Title 26—Internal Revenue--Volume 1
PART 1—INCOME TAXES
§ 1.1502-14Z   Application of opportunity zone rules to members of a consolidated group.
(a) Scope and definitions —(1) Scope. This section provides rules regarding the Federal income tax treatment of QOFs owned by members of a consolidated group (as defined in § 1.1502-1(b) and (h), respectively). Rules in the section 1400Z-2 regulations (as defined in § 1.1400Z2(a)-1(b)(41)) apply to consolidated groups except as modified in this section. Paragraph (b) of this section generally provides rules regarding the effects of an election under § 1.1504-3(b)(2) to treat a subsidiary QOF C corporation as a member of a consolidated group. Paragraph (c) of this section provides rules regarding qualifying investments made by members of a consolidated group (including an election to treat the investment by one member as a qualifying investment by another member) and the application of § 1.1502-13 to intercompany transfers of a qualifying investment. Paragraph (d) of this section provides coordinating rules for basis adjustments within a consolidated group. Paragraph (e) of this section provides coordinating rules for § 1.1502-36(d). Paragraph (f) of this section provides elective transition relief to taxpayers that consolidated a subsidiary QOF C corporation prior to May 1, 2019. Paragraph (g) of this section provides rules regarding the consequences of a deconsolidation of a QOF C corporation. Paragraph (h) of this section provides instructions for making the elections provided by paragraphs (c) and (f) of this section. Paragraph (i) of this section is reserved. Paragraph (j) of this section provides examples. Paragraph (k) of this section provides the applicability dates.
(2) Definitions —(i) In general. The definitions provided in §§ 1.1400Z2(a)-1(b) and 1.1400Z2(d)-1 apply for purposes of this section.
(ii) Definitions for consolidated groups —(A) Day one. The term day one means the date members of the consolidated group formed or acquired section 1504 control of the pre-existing QOF sub. If a pre-existing QOF sub was a member of the consolidated group prior to becoming a QOF C corporation, day one is the first day of the first month in which the member self-certified as, or is treated as, a QOF C corporation, whichever is earlier.
(B) Election date. The term election date means the date on which an election under paragraph (c) or (f) of this section is made.
(C) Pre-existing QOF sub. The term pre-existing QOF sub means a subsidiary QOF C corporation that meets the affiliation requirements in section 1504 (without regard to § 1.1504-3(b)(1)) as of May 1, 2019.
(D) QOF investor member. The term QOF investor member means any member holding a qualifying investment in the QOF member.
(E) QOF member. The term QOF member means a subsidiary QOF C corporation that is treated as a member of a consolidated group pursuant to an election in § 1.1504-3(b)(2).
(F) QOF member stock. The term QOF member stock means the QOF stock of a QOF member.
(G) QOF SAG. The term QOF SAG means, with respect to a QOF member, the affiliated group that would be determined under section 1504(a) if the QOF member were the common parent.
(H) Subsidiary QOF C corporation. The term subsidiary QOF C corporation means a QOF C corporation that meets the requirements to be a member of an affiliated group (as defined in section 1504(a)(1), and without regard to § 1.1504-3(b)(1)) other than the common parent of such consolidated group.
(b) Subsidiary QOF C corporation treated as member of the consolidated group —(1) Effects of election to treat a subsidiary QOF C corporation as a member —(i) Determining whether a distribution is an inclusion event. A distribution of property with respect to qualifying QOF stock by a QOF member to a QOF investor member is an inclusion event to the extent the distribution would create or increase an excess loss account (ELA) in the qualifying QOF stock, without regard to any inclusion resulting from application of this paragraph (b)(1)(i). Solely for purposes of determining whether a distribution creates or increases an ELA during a taxable year, investment adjustments pertaining to a distribution on qualifying QOF stock by a QOF member are made after all other investment adjustments under § 1.1502-32 for that year.
(ii) Determining the amount of deferred gain includible by the QOF investor member. The amount of gain included in gross income of a QOF investor member under section 1400Z-2(a)(1)(B) on a date described in § 1.1400Z2(b)-1(b) (modified by paragraph (c)(3) of this section, as applicable) is determined under this paragraph (b)(1)(ii). The amount of gain included in gross income of the QOF investor member is the lesser of:
(A) The product of:
( 1 ) The percentage of the qualifying investment that gave rise to the inclusion event; and
( 2 ) The remaining deferred gain (see § 1.1400Z2(a)-1(b)(40)), less any basis adjustments pursuant to section 1400Z-2(b)(2)(B)(iii) and (iv); or
(B) The gain that would be recognized on a fully taxable disposition of the qualifying investment that gave rise to the inclusion event.
(iii) Application of ELA rules on the disposition of QOF member stock. When a QOF investor member disposes of a share of qualifying QOF member stock, any ELA in the share is taken into account as income or gain from the disposition under § 1.1502-19(b)(1) before the basis of the share is increased under section 1400Z-2(c), if applicable. See paragraph (g)(3)(i) of this section for the general rule regarding the treatment of an ELA upon the deconsolidation of a QOF member.
(iv) Transactions between the QOF member and other members of the consolidated group —(A) In general. This paragraph (b)(1)(iv) governs transactions between a member of a QOF SAG and other members of the consolidated group.
(B) Sale or exchange of property. A sale or exchange of property between a member of a QOF SAG and a member of the consolidated group that is not a member of a single QOF SAG is not treated as an intercompany transaction (as defined in § 1.1502-13(b)(1)) and is not subject to the rules in § 1.1502-13. In contrast, a sale or exchange of property between members of the QOF SAG is an intercompany transaction that is subject to the rules in § 1.1502-13.
(C) Other transactions. Any transaction between a member of a QOF SAG and a member of the consolidated group that is not a member of that QOF SAG that is not a sale or exchange of property is an intercompany transaction subject to the rules in § 1.1502-13.
(v) Separate-entity application of QOF qualifying rules to QOF member. A consolidated group is not treated as a single entity for purposes of determining whether a QOF member or a qualified opportunity zone business that is a consolidated group member satisfies the investment standard rules in section 1400Z-2(d) and (f) and §§ 1.1400Z2(d)-1 and 1.1400Z2(f)-1. Instead, those investment standard rules apply on a separate-entity basis. Therefore, for example, the QOF member's satisfaction of the requirements under section 1400Z-2(d) is determined by taking into account only property (including qualified opportunity zone stock or qualified opportunity zone partnership interests) held by the QOF member, without regard to property transferred by the QOF member to other members of the consolidated group.
(2) Anti-avoidance rule. The purposes of section 1400Z-2 and the section 1400Z-2 regulations are to provide specified tax benefits to owners of QOFs to encourage the making of longer-term investments, through QOFs and qualified opportunity zone businesses, of new capital in one or more qualified opportunity zones and to increase the economic growth of such qualified opportunity zones. If a transaction is engaged in or structured with a view to avoid the application of the rules of section 1400Z-2, the section 1400Z-2 regulations, or the regulations in this part under section 1502 of the Code (including this section), appropriate adjustments will be made to carry out the purposes of section 1400Z-2 and the section 1400Z-2 regulations. For example, if a consolidated group engages in a restructuring (such as a distribution described in section 355) with a view to using stock basis adjustments under § 1.1502-32 resulting from increases in the basis of stock under section 1400Z-2(b) in a sale or exchange transaction without disposing of any part of the consolidated group's direct ownership of the relevant qualifying investment, the transaction will be treated as an inclusion event with regard to an appropriate amount of deferred gain.
(c) Qualifying investments by members of a consolidated group —(1) In general. Except as otherwise provided in this section or in § 1.1400Z2(b)-1 (see, for example, § 1.1400Z2(b)-1(c)(9)(i)(B)( 1 )), section 1400Z-2 applies separately to each member of a consolidated group. Therefore, for example, the same member of the consolidated group generally must both engage in the sale of a capital asset giving rise to eligible gain and timely invest an amount equal to some or all of such gain in a QOF (as provided in section 1400Z-2(a)(1)) in order to qualify for deferral of such gain under section 1400Z-2.
(2) Election to treat investment of one member as a qualifying investment by another member —(i) Availability of election. If members of a consolidated group satisfy the requirements of this paragraph (c)(2), the consolidated group may elect to treat an investment by one member as a qualifying investment by another member. The election provided by this paragraph (c)(2) is available when a member of a consolidated group (M1) has eligible gain and a second member (M2) makes an investment in a QOF that would be a qualifying investment if M1, rather than M2, had made the investment. For example, if M1 has $100x of eligible gain but M2 has none, and M2 makes a $120x investment in a QOF C corporation, only $100x of M2's investment in the QOF C corporation is eligible for the election under this paragraph (c)(2). See paragraph (h)(2) of this section for the form and manner of making this election. If M2 has its own eligible gain, M2 may make a qualifying investment on its own behalf and defer such eligible gain under section 1400Z-2(a)(1)(A) and § 1.1400Z2(a)-1.
(ii) Effect of election. If a consolidated group makes an election under this paragraph (c)(2), then M1 is treated as having made the investment in the QOF that is actually made by M2. M1 is then treated as having immediately sold such investment to M2 for fair market value. The deemed sale by M1 is subject to the rules in paragraph (c)(3) of this section. The consolidated group must treat the deemed investment by M1 and the deemed sale by M1 to M2 as having occurred for all Federal income tax purposes.
