Treatment of Changes in Elective Entity Classification

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[REG-105162-97]

RIN-1545-AV16

Treatment of Changes in Elective Entity Classification

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations addressing

elective changes in entity classification. The proposed regulations

describe how elective changes in classification will be treated for

federal tax purposes. The proposed regulations would affect business

entities and their members. This document also contains a notice of

public hearing on these proposed regulations.

DATES: Written comments must be received by January 26, 1998. Requests

to speak (with outlines of oral comments) at the public hearing

scheduled for February 24, 1997, must be submitted by January 26, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105162-97), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG-105162-97), Courier's Desk, Internal Revenue Service, 1111

Constitution Avenue NW., Washington, DC. Alternatively, taxpayers may

submit comments electronically via the Internet by selecting the ``Tax

Regs'' option of the IRS Home Page, or by submitting comments directly

to the IRS Internet site at: http://www.irs.ustreas.gov/prod/tax_regs/

comments.html. The public hearing will be held in room 2615, Internal

Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

[[Page 55769]]

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Jeff

Erickson, (202) 622-3070 (not a toll-free number); concerning

international issues, Philip Tretiak or Ronald M. Gootzeit, (202) 622-

3860 (not a toll free number); concerning submissions and the hearing,

Evangelista Lee, (202) 622-7190 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document proposes to amend the current Income Tax Regulations

(26 CFR Parts 1 and 301) relating to the classification of entities for

federal tax purposes. On December 18, 1996, the IRS and Treasury

published final regulations under section 7701 (final regulations),

replacing the former classification rules with an elective regime. See

TD 8697 (1997-2 I.R.B. 11).

Under the final regulations, a business entity that is not

specifically classified as a corporation in the final regulations (an

eligible entity) can elect its classification for federal tax purposes

under certain circumstances. An eligible entity with at least two

members can elect to be classified as a partnership or as an

association taxable as a corporation. An eligible entity with a single

member can elect to be classified as an association or as an entity

that is disregarded as an entity separate from its owner. An eligible

entity may also elect to change its classification, except that an

election may not be made more than once in any sixty month period. An

eligible entity that does not make an election is classified under

certain default provisions.

Explanation of Provisions

Characterization of Elective Changes in Classification

The proposed regulations describe how elective changes in an

entity's classification will be treated for federal tax purposes. Under

the final regulations, there are four possible changes in

classification by election: (i) a partnership elects to be an

association; (ii) an association elects to be a partnership; (iii) an

association elects to be a disregarded entity; and (iv) a disregarded

entity elects to be an association. There are two other possible ways

in which an entity's classification could change (a partnership

converts to a disregarded entity or a disregarded entity converts to a

partnership) but these changes occur only as a result of a change in

the number of members, not as the result of an elective change.

The proposed regulations do not address the form of these two

possible types of changes.

The proposed regulations provide a specific characterization for

each of the four possible elective changes. In each case, the

characterization provided in the proposed regulations attempts to

minimize the tax consequences of the change in classification and

achieve administrative simplicity. The proposed regulations provide

that if an association elects to be classified as a partnership, the

association is deemed to liquidate by distributing its assets and

liabilities to its shareholders. Then, the shareholders are deemed to

contribute all of the distributed assets and liabilities to the

partnership. This characterization of an elective change from an

association to a partnership is consistent with Rev. Rul. 63-107 (1963-

1 C.B. 71).

If a partnership elects to be classified as an association, the

partnership is deemed to contribute all of its assets and liabilities

to the association in exchange for stock in the association. Then, the

partnership is deemed to liquidate by distributing stock in the

association to its partners. The proposed regulations do not affect the

holdings in Rev. Rul. 84-111 (1984-2 C.B. 88), in which the IRS ruled

that it would respect the particular form undertaken by the taxpayers

when a partnership converts to a corporation.

If an association elects to be disregarded as an entity separate

from its owner, the association is deemed to liquidate by distributing

its assets and liabilities to its sole owner. Conversely, if an

eligible entity that is disregarded as an entity separate from its

owner elects to be classified as an association, the owner of the

eligible entity is deemed to contribute all of the assets and

liabilities of that entity to the association in exchange for stock of

the association.

