Unified Rule for Loss on Subsidiary Stock

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9424]

RIN 1545-BB61

Unified Rule for Loss on Subsidiary Stock

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations and removal of temporary regulations.

SUMMARY:

This document contains final regulations under sections 358, 362(e)(2), and 1502 of the Internal Revenue Code (Code). The regulations apply to corporations filing consolidated returns, and corporations that enter into certain tax-free reorganizations. The regulations provide rules for determining the tax consequences of a member's transfer (including by deconsolidation and worthlessness) of loss shares of subsidiary stock. In addition, the regulations provide that section 362(e)(2) generally does not apply to transactions between members of a consolidated group. Finally, the regulations conform or clarify various provisions of the consolidated return regulations, including those relating to adjustments to subsidiary stock basis.

DATES:

Effective Date:

These regulations are effective on September 17, 2008.

Applicability Date:

For dates of applicability, see §§ 1.358-6(f)(3), 1.1502-13(l)(1), 1.1502-19(h), 1.1502-21(h)(1)(iii), 1.1502-30(c), 1.1502-31(h)(1), 1.1502-32(h)(9), 1.1502-33(j)(1), 1.1502-35(j), 1.1502-36(h), 1.1502-75(l), 1.1502-80(a)(4), 1.1502-80(h), 1.1502-80(j), 1.1502-91(h)(2), and 1.1502-99(b)(4).

FOR FURTHER INFORMATION CONTACT:

Marcie P. Barese at (202) 622-7790, Sean P. Duffley at (202) 622-7770, or Theresa Abell at (202) 622-7700 (none of the numbers are toll-free).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-2096. The collection of information in these final regulations is in § 1.1502-36(e)(5). The collection of information is necessary to allow a corporation to redetermine basis under the basis redetermination rule when it sells all the stock of a subsidiary, to modify the application of the attribute reduction rule, to apply the Unified Loss Rule retroactively to certain intercompany transfers, and to reattribute a section 382 limitation.

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.

Books or records relating to the 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 January 23, 2007, the IRS and Treasury Department issued a notice of proposed rulemaking (REG-157711-02, 2007-8 IRB 537, 72 FR 2964) (January 2007 proposal) that included proposed regulations under § 1.1502-36 (Unified Loss Rule). The proposed Unified Loss Rule would implement aspects of the repeal of the General Utilities doctrine and address the duplication of loss by consolidated groups. The proposed Unified Loss Rule consisted of three principal rules that would apply when a member (M) transferred a loss share of stock of a subsidiary (S): A basis redetermination rule (that would reallocate investment adjustments to address both noneconomic and duplicated stock loss), a basis reduction rule (that would address noneconomic stock loss), and an attribute reduction rule (that would address duplicated loss).

In addition, the January 2007 proposal included proposed regulations under § 1.1502-13(e)(4) that would address the application of section 362(e)(2) to certain intercompany transactions. The January 2007 proposal also included proposed regulations that would make various technical and administrative revisions to other provisions of the consolidated return regulations and to regulations regarding stock basis following certain corporate restructuring transactions.

No public hearing regarding the proposed regulations was requested or held. Written, electronic, and oral comments responding to the notice of proposed rulemaking were received. After consideration of all the comments, these final regulations generally adopt the rules of the proposed regulations other than proposed § 1.1502-13(e)(4) and its related provisions. The significant comments and modifications are discussed in this preamble.

1. The Unified Loss Rule

A. General Comments

In general, commentators and practitioners have consistently described the provisions of the proposed Unified Loss Rule as reaching a fair and reasonable systemic balance. They have generally concurred with the major policy decisions reflected in the proposed regulations, including the retention of the loss limitation model, the rejection of a tracing approach, the application of the rule to built-in income, and the systemic prevention of loss duplication. However, commentators and practitioners have also consistently raised concerns regarding both the complexity of the proposed rules and the anticipated difficulty in compiling the data required to implement the proposed rules, especially those relating to transfers of stock of subsidiaries that hold stock in other subsidiaries.

The IRS and Treasury Department recognize that the proposed rules are complex. However, as recognized by commentators and practitioners, the complexity of the rules is a result of the balancing of benefits and burdens arising from the presumptions on which the rules are based. The IRS and Treasury Department are concerned, therefore, that simplifying the proposed rules would adversely impact the fundamental fairness the rules are intended to achieve. Nevertheless, careful consideration has been given to all simplifying suggestions, and they have been incorporated wherever possible.

The suggestions regarding the general application and operation of the rule, and the conclusions reached as to each, are set forth in this section A of this preamble. Suggestions relating to individual paragraphs of the Unified Loss Rule and to other regulations in the January 2007 proposal, including proposed § 1.1502-13(e)(4), and the conclusions reached as to each, are set forth in the following sections.

i. Order of Application of the Unified Loss Rule and Other Adjustments

The January 2007 proposal provided that the Unified Loss Rule would apply to a transfer of a share of subsidiary stock if, after giving effect to all applicable rules of law (other than the Unified Loss Rule), the share is a loss share. The provisions of the proposed Unified Loss Rule would then apply sequentially to adjust subsidiary stock basis and attributes. Any adjustments

required under the Unified Loss Rule would be given effect immediately before the transfer.

Commentators found the timing rules unclear, particularly as they related to the application of other provisions of the consolidated return regulations that also purport to apply immediately before a transaction. The IRS and Treasury Department have considered this comment and agree that there could be some uncertainty in this respect.

To address this concern, § 1.1502-36(a)(3)(i) of these final regulations provides that the Unified Loss Rule applies when a member transfers a share of subsidiary stock and, after taking into account the effects of all rules of law applicable as of the transfer, even those that would not be given effect until after the transfer, the share is a loss share. Such effects may be attributable to lower-tier dispositions and worthlessness, as well as to the application of the Unified Loss Rule. Although the determination of whether a transferred share is a loss share is made as of the transfer, the Unified Loss Rule as a whole applies, and any adjustments required under the Unified Loss Rule are given effect, immediately before the transfer.

When the Unified Loss Rule applies to a transfer, its individual provisions are each applied in order. Thus, as described in § 1.1502-36(a)(3)(i) of these final regulations, the general rule is that paragraph (b) applies first with respect to a transferred loss share (or shares). Then, if there is still a transfer of a loss share after the application of paragraph (b), paragraph (c) applies to the loss share (or shares). Finally, if there is still a transfer of a loss share after the application of paragraph (c), paragraph (d) applies with respect to that loss share (or shares). Section 1.1502-36(a)(3)(ii) provides detailed instruction regarding the order in which the individual provisions of the Unified Loss Rule apply if there are transfers at multiple tiers in the same transaction.

ii. Application of Unified Loss Rule to Nondeconsolidating Transfers

Several commentators have suggested that the final regulations include an election to defer basis recovery in the case of a nondeconsolidating transfer. Under such an election, a group could avoid applying the Unified Loss Rule to such transfers by shifting the basis of a transferred share (to the extent such basis exceeds the share's value) to other shares held by members. As a result, the group would forego any current loss, but the Unified Loss Rule would continue to be applicable to any subsequent transfer of loss shares of stock of that subsidiary.

The IRS and Treasury Department are concerned that such an election could cause significant administrative complexity. The IRS and Treasury Department are also concerned that such an election could cause substantial distortions that could adversely affect the treatment of subsequent deconsolidating transfers. For example, a basis shift resulting from such an election could significantly increase the disconformity amount of the retained shares, potentially causing a substantial and inappropriate reduction in the basis of the retained shares when they are ultimately transferred. Further, because this relief would only address transfers of minority interests, and the IRS and Treasury Department believe that such transfers reflect a small portion of subsidiary stock dispositions, the IRS and Treasury Department do not believe such a rule would give rise to any significant relief. Accordingly, this suggestion was not adopted.

Other suggestions were made that would apply special rules to nondeconsolidating transfers. The final regulations generally do not adopt special rules for nondeconsolidating transfers. The principal reasons are the complexity a dual system would create and the small number of transactions expected to be affected by such rules. In addition, the IRS and Treasury Department believe that taxpayers will typically be able to restructure nondeconsolidating transfers to avoid the application of the Unified Loss Rule, for example, by issuing subsidiary stock.

iii. Application of Unified Loss Rule to Deferred Recognition Transfers

The proposed regulations provided that all transfers of loss shares of subsidiary stock are immediately subject to the Unified Loss Rule when the stock is transferred, even if any loss recognized on the transfer would be deferred. The IRS and Treasury Department had concluded that the immediate application of the Unified Loss Rule was necessary to prevent the significant administrative burden of retroactively applying the Unified Loss Rule to members' bases in shares of subsidiary stock, and to the subsidiary's attributes, long after a stock sale.

Commentators questioned the need to apply the Unified Loss Rule to a transfer in which any loss that would be recognized would be deferred, citing as a model § 1.1502-20(a)(3) (deferring the application of § 1.1502-20, the Loss Disallowance Rule). Commentators also observed that single-entity principles seemed to suggest that an intercompany transfer is not an appropriate time to apply the Unified Loss Rule, urging that it would be more appropriate to apply the Unified Loss Rule to such a transfer when the intercompany item is taken into account.

The IRS and Treasury Department have considered these comments and are persuaded that single-entity principles would be furthered, and group income would be more clearly reflected, if the application of the Unified Loss Rule were coordinated with the intercompany transaction provisions in § 1.1502-13. Accordingly, under these final regulations, if a member transfers a share of subsidiary stock to another member and any gain or loss on the transfer is deferred under § 1.1502-13, the Unified Loss Rule applies to the transfer, or to any subsequent transfer of that share by a member, when the intercompany item is taken into account. At that time, the determination of whether the Unified Loss Rule applies and, if so, the consequences of its application are made by treating the buying and selling members as divisions of a single corporation. The final regulations also provide that appropriate adjustments will be made to intercompany item(s), any member's basis in the subsidiary's share, and/or the subsidiary's attributes in order to further the purposes of both the Unified Loss Rule and the intercompany transaction provisions in § 1.1502-13.

Notwithstanding this modification of the treatment of intercompany transfers, the IRS and Treasury Department continue to believe that the deferral of loss recognized on a sale of subsidiary stock should not, in general, defer the application of the Unified Loss Rule. One reason is that postponing the application of the Unified Loss Rule in transfers that are not intercompany transactions would likely make it much more difficult, and in some cases impossible, to obtain the information and make the determinations necessary to apply the rule. Another reason is that such an approach could require subsequent adjustments to attributes outside the consolidated group. Accordingly, these final regulations continue to apply the Unified Loss Rule to non-intercompany transfers of loss shares at the time the stock is transferred, even if any loss recognized on the transfer is subject to deferral.

These final regulations modify the definition of the term transfer to reflect both the general rule that the deferral of loss does not affect the determination of whether stock is transferred and the limited exception for intercompany transactions.

iv. Application of Unified Loss Rule to Liquidations Under Section 332

The proposed Unified Loss Rule provided that the term transfer generally includes transactions in which a member ceases to own subsidiary stock. However, the proposed regulations included an exception for section 381(a) transactions in which any member acquires assets of the subsidiary, provided that no gain or loss is recognized by member shareholders with respect to the subsidiary's stock. Commentators observed that this exclusion would apply to liquidations in which more than one member owns stock of the subsidiary and that, in such cases, upper-tier distortions could result because the basis redetermination rule would not apply.

The IRS and Treasury Department agree with this observation and are concerned with the potential for distortion and abuse. Accordingly, under the final regulations, a disposition of subsidiary stock in a liquidation to which section 332 applies is not excepted from the definition of a transfer if more than one member owns stock in the liquidating subsidiary. However, the final regulations provide that, in the case of a multiple-member section 332 liquidation, neither paragraph (c) (the basis reduction rule) nor paragraph (d) (the attribute reduction rule) will apply to the transfer. Thus, if more than one member owns stock in a subsidiary and those members dispose of the subsidiary stock in a section 332 liquidation of the subsidiary, the transaction is subject to the other provisions of the Unified Loss Rule, in particular the basis redetermination rule in § 1.1502-36(b).

v. Basis in Lower-Tier Stock

In formulating the proposed Unified Loss Rule, the IRS and Treasury Department believed that, by using information that taxpayers were otherwise required to create and maintain, the administrative burden on taxpayers would be minimal. However, commentators have uniformly expressed concern that taxpayers will find it costly and time-consuming, if not impossible, to obtain the subsidiary stock basis information needed to apply many of the provisions of the Unified Loss Rule. Particular concern has been expressed regarding the lower-tier subsidiary rules in the proposed basis reduction rule (proposed § 1.1502-36(c)) and the proposed attribute reduction rule (proposed § 1.1502-36(d)). The reasons cited include the widespread practice of determining stock basis only when necessary to determine a person's tax liability, complicated intercompany accounting rules that make stock basis determinations prone to error, and the frequent inability to obtain accurate historical basis information when acquiring companies with lower-tier subsidiaries.

To address this problem, several commentators have suggested modifying the proposed rules to apply solely based on the net inside attributes of lower-tier subsidiaries (the “look-through” approach). Those commentators have argued that information regarding inside attributes is much more regularly and reliably maintained and available than stock basis information.

The IRS and Treasury Department recognize that adopting a look-through approach would not only address the problem of inadequate stock basis data, it would also significantly simplify the application of the rules. However, the IRS and Treasury Department are concerned that a look-through approach could produce inappropriate results for groups transferring S stock if S holds stock of another subsidiary (S1) and S's basis in its S1 stock reflects unrecognized appreciation in S1's assets (built-in gain).

Example.

P, the common parent of a consolidated group, transfers $100 to S in exchange for S's sole outstanding share of stock. S purchases the sole outstanding share of S1 stock for $100 when S1 holds one asset with a basis of $0 and a value of $100. S earns $100, increasing P's basis in S to $200. S1's asset declines in value to $0. P sells its S share to X, an unrelated person, for $100, recognizing a loss of $100. Under the basis reduction rule as proposed, P's basis in S stock is reduced by the lesser of S's disconformity amount and S's net positive adjustment. S's disconformity amount is $0, the excess of P's $200 basis in the S share over S's net inside attribute amount ($200, the sum of S's $100 cash and its $100 basis in the S1 share, which is not treated as reduced under the tentative reduction rule because there were no investment adjustments applied to the basis of the S1 share). Accordingly, although S had a $100 net positive adjustment, there is no reduction to P's basis in S stock and so P's $100 loss on the S stock is allowed. However, because the stock loss is duplicated in S's attributes, the attribute reduction rule will apply to eliminate S's inside loss.

If a look-through approach were adopted, however, S's basis in its S1 share would be disregarded and S's disconformity amount would be $100 (the excess of P's $200 basis in its S share over S's $100 net inside attribute amount, computed as the sum of S's $100 cash and S1's $0 basis in its asset). As a result, P's basis in its S share would be reduced by $100, the lesser of S's $100 disconformity amount and S's $100 net positive adjustment. Although S would retain its $100 basis in its S1 share, P would recognize no loss on its sale of the S stock. Thus, the selling group would have suffered an economic loss but the loss would be neither recognized nor allowed. Such a result would be contrary to the general rule adopted in the proposed regulations, that stock basis is not presumed noneconomic to the extent there is no disconformity amount or no net positive adjustment amount.

