[Federal Register Volume 77, Number 73 (Monday, April 16, 2012)]
[Proposed Rules]
[Pages 22516-22519]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-8995]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-139991-08]
RIN 1545-BI84
Certain Transfers of Property to Regulated Investment Companies
[RICs] and Real Estate Investment Trusts [REITs]
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed amendments to regulations
under section 337(d) of the Internal Revenue Code. The proposed
regulations provide guidance concerning certain transfers of property
from a C corporation to a Regulated Investment Company (RIC) or a Real
Estate Investment Trust (REIT) and will affect the parties to such
transactions. This document also invites comments from the public
regarding these proposed regulations.
DATES: Written or electronic comments and requests for a public hearing
must be received by July 16, 2012.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-139991-08), room
5205, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
139991-08), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC, or sent electronically, via the Federal
eRulemaking Portal at http://www.regulations.gov (IRS REG-139991-08).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Grid Glyer (202) 622-7930 or Maury Passman (202) 622-7750 with respect
to the corporate issues, and David H. Kirk (202) 622-3060 with respect
to the partnership issues; concerning submissions of comments,
Oluwafunmilayo Taylor (202) 622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
Congress repealed the General Utilities doctrine in the Tax Reform
Act of 1986 (Pub. L. 99-514, 100 Stat. 2085), as amended by the
Technical and Miscellaneous Revenue Act of 1988 (Pub. L. 100-647, 102
Stat. 3342), when sections 336 and 337 of the Internal Revenue Code
were amended to require corporations to recognize gain or loss on the
distribution of property in connection with complete liquidations other
than certain subsidiary liquidations. Section 337(d)(1) directs the
Secretary to prescribe regulations as may be necessary to carry out the
purposes of General Utilities repeal, including rules to ``ensure that
such purposes may not be circumvented * * * through the use of a
regulated investment company, a real estate investment trust, or tax-
exempt entity * * *.''
On March 18, 2003, regulations under Sec. 1.337(d)-7 (the
regulations) were published in the Federal Register (TD 9047, 68 FR
12817). The regulations generally provide (in paragraphs (a) and
(b)(1)) that if property of a C corporation (the C corporation
transferor) becomes the property of a RIC or REIT by the qualification
of that C corporation as a RIC or REIT or by the transfer of assets of
that C corporation to a RIC or REIT (a conversion transaction), then
the RIC or REIT will be subject to tax on the net built-in gain in the
converted property under the rules of section 1374 and the underlying
regulations. This treatment, however, does not apply if the C
corporation transferor elects to recognize gain and loss as if it sold
the converted property to an unrelated party at fair market value
(deemed sale treatment).
Explanation and Summary of Comments
This preamble first discusses the proposal as it relates to net
built-in gain property acquired by a RIC or REIT either in a like-kind
exchange (where the C corporation transferor's gain is not recognized
by reason of section 1031) or in an involuntary conversion (where such
gain is not recognized by reason of section 1033). This preamble then
discusses a proposed revision to the definition of a C corporation in
the regulations, which provides that a transfer of property by a tax-
exempt entity to a RIC or REIT is not treated as a conversion
transaction unless the tax-exempt entity would have been subject to tax
if a deemed sale election had been made.
In addition, the proposed regulations also add definitions for the
terms RIC, REIT, and S corporation. While these terms are not
explicitly defined in the regulations, their meanings are both self-
evident and unambiguous in that context. Nonetheless, for clarification
and ease of use, the proposed regulations add explicit definitions.
A. Like-Kind Exchanges and Involuntary Conversions
The current regulations generally provide that if property of a C
corporation becomes the property of a RIC or REIT in a conversion
transaction, then, absent a deemed sale election, the RIC or REIT will
be subject to tax on the net built-in gain in the converted property
under the rules of section 1374 and the underlying regulations (as
modified in paragraph (b) of the regulations), as if the RIC or REIT
were an S corporation.
Commentators have expressed concern that the general rule may
inappropriately expose property transferred in certain exchanged basis
transactions--specifically, like-kind exchanges and involuntary
conversions--to this treatment. In these transactions, the C
corporation transferor replaces property it transferred to a RIC or
REIT with property that has an equivalent basis and built-in gain, and
as a result, the built-in gain remains subject to corporate tax in the
hands of the transferor. Therefore, there would not be any
circumvention of the purposes of General Utilities repeal. Section
1.337(d)-4(b)(3) provides an exception in an analogous context (where a
C corporation transfers all or substantially all of its assets to a
tax-exempt entity) to the extent the transaction qualifies for
nonrecognition treatment under section 1031 or section 1033.
