does not have an election in effect under section 953(d) and neither

FT1 nor FT2 is a passive foreign investment company.

(ii) P makes a qualified stock purchase of T and makes a section

338 election for T. T's deemed purchase of the FT1 stock results in

a qualified stock purchase of FT1 and a section 338 election is made

for FT1. Similarly, FT1's deemed purchase of the FT2 stock results

in a qualified stock purchase of FT2 and a section 338 election is

made for FT2.

(iii) T recognizes $125 of gain on the deemed sale of the FT1

stock under paragraph (h)(3) of this section. FT1 does not recognize

$75 of gain on the deemed sale of the FT2 stock under paragraph

(h)(2) of this section. FT2 recognizes $25 of gain on the deemed

sale of its assets. The $125 gain T recognizes on the deemed sale of

the FT1 stock is included in T's income as a dividend under section

1248, because FT1 and FT2 have sufficient earnings and profits for

full recharacterization ($50 of accumulated earnings and profits in

FT1, $50 of accumulated earnings and profits in FT2, and $25 of

deemed sale earnings and profits in FT2). Sec. 1.338-9(b). For

purposes of sections 901 through 908, the source and foreign tax

credit limitation basket of $25 of the recharacterized gain on the

deemed sale of the FT1 stock is determined under section 338(h)(16).

Sec. 1.338-5T Adjusted grossed-up basis (temporary).

(a) Scope. This section provides rules under section 338(b) to

determine the adjusted grossed-up basis (AGUB) for target. AGUB is the

amount for which new target is deemed to have purchased all of its

assets in the deemed purchase under section 338(a)(2). AGUB is

allocated among target's assets in accordance with Sec. 1.338-6T to

determine the price at which the assets are deemed to have been

purchased. When an increase or decrease with respect to an element of

AGUB is required, under general principles of tax law, after the close

of new target's first taxable year, redetermined AGUB is allocated

among target's assets in accordance with Sec. 1.338-7T.

(b) Determination of AGUB--(1) General rule. AGUB is the sum of--

(i) The grossed-up basis in the purchasing corporation's recently

purchased target stock;

(ii) The purchasing corporation's basis in nonrecently purchased

target stock; and

(iii) The liabilities of new target.

(2) Time and amount of AGUB--(i) Original determination. AGUB is

initially determined at the beginning of the day after the acquisition

date of target. General principles of tax law apply in determining the

timing and amount of the elements of AGUB.

(ii) Redetermination of AGUB. AGUB is redetermined at such time and

in such amount as an increase or decrease would be required, under

general principles of tax law, with respect to an element of AGUB. For

example, AGUB is redetermined because of an increase or decrease in the

amount paid or incurred for recently purchased stock or nonrecently

purchased stock or because liabilities not originally taken into

account in determining AGUB are subsequently taken into account. An

increase or decrease to an element of ADSP may cause an increase or

decrease to an element of AGUB. For example, if an increase in the

amount realized for recently purchased stock of target is taken into

account after the acquisition date, any increase in tax liability of

target for the deemed sale gain is also taken into account when AGUB is

redetermined. An increase or decrease to one element of AGUB may also

cause an increase or decrease to another element of AGUB. For example,

if there is an increase in the amount paid or incurred for recently

purchased stock after the acquisition date, any increase in the basis

of nonrecently purchased stock because a gain recognition election was

made is also taken into account when AGUB is redetermined. Increases or

decreases with respect to the elements of AGUB that are taken into

account before the close of new target's first taxable year are taken

into account for purposes of determining AGUB and the basis of target's

assets as if they had been taken into account at the beginning of the

day after the acquisition date. Increases or decreases with respect to

the elements of AGUB

[[Page 1250]]

that are taken into account after the close of new target's first

taxable year result in the reallocation of AGUB among target's assets

under Sec. 1.338-7T.

(iii) Examples. The following examples illustrate this paragraph

(b)(2):

Example 1. In Year 1, T, a manufacturer, purchases a customized

delivery truck from X with purchase money indebtedness having a

stated principal amount of $100,000 . P acquires all of the stock of

T in Year 3 for $700,000 and makes a section 338 election for T.

Assume T has no liabilities other than its purchase money

indebtedness to X. In Year 4, when T is neither insolvent nor in a

title 11 case, T and X agree to reduce the amount of the purchase

money indebtedness to $80,000. Assume that the reduction would be a

purchase price reduction under section 108(e)(5). T and X's

agreement to reduce the amount of the purchase money indebtedness

would, under general principles of tax law that would apply if the

deemed asset sale had actually occurred, change the amount of

liabilities of old target taken into account in determining its

basis. Accordingly, AGUB is redetermined at the time of the

reduction. See paragraph (e)(2) of this section. Thus the purchase

price reduction affects the basis of the truck only indirectly,

through the mechanism of Secs. 1.338-6T and 1.338-7T. See

Sec. 1.338-4T(b)(2)(iii) Example for the effect on ADSP.

Example 2. T, an accrual basis taxpayer, is a chemical

manufacturer. In Year 1, T is obligated to remediate environmental

contamination at the site of one of its plants. Assume that all the

events have occurred that establish the fact of the liability and

the amount of the liability can be determined with reasonable

accuracy but economic performance has not occurred with respect to

the liability within the meaning of section 461(h). P acquires all

of the stock of T in Year 1 and makes a section 338 election for T.