(3) Intercompany transfers of a qualifying investment —(i) In general. Except as otherwise provided in this paragraph (c)(3), when one member (S) transfers its qualifying investment to another member (B), the transaction is not treated as an intercompany transaction within the meaning of § 1.1502-13(b)(1) for purposes of applying the rules of section 1400Z-2 and the section 1400Z-2 regulations. Therefore, § 1.1502-13(c) does not apply to treat S and B as divisions of a single entity for purposes of section 1400Z-2. For example, if S transfers its qualifying investment to B in a section 351 transaction, the transfer is an inclusion event for S under § 1.1400Z2(b)-1(c). In addition, because the transfer is not an intercompany transaction for purposes of section 1400Z-2, § 1.1502-13 does not apply to continue S's deferral under § 1.1400Z2(a)-1(a)(1).
(ii) Application of § 1.1502-13 to fully taxable intercompany transfers of a qualifying investment —(A) Applicable transactions. Notwithstanding paragraph (c)(3)(i) of this section, if S transfers its qualifying investment to B in a fully taxable transaction, the transaction is treated as an intercompany transaction, and § 1.1502-13(c) applies to treat S and B as divisions of a single entity for purposes of applying section 1400Z-2.
(B) Treatment of S's intercompany gain on its qualifying investment. If a transaction is described in paragraph (c)(3)(ii)(A) of this section, § 1.1502-13(c)(6)(ii) is inapplicable in determining the excludability of S's gain (or the treatment of such gain as tax-exempt income) on the application of section 1400Z-2(b) and (c) to S and B as a single entity. Thus, S's gain on the qualifying investment (including the amount includible under § 1.1400Z2(b)-1(e)) may be redetermined to be excluded from gross income (or treated as tax-exempt income), as appropriate, to achieve single-entity treatment between S and B with regard to the ownership and disposal of the qualifying investment. To qualify for benefits under section 1400Z-2, S and B must otherwise satisfy the requirements of section 1400Z-2. See also § 1.1502-13(j)(4) (concerning multiple or successive intercompany transactions).
(C) Investment adjustments and adjustments to earnings and profits. Income of S excluded under section 1400Z-2 by application of paragraphs (c)(3)(ii)(A) and (B) of this section and § 1.1502-13 results in adjustments to S's earnings and profits and is treated as tax-exempt income to S for purposes of § 1.1502-32(b)(2)(ii).
(D) Election under section 1400Z-2(c). To the extent paragraph (c)(3)(ii)(A) of this section applies to S's transfer of its qualifying investment to B, B (and not S) is entitled to make the election under section 1400Z-2(c) at the time when, treating S and B as divisions of a single entity, the single entity would be entitled to make such an election. For example, pursuant to § 1.1502-13(c)(1)(ii), B takes S's holding period into account in determining whether B is treated as holding the transferred qualifying investment for 10 years. In addition, the attributes of S's intercompany item on the transfer of the qualifying investment may be redetermined based on B's election.
(4) Intercompany transfer as qualifying investment in a QOF member. A transfer by a consolidated group member with an eligible gain to a QOF member before January 1, 2027, is not treated as an intercompany transaction within the meaning of § 1.1502-13 and may constitute a qualifying investment. But see § 1.1504-3(b)(2) regarding conditions for consolidating a QOF C corporation.
(5) Intercompany gain as eligible gain. When S sells property to B, § 1.1502-13 applies to determine if, and when, S's intercompany gain and B's corresponding gain constitute eligible gain. S's gain and B's gain are treated as eligible gain only to the extent such gain would be eligible gain if S and B were divisions of a single entity. For example, if S sells a piece of property to B at a gain, B subsequently sells that property to an unrelated party at a further gain, and the gains are treated as capital gain under § 1.1502-13(c)(1) and (4), then both S's gain and B's gain are eligible gains at the time B sells the property to the unrelated party. In contrast, if S sells a piece of property to B at a loss, and B subsequently sells that property to an unrelated party at a gain, then B's corresponding gain on the property is eligible gain only to the extent that S and B, if treated as divisions of a single entity, would have eligible gain on the sale of property to the unrelated party. See § 1.1502-13(a)(1).
(d) Tiering-up of investment adjustments provided by section 1400Z-2. Basis increases in a qualifying investment in a QOF under sections 1400Z-2(b)(2)(B)(iii), 1400Z-2(b)(2)(B)(iv), and 1400Z-2(c) are treated as satisfying the requirements of § 1.1502-32(b)(3)(ii)(A) and thus qualify as tax-exempt income to the QOF owner. Therefore, if the QOF owner is a member of a consolidated group and is owned by other members of the same consolidated group (upper-tier members), the upper-tier members increase their bases in the shares of the QOF owner under § 1.1502-32(b)(2)(ii). However, there is no basis adjustment under § 1.1502-32(b)(2)(ii) or (iii) in shares of upper-tier members with regard to a basis adjustment under section 1400Z-2(c) and § 1.1400Z2(c)-1 unless and until the basis of the qualifying investment is adjusted to its fair market value, as provided in section 1400Z-2(c) and § 1.1400Z2(c)-1.
(e) Application of § 1.1502-36(d). This paragraph (e) clarifies how § 1.1502-36(d) applies if a member (M) transfers a loss share of another member (S) that is a QOF owner that owns a qualifying investment. To determine S's attribute reduction amount under § 1.1502-36(d)(3), S's basis in its qualifying investment is included in S's net inside attribute amount to compute S's aggregate inside loss under § 1.1502-36(d)(3)(iii)(A). However, S's basis in the qualifying investment is not included in S's Category D attributes available for attribute reduction under § 1.1502-36(d)(4). Thus, S's basis in the qualifying investment cannot be reduced under § 1.1502-36(d). If S's attribute reduction amount exceeds S's attributes available for reduction, then to the extent of the lesser of S's basis in the qualifying investment or the remaining attribute reduction amount, the common parent is treated as making the election under § 1.1502-36(d)(6) to reduce M's basis in the transferred loss S shares.
(f) Transition relief —(1) Overview. This paragraph (f) provides options for elective relief to pre-existing QOF subs. An election under this paragraph (f) is made in the manner provided in paragraph (h)(3) of this section. If a timely election under this paragraph (f) is not made, the pre-existing QOF sub is treated as deconsolidating on March 13, 2020.
(2) Reclassification election —(i) In general. For each pre-existing QOF sub of a consolidated group, the consolidated group may make one of the alternative, irrevocable elections provided in paragraphs (f)(2)(ii) through (iv) of this section. All elective relief provided in this paragraph (f)(2) is effective on day one.
(ii) Treatment as a QOF partnership —(A) Election. A consolidated group may elect to treat a pre-existing QOF sub as a QOF partnership (electing QOF partnership). To be eligible for the election in this paragraph (f)(2)(ii)(A), a pre-existing QOF sub must have converted to an entity treated as a partnership for Federal income tax purposes as of the election date.
(B) Effect of the QOF partnership election. As a result of making the election under this paragraph (f)(2)(ii), the pre-existing QOF sub is treated as a QOF partnership from day one. Consequently, the consolidated group must file amended or superseding returns, as applicable, to account for the electing QOF partnership's income, gain, deduction, and loss; the electing QOF partnership also must file its own partnership returns for taxable periods beginning on day one, as applicable. The electing QOF partnership must include its self-certification under § 1.1400Z2(d)-1(a) with its own returns, and the self-certification will be treated as timely so long as the consolidated group filed a timely self-certification under § 1.1400Z2(d)-1(a) for the pre-existing QOF sub. In addition, appropriate adjustments must be made to account for the change in status of the electing QOF partnership from day one, including modifications to investment adjustments to the basis in members' stock made under § 1.1502-32 and adjustments to members' earnings and profits made under § 1.1502-33.
(C) Pre-existing QOF sub with single owner. If a pre-existing QOF sub is wholly owned by one member of a consolidated group, then for purposes of making the election under this paragraph (f)(2)(ii), the electing QOF partnership is deemed to have had a nominal partner from day one until the date the electing QOF partnership is treated as a partnership for Federal income tax purposes without regard to this paragraph (f)(2)(ii).
(D) Example. The following example illustrates the election under this paragraph (f)(2)(ii).
( 1 ) Facts. P, the common parent of a consolidated group (P group), wholly owns M1 and M2. On July 1, 2018, M1 and M2 each sell an asset to an unrelated party and realize $70x and $30x of eligible gain, respectively. On August 13, 2018, M1 and M2 form Q12 (a QOF C corporation that was formed as a corporation under state law). Also on August 13, 2018, M1 and M2 contribute $70x and $30x, respectively, to Q12 in exchange for stock of Q12 and properly elect to defer their respective eligible gains under section 1400Z-2(a) and § 1.1400Z2(a)-1. The P group also makes a timely self-certification under § 1.1400Z2(d)-(1)(a) for Q12. Following March 13, 2020, the P group intends to timely elect under this paragraph (f)(2)(ii) to treat Q12 as a QOF partnership.
( 2 ) Analysis —( i ) Eligibility to elect. For the P group to elect to treat Q12 as a QOF partnership under this paragraph (f)(2)(ii), by the date of the election, Q12 must either convert to a state law partnership or another entity treated as a partnership for Federal income tax purposes.