The proposed regulations also provide that the tax treatment of an

elective change in classification is determined under all relevant

provisions of the Internal Revenue Code and general principles of tax

law, including the step transaction doctrine. This provision in the

proposed regulations is intended to ensure that the tax consequences of

an elective change will be identical to the consequences that would

have occurred if the taxpayer had actually taken the steps described in

the proposed regulations. The IRS and Treasury request comments on the

application of general principles of tax law to the transactions that

are deemed to occur on an elective change in classification.

Change in Number of Members of Entity

The proposed regulations address the effect of a change in the

number of members on the classification of an entity. Under the

proposed regulations, if there is a change in the number of members of

an association, the classification of the entity is not affected. If an

eligible entity classified as a partnership subsequently has only one

member (and is still treated as an entity under local law), the entity

will be disregarded as an entity separate from its owner. If a single

member entity that is disregarded as an entity separate from its owner

subsequently has more than one member, the entity is classified as a

partnership as of the date the entity has more than one member. The

classifications provided in the proposed regulations can be changed by

election, assuming that the entity is not subject to the sixty month

limitation on elections.

Timing of Elective Changes in Classification

The proposed regulations provide that an election to change the

classification of an entity is treated as occurring at the start of the

day for which the election is effective. Any transactions that are

deemed to occur as a result of the change in classification are treated

as occurring immediately before the close of the day before the

effective date of the election. For example, if an election is made to

convert from an association to a partnership effective on January 1,

the entity is treated as a partnership on January 1, and the deemed

transactions specified in the proposed regulations are treated as

occurring immediately before the close of December 31. As a result, the

last day of the association s taxable year will be December 31 and the

first day of the partnership's taxable year will be January 1.

Treatment of Foreign Eligible Entities

Any eligible entity, including a foreign eligible entity whose

classification is not relevant for federal tax purposes, may elect to

change its classification. The IRS and Treasury request comments on the

appropriateness of allowing such a foreign eligible entity to make a

classification election, and comments on what the federal tax

consequences of such an election should be (e.g., with respect to the

basis of property held by the entity).

Foreign Per Se Entities

The final regulations provide a list of the names of certain

foreign business entities that are treated as corporations for federal

tax purposes. In most cases,

[[Page 55770]]

the name by which an entity will be known is provided by the statutory

corporate law of the relevant jurisdiction. In certain cases, however,

the corporate law does not provide a statutory name. In these

jurisdictions, taxpayers and practitioners often fill the statutory

void with a name derived from a number of the statutory characteristics

of the entity. In an effort to make the list of foreign per se

corporations more accessible, the final regulations use the commonly

used non-statutory term in certain cases where the statute does not

provide a defined name. To minimize any uncertainty, however, the

provisions of Sec. 301.7701-2(b)(8) (iii) and (iv) were included in the

final regulations to address this issue. In response to comments from

taxpayers, these subsections of the final regulations are clarified to

provide guidance on the terms used in the final regulations.

Furthermore, the regulations clarify that the term Berhad used with

regard to Malaysia does not include a Sendirian Berhad (the equivalent

of a private limited company). The regulations also clarify that, in

relation to Mexico, the term Sociedad Anonima includes a Sociedad

Anonima that chooses to apply the variable capital provision of Mexican

corporate law (Sociedad Anonima de Capital Variable). The fact that

capital may be varied does not make this a different type of entity

from a Sociedad Anonima that does not choose to apply the variable

capital provision. These clarifications are not intended to change the

interpretation of the final regulations.

The proposed regulations also clarify the treatment of the Finnish,

Maltese, and Norwegian entities specified in the final regulations.

Effective January 1, 1996, Maltese and Norwegian corporate law

recognized a distinction between public and private companies, and the

proposed regulations reflect this change. The proposed regulations also

provide that the rules of the final regulations with regard to the

Maltese and Norwegian entities may be applied (when these proposed

regulations are finalized) as though the entities specified in the

proposed regulations had been included in the final regulations issued

on December 18, 1996. Thus, a Maltese or Norwegian entity that is no

longer treated as a per se corporation under the regulations would be

able to make an election within 75 days of the date these proposed

regulations are finalized, and such election could be effective as of

January 1, 1997. Finnish law, since September 1, 1997, has recognized a

similar distinction between public and private companies. It is

proposed that a Finnish entity that is no longer treated as a per se

corporation under the regulations would be able to make an election

within 75 days of the date these proposed regulations are finalized,

and such election could be effective as of September 1, 1997.