Assume that, if a corporation unrelated to T had actually purchased

T's assets and assumed T's obligation to remediate the

contamination, the corporation would not satisfy the economic

performance requirements until Year 5. Under section 461(h), the

assumed liability would not be treated as incurred and taken into

account in basis until that time. The incurrence of the liability in

Year 5 under the economic performance rules is an increase in the

amount of liabilities properly taken into account in basis and

results in the redetermination of AGUB. (Respecting ADSP, compare

Sec. 1.461-4(d)(5), which provides that economic performance occurs

for old T as the amount of the liability is properly taken into

account in amount realized on the deemed asset sale. Thus ADSP is

not redetermined when new T satisfies the economic performance

requirements.)

corporation's grossed-up basis of recently purchased target stock (as

defined in section 338(b)(6)(A)) is an amount equal to--

(1) The purchasing corporation's basis in recently purchased target

stock at the beginning of the day after the acquisition date determined

without regard to the acquisition costs taken into account in paragraph

(c)(3) of this section;

(2) Multiplied by a fraction, the numerator of which is 100 percent

minus the percentage of target stock (by value, determined on the

acquisition date) attributable to the purchasing corporation's

nonrecently purchased target stock, and the denominator of which is the

percentage of target stock (by value, determined on the acquisition

date) attributable to the purchasing corporation's recently purchased

target stock;

(3) Plus the acquisition costs the purchasing corporation incurred

in connection with its purchase of the recently purchased stock that

are capitalized in the basis of such stock (e.g., brokerage commissions

and any similar costs incurred by the purchasing corporation to acquire

the stock).

(d) Basis of nonrecently purchased stock; gain recognition

election--(1) No gain recognition election. In the absence of a gain

recognition election under section 338(b)(3) and this section, the

purchasing corporation retains its basis in the nonrecently purchased

stock.

(2) Procedure for making gain recognition election. A gain

recognition election may be made for nonrecently purchased stock of

target (or a target affiliate) only if a section 338 election is made

for target (or the target affiliate). The gain recognition election is

made by attaching a gain recognition statement to a timely filed Form

8023 for target. The gain recognition statement must contain the

information specified in the form and its instructions. The gain

recognition election is irrevocable. If a section 338(h)(10) election

is made for target, see Sec. 1.338(h)(10)-1T(d)(1) (providing that the

purchasing corporation is automatically deemed to have made a gain

recognition election for its nonrecently purchased T stock).

(3) Effect of gain recognition election--(i) In general. If the

purchasing corporation makes a gain recognition election, then for all

purposes of the Internal Revenue Code--

(A) The purchasing corporation is treated as if it sold on the

acquisition date the nonrecently purchased target stock for the basis

amount determined under paragraph (d)(3)(ii) of this section; and

(B) The purchasing corporation's basis on the acquisition date in

nonrecently purchased target stock immediately following the deemed

sale in paragraph (d)(3)(i)(A) of this section is the basis amount.

(ii) Basis amount. The basis amount is equal to the amount in

paragraph (c)(1) of this section (the purchasing corporation's basis in

recently purchased target stock at the beginning of the day after the

acquisition date determined without regard to the acquisition costs

taken into account in paragraph (c)(3) of this section) multiplied by a

fraction the numerator of which is the percentage of target stock (by

value, determined on the acquisition date) attributable to the

purchasing corporation's nonrecently purchased target stock and the

denominator of which is 100 percent minus the numerator amount. Thus,

if target has a single class of outstanding stock, the purchasing

corporation's basis in each share of nonrecently purchased target stock

after the gain recognition election is equal to the average price per

share of the purchasing corporation's recently purchased target stock.

(iii) Losses not recognized. Only gains (unreduced by losses) on

the nonrecently purchased target stock are recognized.

(iv) Stock subject to election. The gain recognition election

applies to--

(A) All nonrecently purchased target stock; and

(B) Any nonrecently purchased stock in a target affiliate having

the same acquisition date as target if such target affiliate stock is

held by the purchasing corporation on such date.

(e) Liabilities of new target--(1) In general. The liabilities of

new target are the liabilities of target (and the liabilities to which

target's assets are subject) as of the beginning of the day after the

acquisition date (other than liabilities that were neither liabilities

of old target nor liabilities to which old target's assets were

subject). In order to be taken into account in AGUB, a liability must

be a liability of target that is properly taken into account in basis

under general principles of tax law that would apply if new target had

acquired its assets from an unrelated person for consideration that

included the assumption of, or taking subject to, the liability. See

Sec. 1.338-4T(d)(1) for examples of when tax liabilities are considered

liabilities assumed by new target.

(2) Time and amount of liabilities. The time for taking into

account liabilities of old target in determining AGUB and the amount of

the liabilities taken into account is determined as if new target had

acquired its assets from an unrelated person for consideration that

included the assumption of, or taking subject to, the liabilities. For

example, an increase or decrease in a liability that does not affect

the amount

[[Page 1251]]

of new target's basis arising from the assumption of, or taking subject

to, the liability is not taken into account in redetermining AGUB.

(3) Interaction with deemed sale gain. See Sec. 1.338-4T(d)(3).