( ii ) Consequences of the election. As a result of making the election under this paragraph (f)(2)(ii), Q12 is treated as a QOF partnership from August 13, 2018 (day one). The P group must file amended or superseding returns, as applicable and as necessary, to account for Q12's income, gain, deduction, and loss. In addition, Q12 must file its own returns for the taxable period beginning on August 13, 2018, as applicable. The returns must be filed within the time frame provided in paragraph (h)(3)(iii) of this section. Finally, because the P group filed a timely self-certification under § 1.1400Z2(d)-(1)(a) for Q12 as a QOF C corporation, Q12's self-certification as a QOF partnership would be is considered timely filed.
( 3 ) Deemed nominal partner —( i ) Facts. The facts are the same as in paragraph (f)(2)(iii)(D)( 1 ) of this section, except that on July 1, 2018, only M1 sells an asset to an unrelated party and realizes $70x of eligible gain. On August 13, 2018, M1 contributes cash of $70x to Q12 in exchange for stock of Q12 and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. As of the date the election is made to treat Q12 as a partnership from day one, a second party invests in Q12, and Q12 is an entity treated as a partnership for Federal income tax purposes.
( ii ) Analysis. The analysis is generally the same as in paragraph (f)(2)(iii)(D)( 2 ) of this section. In addition, because Q12 is wholly owned by M1, solely for purposes of treating Q12 as a QOF partnership from August 13, 2018, Q12 is deemed to have a nominal partner from August 13, 2018 until the election date or the date Q12 qualifies as a partnership, if earlier.
(iii) Treatment as a non-member QOF C corporation —(A) Election. A consolidated group may elect to treat a pre-existing QOF sub as a QOF C corporation that is not a member of the consolidated group.
(B) Effect of the non-member QOF C corporation election. As a result of making the election under this paragraph (f)(2)(iii), the pre-existing QOF sub is treated as not being a member of the consolidated group from day one. Consequently, the consolidated group must file amended or superseding returns, as applicable, to exclude all of the pre-existing QOF sub's income, gain, deduction, and loss from the consolidated returns; the pre-existing QOF sub also must file its own returns for taxable periods beginning on day one, as applicable. In addition, all adjustments resulting from the pre-existing QOF sub's operations must be eliminated from the consolidated group, including investment adjustments made under § 1.1502-32 to basis in members' stock (as well as stock in the pre-existing QOF sub) and adjustments made under § 1.1502-33 to members' earnings and profits.
(iv) Treatment as a non-QOF C corporation —(A) Election. A consolidated group may elect to treat a pre-existing QOF sub as if it never self-certified to be a QOF pursuant to § 1.1400Z2(d)-1.
(B) Effect of the non-QOF C corporation election. As a result of making the election under this paragraph (f)(2)(iv), the pre-existing QOF sub is treated from day one as a member of the consolidated group and not as a QOF. Therefore, section 1400Z-2 is not applicable, and amended returns or superseding returns must be filed, as applicable, to account for the eligible gain that was invested in the pre-existing QOF sub. In addition, appropriate adjustments must be made to account for the non-applicability of section 1400Z-2, including adjustments to members' stock basis and earnings and profits under §§ 1.1502-32 and 1.1502-33, respectively.
(3) Election to continue treating pre-existing QOF sub as a member of the consolidated group —(i) Election. A consolidated group may elect to have a pre-existing QOF sub retain its QOF status and remain a member of the consolidated group.
(ii) Effects of electing to remain a QOF and a member of the consolidated group. As a result of making the election under this paragraph (f)(3), the conditions and effects provided in § 1.1504-3(b)(2) and paragraph (b)(1) of this section will apply to the pre-existing QOF sub and the consolidated group as of the effective date of this election. See paragraph (h)(1) of this section for the effective date of this election, and see paragraph (h)(3)(iii) of this section regarding the timing for meeting the requirements in § 1.1504-3(b)(2)(ii).
(g) Deconsolidation rules —(1) In general. This paragraph (g) provides rules applicable on any deconsolidation of a QOF C corporation (deconsolidating QOF).
(2) Deconsolidation and inclusion event. A deconsolidation event is not an inclusion event unless the deconsolidation is the result of an actual transfer of the QOF member stock or a worthlessness event within the meaning of § 1.1502-80(c). For example, when a consolidated group fails to meet the conditions in § 1.1504-3(b)(2) of this section and causes a QOF member to deconsolidate, the deconsolidation event is not an inclusion event solely as a result of the consolidated group's failure to meet the requirements in § 1.1504-3(b)(2) of this section.
(3) Basis in the deconsolidating QOF at time of deconsolidation —(i) ELA in a deconsolidating QOF. Any ELA in stock of the deconsolidating QOF at the time of the deconsolidation is taken into account under the rules of § 1.1502-19. See paragraph (b)(1)(iii) of this section for rules coordinating the application of section 1400Z-2(c) with § 1.1502-19.
(ii) Positive basis in the deconsolidating QOF resulting from § 1.1502-32. Consolidated group members retain any positive basis in the deconsolidating QOF resulting from investment adjustments under § 1.1502-32 following its deconsolidation. However, following the deconsolidation, for purposes of determining the amount includible under § 1.1400Z2(b)-1(e), the amount of basis referred to in section 1400Z-2(b)(2)(A)(ii) is computed by applying only those rules applicable to corporations that do not file a consolidated return (that is, the basis rules under subchapter C and section 1400Z-2). Therefore, any positive basis resulting from § 1.1502-32 adjustments is not taken into account in computing the amount includable under § 1.1400Z2(b)-1(e).
(4) Deconsolidating QOF's earnings and profits —(i) Deconsolidation on or before December 31, 2026. Notwithstanding § 1.1502-33(e)(1), if a deconsolidating QOF deconsolidates before December 31, 2026, the deconsolidating QOF retains its earnings and profits under this paragraph (g)(4)(i). Any earnings and profits of the deconsolidating QOF that were taken into account by any other members under § 1.1502-33 are eliminated from those members as of the end of the day on which the deconsolidating QOF deconsolidates.
(ii) Deconsolidation after December 31, 2026. If the deconsolidating QOF deconsolidates after December 31, 2026, the rules under § 1.1502-33(e) apply.
(5) Consequences under § 1.1502-36. See § 1.1502-36(f)(10)(i)(B) for the treatment of a deconsolidation as a transfer of all of the stock in the deconsolidating member held by other members of the consolidated group.
(h) Form and manner of making an election under this section —(1) In general. The elections provided in this section are irrevocable. The information required for each election is provided in this paragraph (h). A reclassification election under paragraph (f)(2) of this section is effective as of day one. All other elections are effective on the election date.
(2) Election under paragraph (c)(2) of this section to treat investment by M2 as qualifying investment by M1 —(i) Form of election. The election under paragraph (c)(2) of this section must be made in the form of a statement titled “THIS IS AN ELECTION UNDER § 1.1502-14Z(c)(2) TO TREAT AN INVESTMENT BY [insert name and employer identification number (E.I.N.) of M2] AS A QUALIFYING INVESTMENT BY [insert name and E.I.N. of M1].” The statement must be included with the consolidated group's timely filed return (original, superseding, or amended return, as applicable, including extensions). In addition, the statement must include the information required under paragraph (h)(2)(ii) of this section.
(ii) Required information. (A) The amount of M1's eligible gain;
(B) The amount of the investment M2 has made in a QOF, including identification of the amount of the investment that is eligible for treatment as a qualifying investment under paragraph (c)(2) of this section and the amount (if any) that is not eligible for such treatment; and
(C) The date on which M1 recognized its eligible gain, and the date on which M2 made the investment in the QOF.
(3) Elections under paragraph (f) of this section for transition relief —(i) Form of election. The elections under paragraph (f) of this section must be made in the form of a statement titled “THIS IS AN ELECTION UNDER § 1.1502-14Z(f) FOR [insert name and E.I.N. of pre-existing QOF sub].” All actions necessary to make these elections, including the filing of an amended return (or superseding return, as applicable), or filing an original return, as applicable, must be completed within the time designated in paragraph (h)(3)(iii) of this section. The statement must be included on or with any amended prior-year consolidated return (or superseding or original return, as applicable) and on or with the consolidated group's timely filed return (original or amended if filed by the due date for the return, including extensions) for the election year. In addition, the statement must include the information required in paragraph (h)(3)(ii) of this section.
(ii) Required information —(A) Reclassification election under paragraph (f)(2)(ii) of this section. ( 1 ) A statement that the pre-existing QOF sub is electing to be a QOF partnership;
( 2 ) The election date;
( 3 ) The effective date of the election;
( 4 ) Specification of the appropriate adjustments required under paragraph (f)(2)(ii) of this section made by the pre-existing QOF sub and the consolidated group; and
( 5 ) Certification that the appropriate change under state law or the entity classification election under § 301.7701-3 of this chapter (as applicable) has been made, and the date of the change or entity classification election.
(B) Reclassification election under paragraph (f)(2)(iii) or (iv) of this section. ( 1 ) A statement that the pre-existing QOF sub is changing its status;
( 2 ) The pre-existing QOF sub's new status (either a non-member QOF C corporation, under paragraph (f)(2)(iii) of this section, or a non-QOF C corporation, under paragraph (f)(2)(iv) of this section);
( 3 ) The election date;
( 4 ) The effective date of the election; and
( 5 ) Specification of the appropriate adjustments made the by pre-existing QOF sub and the consolidated group pursuant to paragraph (f)(2)(iii) or (iv) of this section, as applicable.