The IRS and Treasury Department recognize that, under the proposed regulations, a very different result follows where it is S1, not S, that earns the $100. In that case, the proposed regulation would treat S's basis in the S1 stock as tentatively reduced by $100 (the lesser of S1's $100 disconformity amount and S1's net positive adjustment). As a result, S would have a disconformity amount of $100 and P's basis in its S share would be reduced by $100 (the lesser of S's $100 disconformity amount and S's $100 net positive adjustment). But the IRS and Treasury Department believe this result is appropriate because S1's disconformity amount evidences that S1 has at least $100 of built-in gain. Further, S1 has a net positive adjustment that evidences the recognition of that built-in gain. Thus, in this case, the facts indicate that S1's income is attributable to the recognition of built-in gain and that, as a result, M's loss on the share of S stock should be treated as noneconomic.

The IRS and Treasury Department recognize that this approach could lead to situations in which the location of an item is manipulated to produce inappropriate results, but believe there are adequate protections against such manipulation. See, for example, section 482 and the various anti-abuse provisions of the consolidated return regulations, including these final regulations.

For all these reasons, the IRS and Treasury Department continue to believe that including lower-tier stock basis in determinations made under the Unified Loss Rule more fully safeguards taxpayers' interests and generally produces more appropriate results.

Several commentators argued that an elective look-through rule would address the concerns inherent in a mandatory look-through rule, as well as the concerns regarding the availability of stock basis information and the complexity of the proposed rules.

The IRS and Treasury Department agree that an elective approach would mitigate the concerns presented by a mandatory look-through rule, but believe that an elective approach would

not provide the desired simplification. The reason is that the decision will affect computations under both the basis reduction rule and the attribute reduction rule, and what may be taxpayer favorable for one rule may be taxpayer unfavorable for the other rule. Thus, the benefit (or burden) of ignoring lower-tier stock basis for the basis reduction rule will need to be weighed against any benefit (or burden) of ignoring lower-tier stock basis for the attribute reduction rule.

The IRS and Treasury Department acknowledge that, in order to simplify compliance, some taxpayers might elect a look-through approach without making detailed alternative computations. However, the IRS and Treasury Department believe that, given the consequences of such an election, the vast majority of taxpayers will compute their tax treatment both with and without a look-through approach before deciding whether to make such an election. Thus, in the vast majority of cases, there would be little or no simplification from an elective look-through approach, and one of the major goals of such a rule would not be achieved.

Moreover, the IRS and Treasury Department believe that taxpayers making both computations will then universally choose the method that produces better results. While taxpayers are free to arrange their affairs so as to legitimately minimize their taxes, a system that will always operate to the disadvantage of one party or the other (in this case, the government) is not properly balanced.

Accordingly, the IRS and Treasury Department believe that a mandatory look-through approach would produce inappropriate results in certain cases, and that an elective look-through approach would fail to achieve a significant amount of simplification and would significantly diminish the balance and fairness of the regulations. The final Unified Loss Rule therefore does not adopt any form of the look-through approach.

Still, the IRS and Treasury Department recognize that determining lower-tier subsidiary stock basis may be difficult for the reasons previously noted. Further, although the need to determine lower-tier subsidiary stock basis is not particular to these regulations, the Unified Loss Rule arguably increases both the frequency and significance of these determinations. Accordingly, the IRS and Treasury Department are considering various proposals that would mitigate these difficulties on a system-wide basis.

One alternative under consideration is a conforming basis election. Under this election, consolidated groups could determine members' bases in shares of subsidiary stock by treating the basis in each share owned by a member as being equal to the share's proportionate interest in the subsidiary's net inside attributes. If such an election were made, the determination would presumably be effective for all Federal income tax purposes. Further, because the determination of subsidiary stock basis is not a concern that is unique to the Unified Loss Rule, consideration is being given to allowing the election with respect to all subsidiaries, with no restrictions on consistency or the time for making elections. However, the IRS and Treasury Department are not certain that such a rule would materially simplify the determination of basis because taxpayers are likely to conclude that they must determine stock basis in judging whether to make the election. Further, the IRS and Treasury Department are concerned about the collateral consequences of such a rule.

Accordingly, the IRS and Treasury Department are requesting comments regarding whether such an election would assist taxpayers and whether it would in fact provide any simplification. Additionally, comments are requested regarding what collateral consequences, if any, such an election should or would have, and whether such consequences are appropriate. The issues include, for example, whether such an election would be an appropriate means of eliminating excess loss accounts, whether it could potentially produce inappropriate cross-chain basis shifts, or whether it could inappropriately facilitate the acceleration of losses.

The IRS and Treasury Department also request comments regarding any other method for addressing this issue.

vi. Items Taken Into Account in Determining the Net Inside Attribute Amount

As a result of various questions and comments received, the IRS and Treasury Department have reconsidered the inclusion of credits in the determination of the net inside attribute amount. Commentators have correctly observed that, at least with respect to credits held at the time of a taxable acquisition of subsidiary stock, credits are economically similar to other valuable attributes and it would be appropriate to take such credits into account in determining the disconformity amount. However, the proper treatment of other credits (that is, credits accruing after the subsidiary stock was acquired) in determining the disconformity amount, and of any credits (whenever accruing) in determining loss duplication, is less clear. Presumably, however, any such methodology would need to be tracing-based, and would therefore be expected to present the significant administrative concerns described in the preamble to the January 2007 proposal. Ultimately, no viable presumptive methodology was identified for determining the proper inclusion of credits, and so no change is made in the final Unified Loss Rule regarding the treatment of credits.

vii. Adjustments for Section 362(e)(2) Transactions

As discussed in Section 3 of this preamble, the IRS and Treasury Department have concluded that section 362(e)(2) should generally not apply to intercompany transactions. However, section 362(e)(2) will apply to transactions occurring prior to September 17, 2008 if the taxpayer does not elect to apply the rule in the final regulations. In such cases, distortions will result and, thus, adjustments will need to be made. The IRS and Treasury Department are also concerned that there are other provisions that could create distortions. Accordingly, the final regulations retain the rule in proposed § 1.1502-36(e)(2) that provided for adjustments to offset the effects of basis reductions required by section 362(e)(2) with respect to intercompany transactions, and the rule that provided for appropriate adjustments in cases raising similar issues. However, under the final regulations, taxpayers may make appropriate adjustments without a determination from the Commissioner.

viii. Effective/Applicability Date Issues

As proposed, the Unified Loss Rule would have been applicable for all transfers on or after the date the regulations were published as final. Several practitioners observed that the proposed effective date caused problems for taxpayers attempting to negotiate transactions because they could not be certain what set of regulations would be in effect when their transactions were completed. Accordingly, commentators and practitioners requested that the regulations include a transition rule that would exclude transfers effected on or after the date the final regulations are published, if such transfers were made pursuant to a binding agreement in place before the publication date.

The IRS and Treasury Department recognized the difficulty created by the proposed effective date and, in Notice 2008-9, 2008-3 IRB 277 (regarding the Internal Revenue Bulletin generally, see

§ 601.601(d)(2)(ii)(

b

)), announced that the final regulations would include a transition rule for transfers between unrelated parties if made pursuant to an agreement that is binding before the date that final regulations are published and at all times thereafter. Further, Notice 2008-9 stated that the IRS and Treasury Department expect that the rule would incorporate the provisions of section 267(b) in determining whether persons are related for this purpose. Accordingly, as stated in Notice 2008-9, the final Unified Loss Rule applies to transfers on or after September 17, 2008, unless the transfer is made pursuant to a binding agreement between unrelated parties that was in effect before September 17, 2008 and at all times thereafter. The final regulations provide that the term related party has the same meaning as in section 267(b).

One comment was also received suggesting that the final regulations include an election to apply their provisions retroactively. The IRS and Treasury Department considered this suggestion but are concerned that adopting such an approach would disrupt taxpayers' otherwise closed transactions and thereby exacerbate the problems caused by the uncertainty and instability in this area over these past years. Accordingly, the final Unified Loss Rule does not include an election to apply its provisions retroactively.

B. Section 1.1502-36(b): Basis Redetermination Rule

Commentators generally recognize and concur with the need for a rule that reallocates investment adjustments to address the problems created when shares of stock are held with disparate bases. As illustrated in Sections B.3, B.4, and E of the preamble to the January 2007 proposal, the allocation of investment adjustments under § 1.1502-32 can create a noneconomic stock loss on an individual share that would be eliminated under § 1.1502-36(c). Similarly, the allocation of investment adjustments under § 1.1502-32 can fail to eliminate a duplicated loss on an individual share. In both cases, however, the allocation creates no net loss if all the shares are taken into account. The basis redetermination rule in § 1.1502-36(b) is designed to address these issues.

Commentators have expressed concern, however, with both the availability of the investment adjustment data required to implement the rule and the complexity of the application of the rule.

The IRS and Treasury Department recognize that the information may be difficult and costly to produce. However, unlike lower-tier subsidiary stock basis information, the information required to implement the basis redetermination rule (specifically, the investment adjustment history of the stock of the subsidiary that is being transferred) is generally information obtained from the group's own tax returns and other records. Groups are therefore, as a general matter, not dependent on other taxpayers for this information.

Furthermore, the IRS and Treasury Department expect that this rule will apply to only a small number of transactions due to the exception for transactions in which members transfer all of their S stock to one or more nonmembers in a fully taxable transaction. Accordingly, it is anticipated that, in most transactions, taxpayers will not be required to redetermine basis. Moreover, in those situations in which it does apply, it accomplishes important objectives for both taxpayers and the government.

Some commentators suggested allowing a member to be treated as having an averaged basis in its shares of S stock if S has only one class of stock outstanding and the member holds all of the S stock. The commentators argue that such an election could significantly reduce the number of taxpayers required to apply the basis redetermination rule. While that might be true, such basis averaging could result in additional complexities and distortions. For example, if a portion of the shares were previously transferred in an intercompany transaction and the bases in all of the subsidiary's shares were averaged, it might be difficult to determine the extent to which particular shares reflect the prior intercompany transaction. Further, averaging the basis in the subsidiary's shares could alter the application of section 267 and section 311.

For all these reasons, the final Unified Loss Rule retains the basis redetermination rule without the suggested modifications.

The final regulations do, however, modify the basis redetermination rule to omit the reallocation of positive investment adjustments applied to preferred shares under § 1.1502-32. The reason is that § 1.1502-32 allocates positive adjustments to preferred shares solely to account for the right to receive distributions. Thus, the positive § 1.1502-32 adjustments allocated to preferred shares, like the adjustments for distributions (which were not reallocated under the proposed Unified Loss Rule), are based on economic changes in the shareholder's investment. As a result, they should have no correlation to unrecognized loss reflected in the bases of the shares and so should not be subject to this rule. The final regulations do, however, continue to permit the reallocation of both positive and negative adjustments from common to preferred shares in order to reduce or eliminate any loss on transferred preferred shares and any gain on either transferred or nontransferred preferred shares. The IRS and Treasury Department believe such reallocations are necessary and appropriate to address any reflection of unrecognized gain or loss in preferred shares attributable, for example, to contributions of assets in exchanged for preferred stock.

i. Exceptions to Basis Redetermination Rule

The proposed basis redetermination rule contained two exceptions to its application, the “no potential for redetermination” exception and the “disposition of entire interest” exception.

The proposed “no potential for redetermination” exception provided that basis redetermination is not required if redetermination would not change any member's basis in S stock. Some commentators found this exception confusing; others suggested that it offered no simplification because it would be necessary to apply the basis redetermination rule to determine whether the exception was available. Other commentators thought that it provided a useful safe harbor. The IRS and Treasury Department have concluded that the rule should be retained, but that it should be revised to state its scope and effect more clearly. Accordingly, under the final regulations, the basis redetermination rule does not apply if members' bases in shares of S common stock are equal (that is, there is no disparity) and members' bases in shares of S preferred stock reflect no gain or loss. The reason is that, under these circumstances, the only effect that a reallocation of investment adjustments could have would be an increase, not a decrease, in basis disparity.

The proposed “disposition of entire interest” exception provided that basis redetermination is not required if, within the group's taxable year in which the transfer occurs, all of the shares of S stock held by members are transferred to a nonmember in a one or more fully taxable transactions. This rule differed from the basis reduction netting rule in proposed § 1.1502-36(c)(7) and the net stock loss definition in proposed § 1.1502-36(d)(3)(ii), which only netted among shares transferred in the same

transaction. Commentators observed that this difference presents a potential for distortion and abuse if items are taken into account by S between transfers. While this problem exists to a certain extent if a transaction is comprised of steps that are not executed simultaneously, the problem may be significantly exacerbated by a rule that allowed netting among all transactions within a year. Moreover, because the netting rule in the basis reduction rule is intended, in part, to protect taxpayers when the basis redetermination rule is not applied, the IRS and Treasury Department believe that the application of these rules should be coextensive. Accordingly, the final regulations provide that this exception only applies if members dispose of their entire interest in S stock to one or more nonmembers, if all members' shares of S stock become worthless, or if all members' shares of S stock are either worthless or disposed of to one or more nonmembers, in one fully taxable transaction.

Commentators also inquired whether the “disposition of entire interest” exception was mandatory, that is, whether the basis redetermination rule could be applied even if a group disposed of its entire interest in a transaction that qualifies for the exception. The IRS and Treasury Department recognize that taxpayers might choose to apply the basis redetermination rule in such cases in order to reduce gain or avoid the Unified Loss Rule with respect to upper-tier shares. The IRS and Treasury Department do not believe that doing so would be inappropriate, as the premise of the basis redetermination rule is that reallocations made under the rule are appropriate allocations. However, because the IRS and Treasury Department believe that taxpayers will most often not want to apply the basis redetermination rule, the final regulations generally provide that basis is not redetermined when the exception applies, but include an election to apply the basis redetermination rule in such cases.

ii. Manner in Which Investment Adjustments Are Reallocated

Some commentators observed that the proposed rules were vague regarding the manner in which reallocations were to be made. The IRS and Treasury Department generally agree with this observation, but had concluded that the rule would work best if taxpayers were given considerable flexibility in determining how to make specific reallocations. In recognition of the fact that such an approach would allow differing interpretations, section F.2 of the preamble to the January 2007 proposal stated that the IRS would respect any reasonable method or formula employed in applying the basis redetermination rule.

The IRS and Treasury Department continue to believe that the rule should be as flexible as possible. However, in response to these comments, the specific provisions of the final basis redetermination rule provide some additional guidance (discussed more fully in the next section). But the rule is still intended to be flexible in its application and, therefore, the final regulations explicitly provide that the reallocation of an investment adjustment may be made using any reasonable method or formula that is consistent with the basis redetermination rule and furthers the purposes of the Unified Loss Rule. Thus, like the proposed regulations, the final regulations contemplate that more than one result may be reasonable in any specific case.

iii. Decreasing Disparity in Basis of Members' Shares

The general operating rules of the proposed basis redetermination rule provided that reallocations are made in a manner that reduces the extent to which there is disparity in members' bases in S stock. The IRS and Treasury Department have received various questions regarding the scope of this rule. Some practitioners read the rule to completely eliminate the loss on transferred shares even if overall disparity were increased. One practitioner suggested that the general rule, in referring only to the manner of redetermination, did not clearly restrict the amount of redetermination that would otherwise be required under the rules.

To address these concerns, each of the specific allocation provisions in the final regulations includes a statement regarding the manner and extent to which allocations are to be made under the provision. In addition, the operating rules generally provide that the overall application of the rule must reduce disparity among members' bases in preferred shares of subsidiary stock (as provided in the applicable reallocation provisions) and among members' bases in common shares of subsidiary stock, to the greatest extent possible.