(f) Adjustments by the Internal Revenue Service. In connection with

the examination of a return, the District Director may increase (or

decrease) AGUB under the authority of section 338(b)(2) and allocate

such amounts to target's assets under the authority of section

338(b)(5) so that AGUB and the basis of target's assets properly

reflect the cost to the purchasing corporation of its interest in

target's assets. Such items may include distributions from target to

the purchasing corporation, capital contributions from the purchasing

corporation to target during the 12-month acquisition period, or

acquisitions of target stock by the purchasing corporation after the

acquisition date from minority shareholders.

(g) Examples. The following examples illustrate this section. For

purposes of the examples in this paragraph (g), T has no liabilities

other than the tax liability for the deemed sale gain, T shareholders

incur no costs in selling the T stock, and P incurs no costs in

acquiring the T stock. The examples are as follows:

Example 1. (i) Before July 1 of Year 1, P purchases 10 of the

100 shares of T stock for $5,000. On July 1 of Year 2, P purchases

80 shares of T stock for $60,000 and makes a section 338 election

for T. As of July 1 of Year 2, T's only asset is raw land with an

adjusted basis to T of $50,400 and a fair market value of $100,000.

T has no loss or tax credit carryovers to Year 2. T's marginal tax

rate for any ordinary income or net capital gain resulting from the

deemed asset sale is 34 percent. The 10 shares purchased before July

1 of Year 1 constitute nonrecently purchased T stock with respect to

P's qualified stock purchase of T stock on July 1 of Year 2.

(ii) The ADSP formula as applied to these facts is the same as

in Sec. 1.338-4T(g) Example 1. Accordingly, the ADSP for T is

$87,672.72. The existence of nonrecently purchased T stock is

irrelevant for purposes of the ADSP formula, because that formula

treats P's nonrecently purchased T stock in the same manner as T

stock not held by P.

(iii) The total tax liability resulting from T's deemed asset

sale, as calculated under the ADSP formula, is $12,672.72.

(iv) If P does not make a gain recognition election, the AGUB of

new T's assets is $85,172.72, determined as follows (In the

following formula below, GRP is the grossed-up basis in P's recently

purchased T stock, BNP is P's basis in nonrecently purchased T

stock, L is T's liabilities, and X is P's acquisition costs for the

recently purchased T stock):

AGUB = GRP + BNP + L + X

AGUB = $60,000 x [(1 - .1)/.8] + $5,000 + $12,672.72 + 0

AGUB = $85,172.72

(v) If P makes a gain recognition election, the AGUB of new T's

assets is $87,672.72, determined as follows:

AGUB = $60,000 x [(1 - .1)/.8] + $60,000 [(1 - .1)/.8] x [.1/(1

- .1)] + $12,672.72

AGUB = $87,672.72

(vi) The calculation of AGUB if P makes a gain recognition

election may be simplified as follows:

AGUB = $60,000/.8 + $12,672.72

AGUB = $87,672.72

(vii) As a result of the gain recognition election, P's basis in

its nonrecently purchased T stock is increased from $5,000 to $7,500

(i.e., $60,000 x [(1 - .1)/.8] x [.1/(1 - .1)]). Thus, P

recognizes a gain in Year 2 with respect to its nonrecently

purchased T stock of $2,500 (i.e., $7,500 - $5,000).

Example 2. On January 1 of Year 1, P purchases one-third of the

T stock. On March 1 of Year 1, T distributes a dividend to all of

its shareholders. On April 15 of Year 1, P purchases the remaining T

stock and makes a section 338 election for T. In appropriate

circumstances, the District Director may decrease the AGUB of T to

take into account the payment of the dividend and properly reflect

the fair market value of T's assets deemed purchased.

Example 3. (i) T's sole asset is a building worth $100,000. At

this time, T has 100 shares of stock outstanding. On August 1 of

Year 1, P purchases 10 of the 100 shares of T stock for $8,000. On

June 1 of Year 2, P purchases 50 shares of T stock for $50,000. On

June 15 of Year 2, P contributes a tract of land to the capital of T

and receives 10 additional shares of T stock as a result of the

contribution. Both the basis and fair market value of the land at

that time are $10,800. On June 30 of Year 2, P purchases the

remaining 40 shares of T stock for $40,000 and makes a section 338

election for T. The AGUB of T is $108,800.

(ii) To prevent the shifting of basis from the contributed

property to other assets of T, the District Director may allocate

$10,800 of the AGUB to the land, leaving $98,000 to be allocated to

the building. See paragraph (f) of this section. Otherwise, applying

the allocation rules of Sec. 1.338-6T would, on these facts, result

in an allocation to the recently contributed land of an amount less

than its value of $10,800, with the difference being allocated to

the building already held by T.

Par. 7. Sections 1.338-6T and 1.338-7T are added to read as

follows:

Sec. 1.338-6T Allocation of ADSP and AGUB among target assets

(temporary).

(a) Scope--(1) In general. This section prescribes rules for

allocating ADSP and AGUB among the acquisition date assets of a target

for which a section 338 election is made.

(2) Fair market value--(i) In general. Generally, the fair market

value of an asset is its gross fair market value (i.e., fair market

value determined without regard to mortgages, liens, pledges, or other

liabilities). However, for purposes of determining the amount of old

target's deemed sale gain, the fair market value of any property

subject to a nonrecourse indebtedness will be treated as being not less

than the amount of such indebtedness. (For purposes of the preceding

sentence, a liability that was incurred because of the acquisition of

the property is disregarded to the extent that such liability was not

taken into account in determining old target's basis in such property.)