(C) Election to continue treating the pre-existing QOF sub as a subsidiary member of the consolidated group under paragraph (f)(3) of this section. ( 1 ) A statement that the pre-existing QOF sub is electing to retain its status as a QOF C corporation and remain a member of the consolidated group;
( 2 ) The election date; and
( 3 ) Certification that the pre-existing QOF sub and the consolidated group are in compliance with the conditions under § 1.1504-3(b)(2)(ii) as of the date that the pre-existing QOF sub and the consolidated group are in compliance with the conditions under § 1.1504-3(b)(2)(ii).
(iii) Time for completing the elections under paragraph (f) of this section. (A) If the pre-existing QOF sub is making an election under paragraph (f)(2)(ii) or (f)(3) of this section, all actions necessary to make such election must be completed by April 13, 2020. Specifically, if the pre-existing QOF sub is making the election under paragraph (f)(3) of this section, the conditions in § 1.1504-3(b)(2)(ii) must be met by April 13, 2020. In addition, the consolidated group's amended return (or superseding return, as applicable), taking into account the relevant changes, if applicable, must be filed by May 12, 2020. Moreover, if the electing QOF partnership had been a QOF partnership on day one and the electing QOF partnership's return would have been due, then such return also must be filed by May 12, 2020.
(B) If the pre-existing QOF sub is making a reclassification election under paragraph (f)(2)(iii) or (iv) of this section, all actions necessary to make such election, including the filing of the pre-existing QOF sub's own return (if the return would have been due had the pre-existing QOF sub not been included in the consolidated group on day one), and the consolidated group's amended return (or superseding return, as applicable), if applicable, must be completed by April 13, 2020.
(iv) Extension of statute of limitations. If, as a result of making a reclassification election in paragraph (f)(2) of this section, the consolidated group is required to file an amended return, and the electing QOF partnership is required to file a return by May 12, 2020 or the pre-existing QOF sub is required to file a return by April 13, 2020 (collectively, the related returns), then the consolidated group (and the pre-existing QOF sub, if an election under paragraph (f)(2)(iii) of this section is made) also must consent to extend the period of limitations on assessment with respect to any issues arising under section 1400Z-2 in the related returns of the consolidated group (and the pre-existing QOF sub, if applicable). This consent must be effected at such time and in such form and manner as may be prescribed by the Commissioner of Internal Revenue in Internal Revenue Service forms or instructions or in publications or guidance published in the Internal Revenue Bulletin (see §§ 601.601(d)(2) and 601.602 of this chapter).
(i) [Reserved]
(j) Examples. The following examples illustrate the rules of this section. For purposes of these examples, and unless otherwise stated: P is the common parent of the P consolidated group (P group); S, B, and M are members of the P group; Q is a QOF C corporation that is not a member of the P group; and X is an unrelated party.
(1) Example 1: Distribution by a QOF member and inclusion events —(i) Facts. P wholly owns S. In 2018, S sells an asset to an unrelated party and realizes $500x of eligible gain. S forms a new QOF C corporation Q2, contributes $500x to Q2 in exchange for stock of Q2, and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. The P group elects under § 1.1504-3(b)(2) to consolidate Q2. In 2024, Q2 distributes $20x to S when S's basis in Q2 is $50x, the value of Q2 exceeds $500x, and Q2 has no earnings and profits. There are no other events in 2024 that result in investment adjustments to Q2 stock.
(ii) Analysis. Under §§ 1.1502-13(f)(2) and 1.1502-32, the intercompany distribution from Q2 to S of $20x reduces S's basis in Q2 to $30x ($50x−$20x). Under paragraph (b)(1)(i) of this section, because the distribution does not create or increase an ELA in Q2 stock, the distribution is not an inclusion event.
(iii) Distribution that creates an ELA. The facts are the same as in paragraph (j)(1)(i) of this section except that in 2024 Q2 distributes $70x to S. Under §§ 1.1502-13(f)(2) and 1.1502-32, the intercompany distribution from Q2 to S of $70x reduces S's basis in Q2 to $0 and creates an ELA of $20x ($50x−$70x). Under paragraph (b)(1)(i) of this section, because an ELA is created in Q2's stock, the distribution is an inclusion event to the extent of the increase in the ELA. S therefore includes $20x of its deferred gain into income in 2024. See § 1.1400Z2(b)-1(e)(2). In addition, under § 1.1400Z2(b)-1(g)(1)(ii), the adjustment to S's basis in Q2 under section 1400Z-2(b)(2)(B)(ii) is applied before determining the other Federal income tax consequences of the distribution. Therefore, as a result of the inclusion event, S's basis in Q2 is first increased to $70x ($50x + $20x), and then S's basis in Q2 is reduced by $70x (the amount of the distribution) to $0 under § 1.1502-32.
(2) Example 2: Basis adjustment when member owns qualifying QOF stock —(i) Facts. P wholly owns S. In 2018, S sells an asset to an unrelated party and realizes $500x of eligible gain. S contributes $500x to Q in exchange for stock of Q and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. S does not otherwise own stock in Q. In 2026, the fair market value of S's qualifying investment in Q exceeds $500x. In 2029, when S still owns its qualifying investment in Q, P sells all of the stock of S to X. S retains its stock in Q.
(ii) Analysis —(A) Five-year and seven-year basis increase and § 1.1502-32 tier-up. In 2023, when S has held the stock of Q for five years, under section 1400Z-2(b)(2)(B)(iii), S increases its basis in its Q stock by $50x (10 percent of $500x, the amount of gain deferred by reason of section 1400Z-2(a)(1)(A)). The 10-percent basis increase qualifies as tax-exempt income to S under paragraph (d) of this section. Thus, P (an upper-tier member) increases its basis in S's stock by $50x under § 1.1502-32(b)(2)(ii). Similarly, in 2025, when S has held the stock of Q for seven years, under section 1400Z-2(b)(2)(B)(iv), S increases its basis in its Q stock by an additional $25x (5 percent of $500x). The 5-percent basis increase also qualifies as tax-exempt income to S under paragraph (d) of this section, and P increases its basis in S's stock by an additional $25x under § 1.1502-32(b)(2)(ii).
(B) S's recognition of deferred capital gain in 2026. S did not dispose of its Q stock prior to December 31, 2026. Therefore, under section 1400Z-2(b)(1)(B) and § 1.1400Z2(b)-1(b)(2), S's remaining deferred gain is included in S's income on December 31, 2026. The amount of gain included under section 1400Z-2(b)(2)(A) and § 1.1400Z2(b)-1(e)(3) is $425x ($500x of remaining deferred gain less S's $75x basis in Q). S's basis in Q is increased by $425x to $500x, and P's basis in S also is increased by $425x under § 1.1502-32(b)(2)(i).
(C) P's disposition of S. P's sale of S stock in 2029 results in the deconsolidation of S. S retains its Q stock, and S is not treated as selling or exchanging its Q stock for purposes of section 1400Z-2(c). Therefore, no basis adjustments under section 1400Z-2 are made as a result of P's sale of S stock.
(iii) S sells the stock of Q after 10 years. The facts are the same as in paragraph (j)(2)(i) of this section, except that in 2029, instead of P selling all of the stock of S, S sells all of the stock of Q to X for its fair market value of $800x. At the time of the sale, S has owned the Q stock for over 10 years, and S elects under section 1400Z-2(c) to adjust its stock basis in Q from $500x (see the analysis in paragraph (j)(2)(ii)(B) of this section) to $800x, the fair market value of Q on the date of the sale. As a result of the election, S has no gain on the sale of Q stock. Additionally, the $300x basis increase in Q is treated as tax-exempt income to S pursuant to paragraph (d) of this section. Thus, P increases its basis in P's S stock by $300x under § 1.1502-32(b)(2)(ii).
(3) Example 3: Intercompany sale of qualifying investment —(i) Facts. In 2018, S sells an asset to an unrelated party and realizes $100x of eligible gain. Also in 2018, S contributes $100x to Q in exchange for Q stock and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. S does not otherwise own stock in Q. In 2021, S sells all of its Q stock to B for $250x in a fully taxable transaction. In 2026, the fair market value of Q is $300x. In 2030, B sells the Q stock to X for $800x.
(ii) Analysis —(A) Intercompany sale treated as an inclusion event. In 2021, S's sale of its Q stock to B is an inclusion event under section 1400Z-2(b)(1) and § 1.1400Z2(b)-1(c). The amount includible pursuant to § 1.1400Z2(b)-1(e)(1) is $100x (the lesser of the remaining deferred gain of $100x and the fair market value of the qualifying investment of $250x, over S's basis in Q, $0). As a result of the inclusion, S's basis in Q increases from $0 to $100x and S also realizes a capital gain of $150x ($250x of amount realized less its $100x basis in the Q stock) from the intercompany sale of Q to B. Because S's sale of its Q stock to B is a fully taxable transaction, paragraph (c)(3)(ii) of this section applies to treat the sale as an intercompany transaction and S's intercompany gains are taken into account under § 1.1502-13(c)(2)(ii). Thus, S defers the inclusion of its $100x of remaining deferred gain and its $150x of capital gain in 2021. B has a $250x basis in its Q stock.