Special Basis Adjustments Under Section 743

Section 743 provides that the basis of partnership property is not

adjusted as the result of a transfer of an interest in the partnership

by sale or exchange unless the partnership has made an election under

section 754. If a section 754 election is made, the transferee partner

is treated as having a special basis adjustment with respect to

partnership property. This adjustment constitutes an adjustment to the

basis of partnership property with respect to the transferee partner

only. Some uncertainty has remained as to the treatment of this special

basis adjustment upon the contribution of the partnership property to a

corporation in a section 351 exchange, and because the proposed

regulations provide for a deemed contribution by the partnership to a

corporation in an elective conversion to an association, the proposed

regulations address this uncertainty.

The proposed regulations provide that a corporate transferee's

basis in property transferred by a partnership in a transfer described

in section 351 includes any special basis adjustment under section 743.

The special basis adjustment is also taken into account in determining

the partner's basis in the stock received in the exchange. For example,

assume a partnership owns Property X, which has a common basis of $100

for the partnership and in which Partner A has a $5 special basis

adjustment under section 743(b). Subsequently, the partnership validly

elects to be classified as an association. The partnership is deemed to

contribute all of its assets and liabilities to the association in

exchange for stock in the association, and immediately thereafter, the

partnership liquidates by distributing the stock of the association to

its partners. If the transfer of the assets to the association would be

a transfer described in section 351, then under the proposed

regulations, the association's basis in Property X includes Partner A's

$5 special basis adjustment. Thus, the association has a $105 basis in

Property X (Partner A's $5 special basis adjustment plus the

partnership's $100 common basis). Partner A's basis in the

association's stock will reflect the $5 special basis adjustment

previously on Property X.

The proposed regulations also provide, however, that the amount of

gain, if any, recognized by the partnership on the transfer is

determined without reference to any special basis adjustment. The

partner with the special basis adjustment can then use the special

basis adjustment to reduce its share of any gain recognized by the

partnership. This approach of determining gain at the partnership level

and allowing the partner to use the special basis adjustment as an

offset is similar to the treatment of a sale of property with a special

basis adjustment.

Proposed Effective Date

Except as otherwise specified, these regulations are proposed to

apply as of the date the final regulations are published in the Federal

Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations, and because these

regulations do not impose on small entities a collection of information

requirement, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does

not apply. Therefore, a Regulatory Flexibility Analysis is not

required. Pursuant to section 7805(f) of the Internal Revenue Code,

this notice of proposed rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (preferably a

signed original and eight (8) copies) that are submitted timely to the

IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for February 24, 1997, at 10

a.m., in room 2615, Internal Revenue Building, 1111 Constitution Avenue

NW., Washington, DC. Because of access restrictions, visitors will not

be admitted beyond the Internal Revenue Building lobby more than 15

minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

[[Page 55771]]

Persons that wish to present oral comments at the hearing must

submit timely written comments and an outline of the topics to be

discussed and the time to be devoted to each topic by (preferably a

signed original and eight (8) copies) January 26, 1998.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are Ann M. Veninga,

Office of Chief Counsel (Passthroughs and Special Industries) and

Philip Tretiak, Office of Associate Chief Counsel (International).

However, other personnel from the IRS and Treasury Department

participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as

follows.

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

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

Par. 2. Section 1.743-2 is added under the undesignated

centerheading ``Transfer of Interests in a Partnership'' to read as

follows:

Sec. 1.743-2 Transfer of property to a corporation.

(a) Basis in transferred property. A corporations adjusted tax

basis in property transferred to the corporation by a partnership in a

transfer described in section 351 is determined with reference to any

special basis adjustment to the property under section 743(b) (other

than any special basis adjustment that reduces a partner's gain under

paragraph (b) of this section).