(ii) Transaction costs. Transaction costs are not taken into

account in allocating ADSP or AGUB to assets in the deemed sale (except

indirectly through their effect on the total ADSP or AGUB to be

allocated).

(iii) Internal Revenue Service authority. In connection with the

examination of a return, the Internal Revenue Service may challenge the

taxpayer's determination of the fair market value of any asset by any

appropriate method and take into account all factors, including any

lack of adverse tax interests between the parties. For example, in

certain cases the Internal Revenue Service may make an independent

showing of the value of goodwill and going concern value as a means of

calling into question the validity of the taxpayer's valuation of other

assets.

(b) General rule for allocating ADSP and AGUB--(1) Reduction in the

amount of consideration for Class I assets. Both ADSP and AGUB, in the

respective allocation of each, are first reduced by the amount of Class

I acquisition date assets. Class I assets are cash and general deposit

accounts (including savings and checking accounts) other than

certificates of deposit held in banks, savings and loan associations,

and other depository institutions. If the amount of Class I assets

exceeds AGUB, new target will immediately realize ordinary income in an

amount equal to such excess. The amount of ADSP or AGUB remaining after

the reduction is to be allocated to the remaining acquisition date

assets.

(2) Other assets--(i) In general. Subject to the limitations and

other rules of paragraph (c) of this section, ADSP and AGUB (as reduced

by the amount of Class I assets) are allocated among Class II

acquisition date assets of target in proportion to the fair market

values of such Class II assets at such time, then among Class III

assets so held in such proportion, then among Class IV assets so held

in such proportion, then

[[Page 1252]]

among Class V assets so held in such proportion, then among Class VI

assets so held in such proportion, and finally to Class VII assets.

(ii) Class II assets. Class II assets are actively traded personal

property within the meaning of section 1092(d)(1) and Sec. 1.1092(d)-1

(determined without regard to section 1092(d)(3)). In addition, Class

II assets include certificates of deposit and foreign currency even if

they are not actively traded personal property. Examples of Class II

assets include U.S. government securities and publicly traded stock.

(iii) Class III assets. Class III assets are accounts receivable,

mortgages, and credit card receivables from customers which arise in

the ordinary course of business.

(iv) Class IV assets. Class IV assets are stock in trade of the

taxpayer or other property of a kind which would properly be included

in the inventory of taxpayer if on hand at the close of the taxable

year, or property held by the taxpayer primarily for sale to customers

in the ordinary course of its trade or business.

(v) Class V assets. Class V assets are all assets other than Class

I, II, III, IV, VI, and VII assets.

(vi) Class VI assets. Class VI assets are all section 197

intangibles, as defined in section 197, except goodwill and going

concern value.

(vii) Class VII assets. Class VII assets are goodwill and going

concern value (whether or not the goodwill or going concern value

qualifies as a section 197 intangible).

(3) Other items designated by the Internal Revenue Service. Similar

items may be added to any class described in this paragraph (b) by

designation in the Internal Revenue Bulletin by the Internal Revenue

Service (see Sec. 601.601(d)(2) of this Chapter).

asset--(1) Allocation not to exceed fair market value. The amount of

ADSP or AGUB allocated to an asset (other than Class VII assets) cannot

exceed the fair market value of that asset at the beginning of the day

after the acquisition date.

(2) Allocation subject to other rules. The amount of ADSP or AGUB

allocated to an asset is subject to other provisions of the Internal

Revenue Code or general principles of tax law in the same manner as if

such asset were transferred to or acquired from an unrelated person in

a sale or exchange. For example, if the deemed asset sale is a

transaction described in section 1056(a) (relating to basis limitation

for player contracts transferred in connection with the sale of a

franchise), the amount of AGUB allocated to a contract for the services

of an athlete cannot exceed the limitation imposed by that section. As

another example, the amount of AGUB allocated to an amortizable section

197 intangible resulting from an assumption-reinsurance transaction is

determined under section 197(f)(5).

(3) Special rule for allocating AGUB when purchasing corporation

has nonrecently purchased stock--(i) Scope. This paragraph (c)(3)

applies if at the beginning of the day after the acquisition date--

(A) The purchasing corporation holds nonrecently purchased stock

for which a gain recognition election under section 338(b)(3) and

Sec. 1.338-5T(d) is not made; and

(B) The hypothetical purchase price determined under paragraph

(c)(3)(ii) of this section exceeds the AGUB determined under

Sec. 1.338-5T(b).

(ii) Determination of hypothetical purchase price. Hypothetical

purchase price is the AGUB that would result if a gain recognition

election were made.

(iii) Allocation of AGUB. Subject to the limitations in paragraphs

(c)(1) and (2) of this section, the portion of AGUB (after reduction by

the amount of Class I assets) to be allocated to each Class II, III,

IV, V, VI, and VII asset of target held at the beginning of the day

after the acquisition date is determined by multiplying--

(A) The amount that would be allocated to such asset under the

general rules of this section were AGUB equal to the hypothetical

purchase price; by (B) A fraction, the numerator of which is actual

AGUB (after reduction by the amount of Class I assets) and the

denominator of which is the hypothetical purchase price (after

reduction by the amount of Class I assets).