[[Page 22517]]
Accordingly, the proposed regulations provide an exception from the
general rule of the current regulations for a transfer of property by a
C corporation to a RIC or REIT to the extent that the transfer
qualifies for non-recognition treatment under either section 1031 or
1033. In such a transaction, the C corporation transferor's basis in
the property it receives is derived from its basis in the transferred
property, and thus reflects the built-in gain. At the same time, the
basis of the transferee RIC or REIT in the converted property has no
relation to the C corporation transferor's basis therein.
Treasury and the IRS are not proposing to extend this treatment to
all exchanged basis transactions, such as exchanges that would
otherwise qualify for nonrecognition treatment under section 351 of the
Code, out of a concern that such an exemption could create
opportunities to avoid corporate-level tax on built-in gains and would
give rise to administrative difficulties that could be addressed only
through extensive rulemaking.
B. Transfers by Tax-Exempt Entities
The regulations apply to property transferred by a C corporation
directly to a RIC or REIT, and indirectly through a partnership to the
extent of any C corporation partner's proportionate share of the
transferred property (the partnership rule). The regulations state that
if the partnership elects deemed sale treatment with respect to such
transfer, then any net gain recognized by the partnership on the deemed
sale must be allocated to the C corporation partner.
Commentators have expressed concern that the partnership rule
presents unintended effects when the partnership has multiple C
corporation partners including both taxable and tax-exempt entities. If
such a partnership transfers built-in gain property to a RIC or REIT in
a conversion transaction without making a deemed sale election (that
is, section 1374 treatment applies), and if the transferee RIC or REIT
sells the converted property during the recognition period, then the
RIC or REIT is subject to a corporate-level tax on the net built-in
gain, including the portion of the net built-in gain that otherwise
would have been allocated to tax-exempt C corporation partners had a
deemed sale election been made. This is because the net recognized
built-in gain is determined with reference to the amount of gain that
would have been allocated to all C corporation partners, regardless of
their taxable or tax-exempt status. In contrast, if the transferring
partnership were to make a deemed sale election, the taxable C
corporation partners would recognize gain that otherwise could have
been deferred if section 1374 treatment had applied.
Treasury and the IRS believe that the inclusion of direct or
indirect transfers by tax-exempt entities in the scope of the final
regulations furthers the purposes of General Utilities repeal only to
the extent that those entities would have been subject to tax had a
deemed sale election been made (for example, if a deemed sale election
would have generated unrelated business taxable income or would have
adversely affected the entity's tax-exempt status). Accordingly, the
proposed regulations would amend the final regulations to provide that
the definition of a C corporation excludes tax-exempt entities within
the meaning of Sec. 1.337(d)-4(c)(2). As a result, transfers of
property by a tax-exempt entity to a RIC or REIT (or by a partnership
to a RIC or REIT to the extent of a tax-exempt partner's distributive
share of the gain in the transferred property) generally will not be
subject to section 1374 treatment. For this purpose, however, an entity
will not be considered to be tax-exempt to the extent it would be
subject to tax (such as under section 511) under Title 26 of the United
States Code with respect to gain (if any) resulting from a deemed sale
election if such an election were made under Sec. 1.337(d)-7(c)(5)
with respect to the transfer. Thus, for example, if a partnership in
which a tax-exempt C corporation described in Sec. 1.337(d)-4(c)(2) is
a partner transfers property to a RIC or REIT in a conversion
transaction, and the tax-exempt entity would not have been subject to
unrelated business income tax under section 511 or to tax under any
other provision of the Code had the partnership made a deemed sale
election in connection with the transfer, the transfer would be
excluded from the scope of the final regulations (and the transferee
RIC or REIT will not be subject to section 1374 treatment) to the
extent of the tax-exempt entity's distributive share of the built-in
gain or loss in the converted property. However, to the extent the tax-
exempt partner would have been subject to unrelated business income tax
under section 511 or to tax under any other provision of the Code with
respect to its distributive share of the built-in gain on the property,
the transferee RIC or REIT would be subject to tax on the built-in gain
on the property under the rules of section 1374 as if the RIC or REIT
were an S corporation unless the transferring partnership elects deemed
sale treatment.
Section 1.337(d)-7(e) provides that the principles of Sec.