(b) Partnership gain. The amount of gain, if any, recognized by a

partnership on a transfer of property by the partnership to a

corporation in a transfer described in section 351 is determined

without reference to any special basis adjustment to the transferred

property under section 743(b). The amount of gain, if any, recognized

by the partnership on the transfer that is allocated to a partner with

a special basis adjustment in the transferred property is adjusted to

reflect the partner's special basis adjustment in the transferred

property.

(c) Basis in stock. The partnership's adjusted tax basis in stock

received from a corporation in a transfer described in section 351 is

determined without reference to the special basis adjustment in

property transferred to the corporation in the section 351 exchange. A

partner with a special basis adjustment in property transferred to the

corporation, however, has a special basis adjustment in the stock

received by the partnership in the section 351 exchange in an amount

equal to the partner's special basis adjustment in the transferred

property, reduced by any special basis adjustment that reduced the

partner's gain under paragraph (b) of this section.

(d) Effective date. This section applies to transfers that occur on

or after the date final regulations are published in the Federal

Register.

PART 301--PROCEDURE AND ADMINISTRATION

Par. 3. The authority citation for part 301 continues to read in

part as follows:

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

Par. 4. Section 301.6109-1 is amended as follows:

1. Paragraph (d)(2)(ii) is removed and reserved.

2. Paragraph (h) is redesignated as paragraph (i) and the first

sentence of newly designated paragraph (i)(1) is amended by removing

the language ``paragraph (h)'' and adding ``paragraph (i)'' in its

place.

3. A new paragraph (h) is added.

The addition reads as follows:

Sec. 301.6109-1 Identifying numbers.

* * * * *

(h) Special rules for certain entities under Sec. 301.7701-3--(1)

General rule. Any entity that has an employer identification number

(EIN) will retain that EIN if its federal tax classification changes

under Sec. 301.7701-3.

(2) Special rules for entities that are disregarded as entities

separate from their owners--(i) When an entity becomes disregarded as

an entity separate from its owner. Except as otherwise provided in

regulations or other guidance, a single owner entity that is

disregarded as an entity separate from its owner under Sec. 301.7701-3,

must use its owner's taxpayer identifying number (TIN) for federal tax

purposes.

(ii) When an entity that was disregarded as an entity separate from

its owner becomes recognized as a separate entity. If a single owner

entity's classification changes so that it is recognized as a separate

entity for federal tax purposes, and that entity had an EIN, then the

entity must use that EIN and not the TIN of the single owner. If the

entity did not already have its own EIN, then the entity must acquire

an EIN and not use the TIN of the single owner.

(3) Effective date. This paragraph (h) applies to changes in

classification that occur on or after the date on which these

regulations are published as final regulations in the Federal Register.

Par. 5. Section 301.7701-2 is amended as follows:

1. Paragraph (b)(8)(i) is amended by revising the entries for

Finland, Malta, and Norway.

2. Paragraph (b)(8)(ii)(A) is redesignated as paragraph

(b)(8)(ii)(A)(1) and the language ``and'' at the end of the paragraph

is removed.

3. Paragraph (b)(8)(ii)(B) is redesignated as paragraph

(b)(8)(ii)(A)(2) and the period at the end of the paragraph is removed

and the language ``; and '' is added in its place.

4. Paragraph (b)(8)(ii) heading and introductory text are

redesignated as paragraph (b)(8)(ii)(A) heading and introductory text,

and a new paragraph heading is added for paragraph (b)(8)(ii).

5. Paragraphs (b)(8)(ii)(A)(3) and (b)(8)(ii)(B) are added.

6. Paragraphs (b)(8)(iii), (b)(8)(iv), and (e) are revised.

The revisions and additions read as follows:

Sec. 301.7701-2 Business entities; definitions.

* * * * *

(b) * * *

(8) * * *

(i) * * *

Finland, Julkinen Osakeyhtio/Publikt Aktiebolag

* * * * *

Malta, Public Limited Company

* * * * *

Norway, Allment Aksjeselskap

* * * * *

(ii) Clarification of list of corporations in paragraph (b)(8)(i)

of this section--(A) Exceptions in certain cases. * * *

* * * * *

(3) With regard to Malaysia, a Sendirian Berhad.