(4) Liabilities taken into account in determining amount realized

on subsequent disposition. In determining the amount realized on a

subsequent sale or other disposition of property deemed purchased by

new target, the entire amount of any liability taken into account in

AGUB is considered to be an amount taken into account in determining

new target's basis in property that secures the liability for purposes

of applying Sec. 1.1001-2(a). Thus, if a liability is taken into

account in AGUB, Sec. 1.1001-2(a)(3) does not prevent the amount of

such liability from being treated as discharged within the meaning of

Sec. 1.1001-2(a)(4) as a result of new target's sale or disposition of

the property which secures such liability.

(d) Examples. The following examples illustrate Secs. 1.338-4T,

1.338-5T, and this section:

Example 1. (i) T owns 90 percent of the outstanding T1 stock. P

purchases 100 percent of the outstanding T stock for $2,000. There

are no acquisition costs. P makes a section 338 election for T and,

as a result, T1 is considered acquired in a qualified stock

purchase. A section 338 election is made for T1. The grossed-up

basis of the T stock is $2,000 (i.e., $2,000 1/1).

(ii) The liabilities of T as of the beginning of the day after

the acquisition date (including the tax liability for the deemed

sale gain) that would, under general principles of tax law, be

properly taken into account before the close of new T's first

taxable year, are as follows:

Liabilities (nonrecourse mortgage plus unsecured $700

liabilities)..............................................

Taxes Payable.............................................. 300

------------

Total.................................................. $1,000

(iii) The AGUB of T is determined as follows:

Grossed-up basis........................................... $2,000

Total liabilities.......................................... 1,000

------------

AGUB................................................... $3,000

(iv) Assume that ADSP is also $3,000.

(v) Assume that, at the beginning of the day after the

acquisition date, T's cash and the fair market values of T's Class

II, III, IV, and V assets are as follows:

------------------------------------------------------------------------

Fair

Asset class Asset market

value

------------------------------------------------------------------------

I.......................... Cash............................ * $200

II......................... Portfolio of actively traded 0

securities.

III........................ Accounts receivable............. 600

IV......................... Inventory....................... 300

V.......................... Building........................ 800

V.......................... Land............................ 200

V.......................... Investment in T1................ 450

--------------------------------------------

Total.................... .............................. $2,850

------------------------------------------------------------------------

*Amount.

(vi) Under paragraph (b)(1) of this section, the amount of ADSP

and AGUB allocable to T's Class II, III, IV, and V assets is reduced

by the amount of cash to $2,800, i.e., $3,000 $200. $300 of ADSP and

of AGUB is then allocated to actively traded securities. $600 of

ADSP and of AGUB is then allocated to accounts receivable. $300 of

ADSP and of AGUB is then allocated to the inventory. Since the

remaining amount of ADSP and of AGUB is $1,600 (i.e., $3,000 ($200 +

$300 + $600 + $300)), an amount which exceeds the sum of the fair

market values of T's Class V assets, the amount of ADSP and of AGUB

allocated to each Class V asset is its fair market value:

Building................................................... $800

Land....................................................... 200

Investment in T1........................................... 450

------------

Total.................................................. $1,450

[[Page 1253]]

(vii) T has no Class VI assets. The amount of ADSP and of AGUB

allocated to T's Class VII assets (goodwill and going concern value)

is $150, i.e., $1,600-$1,450.

(viii) The grossed-up basis of the T1 stock is $500, i.e., $450

x 1/.9.

(ix) The liabilities of T as of the beginning of the day after

the acquisition date (including the tax liability for the deemed

sale gain) that would, under general principles of tax law, be

properly taken into account before the close of new T's first

taxable year, are as follows:

General Liabilities........................................ $100

Taxes Payable.............................................. 20

------------

Total.................................................. $120

(x) The AGUB of T1 is determined as follows:

Grossed-up basis of T1 Stock............................... $500

Liabilities................................................ 120

------------

AGUB................................................... $620

(xi) Assume that ADSP is also $620.

(xii) Assume that at the beginning of the day after the

acquisition date, T1's cash and the fair market values of its Class

IV and VI assets are as follows:

------------------------------------------------------------------------

Fair

Asset class Asset market

value

------------------------------------------------------------------------

I.......................... Cash............................ * $50

IV......................... Inventory....................... 200

VI......................... Patent.......................... 350

----------

Total........................... $600

------------------------------------------------------------------------

*Amount.

(xiii) The amount of ADSP and of AGUB allocable to T1's Class IV

and VI assets is first reduced by the $50 of cash.

(xiv) Because the remaining amount of ADSP and of AGUB ($570) is

an amount which exceeds the fair market value of T1's only Class IV

asset, the inventory, the amount allocated to the inventory is its

fair market value ($200). After that, the remaining amount of ADSP

and of AGUB ($370) exceeds the fair market value of T1's only Class

VI asset, the patent. Thus, the amount of ADSP and of AGUB allocated

to the patent is its fair market value ($350).

(xv) The amount of ADSP and of AGUB allocated to T1's Class VII

assets (goodwill and going concern value) is $20, i.e., $570 - $550.

Example 2. (i) Assume that the facts are the same as in Example

1 except that P has, for five years, owned 20 percent of T's stock,

which has a basis in P's hands at the beginning of the day after the

acquisition date of $100, and P purchases the remaining 80 percent

of T's stock for $1,600. P does not make a gain recognition election

under section 338(b)(3).