1.337(d)-7 apply to property transferred by a partnership to a RIC or
REIT to the extent of any C corporation partner's distributive share of
the gain or loss in the transferred property. The proposed regulations
provide that Sec. 1.337(d)-7(e) also applies to determine the
distributive share of the gain or loss in the transferred property of a
C corporation partner of a higher-tier partnership in a tiered
partnership structure in which the transferor partnership is a lower-
tier partnership.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866, as supplemented by Executive Order 13565. Therefore, a
regulatory assessment is not required. Pursuant to the Regulatory
Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that these
proposed regulations would not have a significant economic impact on a
substantial number of small entities because the proposed regulations
limit the situations in which these regulations apply to all
businesses, including small businesses. This certification is based on
the fact that these proposed regulations do not create additional
obligations for, or impose an economic impact on, small entities.
Therefore, a regulatory flexibility analysis is not required. Pursuant
to section 7805(f) of the Code, these proposed regulations will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are submitted timely to the
IRS. Treasury and the IRS request comments on all aspects of the
proposed rules. All comments will be available for public inspection
and copying. A public hearing may be scheduled if requested in writing
by any person that timely submits written or electronic comments. If a
public hearing is scheduled, notice of the date, time, and place for
the public hearing will be published in the Federal Register.
Drafting Information
The principal authors of these regulations are Grid Glyer and Maury
Passman of the Office of Associate Chief
[[Page 22518]]
Counsel (Corporate). Other personnel from Treasury Department and the
IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.337(d)-7 is also issued under 26 U.S.C. 337(d) * * *
Par. 2. Section 1.337(d)-7 is amended by:
1. Revising paragraphs (a)(2), (d)(1), (e) and (f)
2. Adding paragraph (d)(3),
The revisions and addition read as follows:
Sec. 1.337(d)-7 Tax on property owned by a C corporation that becomes
property of a RIC or REIT.
(a) * * *
(2) Definitions. For purposes of this section:
(i) C corporation. The term C corporation has the meaning provided
in section 1361(a)(2) except that the term does not include a RIC, a
REIT, or a tax-exempt entity within the meaning of paragraph (a)(2)(vi)
of this section.
(ii) Conversion transaction. The term conversion transaction means
the qualification of a C corporation as a RIC or REIT or the transfer
of property owned by a C corporation to a RIC or REIT.
(iii) RIC. The term RIC means a regulated investment company within
the meaning of section 851(a).
(iv) REIT. The term REIT means a real estate investment trust
within the meaning of section 856(a).
(v) S corporation. The term S corporation has the meaning provided
in section 1361(a)(1).
(vi) Tax-exempt entity. The term tax-exempt entity, with respect to
a conversion transaction, means an entity--
(A) Described in Sec. 1.337(d)-4(c)(2), and
(B) That would not be subject to tax under Title 26 of the United
States Code with respect to gain (if any) resulting from a deemed sale
election if such an election were made under paragraph (c)(5) of this
section with respect to the conversion transaction.
* * * * *
(d) Exceptions--(1) Gain otherwise recognized. Paragraph (a) of
this section does not apply to any conversion transaction to the extent
that gain or loss otherwise is recognized on such conversion
transaction by the C corporation that either qualifies as a RIC or a
REIT or that transfers property to a RIC or REIT. See, for example,
sections 311(b), 336(a), 351(b), 351(e), 356, 357(c), 367,
368(a)(2)(F), 1001, 1031(b), and 1033(b).
* * * * *
(3) Special rules for like-kind exchanges and involuntary
conversions--(i) In general. Paragraph (a) of this section does not
apply to a conversion transaction to the extent that a C corporation
transfers property with a built-in gain to a RIC or REIT and the C
corporation's gain is not recognized by reason of either section 1031
or 1033.
(ii) Clarification regarding exchanged property previously subject
to section 1374 treatment. Notwithstanding paragraph (d)(3)(i) of this
section, if, in a transaction described in paragraph (d)(3)(i) of this
section, a RIC or REIT surrenders property that was subject to section
1374 treatment immediately prior to the transaction, the rules of
section 1374(d)(6) will apply to continue section 1374 treatment to the
replacement property acquired by the RIC or REIT in the transaction.
(iii) Examples. The rules of this paragraph (d)(3) are illustrated
by the following examples. In each of the examples, X is a REIT, Y is a
C corporation, and X and Y are not related.
Example 1. Section 1031(a) exchange. (i) Facts. X owned a
building that it leased for commercial use (Property A). Y owned a
building leased for commercial use (Property B). On January 1, Year
3, Y transferred Property B to X in exchange for Property A in a
transaction that qualified for nonrecognition treatment under
section 1031(a). Immediately before the exchange, Properties A and B
each had a value of $100, X had an adjusted basis of $60 in Property
A, Y had an adjusted basis of $70 in Property B, and X was not
subject to section 1374 treatment with respect to Property A.