[[Page 55772]]

(B) Inclusions in certain cases. With regard to Mexico, the term

Sociedad Anonima includes a Sociedad Anonima that chooses to apply the

variable capital provision of Mexican corporate law (Sociedad Anonima

de Capital Variable).

(iii) Public companies. For purposes of paragraph (b)(8)(i) of this

section, with regard to Cyprus, Hong Kong, Jamaica, and Trinidad and

Tobago, the term Public Limited Company includes any Limited Company

that is not defined as a private company under the corporate laws of

those jurisdictions. In all other cases, where the term Public Limited

Company is not defined, that term shall include any Limited Company

defined as a public company under the corporate laws of the relevant

jurisdiction.

(iv) Limited companies. For purposes of this paragraph (b)(8), any

reference to a Limited Company includes, as the case may be, companies

limited by shares and companies limited by guarantee.

* * * * *

(e) Effective date. Except as otherwise provided in this paragraph

(e), the rules of this section apply as of January 1, 1997. The

reference to the Finnish, Maltese, and Norwegian entities in paragraph

(b)(8)(i) of this section is applicable on the date the final

regulations are published in the Federal Register. Any Maltese or

Norwegian entity that becomes an eligible entity as a result of

paragraph (b)(8)(i) of this section in effect on the date final

regulations are published in the Federal Register may elect (within 75

days of the date final regulations are published in the Federal

Register) to be classified for federal tax purposes as an entity other

than a corporation retroactive to any period from and including January

1, 1997. Any Finnish entity that becomes an eligible entity as a result

of paragraph (b)(8)(i) of this section in effect on the date final

regulations are published in the Federal Register may elect (within 75

days of the date final regulations are published in the Federal

Register) to be classified for federal tax purposes as an entity other

than a corporation retroactive to any period from and including

September 1, 1997.

Par. 6. Section 301.7701-3 is amended as follows:

1. A sentence is added at the end of paragraph (c)(1)(iv).

2. Paragraph (c)(2)(iii) is added.

3. A heading is added to paragraph (d)(1).

4. Paragraph (f) is redesignated as paragraph (h) and newly

designated paragraph (h)(1) is revised.

5. Paragraphs (f) and (g) are added.

The revision and additions read as follows:

Sec. 301.7701-3 Classification of certain business entities.

* * * * *

(c) * * *

(1) * * *

(iv) Limitation. * * * An election by a newly-formed eligible

entity that is effective on the date of formation is not considered a

change for purposes of this paragraph (c)(1)(iv).

* * * * *

(2) * * *

(iii) Changes in classification. For purposes of paragraph

(c)(2)(i) of this section, if an election under paragraph (c)(1)(i) of

this section is made to change the classification of an entity, each

person who was an owner on the date that any transactions under

paragraph (g) of this section are deemed to occur, and who is not an

owner at the time the election is filed, must also sign the election.

This paragraph (c)(2)(iii) applies to elections filed on or after the

date final regulations are published in the Federal Register.

(d) Special rules for foreign eligible entities--(1) Definition of

relevance. * * *

* * * * *

(f) Changes in number of members of an entity--(1) Associations.

The classification of an eligible entity as an association is not

affected by any change in the number of members of the entity.

(2) Partnerships and single member entities. An eligible entity

classified as a partnership is disregarded as an entity separate from

its owner as of the date the entity has only one member. A single

member entity disregarded as an entity separate from its owner is

classified as a partnership as of the date the entity has more than one

member.

(3) Effect on sixty month limitation. A change in the number of

members of an entity does not result in the creation of a new entity

for purposes of the sixty month limitation on elections under paragraph

(c)(1)(iv) of this section.

(4) Examples. The following examples illustrate the application of

this paragraph (f):

Example 1. (i) On April 1, 1998, A and B, U.S. persons, form X,

a foreign eligible entity. X is treated as an association under the

default provisions of paragraph (b)(2)(i) of this section, and X

does not make an election to be classified as a partnership. A

subsequently purchases all of B's interest in X.

(ii) Under paragraph (f)(1) of this section, X continues to be

classified as an association. X, however, can subsequently elect to

be disregarded as an entity separate from A. The sixty month

limitation of paragraph (c)(1)(iv) of this section does not prevent

X from making an election because X has not made a prior election

under paragraph (c)(1)(i) of this section.