(B) Five-year basis increase in 2023. Pursuant to paragraph (c)(3)(ii) of this section, S and B are treated as divisions of a single entity for purposes of applying section 1400Z-2. In 2023, the single entity would have held the QOF investment for five years and its basis in Q would be increased to $10x ($100x × 10%) under section 1400Z-2(b)(2)(B)(iii). To achieve this single entity result, $10x of S's $100x of remaining deferred gain is redetermined to be tax-exempt income. See § 1.1502-13(c)(1); see also paragraph (c)(3)(ii)(B) of this section making § 1.1502-13(c)(6)(ii) inapplicable in determining the excludability of S's intercompany gain. Therefore, in 2023, S is treated as having $10x of tax-exempt income, S's remaining deferred gain is $90x ($100x−$10x), while B's basis in Q remains $250x.
(C) Seven-year basis increase in 2025. The same analysis in paragraph (j)(3)(ii)(B) of this section applies for the year 2025. Therefore, in 2025, S is treated as having $5x ($100x × 5%) of tax-exempt income, S's remaining deferred gain is $85x ($90x−$5x), and B's basis in Q remains $250x.
(D) Inclusion of S's remaining deferred gain in 2026. B continues to own the Q stock through 2026, and, treating S and B as divisions of a single entity for purposes of section 1400Z-2, the single entity would include its remaining deferred gain in income on December 31, 2026. See section 1400Z-2(b)(1), § 1.1400Z2(b)-1(b). On a single-entity basis, the amount includible pursuant to § 1.1400Z2(b)-1(e) is $85x (the lesser of the remaining deferred gain of $100x and the fair market value of the qualifying investment of $300x, over the single entity's basis in Q, $15x). B does not otherwise have an income event with respect to its Q stock in 2026. Therefore, under § 1.1502-13(c), all $85x of S's remaining deferred gain is taken into account in 2026. In addition, S's $150x of capital gain on its Q stock sale continues to be deferred, and B's basis in Q remains $250x.
(E) B sells the Q stock in 2030. In 2030, B sells all its Q stock to X for $800x. Under paragraph (c)(3)(ii)(D) of this section, B is entitled to make the election under section 1400Z-2(c) if, treating S and B as a single entity, the single entity would be eligible to make the election. Taking into account S's holding period, B has held Q for over 10 years, and B is eligible for the election when it sells Q to X in 2030. B makes the section 1400Z-2(c) election at the time of sale. Following the election, if S and B were divisions of a single entity, the single entity's basis in Q would increase from $100x to its fair market value of $800x, causing to be excluded the $700x of gain on the sale of Q stock. To achieve this single entity result, § 1.1502-13(c)(1) redetermines B's $550x ($800x−$250x) of gain and S's deferred $150x of capital gain to be tax-exempt income. See paragraph (c)(3)(ii)(B) of this section making § 1.1502-13(c)(6)(ii) inapplicable in determining the excludability of S's intercompany gain. Therefore, as a result of the sale of the Q stock and B making the section 1400Z-2(c) election, S has $150x of tax-exempt income, and B has $550x of tax-exempt income.
(4) Example 4: Intercompany sale of qualifying investment followed by sale of QOF at a loss outside of the consolidated group —(i) Facts. The facts are the same as in paragraph (j)(3)(i) of this section, except that in 2030, B sells the stock of Q for $225x to X.
(ii) Analysis. The analysis for tax years prior to 2030 is the same as in paragraphs (j)(3)(ii)(A) through (D) of this section. In addition, applying the analysis in paragraph (j)(3)(ii)(E) of this section, B is entitled to make the election under section 1400Z-2(c) and B makes the election. Following the election, if S and B were divisions of a single entity, the single entity's basis in Q would increase from $100x to $225x, causing to be excluded the $125x of gain on the sale of Q stock. To achieve this single entity result, § 1.1502-13(c)(1) redetermines B's $25x ($225x−$250x) of loss to be a noncapital, nondeductible expense and S's deferred $150x of capital gain to be tax-exempt income. Therefore, as a result of the sale of Q stock and B making the section 1400Z-2 election, S has $150x of tax-exempt income, and B has $25x of noncapital, nondeductible expense.
(5) Example 5: Intercompany section 351 transfer of qualifying investment —(i) Facts. In 2018, M sells an asset to an unrelated party and realizes $100x of eligible gain. Also in 2018, M contributes $100x to Q in exchange for Q stock and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. M does not otherwise own stock in Q. In 2021, when the value of Q is $200x, M contributes all of its Q stock to S in exchange for S stock in a transaction that qualifies under section 351.
(ii) Analysis. In 2021, M's contribution of its Q stock to S is an inclusion event under section 1400Z-2(b)(1) and § 1.1400Z2(b)-1(c). The amount includible pursuant to § 1.1400Z2(b)-1(e) is $100x (the lesser of the remaining deferred gain of $100x and the fair market value of the qualifying investment of $200x, over S's basis in Q, $0). Because M's contribution of its Q stock to S is not a fully taxable transaction, the general rule in paragraph (c)(3)(i) of this section applies to treat the contribution as not an intercompany transaction for purposes of applying section 1400Z-2, and § 1.1502-13 does not apply to treat M and S as a single entity for purposes of section 1400Z-2. Thus, as a result of the transfer, M takes its $100x of remaining deferred gain into account, M's basis in S is $100x, and S's basis in Q is $100x.
(6) Example 6: Intercompany sale of qualifying investment followed by a tax-free transfer of the qualifying investment —(i) Section 351 transfer to another member of the consolidated group —(A) Facts. In 2018, S sells an asset to an unrelated party and realizes $100x of eligible gain. Also in 2018, S contributes $100x to Q in exchange for Q stock and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. S does not otherwise own stock in Q. In 2021, when the fair market value of the Q stock is $250, S sells all of its Q stock to B for $250x in a fully taxable transaction. In 2024, B transfers all its Q stock to another member of the P group, B2, in a section 351 transaction. At such time, the fair market value of the Q stock is $300x.
(B) Analysis —( 1 ) Intercompany sale in 2021. In 2021, S's sale of its Q stock to B is an inclusion event under section 1400Z-2(b)(1) and § 1.1400Z2(b)-1(c). The amount includible pursuant to § 1.1400Z2(b)-1(e) is $100x (the lesser of the remaining deferred gain of $100x and the fair market value of the qualifying investment of $250x, over S's basis in Q, $0). As a result of the inclusion, S's basis in its Q stock increases from $0 to $100x and S also realizes a capital gain of $150x ($250x of amount realized less its $100x basis in the Q stock) from the intercompany sale of the Q stock to B. Because S's sale of its Q stock to B is a fully taxable transaction, paragraph (c)(3)(ii) of this section applies to treat the sale as an intercompany transaction. Therefore, S's intercompany gains are taken into account under § 1.1502-13(c) and (d). Thus, S defers the inclusion of its $100x of remaining deferred gain and its $150x of capital gain in 2021. B has a $250x basis in its Q stock.
( 2 ) Five-year basis increase in 2023. Pursuant to paragraph (c)(3)(ii) of this section, S and B are treated as divisions of a single entity for purposes of applying section 1400Z-2. In 2023, the single entity has held the QOF investment for five years and its basis in the Q stock would be increased to $10x ($100x × 10%) under section 1400Z-2(b)(2)(B)(iii). To achieve this single entity result, $10x of S's $100x of remaining deferred gain is redetermined to be tax-exempt income. See § 1.1502-13(c)(1); see also paragraph (c)(3)(ii)(B) of this section making § 1.1502-13(c)(6)(ii) inapplicable in determining the excludability of S's intercompany gain. Therefore, in 2023, S is treated as having $10x of tax-exempt income, S's remaining deferred gain is $90x ($100x−$10x), and B's basis in the Q stock remains $250x.
( 3 ) Intercompany transfer in a section 351 transaction. In 2024, B's contribution of its Q stock to B2, a member of the P group, is an inclusion event under section 1400Z-2(b)(1) and § 1.1400Z2(b)-1(c). The amount includible pursuant to § 1.1400Z2(b)-1(e) is $90x (the remaining deferred gain as determined in paragraph (j)(6)(i)(B) of this section). Because B's contribution of its Q stock to B2 is not a fully taxable transaction, the general rule in paragraph (c)(3)(i) of this section applies to prevent the contribution from being treated as an intercompany transaction for purposes of section 1400Z-2. As a result, for purposes of section 1400Z-2, § 1.1502-13 does not apply to treat B and B2 as a single entity, and the application of § 1.1502-13(j) is adjusted accordingly. As a result of the section 351 transfer, S takes its $90x of remaining deferred gain into account. B's basis in its B2 stock is $250x, and B's basis in its Q stock is $250x. However, because S's $150x of capital gain from the intercompany sale of its Q stock to B in 2021 is not an item related to section 1400Z-2, it continues to be deferred under § 1.1502-13 because B2 is a member of the P group. See § 1.1502-13(j)(4) regarding successive intercompany transactions.
(ii) Section 351 transfer to a non-member —(A) Facts. The facts are the same as in paragraph (j)(6)(i)(A) of this section, except that B2 is not a member of the P group, and B contributes all its Q stock to B2 in a transaction that qualifies under section 351.
(B) Analysis —( 1 ) Intercompany sale in 2021 and five-year basis increase in 2023. The analysis for the 2021 and 2023 tax years are the same as in paragraphs (j)(6)(i)(B)( 1 ) and ( 2 ) of this section.
( 2 ) Transfer of Q to a non-member in a section 351 transaction. In 2024, B's contribution of its Q stock to B2, a non-member of the P group, is an inclusion event under section 1400Z-2(b)(1) and § 1.1400Z2(b)-1(c). The amount includible pursuant to § 1.1400Z2(b)-1(e) is $90x (the remaining deferred gain as determined in paragraph (j)(6)(ii)(B)(1) of this section). S's deferred capital gain of $150x is taken into account in 2024 under the acceleration rule of § 1.1502-13(d) because the Q stock has left the P group. B2's holding period for the qualifying investment does not include the time during which B and S held the qualifying investment.