(ii) Analysis. The transfer of property (Property B) by Y (a C
corporation) to X (a REIT) is a conversion transaction within the
meaning of paragraph (a)(2)(ii) of this section. The conversion
transaction qualified for nonrecognition treatment under section
1031(a) as to Y; thus, Y did not recognize any of its $30 gain.
Therefore, the conversion transaction is not subject to paragraph
(a) of this section by reason of paragraph (d)(3)(i) of this
section.
Example 2. Section 1031(a) exchange of section 1374 property.
(i) Facts. The facts are the same as in Example 1, except that X had
acquired Property A in a conversion transaction in Year 2, and
immediately before the Year 3 exchange X was subject to section 1374
treatment with respect to $25 of net built-in gain in Property A.
(ii) Analysis. The Year 3 transfer of Property B by Y to X is a
conversion transaction within the meaning of paragraph (a)(2)(ii) of
this section. The conversion transaction qualified for
nonrecognition treatment under section 1031(a) as to Y; thus, Y did
not recognize any of its $30 gain. Therefore, the Year 3 transfer is
not subject to paragraph (a) of this section by reason of paragraph
(d)(3)(i) of this section. However, X had been subject to section
1374 treatment with respect to $25 of net built-in gain in Property
A immediately before the Year 3 transfer, and X's basis in Property
B is determined (in whole or in part) by reference to its adjusted
basis in Property A. Accordingly, the rules of section 1374(d)(6)
apply and X is subject to section 1374 treatment on Property B with
respect to the $25 net built-in gain. See paragraph (d)(3)(ii) of
this section.
Example 3. Section 1031(b) exchange. (i) Facts. The facts are
the same as in Example 1, except that immediately before the Year 3
exchange Property A had a value of $92, and X transferred Property A
and $8 to Y in exchange for Property B in a transaction that
qualified for nonrecognition treatment under section 1031(b).
(ii) Analysis. The transfer of Property B by Y to X is a
conversion transaction within the meaning of paragraph (a)(2)(ii) of
this section. The conversion transaction qualified for
nonrecognition treatment as to Y under section 1031(b) (resulting
from the receipt of $8 in money or other property in addition to the
replacement property); as a result, Y recognized $8 of its $30 gain,
and did not recognize the remaining $22 of gain. Paragraph (a) of
this section does not apply to the transaction to the extent of the
$8 gain recognized by Y by reason of paragraph (d)(1) of this
section, or to the extent of the $22 gain realized but not
recognized by Y by reason of paragraph (d)(3)(i) of this section.
Example 4. Section 1033(a) involuntary conversion of property
held by a C corporation transferor. (i) Facts. Y owned uninsured,
improved property (Property 1) that was involuntarily converted
(within the meaning of section 1033(a)) in a fire. Y sold Property 1
for $100 to X, which owned an adjacent property and wanted Property
1 for use as a parking lot. Y had a $70 basis in Property 1
immediately before the sale. Y elected to defer gain recognition
under section 1033(a)(2), and purchased qualifying replacement
property (Property 2) for $100 from an unrelated party prior to the
expiration of the period described in section 1033(a)(2)(B).
(ii) Analysis. The transfer of Property 1 by Y to X is a
conversion transaction within the meaning of paragraph (a)(2)(ii) of
this section. The conversion transaction (combined with Y's purchase
of Property 2) qualified for nonrecognition treatment under section
1033(a) as to Y; thus, Y did not recognize any of its $30 gain.
Therefore, the conversion transaction is not subject to paragraph
(a) of this section by reason of paragraph (d)(3)(i) of this
section.
Example 5. Section 1033(a) involuntary conversion of property
held by a REIT. (i)
[[Page 22519]]
Facts. X owned property (Property 1). On January 1, Year 2, Property
1 had a fair market value of $100 and a basis of $70, and X was not
subject to section 1374 treatment with respect to Property 1. On
that date, when Property 1 was under a threat of condemnation, X
sold Property 1 to an unrelated party for $100 (First Transaction).
X elected to defer gain recognition under section 1033(a)(2), and
purchased qualifying replacement property (Property 2) for $100 from
Y (Second Transaction) prior to the expiration of the period
described in section 1033(a)(2)(B).
