Regulations: Anti-loss importation rule, net built-in losses in tax-free transactions

Anti-loss importation rule, net built-in losses

The Treasury Department and IRS today released for publication in the Federal Register final regulations (T.D. 9759) that apply to certain nonrecognition transfers of loss property by persons not subject to federal income tax, to corporations that are subject to federal income tax. The release finalizes regulations that were proposed in 2013 under sections 334(b)(1)(B) and 362(e)(1). These regulations affect corporations receiving loss property, and also amend final regulations under sections 332 and 351 to reflect certain statutory changes.

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Today’s final regulations [PDF 299 KB] will be published in the Federal Register on Monday, March 28, 2016.

Background

Property is designated as “importation property” if two conditions are satisfied:

  • Any gain or loss recognized on a disposition of the property would not be subject to federal income tax in the hands of the transferor immediately before the transfer. 
  • Any gain or loss recognized on a disposition of the property would be subject to federal income tax in the hands of the transferee immediately after the transfer.

There had been questions concerning how to determine whether property is importation property, and questions regarding the application of the anti-loss importation provisions and their interaction with other rules of the Code. The proposed regulations were issued in 2013 to provide a framework for identifying importation property and for determining whether the transfer of the property is a transaction subject to the anti-loss importation provisions (designated a “loss importation transaction”). Comments were received in response to and a hearing was held concerning the proposed regulations.

Final regulations

The preamble to today’s final regulations states that, in general, commenters agreed with the approach of the IRS and Treasury Department and with the framework established by the proposed regulations.  The final regulations, however, include some changes and clarifications in response to comments.

For instance, in response to questions from commenters about how to determine to which partner an item would be allocated, and thus its federal income tax treatment, the final regulations clarify that the partnership agreement as well as any applicable rules of law are taken into account. In a second clarification, the preamble notes that for purposes of determining whether there is an importation of loss for publicly traded partnerships (PTPs), the IRS and Treasury will respect determinations derived by applying generally accepted conventions in determining allocable income.

Another clarification requested concerns examples involving partnership transferors and allocation to partners of resulting adjustments under section 362(e)(1) and (2), including adjustments in the case of a section 362(e)(2)(C) election. In the proposed regulations, the examples directed allocations to the partners that contributed the property transferred by the partnership in order to comply with the legislative purpose of section 362(e)(1) and (2) and to prevent distortions. The preamble to the final regulations, in response to comments, clarifies the authority on which the analyses were based—that is, the analysis reflected in the examples is based on general aggregate and entity principles of partnership tax law, taking into account the aggregate approach reflected in the statutory language of section 362(e)(1), and the purposes and principles of section 362(e)(1) and (2).

One commenter requested that the final regulations clarify the effect of Rev. Rul. 84-111 and Rev. Rul. 99-6 on a transfer of all the interests in a partnership to a single transferee in a loss importation transaction. However, the IRS and Treasury—while recognizing that guidance in this area would be helpful—concluded this would be beyond the scope of this regulatory project. 

The IRS and Treasury also rejected proposals by commenters to apply a closing-of-the-books methodology to transfers by partnerships, to exempt transfers by foreign non-grantor trusts with domestic beneficiaries, and to reduce basis reduction for section 367(b) inclusions.

The preamble examines a situation when a tax-exempt entity transfers debt-financed property (as defined in section 514), the disposition of such property would be subject to federal income tax and thus the property could not be importation property—even if there was only a de minimis amount of indebtedness and so only a small portion of any gain or loss would be subject to federal income tax. Commenters noted the “cliff effect” and resulting potential for avoidance of the anti-loss importation provisions. In response, the final regulations adopt an approach that treats debt-financed property as subject to federal income tax in proportion to the amount of such gain or loss that would be includible in the transferor’s unrelated business taxable income (UBTI) on a sale under sections 511-514. The final regulations also provide that portions of property determined under this rule are generally treated under the anti-loss importation provisions in the same manner as portions of property tentatively divided to reflect multiple owners of gain or loss on the property.

The final regulations expressly provide that, notwithstanding the application of the anti-loss importation or anti-duplication provisions to a transaction, the transferee’s basis is considered determined by reference to the transferor’s basis for federal income tax purposes, except for purposes of section 755.

In response to comments that a number of issues could be the subject of further study, such as the effect of tax treaties, nonfunctional currency, and the application of section 7701(g) (clarification of fair market value in the case of nonrecourse indebtedness), the preamble notes that the IRS and Treasury considered these issues beyond the scope of these regulations and did not address them. The IRS and Treasury are considering whether further study of these issues is to be undertaken. 

Today’s final regulations include modifications to Reg. sections 1.332-2 and 1.351-1 that reflect certain statutory changes under sections 332 (relating to ownership of subsidiary stock) and 351 (relating to property permitted to be received by a transferor without recognition of gain or loss) proposed in 2005 proposed regulations. Because there were no comments received with respect to the statutory modifications, the statutory modifications are adopted as final regulations without change.

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