Regulations Limit Corporate Partner’s Basis Reduction and Gain Elimination Transactions

The IRS finalized regulations that:

  • prevent corporate taxpayers from using a partnership to avoid corporate-level gain;
  • limit rules that cause basis reduction or gain recognition for consolidated group members that are partners in the same partnership; and
  • apply the basis reduction rule when corporations engage in gain elimination transactions.

The regulations apply as of June 15, 2015. They are virtually identical to proposed and temporary regulations that were issued in 2015.

Stock Acquisitions to Avoid Gain on Appreciated Property

A corporation that distributes appreciated property to its shareholders must recognize gain as if it sold the property for fair market value. For example, a corporation recognizes gain if it exchanges appreciated property for its own stock.

However, corporations may try to postpone or avoid this result by taking the following steps:

  1. the corporation joins a partnership and contributes appreciated property; then
  2. the partnership acquires the corporation’s stock; and
  3. the partnership makes a liquidating distribution of that stock back to the corporation.

The regulations use a deemed redemption rule to blunt the effect of these arrangements. This rule requires the corporate partner to recognize gain when a transaction or a series of transactions has the economic effect of an exchange of its appreciated property for an interest in its own stock that is owned, acquired, or distributed by the partnership.

A de minimis exception applies when the corporate partner’s stake in the partnership, and the partnership’s stake in the corporate partner, are very small.

An inadvertence exception applies if the partnership quickly disposes of the stock without distributing any of it to the corporate partner or anyone who controls the corporate partner.

Basis Reduction for Consolidated Group Members

The regulations provide some relief from rules that cause basis reduction or gain recognition for consolidated group members that are partners in the same partnership. These rules apply when:

  1. a partnership (PS) distributes to a corporate partner (Corp A) stock in another corporation (Corp B),
  2. afterwards, Corp A has control of Corp B, and
  3. PS’s basis in the stock immediately before the distribution exceeds Corp A’s basis in the stock immediately after the acquisition.

The basis of Corp B’s property must be reduced by the excess of PS’s basis in the stock immediately before the distribution over Corp A’s basis in the stock immediately after the acquisition. Corp A, the corporation partner, must also recognize gain to the extent basis in Corp B’s property cannot be reduced.

The regulations allow the bases of consolidated group members to be aggregated when:

  1. two or more of the corporate partners receive a distribution of stock in a distributed corporation, and
  2. the distributed corporation is or becomes a member of the distributee partners’ consolidated group following the distribution.

Gain Elimination Transactions

Finally, the regulations restrict the effect of a corporate partner’s gain elimination transaction. In these transactions, the distributee corporation sidesteps the basis reduction rule discussed above by avoiding formal control of the distributed corporation. For example, the situation described above could be a gain elimination transaction if Corp A did not acquire formal control of Corp B.

The regulations make these transaction less effective by applying the basis reduction rule as though the distributee corporation acquired control of the distributed corporation immediately before the gain elimination transaction, regardless of formal control.

T.D. 9833

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CCHTaxGroup

All stories by: CCHTaxGroup