C. Section 1.1502-36(c): Basis Reduction Rule

In general, commentators found the general structure of the basis reduction rule and its components (limiting basis reduction to the lesser of the share's disconformity amount and net positive adjustment) to be a reasonable approach to addressing the issue of noneconomic loss. The principal concern expressed was the anticipated difficulty with respect to gathering the information necessary to implement the lower-tier subsidiary rules. Nevertheless, commentators uniformly agreed that basis adjustments from lower-tier subsidiaries must be taken into account in order to identify and address noneconomic stock loss.

The principal suggestion for addressing the lack of readily accessible and reliable information on lower-tier stock basis was to adopt a look-through approach, as discussed in section 1.A.v. of this preamble. For the reasons set forth in that section of this preamble, the final regulations do not adopt this approach. However, as noted, the IRS and Treasury Department continue to request and consider comments on mechanisms for alleviating the difficulty in determining lower-tier subsidiary stock basis.

Commentators and practitioners did suggest a number of other modifications to the basis reduction rule. Those suggestions and the decisions reached are discussed in the following sections.

i. Treatment of Intercompany Debt

Several commentators suggested revising the net positive adjustment amount to exclude items related to intercompany debt. The rationale for this suggestion was that, in general, the nature of such amounts makes them more like to capital transactions than the recognition of built-in gain or loss. Thus it is argued that these amounts should be treated like contributions and distributions, which are not included in the net positive adjustment amount.

The IRS and Treasury Department recognize that, in certain circumstances, intercompany debt has some inherent similarity to capital contributions and distributions, at least with respect to the principal amounts of such obligations. However, the IRS and Treasury Department also recognize that there are circumstances in which unrecognized appreciation in intercompany debt can be reflected in stock basis. For example, if a subsidiary receives cash in exchange for newly issued stock when it holds an intercompany obligation, the basis of the newly issued shares will reflect a portion of any unrecognized appreciation in the obligation. Because the consequences of having that unrecognized appreciation reflected in stock basis are no different from the consequences of any other built-in gain, the regulations would have to provide a system to identify and monitor those

amounts. Such a system would need to rely on a tracing-based methodology, which the IRS and Treasury Department have rejected for the reasons articulated in the preamble to the January 2007 proposal. Accordingly, the IRS and Treasury Department have concluded that no special rules would be adopted for items related to intercompany debt.

ii. Disconformity Amount: Net Inside Attributes

In the proposed regulations, the term net inside attributes was defined as the excess of the sum of S's loss carryovers, deferred deductions, and asset basis over S's liabilities. Although different rules applied to determine basis in lower-tier subsidiary stock, the terms otherwise had the same meaning for purposes of both the basis reduction and attribute reduction rules.

The proposed regulations defined the term loss carryover to mean any net operating or capital loss carryover attributable to S that is or, under the principles of § 1.1502-21 would be, carried to S's first taxable year, if any, following the year of the transfer. Thus, if a buyer were to waive a loss carryover under § 1.1502-32(b)(4), the loss would not be carried to S's first taxable year after the transfer, and so it would be excluded from the computation of net inside attributes.

Practitioners agree that this definition is appropriate for purposes of measuring loss duplication, as it prevents attributes that cannot be duplicated from being taken into account in computing S's attribute reduction amount. However, one commentator observed that this definition seemed inappropriate for purposes of measuring S's disconformity amount.

The IRS and Treasury Department have considered this comment and agree that the definition is inappropriate for computing S's disconformity amount. As discussed in the January 2007 preamble, the disconformity amount was incorporated in the basis reduction rule in order to limit basis reduction to the net amount of a subsidiary's built-in gain. The IRS and Treasury Department believed that, by limiting basis reduction to the amount of net built-in gain, the basis reduction rule would not reduce stock basis by an amount that could not be attributed to the recognition of built-in gain.

However, by adopting a definition of loss carryovers that required such losses to be carried to a separate return year, the rule allowed a waiver of a loss carryover under § 1.1502-32(b)(4) to reduce the amount of a subsidiary's loss carryovers and, as a result, the subsidiary's net inside attributes. That, in turn, caused an increase in the subsidiary's disconformity amount. But, as the commentator observed, any disconformity created by the waiver of a loss carryover would be unrelated to the existence of built-in gain. Thus, this definition of loss carryovers undermined the protection otherwise afforded by the use of the disconformity amount as a limit on basis reduction.

In addition, other commentators found the proposed rule unclear in its reference to losses that would be carried to a separate return year.

To address these concerns, the final regulations provide that the term loss carryovers means those losses that are attributable to the subsidiary, including any losses that would be apportioned to the subsidiary under the principles of § 1.1502-21(b)(2) if the subsidiary had a separate return year. However, because a waiver under § 1.1502-32(b)(4) does affect the extent to which a loss can be duplicated, the final regulations provide that, solely for purposes of applying the attribute reduction rule, a subsidiary's loss carryovers (and therefore its net inside attributes) do not include the amount of any losses waived under § 1.1502-32(b)(4).

D. Section 1.1502-36(d): The Attribute Reduction Rule

As discussed in the preamble to the January 2007 proposal, the loss duplication component of the Unified Loss Rule addresses loss duplication systemically in order to clearly reflect the income of both the group and its members, including former members. The IRS and Treasury Department view this rule as a necessary and appropriate complement to § 1.1502-32 because, together they work to eliminate the duplication of a group item once the group enjoys the benefit of the item, without regard to which of the duplicative items is recognized and allowed first. The IRS and Treasury Department also view this rule as a necessary and appropriate complement to the basis reduction rule because it eliminates S's unrecognized built-in loss to the extent it prevented the identification of S's recognized built-in gain (and thus prevented the reduction of noneconomic stock basis, and noneconomic stock loss). See sections C.3 and C.4.v of the preamble to the January 2007 proposal for a discussion of the interaction between unrecognized built-in loss and recognized built-in gain.

Commentators generally agreed with the IRS and Treasury Department on the need for, and appropriateness of, the systemic approach to loss duplication. However, like the basis redetermination and basis reduction rules, the attribute reduction rule received considerable commentary regarding the issues of data availability and computational complexity. Commentators and practitioners made several suggestions for technical revisions to the proposed regulations. The IRS and Treasury Department have considered the suggestions received as well as other revisions to the proposed attribute reduction rule. The suggestions and conclusions are discussed in the following sections.

i. Lower-Tier Subsidiary Rules

In general, commentators and practitioners recognize that the rules for measuring and eliminating loss duplication must take into account both the basis in lower-tier subsidiary stock and the attributes of lower-tier subsidiaries in order to be most effective. Nevertheless, as already noted, commentators expressed much concern regarding the administrability of the proposed lower-tier subsidiary rules. Their principal suggestion for addressing this concern was the adoption of a look-through approach that would address loss duplication only by taking lower-tier attributes into account.

The IRS and Treasury Department considered a look-through approach when drafting the January 2007 proposal, but were concerned that such an approach would not adequately address loss duplication. The principal reason for this concern was that loss duplication can reside in the basis of lower-tier subsidiary stock and in the attributes of that lower-tier subsidiary and, moreover, that it can reside in those locations in differing amounts. Therefore, a rule that measures loss duplication solely by reference to lower-tier attributes, or solely by reference to lower-tier stock basis, would permit potentially significant amounts of loss duplication to avoid reduction. To avoid this problem, the IRS and Treasury Department concluded that the loss duplication regulations must measure loss duplication by reference to both.

The IRS and Treasury Department recognized, however, that when duplication is not uniformly reflected in stock basis and attributes, this approach could cause an over-reduction in lower-tier attributes (when loss duplication resides primarily in lower-tier stock basis) or in lower-tier stock basis (when loss duplication resides primarily in lower-tier attributes). To prevent the former result, the conforming limitation on lower-tier attribute reduction limits the application of tiered-down attribute reduction (generally permitting a lower-

tier subsidiary's attributes to be reduced only to the extent necessary to conform them to members' bases in that subsidiary's stock, as reduced under this rule). To prevent the latter result, the basis restoration rule reverses reductions to lower-tier stock basis made by the Unified Loss Rule (generally to the extent necessary to conform members' bases in the subsidiary's stock to the subsidiary's net inside attributes, as reduced under this rule).

Thus, these rules work together to protect the government's interests (by addressing the entire potential for loss duplication) and taxpayers' interests (by preventing the over-reduction of either lower-tier stock basis or lower-tier attributes). Accordingly, the IRS and Treasury Department continue to believe these rules are essential to the balance and fundamental fairness of the Unified Loss Rule.

Nevertheless, the IRS and Treasury Department recognize that the conforming limitation and basis restoration rules can add considerable complexity to the application of the Unified Loss Rule. To address this concern, commentators have suggested that one or the other of these rules could be omitted to simplify the proposed rule. The IRS and Treasury Department are concerned, however, that eliminating either of these rules would considerably undermine the overall fairness of the regulation. But the IRS and Treasury Department are persuaded that, if a taxpayer determines that the expected benefit of applying these rules is outweighed by the additional complexity, then that taxpayer should be permitted to choose not to apply these rules.

Accordingly, these final regulations continue to measure the potential for loss duplication by taking both stock basis and attributes into account and continue to safeguard against over-reduction of either inside attributes or stock basis by applying both the conforming limitation and the basis restoration rules. However, under the final regulations, taxpayers are permitted to elect not to apply the conforming limitation or the basis restoration rule if they decide the protection afforded by either or both of those rules does not outweigh the burden of applying them.

ii. Attribute Reduction Amount Below Five Percent of Value

Although the fundamental structure of the attribute reduction rule has been retained, the IRS and Treasury Department have determined that it is appropriate to provide an exception to the application of the attribute reduction rule if the attribute reduction amount (that is, the duplicated loss) is small relative to the size of the transaction. This decision reflects a balancing of the need to eliminate duplicated loss and the administrative burden of applying the attribute reduction rule. Accordingly, under these final regulations, taxpayers must still compute their attribute reduction amount, but if the total attribute reduction amount is less than five percent of the aggregate value of the subsidiary shares that are transferred by members in the transaction, the attribute reduction rule does not apply to the transfer.

However, the IRS and Treasury Department also recognize that, in certain circumstances, a taxpayer may prefer to have the attribute reduction rule apply. For example, a group may want to apply the rule in order to reattribute a subsidiary's attributes. Accordingly, the final regulations allow taxpayers to elect to apply the attribute reduction rule notwithstanding that their total attribute reduction amount is less than five percent of the aggregate value of the transferred shares. If this election is made, the attribute reduction rule will apply with respect to the entire attribute reduction amount determined in the transaction, and thus applies with respect to all members transferring shares, and all shares transferred, in the transaction.

iii. Ordering of Reduction of Recognized Losses

Commentators generally agreed with the decision to reduce recognized losses (net operating loss (NOL) carryovers, capital loss carryovers, and deferred deductions, identified as Category A, Category B, and Category C attributes, respectively) before reducing asset basis, since the former items represent actual, identified losses. The proposed regulations provided that the attribute reduction amount would be first applied to reduce NOL carryovers (from oldest to newest), then capital loss carryovers (from oldest to newest), and then deferred deductions (proportionately). However, several commentators questioned the need for a mandatory order in which these attributes would be reduced. These commentators observed that, because loss duplication is a mathematical determination under the Unified Loss Rule, and because it is difficult (if not impossible) to know which attributes are economically duplicative of a stock loss, the reduction of any item in those categories should be equally appropriate and effective.

The IRS and Treasury Department have reconsidered this issue and agree with the commentators. Accordingly, the final regulations provide that if the attribute reduction amount is less than the total attributes in Category A, Category B, and Category C, the taxpayer may specify the allocation of S's attribute reduction amount among the attributes in those categories.

The final regulations do, however, prescribe a default allocation for the reduction of such attributes that is used to the extent the taxpayer does not specify an allocation. This default allocation differs from the order provided in the proposed rule in that capital loss carryovers (not NOLs) are reduced first. This modification was made in response to a commentator's suggestion, based on the observation that capital loss carryovers have a significantly shorter expiration period and are therefore more likely than NOLs to expire unused. Accordingly, except to the extent a taxpayer elects to specify an allocation, the final regulations first reduce capital loss carryovers (oldest to newest), then NOL carryovers (oldest to newest), and then deferred deductions (proportionately). This change in the order of reduction is intended to minimize the possibility that the attribute reduction rule will reduce attributes in an amount greater than the amount that would ultimately be available for duplicative use.

The final regulations continue to provide that, regardless of the order in which attributes in these categories are reduced, they are reduced in full before any reduction is made to asset basis.

iv. Methodology for Reduction of Asset Basis

Several commentators have suggested simplifying modifications to the manner in which asset basis is reduced under the attribute reduction rule. One is the elimination of the proposed Category D attributes (unrecognized losses on publicly traded property). This category was included in the proposed rule because the IRS and Treasury Department recognized that these amounts represent a readily identifiable loss that could be eliminated before the presumptive reduction of the bases of other assets. This approach prevented the attribute reduction rule from creating or increasing gain in publicly traded assets. However, commentators viewed this rule as increasing the complexity of an already complex analysis while providing only a marginal benefit.

The IRS and Treasury Department are persuaded that this extra complexity might not be warranted in this context

and that the elimination of this rule would not materially affect the balance otherwise reached by the Unified Loss Rule. Accordingly, the final regulations include publicly traded property in the general asset basis category (now designated Category D).

Another suggestion made by commentators was to apply the attribute reduction amount remaining after reducing Category A, Category B, and Category C attributes to reduce asset basis in the reverse order of the residual method of allocating consideration paid or received in a transaction under section 1060.

The IRS and Treasury Department have concluded that this approach is readily administrable and reflects an appropriate balancing of presumptions regarding the location of duplicated loss. An important consideration is that such a rule reduces basis in purchased goodwill and going concern value before basis in other assets, and the IRS and Treasury Department are persuaded that duplicated loss is generally more likely to be reflected in the bases of such assets. Therefore, the elimination of the basis in those assets first seems particularly appropriate. Further, the IRS and Treasury Department believe that this approach would generally be more administrable than the proposed pro rata reduction of asset basis.

Accordingly, these final regulations adopt this suggestion and generally provide that the attribute reduction amount is applied to reduce the basis of assets in the asset classes specified in § 1.338-6(b) other than Class I (cash and general deposit accounts, other than certificates of deposit held in depository institutions), but in the reverse order from the order specified in that section. Thus, under this reverse residual method, any attribute reduction amount applied to reduce asset basis is generally applied first to reduce any basis of assets in Class VII (proportionately, based on basis instead of value, until all such basis is eliminated). Any remaining attribute reduction amount is then applied in the same manner to reduce the basis of assets in each succeeding lower asset class, other than Class I.

Notwithstanding the general adoption of this allocation methodology for Category D attributes, these final regulations provide that the portion of the attribute reduction amount that is not applied to attributes in Category A, Category B, and Category C, is first allocated between S's basis in any stock of lower-tier subsidiaries (treating all S's shares of any one lower-tier subsidiary as a deemed single share) and the subsidiary's other assets (treating the non-stock Category D assets as one asset). The allocation is made in proportion to S's deemed basis in each single share of lower-tier subsidiary stock and S's basis in the non-stock Category D asset (S's aggregate basis in all of its Category D assets other than subsidiary stock). Only the portion of the attribute reduction amount not allocated to lower-tier subsidiary stock is applied under the reverse residual method. This initial allocation between lower-tier subsidiary stock and other assets is necessary to ensure that, to the extent the attribute reduction amount reflects items attributable to a lower-tier subsidiary's stock basis or attributes, the attribute reduction amount is properly directed and applied to those items.

v. Suspension of Excess Attribute Reduction Amount

Several commentators and practitioners questioned the need to suspend attribute reduction amounts in excess of reducible attributes and apply those suspended amounts to reduce or eliminate attributes otherwise arising when all or part of the liability is paid or otherwise satisfied, whether by S or another person. The IRS and Treasury Department proposed this rule because the mathematical operation of the formula for computing the attribute reduction amount results in such an excess only if there is a liability or similar item that has reduced economic value but that has not been taken into account for tax purposes (generally a contingent liability).