(iii) Section 721(a) transfer to a partnership —(A) Facts. The facts are the same as in paragraph (j)(6)(i)(A) of this section, except that B2 is a partnership, and an unrelated party is the other partner in B2. B's transfer of all of its Q stock to B2 qualifies for non-recognition treatment under section 721(a). In 2026, the fair market value of Q is $330x.
(B) Analysis —( 1 ) Intercompany sale in 2021 and five-year basis increase in 2023. The analysis for the 2021 and 2023 tax years are the same as in paragraphs (j)(6)(i)(B)( 1 ) and ( 2 ) of this section.
( 2 ) Transfer of Q stock to a partnership in a section 721(a) transaction. In 2024, B transfers its Q stock to B2, a partnership, in a section 721(a) transaction. Although a section 721(a) transaction is not an inclusion event under § 1.1400Z2(b)-1(c)(7), under the acceleration rule of § 1.1502-13(d), S must take into account its $90x of remaining deferred gain because B2 has benefited from an increased basis in the Q stock as a result of the intercompany sale between S and B such that this is the appropriate time to take the remaining deferred gain into account. S's deferred capital gain of $150x is taken into account in 2024 for the same reason.
(7) Example 7: Computation and application of the attribute reduction amount under § 1.1502-36(d) when S owns a QOF —(i) Facts. In 2018, S sells an asset to an unrelated party and realizes $5,000x of eligible gain. S contributes $5,000x to Q in exchange for stock of Q and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. In 2024, M sells all of its S stock to X for its fair market value of $100x, and M's basis in the stock of S is $300x. At the time of sale, S owns the Q stock with a basis of $500x (S's basis in its Q stock was increased under section 1400Z-2(b)(2)(B)(iii) to $500x in 2023), and S has a net operating loss carryover of $50x. M's transfer of the S shares is a transfer of loss shares under § 1.1502-36. Assume that no basis redetermination is required under § 1.1502-36(b) and no basis reduction is required under § 1.1502-36(c).
(ii) Attribute reduction under § 1.1502-36(d). Under § 1.1502-36(d), S's attributes are reduced by S's attribute reduction amount. Section 1.1502-36(d)(3) provides that S's attribute reduction amount is the lesser of the net stock loss and S's aggregate inside loss. The net stock loss is the excess of the $300x aggregate basis of the transferred S shares over the $100x aggregate value of those shares, or $200x. S's aggregate inside loss, which includes the basis of the stock of Q as provided by paragraph (e) of this section, is the excess of S's net inside attribute amount over the value of the S share. S's net inside attribute amount is $550x, computed as the sum of S's $50x loss carryover and its $500x basis in Q. S's aggregate inside loss is therefore $450x ($550x net inside attribute amount over the $100x value of the S share). Accordingly, S's attribute reduction amount is the lesser of the $200x net stock loss and the $450x aggregate inside loss, or $200x. Under § 1.1502-36(d)(4), S's $200x attribute reduction is first allocated and applied to reduce S's $50x loss carryover to $0. Under § 1.1502-36(d)(4)(i)(D), S generally would be able to reduce the basis of its category D assets (including stock in other corporations) by the remaining attribute reduction amount ($150x). However, paragraph (e) of this section provides that S's basis in the stock of Q is not included in S's Category D attributes that are available for reduction under § 1.1502-36(d)(4), and the remaining $150x of attribute reduction amount cannot be used to reduce the basis of Q shares under § 1.1502-36(d). Rather, under paragraph (e) of this section, P is treated as making the election under § 1.1502-36(d)(6) to reduce M's basis in the transferred loss S shares by $150x. As a result, P's basis in its M stock is also reduced by $150x.
(k) Applicability dates —(1) In general. This section applies for taxable years beginning after March 13, 2020.
(2) Prior periods. With respect to the portion of a consolidated group's first taxable year ending after December 21, 2017, and for taxable years beginning after December 21, 2017, and on or before March 13, 2020, a consolidated group may choose either—
(i) To apply the section 1400Z-2 regulations, if applied in a consistent manner for all such taxable years; or
(ii) To rely on the rules in proposed § 1.1400Z2(g)-1 contained in the notice of proposed rulemaking (REG-120186-18) published on May 1, 2019, but only if applied in a consistent manner for all such taxable years.
§ 1.1502-15   SRLY limitation on built-in losses.
(a) SRLY limitation. Except as provided in paragraph (f) of this section (relating to built-in losses of the common parent) and paragraph (g) of this section (relating to an overlap with section 382), built-in losses are subject to the SRLY limitation under §§ 1.1502-21(c) and 1.1502-22(c) (including applicable subgroup principles). Built-in losses are treated as deductions or losses in the year recognized, except for the purpose of determining the amount of, and the extent to which the built-in loss is limited by, the SRLY limitation for the year in which it is recognized. Solely for such purpose, a built-in loss is treated as a hypothetical net operating loss carryover or net capital loss carryover arising in a SRLY, instead of as a deduction or loss in the year recognized. To the extent that a built-in loss is allowed as a deduction under this section in the year it is recognized, it offsets any consolidated taxable income for the year before any loss carryovers or carrybacks are allowed as a deduction. To the extent not so allowed, it is treated as a separate net operating loss or net capital loss carryover or carryback arising in the year of recognition and, under § 1.1502-21(c) or 1.1502-22(c), the year of recognition is treated as a SRLY.
(b) Built-in losses —(1) Defined. If a corporation has a net unrealized built-in loss under section 382(h)(3) (as modified by this section) on the day it becomes a member of the group (whether or not the group is a consolidated group), its deductions and losses are built-in losses under this section to the extent they are treated as recognized built-in losses under section 382(h)(2)(B) (as modified by this section). This paragraph (b) generally applies separately with respect to each member, but see paragraph (c) of this section for circumstances in which it is applied on a subgroup basis.
(2) Operating rules. Solely for purposes of applying paragraph (b)(1) of this section, the principles of § 1.1502-94(c) apply with appropriate adjustments, including the following:
(i) Stock acquisition. A corporation is treated as having an ownership change under section 382(g) on the day the corporation becomes a member of a group, and no other events (e.g., a subsequent ownership change under section 382(g) while it is a member) are treated as causing an ownership change.
(ii) Asset acquisition. In the case of an asset acquisition by a group, the assets and liabilities acquired directly from the same transferor (whether corporate or non-corporate, foreign or domestic) pursuant to the same plan are treated as the assets and liabilities of a corporation that becomes a member of the group (and has an ownership change) on the date of the acquisition.
(iii) Recognized built-in gain or loss. A loss that is included in the determination of net unrealized built-in gain or loss and that is recognized but disallowed or deferred (e.g., under § 1.337(d)-2, § 1.1502-35, § 1.1502-36, or section 267) is not treated as a built-in loss unless and until the loss would be allowed during the recognition period without regard to the application of this section. Section 382(h)(1)(B)(ii) does not apply to the extent it limits the amount of recognized built-in loss that may be treated as a pre-change loss to the amount of the net unrealized built-in loss.
(c) Built-in losses of subgroups —(1) In general. In the case of a subgroup, the principles of paragraph (b) of this section apply to the subgroup, and not separately to its members. Thus, the net unrealized built-in loss and recognized built-in loss for purposes of paragraph (b) of this section are based on the aggregate amounts for each member of the subgroup.
(2) Members of subgroups. A subgroup is composed of those members that have been continuously affiliated with each other for the 60 consecutive month period ending immediately before they become members of the group in which the loss is recognized. A member remains a member of the subgroup until it ceases to be affiliated with the loss member. For this purpose, the principles of § 1.1502-21(c)(2)(iv) through (vi) apply with appropriate adjustments.
(3) Coordination of 60 month affiliation requirement with the overlap rule. If one or more corporations become members of a group and are included in the determination of a net unrealized built-in loss that is subject to the overlap rule described in paragraph (g)(1) of this section, then for purposes of paragraph (c)(2) of this section, such corporations that become members of the group are treated as having been affiliated for 60 consecutive months with the common parent of the group and are also treated as having been affiliated with any other members who have been affiliated or are treated as having been affiliated with the common parent at such time. The corporations are treated as having been affiliated with such other members for the same period of time that those members have been affiliated or are treated as having been affiliated with the common parent. If two or more corporations become members of the group at the same time, but this paragraph (c)(3) does not apply to every such corporation, then immediately after the corporations become members of the group, and solely for purposes of paragraph (c)(2) of this section, the corporations to which this paragraph (c)(3) applies are treated as having not been previously affiliated with the corporations to which this paragraph (c)(3) does not apply. If the common parent has become the common parent of an existing group within the previous five year period in a transaction described in § 1.1502-75(d)(2)(ii) or (3), the principles of §§ 1.1502-91(g)(6) and 1.1502-96(a)(2)(iii) shall apply.
(4) Built-in amounts. Solely for purposes of determining whether the subgroup has a net unrealized built-in loss or whether it has a recognized built-in loss, the principles of § 1.1502-91(g) and (h) apply with appropriate adjustments.