(ii) Under Sec. 1.338-5T(c), the grossed-up basis of recently

purchased T stock is $1,600, i.e., $1,600 x (1 - .2)/.8.

(iii) The AGUB of T is determined as follows:

Grossed-up basis of recently purchased stock as determined $1,600

under Sec. 1.338-5T(c) ($1,600 x (1 - .2)/.8)..........

Basis of nonrecently purchased stock....................... 100

Liabilities................................................ 1,000

------------

AGUB................................................... $2,700

(iv) Since P holds nonrecently purchased stock, the hypothetical

purchase price of the T stock must be computed and is determined as

follows:

Grossed-up basis of recently purchased stock as determined $1,600

under Sec. 1.338-5T(c) ($1,600 x (1 - .2)/.8)..........

Basis of nonrecently purchased stock as if the gain 400

recognition election under Sec. 1.338-5T(d)(2) had been

made ($1,600 x .2/(1 - .2)).............................

Liabilities................................................ 1,000

------------

Total.................................................. $3,000

(v) Since the hypothetical purchase price ($3,000) exceeds the

AGUB ($2,700) and no gain recognition election is made under section

338(b)(3), AGUB is allocated under paragraph (c)(3) of this section.

(vi) First, an AGUB amount equal to the hypothetical purchase

price ($3,000) is allocated among the assets under the general rules

of this section. The allocation is set forth in the column below

entitled Original Allocation. Next, the allocation to each asset in

Class II through Class VII is multiplied by a fraction having a

numerator equal to the actual AGUB reduced by the amount of Class I

assets ($2,700 - $200 = $2,500) and a denominator equal to the

hypothetical purchase price reduced by the amount of Class I assets

($3,000 - $200 = $2,800), or 2,500/2,800. This produces the Final

Allocation:

------------------------------------------------------------------------

Original Final

Class Asset allocation allocation

------------------------------------------------------------------------

I.................... Cash..................... $200 $200

II................... Portfolio of actively 300 * 268

traded securities.

III.................. Accounts receivable...... 600 536

IV................... Inventory................ 300 268

V.................... Building................. 800 714

V.................... Land..................... 200 178

V.................... Investment in T1......... 450 402

VII.................. Goodwill and going 150 134

concern value.

-----------------------

Total.............. $3,000 $2,700

------------------------------------------------------------------------

*All numbers rounded for convenience.

Sec. 1.338-7T Allocation of redetermined ADSP and AGUB among target

assets (temporary).

(a) Scope. ADSP and AGUB are redetermined at such time and in such

amount as an increase or decrease would be required under general

principles of tax law for the elements of ADSP or AGUB. This section

provides rules for allocating redetermined ADSP or AGUB when increases

or decreases with respect to the elements of ADSP or AGUB are required

after the close of new target's first taxable year. For determining and

allocating ADSP or AGUB when increases or decreases are required with

respect to the elements of ADSP or AGUB before the close of new

target's first taxable year, see Secs. 1.338-4T, 1.338-5T, and 1.338-

6T.

(b) Allocation of redetermined ADSP and AGUB. When ADSP or AGUB is

redetermined, a new allocation of ADSP or AGUB is made by allocating

the redetermined ADSP or AGUB amount under the rules of Sec. 1.338-6T.

If the allocation of the redetermined ADSP or AGUB amount under

Sec. 1.338-6T to a given asset is different from the original

allocation to it, the difference is added to or subtracted from the

original allocation to the asset, as appropriate. Amounts allocable to

an acquisition date asset (or with respect to a disposed-of acquisition

date asset) are subject to all the asset allocation rules (for example,

the fair market value limitation in Sec. 1.338-6T(c)(1)) as if the

redetermined ADSP or AGUB were the ADSP or AGUB on the acquisition

date.

sale gain taxable notwithstanding old target ceases to exist. To the

extent general principles of tax law would require a seller in an

actual asset sale to account for events relating to the sale that occur

after the sale date, target must make

[[Page 1254]]

such an accounting. Target is not precluded from realizing additional

deemed sale gain because the target is treated as a new corporation

after the acquisition date.

(2) Procedure for transactions in which section 338(h)(10) is not

elected--(i) Deemed sale gain included in new target's return. If an

election under section 338(h)(10) is not made, any additional deemed

sale gain of old target resulting from an increase or decrease in the

ADSP is included in new target's income tax return for new target's

taxable year in which the increase or decrease is taken into account.

For example, if after the acquisition date there is an increase in the

allocable ADSP of section 1245 property for which the recomputed basis

(but not the adjusted basis) exceeds the portion of the ADSP allocable

to that particular asset on the acquisition date, the additional gain

is treated as ordinary income to the extent it does not exceed such

excess amount. See paragraph (c)(2)(ii) of this section for the special

treatment of old target's carryovers and carrybacks. Although included

in new target's income tax return, the deemed sale gain is separately

accounted for as an item of old target and may not be offset by income,

gain, deduction, loss, credit, or other amount of new target. The

amount of tax on income of old target resulting from an increase or

decrease in the ADSP is determined as if such deemed sale gain had been

recognized in old target's taxable year ending at the close of the

acquisition date.