The IRS and Treasury Department continue to believe that it is inappropriate to permit the duplication of economic losses that have not accrued for tax purposes and, therefore, that this rule is both necessary and appropriate. Accordingly, the rule is retained in the final regulations.

The IRS and Treasury Department recognize that this rule could create an administrative burden that could last for many years and transfer to taxpayers beyond the initial buyer and seller. However, the IRS and Treasury Department believe that the elimination of the special rule for publicly traded property substantially lessens the administrative burden of this rule. The reason is that, under this revised approach in the final regulations, a subsidiary's attribute reduction amount can only exceed reducible assets to the extent of the subsidiary's Class I assets. In such cases, the IRS and Treasury Department do not believe the burden imposed to be unreasonable or, in most cases, substantial. Moreover, a taxpayer believing the rule to be overly burdensome in its situation can readily avoid any suspension of its attribute reduction amount by converting its Class I assets into assets of another class; in that case, the remaining attribute reduction amount will be applied to the bases of those assets and will not give rise to a suspended attribute reduction amount.

The IRS and Treasury Department received a comment that, if the suspended attribute reduction rule is retained, it should be clarified to provide that present value principles are to be taken into account in valuing liabilities. The final regulations do not include an explicit statement on this point because the rule implicitly incorporates present value principles (by limiting the attribute reduction amount to the lesser of the net stock loss and the aggregate inside loss, which are both a function of value).

vi. Election to Reduce Stock Basis and/or Reattribute Attributes

Several commentators suggested that the final regulations should expressly permit taxpayers to make a protective election to reattribute attributes (other than asset basis) and/or to reduce stock basis (and thereby reduce stock loss) in order to avoid attribute reduction. The IRS and Treasury Department intend these elections to be as flexible as possible. Accordingly, the final regulations explicitly provide that, if the election is made and it is ultimately determined that S has no attribute reduction amount, the election will have no effect, or if the election is made for an amount that exceeds S's finally determined attribute reduction amount, the election will have no effect to the extent of that excess.

In addition, the final regulations permit taxpayers to reduce (or not reduce) stock basis, or to reattribute (or not reattribute) attributes, or some combination thereof, in any amount that does not exceed S's attribute reduction amount.

Thus, under the final regulations, taxpayers have considerable flexibility in making this election, and may make a protective election.

Further, in order to protect against inadvertent attribute reduction, these final regulations provide for a deemed stock basis reduction election equal to the net stock loss (taking into account any actual elections under § 1.1502-36(d)(6)) in the case of a transfer in which the stock loss in the transferred shares would otherwise be permanently disallowed (for example under section 311(a)).

Several commentators also questioned the need for a mandatory order for the reattribution of losses for the same

reasons they questioned the need for a mandatory order for the reduction of such attributes. For the reasons discussed in section 1.D.iii. of this preamble, the IRS and Treasury Department agree that a mandatory order of reattribution is not necessary. Thus, under the final regulations, attributes are reattributed in the same amount, order, and category that they would otherwise be reduced under the attribute reduction rule. Accordingly, because the final regulations provide that taxpayers can specify the attributes in Category A, Category B, and Category C to be reduced, taxpayers may similarly specify the attributes in Category A, Category B, and Category C to be reattributed. Similar to the rule regarding the allocation of the attribute reduction amount, to the extent the taxpayer elects to reattribute attributes but does not specify the attributes to be reattributed, any attributes not specifically reattributed will be reattributed in the default amount, order, and category applicable for attribute reduction.

Additionally, the final regulations revise the provisions regarding the election to reattribute attributes to provide for the reattribution of a section 382 limitation. The final regulations also include conforming amendments to the consolidated section 382 rules in §§ 1.1502-90, 1.1502-91(h)(2), 1.1502-95(d), 1.1502-96(d), and 1.1502-99(b)(4).

vii. The Conforming Limitation

As previously discussed, the proposed regulations limited the application of the attribute reduction amount that tiered down to a lower-tier subsidiary in order to prevent an excessive reduction to that subsidiary's attributes. Under this limitation (the conforming limitation), the tier-down attribute reduction amount (when combined with any attribute reduction amount computed with respect to a transfer of the shares of the lower-tier subsidiary) could be applied to reduce a lower-tier subsidiary's attributes only to the extent necessary to conform those attributes to an amount equal to the sum of all members' bases in nontransferred shares, and the value of all members' transferred shares, of that subsidiary's stock.

Commentators observed that the conforming limitation could allow duplication to survive the application of the attribute reduction rule when lower-tier stock basis reflects noneconomic basis. The commentators illustrated their observation with the following example:

Example.

M forms S with $100 of cash. S has no other assets or operations. S acquired S1 stock for $100 and no section 338 election is made with respect to such acquisition. S1 has one asset (A1) with a basis of $20 and a value of $100. S1 sells A1 for $100. M's basis in its S stock, and S's basis in its S1 stock, both increase by $80 to $180. S1 invests the $100 of proceeds in another asset (A2). A2 subsequently, declines in value to $40. M sells the S stock for $40.

Under the proposed basis reduction rule, M's basis in the S stock is reduced by the lesser of S's $80 net positive adjustment and S's $80 disconformity amount (determined by treating S's $180 basis in the S1 stock as tentatively reduced by $80, the lesser of S1's $80 net positive adjustment and S1's $80 disconformity amount). After the application of the proposed basis reduction rule, M would recognize a $60 loss on the sale of the S stock.

Under the proposed attribute reduction rule, S's attribute reduction amount is $60 (the lesser of the $60 net stock loss, and S's $140 aggregate inside loss), and S would reduce its basis in the S1 stock by $60 to $120. Under the proposed attribute reduction rule, S's $60 attribute reduction amount allocated to the S1 stock becomes an attribute reduction amount of S1. However, under the proposed conforming limitation on tier-down attribute reduction, S1 is not required to reduce its $100 basis in A2 because S1's $100 of attributes do not exceed S's post-reduction $120 basis in the S1 stock. As a result, M's $60 loss continues to be duplicated in both S's basis in the S1 stock and S1's basis in A2.

The IRS and Treasury Department agree that, under these facts, the attribute reduction rule does not eliminate all lower-tier duplication. However, this effect follows directly from policy decisions underlying the Unified Loss Rule, specifically, that it would be a loss limitation rule and that the basis reduction rule would apply only upon a disposition, deconsolidation, or worthlessness of a loss share. Under this approach, as long as a share is held by the same person and is subject to the consolidated return provisions, noneconomic lower-tier subsidiary stock basis is preserved. As a result, subsequent appreciation can permit the stock to be transferred without being subject to the Unified Loss Rule, and the noneconomic stock basis can reduce any gain that would otherwise be recognized. It is the preservation of that noneconomic stock basis that prevents the full elimination of duplicated loss in S1's attributes.

The issue could be addressed in several ways. First, the decision to preserve basis until there is a loss transfer could be reversed. However, the rule would then either reduce lower-tier stock basis below value or rely on valuation to limit such basis reduction. The IRS and Treasury Department are concerned that adding a valuation component to this rule would present substantial administrative concerns. More importantly, however, the IRS and Treasury Department do not believe that such an approach adequately protects the balance struck in the regulation as proposed and so are not reconsidering that decision.

Alternatively, the conforming limitation could be revised such that any conforming limit would be reduced by the amount of any tentative reduction to stock basis under the basis reduction rule. In the example set forth by the commentators, this would reduce S1's conforming limitation by $80 (S1's tentative reduction amount), from $120 to $40. As a result, S1's basis in A2 would be reduced to $40. While this would produce an appropriate result with respect to A2, it leaves S's basis in the S1 stock reflecting $80 of disconformity. Accordingly, absent additional adjustments, S's basis in the S1 stock could appear to reflect a noneconomic loss, and so the rule would remain imperfect.

Moreover, the effect of such an approach would be to create a disconformity amount that is not related to built-in gain. Consequently, when the S1 stock is ultimately sold, economic loss could appear noneconomic and, therefore, could be eliminated under the basis reduction rule. Although the Unified Loss Rule affords some protection for this situation in the operating rules (see the discussion in section A.1.vii. of this preamble), the IRS and Treasury Department are concerned that the tracing necessary to make the adjustments to prevent the elimination of economic loss will present substantial administrative difficulty and, in many cases, may not be possible.

Furthermore, in certain circumstances, the proposed conforming limitation on tier-down attribute reduction could prevent an unnecessary reduction in lower-tier inside attributes, for example, when the loss on S stock is attributable to the loss of built-in gain on an asset held by S (other than subsidiary stock).

Based on all of these considerations, the IRS and Treasury Department have decided not to revise this rule in the final regulations, but will continue to consider the issue.

viii. Attribute Reduction in the Case of Certain Dispositions Due to Worthlessness and Where the Subsidiary Ceases to be a Member and Does Not Become a Nonmember

Section 1.1502-35(f) generally provides that, if a member treats stock of S as worthless under section 165

(taking into account § 1.1502-80(c)) and S continues as a member, or if M recognizes a loss on S stock and on the following day S is not a member and does not have a separate return year following the recognition of the loss, all losses treated as attributable to S under the principles of § 1.1502-21(b)(2)(iv) are treated as expired as of the beginning of the day following the last day of the group's taxable year. This rule was intended to prevent any implication that S's share of the consolidated losses could be treated as remaining part of the consolidated net operating or capital loss carryover after S becomes worthless or is dissolved in a taxable transaction. The IRS and Treasury Department continue to believe that the regulations should explicitly clarify that such losses are removed from the consolidated losses.

Commentators have observed that, in the specified circumstances, any credits and built-in losses attributable to S should also be eliminated to prevent their use after S either becomes worthless or is dissolved in a taxable transaction. The IRS and Treasury Department agree that, in such cases, S's credits and other attributes should no longer be available to the group.

Accordingly, these final regulations provide a special attribute elimination rule that applies to transfers that result from one of two events. The first is M's transfer of a share of S stock caused solely by M treating the share as worthless under section 165 (taking into account the provisions of § 1.1502-80(c)), if S remains a member of the group and M has a deduction or recognizes a loss with respect to the transfer of the share. The second is M's transfer of a share of S stock caused by S ceasing to be a member, if S has no separate return year and M recognizes a net deduction or loss on its S shares transferred in the transaction. When there is a transfer of S stock in either of these situations, S's net operating loss carryovers, capital loss carryovers, and deferred deductions (including S's share of such consolidated tax attributes) that are not otherwise reduced or reattributed under § 1.1502-36(d), and S's credits (including S's share of consolidated credits), are eliminated. The IRS and Treasury Department do not believe that any special rule is required regarding any built-in loss in assets because excess asset basis should not survive the transactions to which this rule applies.

In considering this rule, the IRS and Treasury Department recognized that the reason for eliminating S's attributes, including credits and deferred deductions, arises from the nature of the specified transactions, not from the amount of the member's basis in the stock transferred in the transaction. Further, as provided in § 1.1502-19(a)(2)(ii), an excess loss account is treated as basis that is a negative amount and a reference to P's basis in S's stock includes a reference to P's excess loss account. Accordingly, the IRS and Treasury Department have concluded that the elimination of S's attributes should occur whenever one of the specified transactions occurs, without regard to the amount of the basis of the transferred share. Under such an approach, the treatment of S's attributes following one of the specified transfers would be consistent irrespective of whether the aggregate basis in the members' shares is a positive number (which produces a net loss or deduction), a negative number (an excess loss account, which produces income or gain under § 1.1502-19), or zero (which produces no income, gain, deduction or loss).

Accordingly, these final regulations include a provision in § 1.1502-19 that applies to the same two transactions that will result in the complete elimination of S's attributes when members have net loss on S stock. Thus, it will apply when a share of S stock is worthless under section 165, the requirements of § 1.1502-19(c)(1)(iii) are satisfied, members do not have a net deduction or loss on the S stock, and S continues as a member. It will also apply when S ceases to be a member, S has no separate return year, and members recognize an amount that is not a net loss on the subsidiary's stock in the transaction. When it applies, it will eliminate S's net operating loss carryovers, capital loss carryovers, and deferred deductions (including S's share of such consolidated tax attributes), and S's credits (including S's share of consolidated credits).

Under both the § 1.1502-36 and the § 1.1502-19 elimination rules, attributes other than consolidated tax attributes (determined as of the event) are eliminated immediately before the event resulting in the application of the rule. Because consolidated tax attributes are first carried to the consolidated return year before being apportioned to a member's first separate return year, the IRS and Treasury Department do not believe that any special timing rule is required regarding the elimination of the portion of any consolidated tax attributes attributable to the member under either of these rules. Mechanically, the elimination of the member's portion of any consolidated tax attributes under either rule can only occur immediately after the close of the group's tax year that includes the event.

To clarify that there is no duplicative adjustment, these final regulations provide that the elimination of these attributes under either rule is not a noncapital, nondeductible expense.

2. Other Sections Addressing Subsidiary Stock Loss: §§ 1.337(d)-1, 1.337(d)-2, 1.1502-20, and 1.1502-35

In general, transfers of loss shares of subsidiary stock on or after September 17, 2008 will be subject to the Unified Loss Rule and not § 1.337(d)-1, § 1.337(d)-2, § 1.1502-20, or § 1.1502-35. The IRS and Treasury Department do not expect that § 1.1502-20 will affect any transactions occurring on or after September 17, 2008. However, because of the binding-commitment transition rule, the IRS and Treasury Department expect there will be some transactions occurring on or after September 17, 2008 that will be subject to §§ 1.337(d)-1, 1.337(d)-2, and 1.1502-35. In addition, dispositions subject to § 1.1502-35 will continue to be subject to the loss suspension and anti-loss reimportation rules in § 1.1502-35. Accordingly, the IRS and Treasury Department are removing § 1.1502-20 and retaining §§ 1.337(d)-1, 1.337(d)-2, and 1.1502-35, subject to certain modifications described below.

Under these final regulations, §§ 1.337(d)-1 and 1.337(d)-2 are modified to state explicitly that they do not apply to transactions subject to the Unified Loss Rule. However, those sections remain otherwise applicable.

Section 1.1502-35 is also modified to state explicitly that it does not apply to transfers subject to the Unified Loss Rule. Although the provisions of § 1.1502-35 are largely unchanged in these final regulations, there are some significant modifications, and those modifications are described in the following paragraphs.

A. Ten-Year Termination of Application of § 1.1502-35

Under the final regulations, the loss suspension rule is revised to provide that it ceases to apply ten years after the stock disposition that gave rise to the suspended loss. The purpose of this modification is to conform the loss suspension rule and the anti-loss reimportation rule.

In addition, the general provisions of § 1.1502-35 are revised to apply only to losses allowed within ten years of the date that they are recognized. Thus, if a loss is deferred and taken into account more than ten years after the disposition, or if an exchanged basis asset is sold at a loss more than ten

years after the exchanged basis asset is acquired, the section will have no application to the loss. The purpose of this modification is to conform all application of § 1.1502-35 to the ten-year rule applicable to loss suspension and anti-loss reimportation.