(d) Examples. For purposes of the examples in this section, unless otherwise stated, all groups file consolidated returns, all corporations have calendar taxable years, the facts set forth the only corporate activity, value means fair market value and the adjusted basis of each asset equals its value, all transactions are with unrelated persons, and the application of any limitation or threshold under section 382 is disregarded. The principles of this section are illustrated by the following examples:
(ii) Under paragraph (b)(2)(i) of this section, and solely for purposes of applying paragraph (b)(1) of this section, T is treated as having an ownership change under section 382(g) on becoming a member of the P group. Under paragraph (b)(1) of this section, none of T's $55 of unrealized loss is treated as a built-in loss unless T has a net unrealized built-in loss under section 382(h)(3) on becoming a member of the P group.
(iii) Under section 382(h)(3)(A), T has a $35 net unrealized built-in loss on becoming a member of the P group (($55) + $20 = ($35)). Assume that this amount exceeds the threshold requirement in section 382(h)(3)(B). Under section 382(h)(2)(B), the entire amount of T's $55 unrealized loss is treated as a built-in loss to the extent it is recognized during the 5-year recognition period described in section 382(h)(7). Under paragraph (b)(2)(iii) of this section, the restriction under section 382(h)(1)(B)(ii), which limits the amount of recognized built-in loss that is treated as pre-change loss to the amount of the net unrealized built-in loss, is inapplicable for this purpose. Consequently, the entire $55 of unrealized loss (not just the $35 net unrealized loss) is treated under paragraph (b)(1) of this section as a built-in loss to the extent it is recognized within 5 years of T's becoming a member of the P group. Under paragraph (a) of this section, a built-in loss is subject to the SRLY limitation under § 1.1502-21(c)(1).
(iv) Under paragraph (b)(2)(ii) of this section, the built-in loss would similarly be subject to a SRLY limitation under § 1.1502-21(c)(1) if T transferred all of its assets and liabilities to a subsidiary of the P group in a single transaction described in section 351. To the extent the built-in loss is recognized within 5 years of T's transfer, all of the items contributed by the acquiring subsidiary to consolidated taxable income (and not just the items attributable to the assets and liabilities transferred by T) are included for purposes of determining the SRLY limitation under § 1.1502-21(c)(1).
(ii) Although T has an ownership change for purposes of section 382 in Year 1 and not Year 2, T's joining the P group in Year 2 is treated as an ownership change under section 382(g) solely for purposes of this section. Consequently, for purposes of this section, whether T has a net unrealized built-in loss under section 382(h)(3) is determined as if the day T joined the P group were a change date.
(ii) Under paragraph (c) of this section, P and S compose a subgroup on becoming members of the M group because P and S were continuously affiliated for the 60 month period ending immediately before they became members of the M group. Consequently, paragraph (b) of this section does not apply to P and S separately. Instead, their separately computed unrealized gains and losses are aggregated for purposes of determining whether, and the extent to which, any unrealized loss is treated as built-in loss under this section and is subject to the SRLY limitation under § 1.1502-21(c).
(iii) Under paragraph (c) of this section, the P subgroup has a net unrealized built-in loss on the day P and S become members of the M group, determined by treating the day they become members as a change date. The net unrealized built-in loss is the aggregate of P's net unrealized built-in gain of $10 and S's net unrealized built-in loss of $75, or an aggregate net unrealized built-in loss of $65. (The stock of S owned by P is disregarded for purposes of determining the net unrealized built-in loss. However, any loss allowed on the sale of the stock within the recognition period is taken into account in determining recognized loss.) Assume that the $65 net unrealized built-in loss exceeds the threshold requirement under section 382(h)(3)(B).
(iv) Under paragraphs (b)(1), (b)(2)(iii), and (c) of this section, a loss recognized during the 5-year recognition period on an asset of P or S held on the day that P and S became members of the M group is a built-in loss except to the extent the group establishes that such loss exceeds the amount by which the adjusted basis of such asset on the day the member became a member exceeded the fair market value of such asset on that same day. If P sells asset 2 for $45 in Year 7 and recognizes a $10 loss, the entire $10 loss is treated as a built-in loss under paragraphs (b)(2)(iii) and (c) of this section. If S sells asset 3 for $10 in Year 7 and recognizes an $85 loss, the entire $85 loss is treated as a built-in loss under paragraphs (b)(2)(iii) and (c) of this section (not just the $55 balance of the P subgroup's $65 net unrealized built-in loss).
(v) The determination of whether P and S constitute a SRLY subgroup for purposes of loss carryovers and carrybacks, and the extent to which built-in losses are not allowed under the SRLY limitation, is made under § 1.1502-21(c).
(iii) For Year 3, § 1.1502-21(c) limits T's $100 built-in loss and $100 net operating loss carryover from Year 1 to the aggregate of the P group's consolidated taxable income through Year 3, determined by reference to only T's items. For this purpose, consolidated taxable income is determined without regard to any consolidated net operating loss deductions under § 1.1502-21(a).
(iv) The P group's consolidated taxable income through Year 3 is $60 when determined by reference to only T's items. Under § 1.1502-21(c), the SRLY limitation for Year 3 is therefore $60.
(v) Under paragraph (a) of this section, the $100 built-in loss is treated as a current deduction for all purposes other than determination of the SRLY limitation under § 1.1502-21(c). Consequently, a deduction for the built-in loss is allowed in Year 3 before T's loss carryover from Year 1 is allowed, but only to the extent of the $60 SRLY limitation. None of T's Year 1 loss carryover is allowed because the built-in loss ($100) exceeds the SRLY limitation for Year 3.
(vi) The $40 balance of the built-in loss that is not allowed in Year 3 because of the SRLY limitation is treated as a $40 net operating loss arising in Year 3 that is carried to other years in accordance with the rules of § 1.1502-21(b). The $40 net operating loss is treated under paragraph (a) of this section and § 1.1502-21(c)(1)(ii) as a loss carryover or carryback from Year 3 that arises in a SRLY, and is subject to the rules of § 1.1502-21 (including § 1.1502-21(c)) rather than this section. See also § 1.1502-21(c)(1)(iii) Example 4.
(vii) The facts are the same as in paragraphs (i) through (vi) of this Example 4, except that T has an additional built-in loss when it joins the P group which is recognized in Year 4. For purposes of determining the SRLY limitation for this additional loss in Year 4 (or any subsequent year), the $60 of built-in loss allowed as a deduction in Year 3 is treated under paragraph (a) of this section as a deduction in Year 3 that reduces the P group's consolidated taxable income when determined by reference to only T's items.
(ii) T's $45 loss is recognized in Year 2 and, under paragraph (b) of this section, constitutes a built-in loss. Under paragraph (a) of this section and § 1.1502-21(c)(1)(ii), the loss is treated as a net operating loss carryover to Year 2 for purposes of applying the SRLY limitation under § 1.1502-21(c).
(iii) For Year 2, T's SRLY limitation is the aggregate of the P group's consolidated taxable income through Year 2 determined by reference to only T's items. For this purpose, consolidated taxable income is determined by disregarding any built-in loss that is treated as a net operating loss carryover, and any consolidated net operating loss deductions under § 1.1502-21(a). Consolidated taxable income so determined is $25.
(iv) Under § 1.1502-21(c), $25 of the $45 built-in loss could be deducted in Year 2. Because the P group has only $10 of consolidated taxable income (determined without regard to the $45), the $25 loss creates a consolidated net operating loss of $15. This loss is carried back or forward under the rules of § 1.1502-21(b) and absorbed under the rules of § 1.1502-21(a). This loss is not treated as arising in a SRLY (see § 1.1502-21(c)(1)(ii)) and therefore is not subject to the SRLY limitation under § 1.1502-21(c) in any consolidated return year of the group to which it is carried. The remaining $20 is treated as a loss carryover arising in a SRLY and is subject to the limitation of § 1.1502-21(c) in the year to which it is carried.
(e) Predecessors and successors. For purposes of this section, any reference to a corporation or member includes, as the context may require, a reference to a successor or predecessor, as defined in § 1.1502-1(f)(4).
(f) Built-in losses recognized by common parent of group —(1) General rule. Paragraph (a) of this section does not apply to any loss recognized by the group on an asset held by the common parent on the date the group is formed. Following an acquisition described in § 1.1502-75(d)(2) or (3), references to the common parent are to the corporation that was the common parent immediately before the acquisition.
(2) Anti-avoidance rule. If a corporation that becomes a common parent of a group acquires assets with a net unrealized built-in loss in excess of the threshold requirement of section 382(h)(3)(B) (and thereby increases its net unrealized built-in loss or decreases its net unrealized built-in gain) prior to, and in anticipation of, the formation of the group, paragraph (f)(1) of this section does not apply.
(g) Overlap with section 382 —(1) General rule. The limitations provided in §§ 1.1502-21(c) and 1.1502-22(c) do not apply to recognized built-in losses or to loss carryovers or carrybacks attributable to recognized built-in losses when the application of paragraph (a) of this section results in an overlap with the application of section 382.
(2) Definitions —(i) Generally. For purposes of this paragraph (g), the definitions and nomenclature contained in section 382, the regulations thereunder, and §§ 1.1502-90 through 1.1502-99 apply.
(ii) Overlap —(A) An overlap of the application of paragraph (a) of this section and the application of section 382 with respect to built-in losses occurs if a corporation becomes a member of a consolidated group (the SRLY event) within six months of the change date of an ownership change giving rise to a section 382(a) limitation that would apply with respect to the corporation's recognized built-in losses (the section 382 event). Except as provided in paragraph (g)(3) of this section, application of the overlap rule does not require that the size and composition of the corporation's net unrealized built-in loss is the same on the date of the section 382 event and the SRLY event.