Example 2. (i) On April 1, 1998, A and B, U.S. persons, form X,

a foreign eligible entity. X is treated as an association under the

default provisions of paragraph (b)(2)(i) of this section, and X

does not make an election to be classified as a partnership. On

January 1, 1999, X elects to be classified as a partnership

effective on that date. Under the sixty month limitation of

paragraph (c)(1)(iv) of this section, X cannot elect to be

classified as an association until January 1, 2004 (i.e., sixty

months after the effective date of the election to be classified as

a partnership).

(ii) On June 1, 1999, A purchases all of B's interest in X.

After A's purchase of B's interest, X can no longer be classified as

a partnership because X has only one member. Under paragraph (f)(2)

of this section, X is disregarded as a separate entity as of the

date A becomes the only member of X. X, however, is not treated as a

new entity for purposes of paragraph (c)(1)(iv) of this section. As

a result, the sixty month limitation of paragraph (c)(1)(iv) of this

section continues to apply to X and X cannot elect to be classified

as an association until January 1, 2004 (i.e., sixty months after

January 1, 1999, the effective date of the election by X to be

classified as a partnership).

(5) Effective date. This paragraph (f) applies as of the date the

final regulations are published in the Federal Register.

(g) Elective changes in classification--(1) Deemed treatment of

elective change--(i) Partnership to association. If an eligible entity

classified as a partnership elects under paragraph (c)(1)(i) of this

section to be classified as an association, the following is deemed to

occur: The partnership contributes all of its assets and liabilities to

the association in exchange for stock in the association, and

immediately thereafter, the partnership liquidates by distributing the

stock of the association to its partners.

(ii) Association to partnership. If an eligible entity classified

as an association elects under paragraph (c)(1)(i) of this section to

be classified as a partnership, the following is deemed to occur: The

association distributes all of its assets and liabilities to its

shareholders in liquidation of the association, and immediately

thereafter, the shareholders contribute all of the distributed assets

and liabilities to a newly formed partnership.

(iii) Association to disregarded entity. If an eligible entity

classified as an association elects under paragraph (c)(1)(i) of this

section to be disregarded as an entity separate from its owner, the

following is deemed to occur: The association distributes all of its

assets

[[Page 55773]]

and liabilities to its single owner in liquidation of the association.

(iv) Disregarded entity to an association. If an eligible entity

that is disregarded as an entity separate from its owner elects under

paragraph (c)(1)(i) of this section to be classified as an association,

the following is deemed to occur: The owner of the eligible entity

contributes all of the assets and liabilities of the entity to the

association in exchange for stock of the association.

(2) Effect of elective changes. The tax treatment of a change in

the classification of an entity for federal tax purposes by election

under paragraph (c)(1)(i) of this section is determined under all

relevant provisions of the Internal Revenue Code and general principles

of tax law, including the step transaction doctrine.

(3) Timing of election. An election under paragraph (c)(1)(i) of

this section that changes the classification of an eligible entity for

federal tax purposes is treated as occurring at the start of the day

for which the election is effective. Any transactions that are deemed

to occur under this paragraph (g) as a result of a change in

classification are treated as occurring immediately before the close of

the day before the election is effective. For example, if an election

is made to change the classification of an entity from an association

to a partnership effective on January 1, the deemed transactions

specified in paragraph (g)(1)(ii) of this section (including the

liquidation of the association) are treated as occurring immediately

before the close of December 31 and must be reported by the owners of

the entity on December 31. As a result, the last day of the

association's taxable year will be December 31 and the first day of the

partnership's taxable year will be January 1.

(4) Effective date. This paragraph (g) applies to elections that

are filed on or after the date the final regulations are published in

the Federal Register.

(h) Effective date--(1) In general. Except as otherwise provided in

this section, the rules of this section are applicable as of January 1,

1997.

* * * * *

Michael P. Dolan,

Acting Commissioner of Internal Revenue.

[FR Doc. 97-28165 Filed 10-27-97; 8:45 am]

BILLING CODE 4830-01-U