B. Location of Suspended Loss

These final regulations modify § 1.1502-35 to state explicitly that if M recognized a loss on S stock and the loss was suspended under § 1.1502-35(c), and if M ceases to be a member when S remains a member, then, immediately before M ceases to be a member, P is treated as succeeding to the loss in a transaction to which section 381(a) applies. Thus, the suspended loss is explicitly preserved for use by the group that disposed of the loss stock, and the location of the loss is specified. However, § 1.1502-35(c)(5)(i) provides that, “[t]o the extent not reduced * * *, any loss suspended * * * shall be allowed * * * on a return filed by the group of which the subsidiary was a member on the date of the disposition of subsidiary stock that gave rise to the suspended loss * * * for the taxable year that includes the day before the first date on which the subsidiary * * * is not a member of such group or the date the group is allowed a worthless stock loss * * *.” Further, § 1.1502-35(c)(3) provides that “any loss suspended * * * is treated as a noncapital, nondeductible expense of the member that disposes of subsidiary stock, incurred during the taxable year that includes the date of the disposition of stock [that gave rise to the suspended loss].” Accordingly, the IRS and Treasury Department believe these final regulations merely clarify the rule in § 1.1502-35.

C. Effect of Elimination of Reimported Item

Under the anti-loss reimportation rule, a reimported item is generally eliminated immediately before it would be taken into account by the group. The regulations provided that the elimination of the item was a noncapital, nondeductible expense under §§ 1.1502-32(b)(2)(iii) and 1.1502-32(b)(3)(iii). A practitioner suggested that this result would inappropriately reduce upper-tier stock basis and, as a result, would either create noneconomic gain or eliminate economic loss. The IRS and Treasury Department considered modifying this provision but have concluded that the elimination of a reimported item is similar to the expiration of a separate return limitation year loss and should be similarly treated. Accordingly, this rule is not modified in the final regulations.

3. The Application of Section 362(e)(2) to Intercompany Transfers

The proposed regulations included rules for suspending the application of section 362(e)(2) in the case of transactions between members of a consolidated group. The IRS and Treasury Department had proposed the rule because the interaction of section 362(e)(2) and the consolidated return provisions (which already address duplication issues) causes significant distortions, administrative burden, and the potential for inappropriate loss disallowance and gain creation. In general, the proposed rules were intended to postpone the application of section 362(e)(2) to an intercompany transaction until the consolidated return provisions could no longer address the loss duplication created in the intercompany transaction.

To implement such a regime, however, complex tracing rules would be necessary to identify the extent to which duplication is eliminated and to continuously monitor the extent to which duplication could continue to be eliminated by the consolidated return provisions. Although the intent was to simplify the application of section 362(e)(2) in the consolidated return setting and to prevent the adjustments otherwise made under section 362(e)(2) from causing inappropriate results under the consolidated return provisions, commentators found these rules to be extremely complex and expect them to be extremely burdensome to administer. The IRS and Treasury Department concur with these views.

Commentators offered two suggestions for addressing the concerns raised by the application of section 362(e)(2) to intercompany transactions.

The first suggestion was to treat intercompany section 362(e)(2) transactions as taxable transactions to the extent of the net loss in the transferred assets. Thus, the losses would not be duplicated and, because the transfers would be intercompany transactions, § 1.1502-13 would police the recognition of the losses. The rationale supporting this approach was that using a familiar regime (specifically, the intercompany transaction provisions of § 1.1502-13) would lessen the overall complexity of the provisions as well as the administrative burden placed on taxpayers and the government. Although this approach would be less burdensome than the approach in the proposed regulations, the IRS and Treasury Department are concerned that this approach would still impose an unnecessary administrative burden. Further, unlike either the general application of § 1.1502-13 to a nonrecognition transaction or the general application of section 362(e)(2), this approach would effectively preserve the original location of the net loss in the transferred assets.

The second suggestion was to modify the consolidated return provisions to make section 362(e)(2) generally inapplicable to intercompany transactions. Commentators stated that applying section 362(e)(2) to intercompany transactions gives rise to administrative burden and complexity even if the taxable intercompany transaction model were adopted. Further, they argued that applying section 362(e)(2) to intercompany transactions is unnecessary because the consolidated return regulations (including the Unified Loss Rule) are already structured to address duplication of loss (and gain) within the group (including its members and former members) in a manner and scope that has been determined appropriate in the consolidated return setting, given the competing single and separate entity policy issues. The application of section 362(e)(2) to intercompany transactions is thus not only generally unnecessary and burdensome, it is disruptive of the balance struck in the various consolidated return provisions, most notably the investment adjustment rules in § 1.1502-32 and the Unified Loss Rule in § 1.1502-36.

For these reasons, the IRS and Treasury Department have concluded that section 362(e)(2) should generally not apply to intercompany transactions. Accordingly, these final regulations add a new paragraph (h) in § 1.1502-80, which makes section 362(e)(2) generally inapplicable to intercompany transactions. The purpose of the provision is to allow the consolidated return provisions to address loss duplication. The IRS and Treasury Department are therefore withdrawing proposed § 1.1502-13(e)(4), which proposed the suspension of the application of section 362(e)(2) to intercompany transactions.

Notwithstanding the decision to make section 362(e)(2) generally inapplicable to intercompany transactions, the IRS and Treasury Department are concerned that the inapplicability of section 362(e)(2) could be used to reach inappropriate results. For example, assume M transfers a loss asset to S in exchange for new shares in a transaction to which section 351(a) applies, S has an asset with offsetting appreciation,

and later M sells only the new shares received in exchange for the loss asset. If S has no aggregate inside loss, the Unified Loss Rule will not require any attribute reduction. Accordingly, if S remains a member, the group could obtain more than a single benefit for its economic loss. The final regulations therefore include an anti-abuse rule that provides for appropriate adjustments to be made to clearly reflect the income of the group if a taxpayer acts with a view to prevent the consolidated return provisions from properly addressing loss duplication. The final regulations also include an example that illustrates both an abusive fact pattern (similar to the one described) and a nonabusive fact pattern (similar to the one described, except that all the stock is sold).

4. Proposed Revisions to the Investment Adjustment Provisions, § 1.1502-32

In the January 2007 proposal, the IRS and Treasury Department proposed several modifications to the investment adjustment rules in § 1.1502-32. The principal modifications that were proposed related to the treatment of items attributable to property transferred in an intercompany section 362(e)(2) transaction and to the treatment of items attributable to the application of § 1.1502-36(d).

As discussed in section 3 of this preamble, these final regulations make section 362(e)(2) generally inapplicable to intercompany transactions. Accordingly, the IRS and Treasury Department are withdrawing proposed § 1.1502-32(c)(1)(ii)(A) (regarding the allocation of items otherwise attributable to intercompany section 362(e)(2) transactions).

Proposed regulations addressing the treatment of items attributable to the application of § 1.1502-36(d) are finalized as § 1.1502-32(c)(1)(ii). The IRS and Treasury Department have clarified the language of the proposed rule, but have made no substantive change to that rule.

In addition, the proposed regulations made various nonsubstantive modifications to the language of § 1.1502-32 that were intended to simplify, clarify, and then conform various sections of the regulations. Those proposed changes are adopted without substantive change.

5. Miscellaneous Amendments to Other Regulations

In addition to the various provisions directly related to the treatment of losses on subsidiary stock and to the treatment of intercompany section 362(e)(2) transactions, the January 2007 proposal included a number of proposed modifications to regulations unrelated to subsidiary stock loss issues. The proposed revisions are described in Section I of the preamble to the January 2007 proposal. These final regulations adopt those proposed regulations without substantive change.

These final regulations also include several additional provisions that are either additional technical corrections to existing regulations or expansions of regulatory modifications proposed in the January 2007 proposal and adopted as final in this Treasury decision.

A. Technical Amendment to § 1.1502-13(g)(3)(i)(B)(2)

One commentator suggested an expansion of § 1.1502-13(g)(3)(i)(B)(

2

), which prevents the application of § 1.1502-13(c)(6)(i) to items of income or gain attributable to the reduction in basis of an intercompany obligation by reason of sections 108 and 1017 and § 1.1502-28 (and thereby prevents such items from being excluded from income). The commentator noted that the same rule should be applied to items of income or gain attributable to the reduction in basis of an intercompany obligation by reason of § 1.1502-36(d), in order to prevent the circumvention of the effects of attribute reduction. The IRS and Treasury Department agree that such a revision would be a helpful clarification and that change is incorporated in these final regulations.

B. Amendments to § 1.1502-33(e) “Whole-Group” Exception

In the January 2007 proposal, modifications were proposed to the “whole-group” exceptions in § 1.1502-13(j)(5) (excepting whole-group acquisitions from the general rule that deconsolidations require intercompany items to be taken into account) and § 1.1502-19(c)(3) (excepting whole-group acquisitions from the general rule that deconsolidations require excess loss accounts to be taken into account).

In response to the proposed changes to the whole-group exceptions in §§ 1.1502-13 and 1.1502-19, commentators suggested that a similar revision would be appropriate for the whole-group exception in § 1.1502-33(e)(2). That rule excepts whole-group acquisitions from the general rule in § 1.1502-33(e)(1) that eliminates a member's earnings and profits upon deconsolidation. The IRS and Treasury Department agree that the same reasoning supports the modification of all three whole-group exceptions.

Accordingly, these final regulations modify the whole-group exception in all three provisions, §§ 1.1502-13(j)(5), 1.1502-19(c)(3), and 1.1502-33(e)(2), to allow for their application without regard to whether the acquirer is a member of a consolidated group prior to the acquisition. Further, these final regulations provide that taxpayers may elect to apply each of these modified whole-group exceptions retroactively.

C. Anti-Duplicative Adjustments Provisions

The January 2007 proposal included a set of modifications that was intended to simplify several existing provisions by removing all references to the continued applicability of the Code and all of the anti-duplicative adjustment rules, and including such rule in a single paragraph in § 1.1502-80. The IRS and Treasury Department believed this change would simplify the regulations, as well as remove any potential for inadvertent omission or negative implication in other provisions where such concepts are or should be applicable.

Commentators questioned whether the removal of the discussion of the anti-duplicative adjustment rule in various sections of the consolidated return regulations would eliminate guidance that is helpful to taxpayers and that establishes certain policy determinations. The IRS and Treasury Department have considered these comments and concluded that it is appropriate to retain the anti-duplicative adjustment rule in the various sections of the consolidated return regulations, but to add a cross reference to the rule in § 1.1502-80(a). To provide additional guidance in § 1.1502-80(a), the final regulations provide that, in determining the application of the anti-duplicative adjustment rule, the purposes of the provisions and single-entity principles are taken into account.

In addition, the final regulations modify the general anti-duplicative adjustment rule in § 1.1502-80 to clarify that its principles apply to adjustments, inclusions, and all similar items.

D. Technical Correction to Text Example in § 1.1502-75(d)(1)

A practitioner informed the IRS and Treasury Department that the rationale in the text example in § 1.1502-75(d)(1) needed modification. Section 1.1502-75(d)(1) provides that a group remains in existence for a tax year if the common parent remains as the common parent and at least one subsidiary that was affiliated with it at the end of the prior year remains affiliated with it at the beginning of the year. It then sets forth an example in which, at the end of 1965, P is the common parent of a group

that includes S and, at the beginning of 1966, P is still the common parent of a group that includes S. The example concludes that the group continues through 1966 even though P acquires another subsidiary and S leaves the group.

The practitioner noted that the result is correct, but that the rationale is misleading and appears to be based on a prior formulation of the continuation of the group rule. Accordingly, these final regulations revise the analysis of this text example so that the rationale reflects the current continuation of the group rule.

E. Amendment to the Section 358 Stock Basis Rules for Certain Triangular Reorganizations

In addition to adopting the proposed technical correction to the cross-reference paragraph in § 1.358-6(e), these final regulations add triangular G reorganizations (other than by statutory merger) to the definition of triangular reorganizations in § 1.358-6(b)(2).

F. Request for Comments on Gain Duplication

Finally, in the preamble to the January 2007 proposal, the IRS and Treasury Department requested comments on the need for a provision that would address the gain duplication that occurs when S stock is sold at a gain and that gain is attributable to unrecognized net appreciation in S's assets. The IRS and Treasury Department have not previously addressed this form of gain duplication directly because taxpayers can structure their transactions to avoid duplicative recognition of the gain, for example, by selling assets directly or by electing to have their stock sales treated as assets sales under section 338. While it is believed that taxpayers generally have adequate means to mitigate this problem, comments were requested.

In response, commentators expressed the view that the IRS and Treasury Department underestimate the frequency and extent of gain duplication and overestimate the efficacy of self-help mechanisms.

Some commentators suggested that gain duplication could be addressed through a section 338-like election, pursuant to which gain recognized on subsidiary stock could be allocated to the basis of the subsidiary's assets, at least to the extent necessary to bring the basis of the assets into conformity with the basis of the stock in the buyer's hands. However, those commentators have explicitly stated that they are not urging this or any other particular model. Moreover, the IRS and Treasury Department have been advised that there is disagreement among commentators and practitioners as to whether the additional burden and complexity inherent in such additional rules would be warranted by the potential relief they could provide.

Accordingly, the IRS and Treasury Department will continue to accept comments and consider this issue.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required.

These regulations are necessary to provide taxpayers with immediate guidance regarding the tax consequences of a member's transfer of loss shares of subsidiary stock to prevent the creation and recognition of noneconomic stock loss and prevent the group from obtaining more than one tax loss from a single economic loss. Further, these regulations are necessary to provide taxpayers with immediate guidance regarding various other provisions of the consolidated return regulations. Therefore, good cause is found for dispensing with a delayed effective date pursuant to 5 U.S.C. 553(d)(3).

Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that these regulations primarily affect affiliated groups of corporations that have elected to file consolidated returns, which tend to be larger businesses. Moreover, the number of taxpayers affected is minimal. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required.

Drafting Information

The principal authors of these regulations are Marcie Barese, Sean Duffley, and Theresa Abell of the Office of Associate Chief Counsel (Corporate). 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 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 adding entries in numerical order to read as follows:

Authority:

26 U.S.C. 7805 * * *

Section 1.1502-36 also issued under 26 U.S.C. 1502 * * *

Section 1.1502-36 also issued under 26 U.S.C. 337(d). * * *

Par. 2.

Section 1.337(d)-1 is amended by adding two sentences at the end of paragraph (a)(1) to read as follows:

§ 1.337(d)-1

Transitional loss limitation rule.

(a) * * * (1) * * * However, for transactions involving loss shares of subsidiary stock occurring on or after September 17, 2008, see § 1.1502-36. Further, this section does not apply to a transaction that is subject to § 1.1502-36.

Par. 3.

Section 1.337(d)-2 is amended by adding two sentences at the end of paragraph (a)(1) to read as follows:

§ 1.337(d)-2

Loss limitation rules.

(a) * * * (1) * * * However, for transactions involving loss shares of subsidiary stock occurring on or after September 17, 2008, see § 1.1502-36. Further, this section does not apply to a transaction that is subject to § 1.1502-36.

Par. 4.

Section 1.358-6 is amended by:

1. Adding paragraph (b)(2)(v).

2. Revising paragraph (e).

3. Revising the heading for paragraph (f) and adding paragraph (f)(3).

The additions and revisions read as follows:

§ 1.358-6

Stock basis in certain triangular reorganizations.

(b) * * *

(2) * * *

(v)

Triangular G reorganization.

A triangular G reorganization is an acquisition by S (other than by statutory merger) of substantially all of T's assets in a title 11 or similar case in exchange for P stock in a transaction that qualifies as a reorganization under section

368(a)(1)(G) by reason of the application of section 368(a)(2)(D).