(ii) Carryovers and carrybacks--(A) Loss carryovers to new target

taxable years. A net operating loss or net capital loss of old target

may be carried forward to a taxable year of new target, under the

principles of section 172 or 1212, as applicable, but is allowed as a

deduction only to the extent of any recognized income of old target for

such taxable year, as described in paragraph (c)(2)(i) of this section.

For this purpose, however, taxable years of new target are not taken

into account in applying the limitations in section 172(b)(1) or

1212(a)(1)(B) (or other similar limitations). In applying sections

172(b) and 1212(a)(1), only income, gain, loss, deduction, credit, and

other amounts of old target are taken into account. Thus, if old target

has an unexpired net operating loss at the close of its taxable year in

which the deemed asset sale occurred that could be carried forward to a

subsequent taxable year, such loss may be carried forward until it is

absorbed by old target's income.

(B) Loss carrybacks to taxable years of old target. An ordinary

loss or capital loss accounted for as a separate item of old target

under paragraph (c)(2)(i) of this section may be carried back to a

taxable year of old target under the principles of section 172 or 1212,

as applicable. For this purpose, taxable years of new target are not

taken into account in applying the limitations in section 172(b) or

1212(a) (or other similar limitations).

paragraphs (c)(2)(ii)(A) and (B) of this section apply to carryovers

and carrybacks of amounts for purposes of determining the amount of a

credit allowable under part IV, subchapter A, chapter 1 of the Internal

Revenue Code. Thus, for example, credit carryovers of old target may

offset only income tax attributable to items described in paragraph

(c)(2)(i) of this section.

(3) Procedure for transactions in which section 338(h)(10) is

elected. If an election under section 338(h)(10) is made, any

additional deemed sale gain resulting from an increase or decrease in

the ADSP is accounted for in determining the taxable income (or other

amount) of the member of the selling consolidated group, the selling

affiliate, or the S corporation shareholders to which such income,

loss, or other amount is attributable for the taxable year in which

such increase or decrease is taken into account.

(d) Special rules for AGUB--(1) Effect of disposition or

depreciation of acquisition date assets. If an acquisition date asset

has been disposed of, depreciated, amortized, or depleted by new target

before an amount is added to the original allocation to the asset, the

increased amount otherwise allocable to such asset is taken into

account under general principles of tax law that apply when part of the

cost of an asset not previously taken into account in basis is paid or

incurred after the asset has been disposed of, depreciated, amortized,

or depleted. A similar rule applies when an amount is subtracted from

the original allocation to the asset. For purposes of the preceding

sentence, an asset is considered to have been disposed of to the extent

that its allocable portion of the decrease in AGUB would reduce its

basis below zero.

(2) Section 38 property. Section 1.47-2(c) applies to a reduction

in basis of section 38 property under this section.

(e) Examples. The following examples illustrate this section. Any

amount described in the following examples is exclusive of interest.

For rules characterizing deferred contingent payments as principal or

interest, see Secs. 1.483-4, 1.1274-2(g), and 1.1275-4(c). The examples

are as follows:

Example 1. (i)(A) T's assets other than goodwill and going

concern value, and their fair market values at the beginning of the

day after the acquisition date, are as follows:

------------------------------------------------------------------------

Fair

Asset Class Asset market

value

------------------------------------------------------------------------

V.......................... Building........................ $100

V.......................... Stock of X (not a target)....... 200

--------------------------------------------

Total.................... ................................ $300

------------------------------------------------------------------------

(B) T has no liabilities other than a contingent liability that

would not be taken into account under general principles of tax law

in an asset sale between unrelated parties when the buyer assumed

the liability or took property subject to it.

(ii)(A) On September 1, 2000, P purchases all of the outstanding

stock of T for $270 and makes a section 338 election for T. The

grossed-up basis of the T stock and T's AGUB are both $270. The AGUB

is ratably allocated among T's Class V assets in proportion to their

fair market values as follows:

------------------------------------------------------------------------

Asset Basis

------------------------------------------------------------------------

Building ($270 x 100/300)................................ $90

Stock ($270 x 200/300)................................... 180

------------

Total.................................................... $270

------------------------------------------------------------------------

(B) No amount is allocated to the Class VII assets. New T is a

calendar year taxpayer. Assume that the X stock is a capital asset

in the hands of new T.

(iii) On January 1, 2001, new T sells the X stock and uses the

proceeds to purchase inventory.

(iv) Pursuant to events on June 30, 2002, the contingent

liability of old T is at that time properly taken into account under

general principles of tax law. The amount of the liability is $60.

(v) T's AGUB increases by $60 from $270 to $330. This $60

increase in AGUB is first allocated among T's acquisition date

assets in accordance with the provisions of Sec. 1.338-6T. Because

the redetermined AGUB for T ($330) exceeds the sum of the fair

market values at the beginning of the day after the acquisition date

of the Class V acquisition date assets ($300), AGUB allocated to

those assets is limited to those fair market values under

Sec. 1.338-6T(c)(1). As there are no Class VI assets, the remaining

AGUB of $30 is allocated to goodwill and going concern value (Class

VII assets). The amount of increase in AGUB allocated to each

acquisition date asset is determined as follows:

[[Page 1255]]

----------------------------------------------------------------------------------------------------------------

Redetermined

Asset Original AGUB AGUB Increase

----------------------------------------------------------------------------------------------------------------

Building........................................................ $90 $100 $10

X Stock......................................................... 180 200 20

Goodwill and going concern value................................ 0 30 30

-----------------------------------------------

Total......................................................... $270 $330 $60

----------------------------------------------------------------------------------------------------------------

(vi) Since the X stock was disposed of before the contingent

liability was properly taken into account for tax purposes, no

amount of the increase in AGUB attributable to such stock may be

allocated to any T asset. Rather, such amount ($20) is allowed as a

capital loss to T for the taxable year 2002 under the principles of

Arrowsmith v. Commissioner, 344 U.S. 6 (1952). In addition, the $10

increase in AGUB allocated to the building and the $30 increase in

AGUB allocated to the goodwill and going concern value are treated

as basis redeterminations in 2002. See paragraph (d)(1) of this

section.