(ii) Analysis. The transfer of Property 2 by Y to X in the
Second Transaction is a conversion transaction within the meaning of
paragraph (a)(2)(ii) of this section. The Second Transaction
(combined with the First Transaction) qualified for nonrecognition
treatment under section 1033(a) as to X, but not as to Y. Assume no
nonrecognition provision applied to Y; thus, Y recognized gain or
loss on its sale of Property 2 in the Second Transaction, and the
Second Transaction is not subject to paragraph (a) of this section
by reason of paragraph (d)(3)(i) of this section.
(e) Special rule for partnerships--(1) In general. The principles
of this section apply to property transferred by a partnership to a RIC
or REIT to the extent of any gain or loss in the converted property
that would be allocated directly or indirectly, through one or more
partnerships, to a C corporation if the partnership sold the converted
property to an unrelated party at fair market value on the deemed sale
date (as defined in paragraph (c)(3) of this section). If the
partnership were to elect deemed sale treatment under paragraph (c) of
this section in lieu of section 1374 treatment under paragraph (b) of
this section with respect to such transfer, then any net gain
recognized by the partnership on the deemed sale must be allocated to
the C corporation partner, but does not increase the capital account of
any partner. Any adjustment to the partnership's basis in the RIC or
REIT stock as a result of deemed sale treatment under paragraph (c) of
this section shall constitute an adjustment to the basis of that stock
with respect to the C corporation partner only. The principles of
section 743 apply to such basis adjustment.
(2) Example. Transfer by partnership of property to REIT. (i)
Facts. PRS, a partnership for Federal income tax purposes, has three
partners: TE, a tax-exempt entity (within the meaning of Sec.
1.337(d)-7(a)(2)(vi)), owns 50 percent of the capital and profits of
PRS; A, an individual, owns 30 percent of the capital and profits of
PRS; and Y, a C corporation (within the meaning of Sec. 1.337(d)-
7(a)(2)(i)), owns the remaining 20 percent. PRS owns a building that
it leases for commercial use (Property 1). On January 1, Year 2,
when PRS has an adjusted basis in Property 1 of $100 and Property 1
has a fair market value of $500, PRS transfers Property 1 to X, a
REIT, in exchange for stock of X in an exchange described in section
351. PRS does not elect deemed sale treatment under paragraph (c) of
this section.
(ii) Analysis. The transfer of Property 1 by PRS to X is a
conversion transaction within the meaning of paragraph (a)(2)(ii) of
this section to the extent of any gain or loss that would be
allocated to any C corporation partner if PRS sold Property 1 at
fair market value to an unrelated party on the deemed sale date. Y
is a C corporation, but neither TE nor A is a C corporation within
the meaning of paragraph (a)(2)(i) of this section. Therefore, the
transfer of Property 1 by PRS to X is a conversion transaction
within the meaning of paragraph (a)(2)(ii) of this section to the
extent of Y's share of any such gain of PRS in Property 1. If PRS
were to sell Property 1 to an unrelated party at fair market value
on the deemed sale date, PRS would allocate $80 of built-in gain to
Y. Thus, X is subject to section 1374 treatment on Property 1 with
respect to $80 of built-in gain.
(f) Effective/Applicability date--(1) In general. Except as
provided in paragraph (f)(2) of this section, this section applies
to conversion transactions that occur on or after January 2, 2002.
For conversion transactions that occurred on or after June 10, 1987,
and before January 2, 2002, see Sec. Sec. 1.337(d)-5 and 1.337(d)-
6.
(2) Special rule. Paragraphs (a)(2), (d)(1), (d)(3) and (e) of
this section apply to conversion transactions that occur on or after
[INSERT DATE OF PUBLICATION OF THE TREASURY DECISION ADOPTING THESE
RULES AS FINAL REGULATIONS IN THE FEDERAL REGISTER]. However,
taxpayers may apply paragraphs (a)(2), (d)(1), (d)(3) and (e) of
this section to conversion transactions that occurred before [INSERT
DATE OF PUBLICATION OF THE TREASURY DECISION ADOPTING THESE RULES AS
FINAL REGULATIONS IN THE FEDERAL REGISTER]. For conversion
transactions that occurred on or after January 2, 2002 and before
[INSERT DATE OF PUBLICATION OF THE TREASURY DECISION ADOPTING THESE
RULES AS FINAL REGULATIONS IN THE FEDERAL REGISTER], see Sec.
1.337(d)-7 as contained in 26 CFR part 1 in effect on April 1, 2011.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-8995 Filed 4-13-12; 8:45 am]
BILLING CODE 4830-01-P