(e)

Cross-reference regarding triangular reorganizations involving members of a consolidated group.

For rules relating to stock basis adjustments made as a result of a triangular reorganization in which P and S, or P and T, as applicable, are, or become, members of a consolidated group, see § 1.1502-30. However, if a transaction is a group structure change, stock basis adjustments are determined under § 1.1502-31 and not under § 1.1502-30, even if the transaction also qualifies as a triangular reorganization otherwise subject to § 1.1502-30.

(f)

Effective/applicability dates.

* * *

(3)

Triangular G reorganization and special rule for triangular reorganizations involving members of a consolidated group.

Paragraphs (b)(2)(v) and (e) of this section shall apply to triangular reorganizations occurring on or after September 17, 2008. However, taxpayers may elect to apply paragraph (b)(2)(v) of this section to triangular reorganizations occurring before September 17, 2008 and on or after December 23, 1994.

Par. 5.

Section 1.362-4 is added to read as follows:

§ 1.362-4

Limitations on built-in loss duplication.

(a)

Purpose and scope

—(1)

In general.

[Reserved].

(2)

Intercompany transactions.

For rules relating to the application of section 362(e)(2) to transfers between members of a consolidated group on or after October 22, 2004, see § 1.1502-80(h).

(b) [Reserved].

Par. 6.

Section 1.1502-13 is amended by:

1. Revising the heading and adding a new first sentence in paragraph (a)(4).

2. Revising paragraphs (f)(6)(ii), (g)(3)(ii)(B)(

2

), (j)(5)(i)(A).

3. Revising the last sentence of paragraph (f)(6)(iv)(A).

4. Removing the second sentence in paragraph (f)(6)(v).

5. Revising the heading for paragraph (l) and adding two sentences at the end of paragraph (l)(1).

The revisions and additions read as follows:

§ 1.1502-13

Intercompany transactions.

(a) * * *

(4) Application of other rules of law. See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. * * *

(f) * * *

(6) * * *

(ii)

Gain stock.

For dispositions of P stock occurring before May 16, 2000, see § 1.1502-13(f)(6)(ii) as contained in 26 CFR part 1 in effect on April 1, 2000. For dispositions of P stock occurring on or after May 16, 2000, see § 1.1032-3.

(

iv

) * * *

(A) * * * If P grants M an option to acquire P stock in a transaction meeting the requirements of § 1.1032-3, M is treated as having purchased the option from P for fair market value with cash contributed to M by P.

(g) * * *

(3) * * *

(ii) * * *

(B) * * *

(

2

) Paragraph (c)(6)(i) of this section (treatment of intercompany items if corresponding items are excluded or nondeductible) will not apply to exclude any amount of income or gain attributable to a reduction of the basis of an intercompany obligation pursuant to sections 108 and 1017 and § 1.1502-28 or to § 1.1502-36(d); and

(j) * * *

(5) * * *

(i) * * *

(A) The acquisition of either the assets of the common parent of the terminating group in a reorganization described in section 381(a)(2), or the stock of the common parent of the terminating group; or

(l)

Effective/applicability dates.

* * *

(1) * * * Paragraphs (a)(4), (f)(6)(ii), (f)(6)(iv)(A), (g)(3)(ii)(B)(

2

), and (j)(5)(i)(A) of this section apply with respect to transactions occurring on or after September 17, 2008. However, taxpayers may elect to apply paragraph (j)(5)(i)(A) of this section to transactions that occurred prior to September 17, 2008.

Par. 7.

Section 1.1502-19 is amended by:

1. Removing the language “P” throughout the entire section and adding “M” in its place.

2. Adding a new sentence at the end of paragraph (a)(1).

3. Revising paragraphs (a)(3), (c)(1)(iii)(A), and (c)(3)(i)(A).

4. Adding new paragraph (b)(1)(iv).

5. Revising the heading for paragraph (h) and adding three sentences at the end of paragraph (h)(1).

The revisions and additions read as follows:

§ 1.1502-19

Excess loss accounts.

(a)

In general

—(1)

Purpose.

* * * This section also provides rules for eliminating losses and other attributes attributable to S in certain cases in which S stock becomes worthless or S ceases to be a member and does not have a separate return year.

(3)

Application of other rules of law, duplicative recapture.

See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments and recapture.

(b) * * *

(1) * * *

(

iv

)

Reduction of attributes in the case of certain dispositions by worthlessness or where S ceases to be a member and does not become a nonmember.

If this paragraph (b)(1)(iv) applies, any net operating or capital loss carryover that is attributable to S, including any losses that would be apportioned to S under the principles of § 1.1502-21(b)(2) if S had a separate return year, any deferred deductions attributable to S, including S's portion of such consolidated tax attributes (for example, consolidated excess charitable contributions that would be apportioned to S under the principles of § 1.1502-79(e) if S had a separate return year), and any credit carryover attributable to S, including any consolidated credits that would be apportioned to S under the principles of § 1.1502-79 if S had a separate return year, are eliminated. Attributes other than consolidated tax attributes (determined as of the disposition) are eliminated under this paragraph (b)(1)(iv) immediately before the disposition resulting in the application of this paragraph (b)(1)(iv). The elimination of attributes under this paragraph (b)(1)(iv) is not a noncapital, nondeductible expense described in § 1.1502-32(b)(2)(iii). This paragraph (b)(1)(iv) applies if—

(A) A share of S stock becomes worthless under section 165, the requirements of paragraph (c)(1)(iii) of this section are satisfied, M does not recognize a net deduction or loss on the S stock, and S is a member of the group on the day following the last day of the group's taxable year during which the share becomes worthless; or

(B) M recognizes any amount that is not a net deduction or loss on the stock of S in a transaction in which S ceases to be a member and does not become a nonmember.

(c) * * *

(1) * * *

(iii) * * *

(A) All of S's assets (other than its corporate charter and those assets, if

any, necessary to satisfy state law minimum capital requirements to maintain corporate existence) are treated as disposed of, abandoned, or destroyed for Federal income tax purposes (for example, under section 165(a) or § 1.1502-80(c), or, if S's asset is stock of a lower-tier member, the stock is treated as disposed of under this paragraph (c)). An asset of S is not considered to be disposed of or abandoned to the extent the disposition is in complete liquidation of S under section 332 or is in exchange for consideration (other than relief from indebtedness);

(3) * * *

(i) * * *

(A) The acquisition of either the assets of the common parent of the terminating group in a reorganization described in section 381(a)(2), or the stock of the common parent of the terminating group; or

(h)

Effective/applicability dates

—(1) * * * Paragraphs (a)(3), (c)(1)(iii)(A), and (c)(3)(i)(A) of this section apply with respect to determinations and transactions occurring on or after September 17, 2008. However, taxpayers may elect to apply paragraph (c)(3)(i)(A) of this section to transactions that occurred prior to September 17, 2008. The last sentence of paragraph (a)(1) and paragraph (b)(1)(iv) of this section applies with respect to dispositions on or after December 16, 2008.

§ 1.1502-20

[Removed]

Par. 8.

Section 1.1502-20 is removed.

§ 1.1502-20T

[Removed]

Par. 9.

Section 1.1502-20T is removed.

Par. 10.

Section 1.1502-21 is amended by:

1. Removing the last sentence of paragraph (b)(1).

2. Removing paragraph (b)(3)(v).

3. Revising paragraphs (b)(2)(ii)(A), (b)(2)(iv)(B)(

2

)(

iv

), and (h)(6).

4. Adding a new paragraph (b)(2)(iv)(B)(

2

)(v).

5. Revising the heading for paragraph (h) and adding new paragraph (h)(1)(iii).

6. Revising the first sentence of paragraph (h)(8).

The revisions and addition reads as follows:

§ 1.1502-21

Net operating losses.

(b) * * *

(2) * * *

(ii)

Special rules

—(A)

Year of departure from group.

If a corporation ceases to be a member during a consolidated return year, net operating loss carryovers attributable to the corporation are first carried to the consolidated return year, then are subject to reduction under section 108 and § 1.1502-28 (regarding discharge of indebtedness income that is excluded from gross income under section 108(a)), and then are subject to reduction under § 1.1502-36 (regarding transfers of loss shares of subsidiary stock). Only the amount that is neither absorbed by the group in that year nor reduced under section 108 and § 1.1502-28 or under § 1.1502-36 may be carried to the corporation's first separate return year. For rules concerning a member departing a subgroup, see paragraph (c)(2)(vii) of this section.

(iv) * * *

(B) * * *

(

2

) * * *

(

iv

)

Reduction of attributes for stock loss.

If during a taxable year a member does not cease to be a member of the group and any portion of the CNOL attributable to any member is reduced under § 1.1502-36, the percentage of the CNOL attributable to each member as of immediately after the reduction of attributes under § 1.1502-36 shall be recomputed pursuant to paragraph (b)(2)(iv)(B)(

2

)(

v

) of this section.

(

v

)

Recomputed percentage.

The recomputed percentage of the CNOL attributable to each member shall equal the unabsorbed CNOL attributable to the member at the time of the recomputation divided by the sum of the unabsorbed CNOL attributable to all of the members at the time of the recomputation. For purposes of the preceding sentence, a CNOL that is reduced under section 108 and § 1.1502-28, or under § 1.1502-36, or that is otherwise permanently disallowed or eliminated, shall be treated as absorbed.

(h)

Effective/applicability dates

—(1) * * *

(iii) Paragraphs (b)(2)(ii)(A) and (b)(2)(iv)(B)(

2

) of this section apply to taxable years for which the due date of the original return (without regard to extensions) is on or after September 17, 2008.

(6)

Certain prior periods.

Paragraphs (b)(1), (b)(2)(iv)(A), (b)(2)(iv)(B)(

1

), and (c)(2)(vii) of this section apply to taxable years for which the due date of the original return (without regard to extensions) is after March 21, 2005. Paragraphs (b)(2)(ii)(A) and (b)(2)(iv)(B)(

2

) (as contained in 26 CFR part 1 revised as of April 1, 2008) apply to taxable years for which the due date of the original return (without regard to extensions) is on or after March 21, 2005, and before September 17, 2008. Paragraph (b)(2)(ii)(A) of this section and § 1.1502-21T(b)(1), (b)(2)(iv), and (c)(2)(vii), as contained in 26 CFR part 1 revised as of April 1, 2004, apply to taxable years for which the due date of the original return (without regard to extensions) is after August 29, 2003, and on or before March 21, 2005. For taxable years for which the due date of the original return (without regard to extensions) is on or before August 29, 2003, see paragraphs (b)(1), (b)(2)(ii)(A), (b)(2)(iv), and (c)(2)(vii) of this section and § 1.1502-21T(b)(1) as contained in 26 CFR part 1 revised as of April 1, 2003.

(8)

Losses treated as expired under § 1.1502-35(f)(1).

For rules regarding losses treated as expired under § 1.1502-35(f) on or after March 10, 2006, see § 1.1502-21(b)(3)(v) as contained in 26 CFR part 1 in effect on April 1, 2006. * * *

Par. 11.

Section 1.1502-30 is amended by:

1. Revising paragraph (b)(4).

2. Revising the heading for paragraph (c) and adding a second sentence.

The revision and addition reads as follows:

§ 1.1502-30

Stock basis after certain triangular reorganizations.

(b) * * *

(4)

Application of other rules of law.

If a transaction otherwise subject to this section is also a group structure change subject to § 1.1502-31, the provisions of § 1.1502-31 and not this section apply to determine stock basis. See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. See § 1.1502-80(d) for the non-application of section 357(c) to P.

(c)

Effective/applicability date.

* * * However, paragraph (b)(4) of this section applies to reorganizations occurring on or after September 17, 2008.

Par. 12.

Section 1.1502-31 is amended by:

1. Revising paragraph (a)(2).

2. Revising the heading for paragraph (h) and revising paragraph (h)(1).

3. Removing paragraphs (i) and (j).

The revisions read as follows:

§ 1.1502-31

Stock basis after a group structure change.

(a) * * *

(2)

Application of other rules of law.

If a transaction subject to this section is also a triangular reorganization otherwise subject to § 1.1502-30, the provisions of this section and not those of § 1.1502-30 apply to determine stock basis. See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments.

(h)

Effective/applicability dates

—(1)

General rule.

This section applies to group structure changes that occur after April 26, 2004. However, a group may apply this section to group structure changes that occurred on or before April 26, 2004, and in consolidated return years beginning on or after January 1, 1995. In addition, paragraph (a)(2) of this section applies to group structure changes that occurred on or after September 17, 2008. Paragraph (e)(2) of this section applies to any original consolidated Federal income tax return due (without extensions) after June 14, 2007. For original consolidated Federal income tax returns due (without extensions) after May 30, 2006, and on or before June 14, 2007, see § 1.1502-31T as contained in 26 CFR part 1 in effect on April 1, 2007. For original consolidated Federal income tax returns due (without extensions) on or before May 30, 2006, see § 1.1502-31 as contained in 26 CFR part 1 in effect on April 1, 2006.

Par. 13.

Section 1.1502-32 is amended by:

1. Removing the language “P” throughout the entire section and adding “M” in its place.

2. Revising the heading, adding a new first sentence, and removing the last two sentences in paragraph (a)(2).

3. Revising paragraphs (b)(3)(ii)(C)(

2

), (c)(1), and (c)(2)(i).

4. Revising the first sentence of paragraphs (c)(2)(ii)(A) and (c)(3), and the first three sentences of paragraph (c)(4)(i), introductory text.

5. Removing paragraphs (b)(3)(iii)(C) and (b)(3)(iii)(D).

6. Revising the heading for paragraph (h) and adding paragraph (h)(9).

The revisions and addition read as follows:

§ 1.1502-32

Investment adjustments.

(a) * * *

(2)

Application of other rules of law, duplicative adjustments.

See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. * * *

(b) * * *

(3) * * *

(ii) * * *

(C) * * *

(

2

)

Expired loss carryovers.

If the amount of the discharge exceeds the amount of the attribute reduction under sections 108 and 1017, and § 1.1502-28, the excess nevertheless is treated as applied to reduce tax attributes to the extent a loss carryover attributable to S expired without tax benefit, the expiration was taken into account as a noncapital, nondeductible expense under paragraph (b)(3)(iii) of this section, and the loss carryover would have been reduced had it not expired.

(c)

Allocation of adjustments among shares of stock

—(1)

In general

—(i)

Distributions.

The adjustment that is described in paragraph (b)(2)(iv) of this section (negative adjustments for distributions) is allocated to the shares of S stock to which the distribution relates.

(ii)

Special rules applicable in the case of certain loss transfers of subsidiary stock

—(A)

Losses reattributed pursuant to an election under § 1.1502-36(d)(6)

—(

1

)

General rule.

If a member transfers loss shares of S stock and the common parent elects under § 1.1502-36(d)(6) to reattribute all or a portion of S's attributes, S's resulting noncapital, nondeductible expense is allocated to all loss shares of S stock transferred by members in the transaction. The expense is allocated among those S shares in proportion to the loss in the shares. The tier-up of that expense is included in the remaining adjustment (see paragraph (c)(1)(iii) of this section).

(

2

)

Reattribution of attributes of a subsidiary that is lower-tier to S.