Example 2. (i) On January 1, 2002, P purchases all of the

outstanding stock of T and makes a section 338 election for T.

Assume that ADSP and AGUB of T are both $500 and are allocated among

T's acquisition date assets as follows:

------------------------------------------------------------------------

Asset Class Asset Basis

------------------------------------------------------------------------

V.......................... Machinery....................... $150

V.......................... Land............................ 250

VII........................ Goodwill and going concern value 100

--------------------------------------------

Total.................... ................................ $500

------------------------------------------------------------------------

(ii) On September 30, 2004, P filed a claim against the selling

shareholders of T in a court of appropriate jurisdiction alleging

fraud in the sale of the T stock.

(iii) On January 1, 2007, the former shareholders refund $140 of

the purchase price to P in a settlement of the lawsuit. Assume that,

under general principles of tax law, both the seller and the buyer

properly take into account such refund when paid. Assume also that

the refund has no effect on the tax liability for the deemed sale

gain. This refund results in a decrease of T's ADSP and AGUB of

$140, from $500 to $360.

(iv) The redetermined ADSP and AGUB of $360 is allocated among

T's acquisition date assets. Because ADSP and AGUB do not exceed the

fair market value of the Class V assets, the ADSP and AGUB amounts

are allocated to the Class V assets in proportion to their fair

market values at the beginning of the day after the acquisition

date. Thus, $135 ($150 x ($360/($150 + $250))) is allocated to the

machinery and $225 ($250 x ($360/($150 + $250))) is allocated to

the land. Accordingly, the basis of the machinery is reduced by $15

($150 original allocation -$135 redetermined allocation) and the

basis of the land is reduced by $25 ($250 original allocation -$225

redetermined allocation). No amount is allocated to the Class VII

assets. Accordingly, the basis of the goodwill and going concern

value is reduced by $100 ($100 original allocation -$0 redetermined

allocation).

(v) Assume that, as a result of deductions under section 168,

the adjusted basis of the machinery immediately before the decrease

in AGUB is zero. The machinery is treated as if it were disposed of

before the decrease is taken into account. In 2007, T recognizes

income of $15, the character of which is determined under the

principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and the

tax benefit rule. No adjustment to the basis of T's assets is made

for any tax paid on this amount. Assume also that, as a result of

amortization deductions, the adjusted basis of the goodwill and

going concern value immediately before the decrease in AGUB is $40.

A similar adjustment to income is made in 2007 with respect to the

$60 of previously amortized goodwill and going concern value.

(vi) In summary, the basis of T's acquisition date assets, as of

January 1, 2007, is as follows:

------------------------------------------------------------------------

Asset Basis

------------------------------------------------------------------------

Machinery.................................................. $0

Land....................................................... 225

Goodwill and going concern value........................... 0

------------------------------------------------------------------------

Example 3. (i) Assume that the facts are the same as Sec. 1.338-

6T(d) Example 2 except that the recently purchased stock is acquired

for $1,600 plus additional payments that are contingent upon T's

future earnings. Assume that, under general principles of tax law,

such later payments are properly taken into account when paid. Thus,

T's AGUB, determined as of the beginning of the day after the

acquisition date (after reduction by T's cash of $200), is $2,500

and is allocated among T's acquisition date assets under Sec. 1.338-

6T(c)(3)(iii) as follows:

------------------------------------------------------------------------

Final

Class Asset Allocation

------------------------------------------------------------------------

I....................................... Cash $200

II...................................... Portfolio of *268

actively

traded

securities

III..................................... Accounts 536

receivable

IV...................................... Inventory 268

V....................................... Building 714

V....................................... Land 178

V....................................... Investment in 402

VII..................................... Goodwill and 134

going concern

value

-------------------------------

Total................................. .............. $2,700

------------------------------------------------------------------------

*All numbers rounded for convenience.

(ii) After the close of new target's first taxable year, P pays

an additional $200 for its recently purchased T stock. Assume that

the additional consideration paid would not increase T's tax

liability for the deemed sale gain.

(iii) T's AGUB increases by $200, from $2,700 to $2,900. This

$200 increase in AGUB is accounted for in accordance with the

provisions of Sec. 1.338-6T(c)(3)(iii).

(iv) The hypothetical purchase price of the T stock is

redetermined as follows:

[[Page 1256]]

Grossed-up basis of recently purchased stock as determined $1,800

under Sec. 1.338-5T(c) ($1,800 x (1 - .2)/.8)..........

Basis of nonrecently purchased stock as if the gain 450

recognition election under Sec. 1.338-5T(d)(2) had been

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