If a member transfers loss shares of S stock and the common parent elects under § 1.1502-36(d)(6) to reattribute attributes of a subsidiary (S2) that is lower-tier to S, S2's resulting noncapital, nondeductible expense is allocated among S2 shares held by members as of the transaction, other than those transferred in the transaction and with respect to which gain or loss was recognized (recognition transfer), in a manner that permits the full amount of the expense to tier up and be applied to the bases of the loss shares of S stock transferred by members in the transaction. The expense is allocated among those S2 shares with positive basis in a manner that, first, reduces the bases of S2's preferred shares to equalize and then eliminate loss and, second, reduces the bases of S2's common shares in a manner that reduces disparity among the bases of those common shares to the greatest extent possible. The noncapital, nondeductible expense applied to the S2 shares tiers up and is applied to the stock of any subsidiaries that are lower-tier to S (middle-tier subsidiaries) in a manner that will permit the full amount of this expense to be applied to reduce the bases of the loss shares of S stock transferred by members in the transaction. Similar to the allocation among the S2 shares, the tier-up of this expense is allocated among the middle-tier subsidiary shares held by members as of the transaction, other than those transferred in a recognition transfer, in a manner that permits the full amount of the expense to tier up and be applied to the bases of the loss shares of S stock transferred by members in the transaction. The tier-up of this expense is allocated among those middle-tier subsidiary shares with positive basis in a manner that, first, reduces the bases of the middle-tier subsidiary's preferred shares to equalize and then eliminate loss and, second, reduces the bases of the middle-tier subsidiary's common shares in a manner that reduces disparity among the bases of those common shares to the greatest extent possible. The tier-up of this expense is allocated to the loss shares of S stock transferred by members in the transaction in the same manner as provided in paragraph (c)(1)(ii)(A)(

1

) of this section, and thereafter the tier-up of that expense is included in the remaining adjustment (see paragraph (c)(1)(iii) of this section).

(

3

)

Example.

The following example illustrates the rules of this paragraph (c)(1)(ii)(A).

Example.

Assume P owns M1, P and M1 own M2, M2 owns S, M1 and S own S1, and M1 and S1 own S2. If S sells a portion of the S1 shares at a gain and M2 sells all of the S stock at a net loss (after adjusting the basis for the gain recognized by S on the sale of the S1 shares), and P elects under § 1.1502-36(d)(6) to reattribute attributes of S2, the resulting noncapital, nondeductible expense is allocated entirely to the S2 shares held by S1 with positive basis in a manner that reduces the disparity in those bases to the greatest extent possible. The tier-up of this amount is allocated entirely to the S1 shares held by S (excluding the S1 shares sold) with positive basis in a manner that reduces the disparity in those bases to the greatest extent possible. The tier-up of this amount is allocated to the loss shares of S stock sold by M2 in proportion to the loss in those shares. The tier-up of this amount is then included in the remaining adjustment and tiers up from M2 to M1 and P, and from M1 to P under the general rules of this section.

(B)

Tier-up of reallocated investment adjustments subject to prior use limitation.

If the reallocation of an investment adjustment under § 1.1502-36(b)(2) is subject to the prior use limitation in § 1.1502-36(b)(2)(iii)(B)(2), no amount of the tier-up of such reallocated investment adjustment shall be allocated to any share whose prior use resulted in the application of the limitation. Thereafter, the tier-up of this amount is included in the remaining adjustment (see paragraph (c)(1)(iii) of this section).

(iii)

Remaining adjustment.

The

remaining adjustment

is the adjustment that consists of the items described in paragraphs (b)(2)(i) through (b)(2)(iii) of this section (adjustments for taxable income or loss, tax-exempt income, and noncapital, nondeductible expenses), including adjustments to lower-tier stock basis that tier up under paragraph (a)(3)(iii) of this section, but only to the extent not specially allocated under paragraph (c)(1)(ii) of this section. The remaining adjustment is allocated among the shares of S stock as provided in paragraphs (c)(2) through (c)(4) of this section. If the remaining adjustment is positive, it is allocated first to any preferred stock as provided in paragraph (c)(3) of this section, and then to the common stock as provided in paragraph (c)(2) of this section. If the remaining adjustment is negative, it is allocated only to common stock as provided in paragraph (c)(2) of this section.

(iv)

Nonmember shares.

No adjustment under this section that is allocated to a share for the period it is owned by a nonmember affects the basis of the share.

(v)

Cross-references.

See paragraph (c)(4) of this section for the reallocation of adjustments, and paragraph (d) of this section for definitions. See § 1.1502-19(d) for special allocations of basis determined or adjusted under the Internal Revenue Code (Code) with respect to excess loss accounts.

(2)

Common stock

—(i)

Allocation within a class.

The remaining adjustment described in paragraph (c)(1)(iii) of this section that is allocable to a class of common stock is generally allocated equally to each share within the class. However, if a member has an excess loss account in a share of a class of common stock at the time a positive remaining adjustment is to be allocated, the portion of the positive remaining adjustment allocable to the member with respect to the class is allocated first to equalize and then eliminate that member's excess loss accounts. It is then allocated equally among the members' shares in that class. Similarly, the portion of any negative remaining adjustment allocable to the member with respect to the class is allocated equally to the member's shares with positive bases, eliminating all positive basis in shares of the class before creating or increasing any excess loss accounts. After positive basis is eliminated, any remaining portion of the negative remaining adjustment is allocated to equalize the member's excess loss accounts in the shares of that class to the greatest extent possible. Distributions and any adjustments or determinations under the Internal Revenue Code (for example, under section 358, including any modifications under § 1.1502-19(d)) are taken into account before the allocation is made under this paragraph (c)(2)(i).

(ii) * * *

(A) * * * If S has more than one class of common stock, the extent to which the remaining adjustment described in paragraph (c)(1)(iii) of this section is allocated to each class is determined, based on consistently applied assumptions, by taking into account the terms of each class and all other facts and circumstances relating to the overall economic arrangement. * * *

(3) * * * If the remaining adjustment described in paragraph (c)(1)(iii) of this section is positive, it is allocated to preferred stock to the extent required (when aggregated with prior allocations to the preferred stock during the period that S is a member of the consolidated group) to reflect distributions described in section 301 (and all other distributions treated as dividends) to which the preferred stock becomes entitled, and arrearages arising, during the period that S is a member of the consolidated group. * * *

(4) * * * (i) * * * A member's basis in each share of S preferred and common stock must be redetermined whenever necessary to determine the tax liability of any person. See paragraph (b)(1) of this section. The redetermination is made by reallocating S's adjustments described in paragraphs (c)(1)(ii)(B) (specially allocated adjustments for tier-up of reallocated investment adjustments subject to prior use limitation) and (c)(1)(iii) (remaining adjustments) of this section for each consolidated return year (or other applicable period) of the group by taking into account all of the facts and circumstances affecting allocations under this paragraph (c) as of the redetermination date with respect to all of the S shares. * * *

(h)

Effective/applicability date.

* * *

(9)

Allocations of investment adjustments, including adjustments attributable to certain loss transfers; certain conforming amendments.

Paragraphs (a)(2), (b)(3)(ii)(C)(

2

), (c)(1), (c)(2)(i), (c)(2)(ii)(A), (c)(3), and (c)(4)(i) of this section are applicable for determinations of the basis of stock of a subsidiary on or after September 17, 2008.

§ 1.1502-32T

[Removed]

Par. 14.

Section 1.1502-32T is removed.

Par. 15.

Section 1.1502-33 is amended by:

1. Revising the heading and adding a new first sentence to paragraph (a)(2).

2. Revising paragraph (e)(2)(i)(A).

3. Revising the heading for paragraph (j) and adding two sentences to the end of paragraph (j)(1).

The additions and revision read as follows:

§ 1.1502-33

Earnings and profits.

(a) * * *

(2)

Application of other rules of law, duplicative adjustments.

See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. * * *

(e) * * *

(2) * * *

(i) * * *

(A) The acquisition of either the assets of the common parent of the terminating group in a reorganization described in section 381(a)(2), or the stock of the common parent of the terminating group; or

(j)

Effective/applicability date

—(1) * * * Paragraphs (a)(2) and (e)(2)(i)(A) of this section apply with respect to determinations of the earnings and profits of a member in consolidated return years beginning on or after September 17, 2008. However, taxpayers may elect to apply paragraph (e)(2)(i)(A) of this section with respect to determinations of the earnings and profits of a member in consolidated return years beginning prior to September 17, 2008.

Par. 16.

Section 1.1502-35 is amended by:

1. Revising paragraphs (a), (c)(3), (c)(4)(i), (c)(5)(i), (g)(3), (g)(6), (h), and (j).

2. Revising the heading of paragraph (c)(8).

3. Removing paragraph (k).

§ 1.1502-35

Transfers of subsidiary stock and deconsolidations of subsidiaries.

(a)

In general

—(1)

Purpose.

The purpose of this section is to prevent a group from obtaining more than one tax benefit from a single economic loss. The provisions of this section shall be construed in a manner that is consistent with that purpose and in a manner that reasonably carries out that purpose.

(2)

Dates of applicability.

This section applies if—

(i) On or after March 7, 2002, a member recognizes a loss on the disposition of a share of stock of a subsidiary (or, on or after April 10, 2007, a share of stock of a former subsidiary) or a carryover basis asset (subject to paragraph (c)(6) of this section),

(ii) The member's loss on the share of subsidiary stock or the carryover basis asset is allowed on or before the date that is ten years after the disposition of the share or carryover basis asset, and

(iii) If the disposition is of a share of subsidiary stock, it is not a transfer to which § 1.1502-36 applies.

(c) * * *

(3)

Treatment of suspended loss

—(i)

General rule.

For purposes of the rules of § 1.1502-32, any loss suspended pursuant to paragraph (c)(1) or (c)(2) of this section is treated as a noncapital, nondeductible expense of the member that disposes of subsidiary stock, incurred during the taxable year that includes the date of the disposition of stock to which paragraph (c)(1) or (c)(2) of this section applies. See § 1.1502-32(b)(3)(iii)(C). Consequently, the basis of a higher-tier member's stock of the member that disposes of subsidiary stock is reduced by the suspended loss in the year it is suspended.

(ii)

Location of suspended loss following deconsolidation of selling member.

If a member recognizes a loss that is suspended under this paragraph (c) but that member ceases to be a member of the group before the loss is allowable, the common parent is treated as succeeding to the loss in a transaction to which section 381(a) applies.

(4)

Reduction of suspended loss

—(i)

General rule.

The amount of any loss suspended pursuant to paragraph (c)(1) or (c)(2) of § 1.1502-35 shall be reduced, but not below zero, by the subsidiary's (and any successor's) items of deduction and loss, and the subsidiary's (and any successor's) allocable share of items of deduction and loss of all lower-tier subsidiaries, that are allocable to the period beginning on the date of the disposition that gave rise to the suspended loss and ending on the day before the first date on which the subsidiary (and any successor) is not a member of the group of which it was a member immediately prior to the disposition (or any successor group), and that are taken into account in determining consolidated taxable income (or loss) of such group for any taxable year that includes any date on or after the date of the disposition and before the first date on which the subsidiary (and any successor) is not a member of such group; provided, however, that such reduction shall not exceed the excess of the amount of such items over the amount of such items that are taken into account in determining the basis adjustments made under § 1.1502-32 to stock of the subsidiary (or any successor) owned by members of the group. The preceding sentence shall not apply to items of deduction and loss to the extent that the group can establish that all or a portion of such items was not reflected in the computation of the duplicated loss with respect to the subsidiary on the date of the disposition of stock that gave rise to the suspended loss.

(5)

Allowable loss

—(i)

General rule.

To the extent not reduced under paragraph (c)(4) of this section, any loss suspended pursuant to paragraph (c)(1) or (c)(2) of this section shall be allowed, to the extent otherwise allowable under applicable provisions of the Internal Revenue Code and regulations, on a return filed by the group of which the subsidiary was a member on the date of the disposition of subsidiary stock that gave rise to the suspended loss (or any successor group) for the taxable year that includes the earlier of—

(A) The day before the first date on which the subsidiary (and any successor) is not a member of such group or the date the group is allowed a worthless stock loss under section 165 (taking into account the provisions of § 1.1502-80(c)) with respect to all of the subsidiary stock owned by members and;

(B) The date that is ten years after the date of the disposition of subsidiary stock that gave rise to the suspended loss.

(8)

No elimination of economic loss.

* * *

(g) * * *

(3)

Anti-loss reimportation rule

—(i)

Conditions for application.

This paragraph (g)(3) applies when—

(A) A member of a group (selling group) recognized and was allowed a loss with respect to a share of stock of S, a subsidiary or former subsidiary of the selling group;

(B) That stock loss was duplicated (in whole or in part) in S's attributes (duplicating items) at the earlier of the time that the loss was recognized or that S ceased to be a member; and

(C) Within ten years of the date that S ceased to be a member, there is a reimportation event. For this purpose, a reimportation event is any event after which a duplicating item is a reimported item. A reimported item is any duplicating item that is reflected in the attributes of any member of the selling group, including S, or, if not reflected in the attributes, would be properly taken into account by any member of the selling group (for example as the result of a carryback).

(ii)

Effect of application.

Immediately before the time that a reimported item (or any portion of a reimported item) would be properly taken into account (but for the application of this paragraph (g)(3)), such item (or such portion of the item) is reduced to zero and no deduction or loss is allowed, directly or indirectly, with respect to that item.

(iii)

Operating rules.

For purposes of this paragraph (g)(3)—

(A) The terms

member, subsidiary,

and

group

include their predecessors and successors to the extent necessary to effectuate the purposes of this section; and

(B) The reduction of a reimported item (other than duplicating items that are carried back to a consolidated return year of the selling group) is a noncapital, nondeductible expense within the meaning of § 1.1502-32(b)(3)(iii).

(6)

General anti-avoidance rule.

If a taxpayer acts with a view to avoid the purposes of this section, appropriate adjustments will be made to carry out the purposes of this section.

(h)

Application of other rules of law.

See § 1.1502-80(a) regarding the general applicability of other rules of law.

(j)

Effective/applicability dates.

This section applies with respect to stock transfers, deconsolidations of subsidiaries, determinations of worthlessness, and stock dispositions on or after September 17, 2008. For prior law, see §§ 1.1502-35 and 1.1502-35T as contained in 26 CFR part 1 in effect on April 1, 2008.

§ 1.1502-35T

[Removed]

Par. 17.

Section 1.1502-35T is removed.

Par. 18.

Section 1.1502-36 is added to read as follows:

§ 1.1502-36

Unified loss rule.

(a)

In

general

—(1)

Scope.

This section provides rules for adjusting members' bases in stock of a subsidiary (S) and for reducing S's attributes when a member (M) transfers a loss share of S stock. See paragraph (f) of this section for definitions of the terms used in this section, including

transfer

and

value.

(2)

Purpose.

The rules in this section have two principal purposes. The first is to prevent the consolidated return provisions from reducing a group's consolidated taxable income through the creation and recognition of noneconomic loss on S stock. The second is to prevent members (including former members) of the group from collectively obtaining more than one tax benefit from a single economic loss. Additional purposes are set forth in other paragraphs of this section. The rules of this section must be interpreted and applied in a manner that is consistent with and reasonably carries out the purposes of this section.

(3)

Overview

—(i)

General application of section.

This section applies when M transfers a share of S stock and, after taking into account the effects of all applicable rules of law (even if the adjustments required by such provisions are not deemed effective until after the transfer, such as certain adjustments required under sections 108 and 1017 and § 1.1502-28), the share is a loss share. When this section applies, paragraph (b) of this section applies first and may redetermine members' bases in their shares of S stock. If the transferred share is a loss share after any basis redetermination under paragraph (b) of this section, paragraph (c) of this section applies and may reduce M's basis in the transferred loss share. If the transferred share is a loss share after any basis reduction required by paragraph (c) of this section, paragraph (d) of this section applies and may reduce attributes of S and subsidiaries that are lower-tier to S. Although the determination of whether there is a transfer of a loss share is made as of the transfer, this section applies, and any adjustments it requires are given effect, immediately before the transfer. Paragraphs (e), (f), and (g) of this section provide general operating rules (including rules for transfers of S stock between members), definitions, and an anti-abuse rule, respectively.

(ii)

Stock of multiple subsidiaries transferred in the transaction

—(A)

Initial application of section to transferred shares in lowest tier.

If shares of stock of more than one subsidiary are transferred in a transaction, the application of this section begins at the lowest tier. If no transferred shares of stock of the lowest-tier subsidiary (S2) are loss shares, any gain recognized with respect to the S2 shares immediately tiers up and adjusts members' bases in subsidiary stock under § 1.1502-32. However, if any of the transferred S2 shares are loss shares, paragraph (b) of this section applies with respect to those shares. If, after the application of paragraph (b) of this section, any transferred S2 shares are still loss shares, paragraph (c) of this section applies with respect to those shares. If, after the application of paragraph (c) of this section, any transferred S2 shares are still loss shares and P makes an election under paragraph (d)(6) of this section with respect to those S2 shares, then paragraph (d) of this section applies with respect to those shares, but only to the extent necessary to give effect to the election. After taking into account the effects of any adjustments required by this initial application of this section, recognized gain or loss is computed on all transferred S2 shares. Any adjustments under paragraph (b) or (c) of this section, the effect of any election under paragraph (d)(6) of this section, any gain or loss recognized on the transferred S2 shares (whether allowed or disallowed), and any other related or resulting adjustments then tier-up and apply to adjust members' bases in subsidiary stock under § 1.1502-32.

(B)

Initial application of section to transferred shares in higher tiers.

After taking into account the effects of any adjustments described in paragraph (a)(3)(ii)(A) of this section, transferred shares in the next higher tier, and then in each next higher tier successively, other than the transferred loss shares at the highest tier, are treated in the manner described in paragraph (a)(3)(ii)(A) of this section.

(C)

Application of section to transferred shares in highest tier.

After paragraphs (b) and (c) of this section, and, to the extent necessary to give effect to any election under paragraph (d)(6) of this section, paragraph (d) of this section, have been applied to or with respect to all lower-tier transferred loss shares, and after all lower-tier adjustments have been taken into account (whether resulting from the application of paragraph (b) or (c) of this section, an election under paragraph (d)(6) of this section, the recognition of gain or loss on a transfer, or otherwise), paragraphs (b), then (c), and then (d) of this section apply with respect to the highest-tier shares that are transferred loss shares.

(D)

Final application of section to transferred shares in lower tiers.

After paragraph (d) of this section has been applied with respect to transferred loss shares in the highest tier, it is applied with respect to transferred shares in each next lower tier, successively, to the extent such shares are loss shares after the application of paragraph (d) of this section.

(4)

Other rules of law and coordination with deferral and disallowance provisions.

In general, this section applies and has effect immediately upon the transfer of a loss share even if the loss is deferred, disallowed, or otherwise not taken into account under any other applicable rules of law. However, see paragraph (e)(3) of this section for special rules applicable to shares of S stock transferred in an intercompany transaction. See section § 1.1502-80(a) for the general applicability of other rules of law and a limitation on duplicative adjustments.

(5)

Nomenclature, factual assumptions adopted in this section.

Unless otherwise stated, for purposes of this section, the following nomenclature and assumptions are adopted. P is the common parent of a consolidated group of which S, M, and M1 are members. X is not a member of the P group. If a corporation has preferred stock outstanding, it is stock described in section 1504(a)(4). The examples set forth the only facts, elections, and activities relevant to the example. All transactions are between unrelated persons and are independent of each other. Tax liabilities and their effect, and the application of any other loss disallowance or deferral provisions of the Internal Revenue Code (Code) or regulations, including but not limited to section 267, are disregarded. All persons report on a calendar year basis and use the accrual method of accounting. All parties comply with filing and other requirements of this section and all other provisions of the Code and regulations.

(b)

Basis redetermination to reduce disparity

—(1)

In general

—(i)

Purpose and scope.

The rules of this paragraph (b) reduce the extent to which there is disparity in members' bases in shares of S stock. These rules supplement the operation of the investment adjustment system; their purpose is to prevent the realization of noneconomic loss and facilitate the elimination of duplicated loss when members hold S shares with disparate bases. The rules of this paragraph (b) only reallocate investment adjustments previously applied to members' bases in shares of S stock, thus they do not alter the aggregate amount of basis in shares of S stock held by members or the aggregate amount of

investment adjustments applied to shares of S stock.

(ii)

Special rules for applicability of redetermination rule.

Notwithstanding the general rule in paragraph (b)(2) of this section, members' bases in shares of S stock are not redetermined under this paragraph (b) if—

(A) There is no disparity among members' bases in shares of S common stock and no member owns a share of S preferred stock with respect to which there is unrecognized gain or loss; or

(B) All the shares of S stock held by members are transferred to one or more nonmembers, become worthless under section 165 (taking into account the provisions of § 1.1502-80(c)), or a combination thereof, in one fully taxable transaction. However, in such a case, P may elect to redetermine such bases under this paragraph (b). Such an election is made in the manner provided in paragraph (e)(5) of this section. If stock of more than one subsidiary is transferred in the transaction, the election may be made with respect to one or more of such subsidiaries.

(iii)

Investment adjustment.

For purposes of this paragraph (b), the term

investment adjustment

includes adjustments specially allocated under § 1.1502-32(c)(1)(ii)(B) and remaining adjustments described in § 1.1502-32(c)(1)(iii). In applying any provision of this section, the term includes all such adjustments reflected in the basis of the share as of the application of the provision, whether originally allocated under § 1.1502-32 or otherwise. The term therefore includes adjustments previously reallocated to the share, and it does not include adjustments previously reallocated from the share, whether pursuant to this section or any other provision of law. It also includes the proportionate amount of adjustments reflected in the exchanged basis of a share, such as the basis determined under section 358 in connection with a reorganization or a transaction qualifying under section 355.

(2)

Basis redetermination rule.

If M transfers a loss share of S stock, all members' bases in all their shares of S stock are subject to redetermination under this paragraph (b). The determination of whether a share is a loss share is made as of the transfer, taking into account the effects of all applicable rules of law. The redeterminations are made immediately before applying paragraph (c) of this section and in accordance with the following:

(i)

Decreasing the bases of transferred loss shares

—(A)

Removing positive investment adjustments from transferred loss shares of common stock.

M's basis in each of its transferred loss shares of S common stock is first reduced, but not below value, by removing positive investment adjustments previously applied to the basis of the share. The positive investment adjustments removed from transferred loss shares of S common stock are reallocated under paragraph (b)(2)(ii) of this section after negative investment adjustments are reallocated under paragraph (b)(2)(i)(B) of this section.

(B)

Reallocating negative investment adjustments from shares of S common stock.

If a transferred share is still a loss share after applying paragraph (b)(2)(i)(A) of this section, M's basis in the share is reduced, but not below value, by reallocating negative investment adjustments to the transferred loss share (whether common or preferred stock) from members' shares of S common stock that are not transferred loss shares. The adjustments reallocated under this paragraph (b)(2)(i)(B) are reallocated and applied first to M's bases in transferred loss shares of S preferred stock and then to M's bases in transferred loss shares of S common stock. Reallocations under this paragraph (b)(2)(i)(B) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all transferred loss shares of S preferred stock, and reduces the disparity among members' bases in all shares of S common stock.

(ii)

Increasing the bases of gain preferred and all common shares

—(A)

Preferred stock.

After the application of paragraph (b)(2)(i) of this section, the positive investment adjustments removed from transferred loss shares of S common stock under paragraph (b)(2)(i)(A) of this section are reallocated and applied to increase, but not above value, members' bases in shares of S preferred stock (without regard to whether such shares are transferred in the transaction). Reallocations under this paragraph (b)(2)(ii)(A) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all shares of S preferred stock.

(B)

Common stock.

Any positive investment adjustments removed from transferred loss shares of S common stock under paragraph (b)(2)(i)(A) of this section and not reallocated and applied to S preferred shares are reallocated and applied to increase members' bases in shares of S common stock. Reallocations are made to shares of S common stock without regard to whether a particular share is a loss share or a transferred share, and without regard to the share's value. Reallocations under this paragraph (b)(2)(ii)(B) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all shares of S common stock.

(iii)

Operating rules

—(A)

Method.

In general, reallocations should be made first with respect to the earliest available adjustments. However, the overall application of this paragraph (b) to a transaction must be made in a manner that, to the greatest extent possible, reduces basis disparity (as provided in paragraphs (b)(2)(i)(B) and (b)(2)(ii) of this section). The specific reallocation of an investment adjustment under this paragraph (b) may be made using any reasonable method or formula that is consistent with the provisions of this paragraph (b)(2) and furthers the purposes of this section.

(B)

Limits on reallocation

—(

1

)

Restriction to members' outstanding shares.

Investment adjustments can only be reallocated to shares that were held by members at the time the adjustment was originally applied.

(

2

)

Limitation by prior use

—(

i

)

In general.

In order to prevent the reallocation of investment adjustments from either increasing or decreasing members' aggregate bases in subsidiary stock, no investment adjustment (positive or negative) may be reallocated under this paragraph (b)(2) to the extent that it was (or would have been) used prior to the time that it would otherwise be reallocated under this paragraph (b)(2). For this purpose, an investment adjustment was used (or would have been used) to the extent that it was reflected in (or would have been reflected in) the basis of a share of subsidiary stock and the basis of that share has already been taken into account, directly or indirectly, in determining income, gain, deduction, or loss (including by affecting the application of this section to a prior transfer of subsidiary stock) or in determining the basis of any property that is not subject to § 1.1502-32. However, if the prior use was in an intercompany transaction, an investment adjustment may be reallocated to the extent that § 1.1502-13 has prevented the gain or loss on the transaction from being taken into account. (In that case, appropriate adjustments must be made to the intercompany item from the prior intercompany transaction that has not yet been taken into account.) Further, if an investment adjustment was reflected in (or would have been reflected in) the basis of a share that has been taken into account, the limitation on reallocation under this paragraph (b)(2)(iii)(B)(

2

)

does not apply to the extent the basis of that share would not change as a result of the reallocation (for example, because the reallocation is between shares that are both lower-tier to the share with the previously used basis). See § 1.1502-32(c)(1)(ii)(B) regarding special allocations applicable to the tier-up of the reallocated investment adjustment if the reallocation is limited under this paragraph (b)(2)(iii)(B)(

2

) due to prior use at a higher tier.

(ii) Example.

The application of this paragraph (b)(2)(iii)(B)(

2

) is illustrated by the following example:

Example.

(i)

Facts.

P owns all 20 shares of M stock, and 10 shares of S stock. M owns the remaining 10 shares of S stock. In year 1, S recognizes $200 of income that results in a $10 positive investment adjustment being allocated to each share of S stock. The group does not recognize any other items. The $100 positive adjustment to M's basis in the S stock tiers up, and results in a $5 positive adjustment to each share of M stock. In year 2, P sells one share of M stock and recognizes a gain. In year 3, M sells one loss share of S stock, and this paragraph (b) applies and requires a reallocation of the year 1 positive investment adjustment applied to the basis of the transferred S share.

(ii)

Application of limitation by prior use.

M's basis in the transferred loss share of S stock reflects a $10 positive investment adjustment attributable to S's year 1 income. Under the general rule of this paragraph (b), that $10 would be subject to reallocation to reduce basis disparity. However, that $10 adjustment had originally tiered up to adjust P's basis in its M shares and, as a result, $.50 of that adjustment was reflected in P's basis in each share of M stock. When P sold the share of M stock, the basis of that share (which included the tiered-up $.50) was used in determining the gain on the sale. Thus, $.50 of the $10 investment adjustment originally allocated to the transferred S share that tiered-up to the sold M share was previously used and, as such, cannot be reallocated in a manner that would (if it were the original allocation) affect the basis of the sold M share. Accordingly, no more than $9.50 of the adjustment to M's transferred S share could be reallocated to P's shares of S stock. If so, under the special allocation rule in § 1.1502-32(c)(1)(ii)(B), the tier-up of this $9.50 would only be allocated among P's remaining 19 shares of M stock. Alternatively, all $10 of the investment adjustment could be reallocated to M's other S shares (because the tier-up to P's M shares would have been the same regardless which of M's shares of S stock were adjusted).

(iii)

Application of limitation where adjustment would have been used.

The facts are the same as in paragraph (i) of this

Example

except that M does not sell any shares of S stock and, in year 3, P sells a loss share of S stock. As in paragraph (i) of this

Example

, when P sold the share of M stock, the basis of that share was used in determining the gain on the share. When P sells the loss share of S stock, the $10 positive investment adjustment from S's year 1 income cannot be reallocated in a manner that would (if it were the original adjustment) affect the basis of the sold M share. If this $10 positive investment adjustment had originally been allocated to the S shares held by M, $.50 of the $10 investment adjustment would have tiered up to the M share that P sold, would have been reflected in P's basis in that M share, and would have been used in determining P's gain or loss on the sale. Accordingly, up to $9.50 of the $10 investment adjustment applied to the basis of P's transferred S share could be reallocated to M's shares of S stock. If so, under the special allocation rule in § 1.1502-32(c)(1)(ii)(B), the tier-up of this $9.50 would only be allocated among P's remaining 19 shares of M stock. Alternatively, all $10 of the investment adjustment could be reallocated to P's other S shares.

(3)

Examples.

The general application of this paragraph (b) is illustrated by the following examples:

Example 1.

Transfer of stock received in section 351 exchange.

(i)

Redetermination to prevent noneconomic loss.

(A)

Facts.

For many years, M has owned two assets, Asset 1 and Asset 2. On January 1, year 1, M receives the only four outstanding shares of S common stock (Block 1 shares) in exchange for Asset 1, which has a basis and value of $80. Section 351 applies to the exchange and, therefore, under section 358, M's aggregate basis in the Block 1 shares is $80 ($20 per share). On July 1, year 2, M receives another share of S common stock (Block 2 share) in exchange for Asset 2, which has a basis of $0 and value of $20. Section 351 applies to this exchange and, under section 358, M's basis in the Block 2 share is $0. On October 1, year 3, S sells Asset 2 for $20, recognizing a $20 gain. On December 31, year 3, M sells one of its Block 1 shares to X for $20. After taking into account the effects of all applicable rules of law, M's basis in each Block 1 share is $24 (M's original $20 basis increased under § 1.1502-32 by $4, the share's allocable portion of the $20 gain recognized on the sale of Asset 2). In addition, M's basis in its Block 2 share is $4 (M's original $0 basis increased under § 1.1502-32 by $4 (the share's allocable portion of the $20 gain recognized on the sale of Asset 2)). M's sale of the Block 1 share is a transfer of a loss share and therefore subject to this section.

(B)

Basis redetermination under this paragraph (b).

Under this paragraph (b), M's bases in all its shares of S stock are subject to redetermination. First, paragraph (b)(2)(i)(A) of this section applies to reduce M's basis in the transferred loss share, but not below value, by removing positive investment adjustments applied to the basis of the share. Accordingly, M's basis in the transferred Block 1 share is reduced by $4 (the amount of the positive investment adjustment applied to the share), from $24 to $20. Even if there were negative investment adjustments applied to adjust the bases of nontransferred common shares, no further reduction to the basis of the share would be r

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