(B) For special rules in the event that there is a SRLY subgroup and/or a loss subgroup as defined in § 1.1502-91(d)(2) with respect to built-in losses, see paragraph (g)(4) of this section.
(3) Operating rules —(i) Section 382 event before SRLY event. If a SRLY event occurs on the same date as a section 382 event or within the six month period beginning on the date of the section 382 event, paragraph (g)(1) of this section applies beginning with the tax year that includes the SRLY event. Paragraph (g)(1) of this section does not apply, however, if a corporation that would otherwise be subject to the overlap rule acquires assets from a person other than a member of the group with a net unrealized built-in loss in excess of the threshold requirement of section 382(h)(3)(B) (and thereby increases its net unrealized built-in loss) after the section 382 event, and before the SRLY event.
(ii) SRLY event before section 382 event. If a section 382 event occurs within the period beginning the day after the SRLY event and ending six months after the SRLY event, paragraph (g)(1) of this section applies starting with the first tax year that begins after the section 382 event. However, paragraph (g)(1) of this section does not apply at any time if a corporation that otherwise would be subject to paragraph (g)(1) of this section transfers assets with an unrealized built-in loss to another member of the group after the SRLY event, but before the section 382 event, unless the corporation recognizes the built-in loss upon the transfer.
(4) Subgroup rules. In general, in the case of built-in losses for which there is a SRLY subgroup and the corporations joining the group at the time of the SRLY event also constitute a loss subgroup (as defined in § 1.1502-91(d)(2)), the principles of this paragraph (g) apply to the SRLY subgroup, and not separately to its members. However, paragraph (g)(1) of this section applies with respect to built-in losses only if—
(i) All members of the SRLY subgroup with respect to those built-in losses are also included in a loss subgroup (as defined in § 1.1502-91(d)(2)); and
(ii) All members of a loss subgroup (as defined in § 1.1502-91(d)(2)) are also members of a SRLY subgroup with respect to those built-in losses.
(5) Asset acquisitions. Notwithstanding the application of this paragraph (g), paragraph (a) of this section applies to asset acquisitions by the corporation that occurs after the latter of the SRLY event and the section 382 event. See, paragraph (b)(2)(ii) of this section.
(6) Examples. The principles of this paragraph (g) are illustrated by the following examples:
(ii) At the beginning of Year 7, M acquires all of the stock of P from Individual A, and, as a result, P, P1, and S become members of the M group. At the time of M's acquisition of the P stock, P has a $15 net unrealized built-in loss (disregarding the stock of P1), P1 has a net unrealized built-in gain of $10, and S has a net unrealized built-in gain of $5.
(iii) During Year 8, M acquires all of the stock of T, and T joins the M group. At the time of M's acquisition of the T stock, T had an unrealized built-in loss of $15. At the beginning of Year 9, K acquires all of the stock of M from Individual B, and the members of the M consolidated group including P, P1, S, and T become members of the K group. At the time of K's acquisition of the M stock, M has (disregarding the stock of P and T) a $15 net unrealized built-in loss, P has a $20 net unrealized built-in loss (disregarding the stock of P1), P1 has a net unrealized built-in gain of $5, S has a net unrealized built-in loss of $35, and T has a $15 net unrealized built-in loss.
(iv) M's acquisition of P in Year 7 results in P, P1, and S becoming members of the M group (the SRLY event). Under paragraph (c) of this section, P and P1 compose a SRLY built-in loss subgroup because they have been affiliated for the 60 consecutive month period immediately preceding joining the M group. S is not a member of the subgroup because on becoming a member of the M group it had not been continuously affiliated with P and P1 for the 60 month period ending immediately before it became a member of the M group. Consequently, § 1.1502-15 applies to S separately from the P and P1 subgroup.
(v) Assuming that the $5 net unrealized built-in loss of the P/P1 subgroup exceeds the threshold requirement under section 382(h)(3)(B), M's acquisition of P resulted in an ownership change of P and P1 within the meaning of section 382(g) that subjects P and P1 to a limitation under section 382(a) (the section 382 event). Because, with respect to P and P1, the SRLY event and the change date of the section 382 event occur on the same date and because the loss subgroup and SRLY subgroup are coextensive, there is an overlap of the application of the SRLY rules and the application of section 382.
(vi) S was not a loss corporation because it did not have a net operating loss carryover, or a net unrealized built-in loss, and therefore, M's acquisition of P did not result in an ownership change of S within the meaning of section 382(g). S, therefore is not subject to the overlap rule of paragraph (g) of this section.
(vii) M's acquisition of T resulted in T becoming a member of the M group (the SRLY event). Assuming that T's $15 net unrealized built-in loss exceeds the threshold requirement under section 382(h)(3)(B), M's acquisition of T also resulted in an ownership change of T within the meaning of section 382(g) that subjects T to a limitation under section 382(a) (the section 382 event). Because, with respect to T, the SRLY event and the change date of the section 382 event occur on the same date, there is an overlap of the application of the SRLY rules and the application of section 382 within the meaning of paragraph (g) of this section.
(viii) K's acquisition of M results in the members of the M consolidated group, including T, P, P1, and S, becoming members of the K group (the SRLY event). Because T, P, and P1 were each included in the determination of a net unrealized built-in loss that was subject to the overlap rule described in paragraph (g)(1) of this section when they each became members of the M group, they are deemed under paragraph (c)(3) of this section to have been continuously affiliated with M for the 60 month period ending immediately before becoming a member of the M group, notwithstanding their actual affiliation history. As a result, M, T, P, and P1 compose a SRLY built-in loss subgroup under paragraph (c)(2) of this section. K's acquisition of M is not subject to paragraph (g) of this section because it does not result in a section 382 event.
(ix) S, however, is not a member of the subgroup under paragraph (c)(2) of this section. Because S was not included in the determination of a net unrealized built-in loss that was subject to the overlap rule described in paragraph (g)(1) of this section when it joined the M group, S is treated as becoming an affiliate of M on the date it joined the M group. Furthermore, under paragraph (c)(3) of this section, S is deemed to have begun its affiliation with P and P1 on the date it joined the M group. Consequently, § 1.1502-15 applies to S separately to the extent its built-in loss is recognized within the recognition period.
(ii) P's acquisition of T results in T becoming a member of the P group (the SRLY event) and also results in an ownership change of T, within the meaning of section 382(g), that gives rise to a limitation under section 382(a) (the section 382 event).
(iii) Because the SRLY event and the change date of the section 382 event occur on the same date, there is an overlap of the application of the SRLY rules and the application of section 382. Consequently, under paragraph (g) of this section, the limitation under paragraph (a) of this section does not apply to T's net unrealized built-in loss when it joined the P group.
(iv) Individual A's Year 4 contribution of a depreciable asset occurred after T was a member of the P group. Assuming that the amount of the net unrealized built-in loss exceeds the threshold requirement of section 382(h)(3)(B), the sale of asset 3 within the recognition period is subject to the SRLY limitation of paragraphs (a) and (b)(2)(ii) of this section.
(ii) The February 28 purchase of 55% of T is a section 382 event because it results in an ownership change of T that gives rise to a section 382(a) limitation. The June 30 purchase of 35% of T results in T becoming a member of the P group and is therefore a SRLY event.
(iii) Because the SRLY event occurred within six months of the change date of the section 382 event, there is an overlap of the application of the SRLY rules and the application of section 382, and paragraph (a) of this section does not apply. Therefore, the SRLY limitation does not apply to any of the $55 loss in asset 1 recognized by T after T joined the P group. See § 1.1502-94 for rules relating to the application of section 382 with respect to T's $25 unrealized built-in loss.
(ii) Because paragraph (a) of this section does not apply, the further decrease in asset 1's value is disregarded. Consequently, the results are the same as in Example 3.
(h) Effective date —(1) In general. This section generally applies to built-in losses recognized in taxable years for which the due date (without extensions) of the consolidated return is after June 25, 1999. However—
(i) In the event that paragraphs (f)(1) and (g)(1) of this section do not apply to a particular built-in loss in the current group, then solely for purposes of applying paragraph (a) of this section to determine a limitation with respect to that built-in loss and with respect to which the SRLY register (consolidated taxable income determined by reference to only the member's (or subgroup's) items of income, gain, deduction, or loss) began in a taxable year for which the due date of the return was on or before June 25, 1999, paragraph (c)(3) of this section shall not apply; and
(ii) For purposes of paragraph (g) of this section, only an ownership change to which section 382(a) as amended by the Tax Reform Act of 1986 applies shall constitute a section 382 event.
(2) Prior periods. For certain taxable years ending on or before June 25, 1999, see § 1.1502-15T in effect prior to June 25, 1999, as contained in 26 CFR part 1 revised April 1, 1999, as applicable.
§ 1.1502-16   Mine exploration expenditures.
(a) Section 617 —(1) In general. If the aggregate amount of the expenditures to which section 617(a) applies, paid or incurred with respect to mines or deposits located outside the United States (as defined in section 638 and the regulations thereunder), does not exceed:
(i) $400,000 minus
(ii) All amounts deducted or deferred during the taxable year and all preceding taxable years under section 617 or section 615 of the Internal Revenue Code of 1954 and section 23(ff) of the Internal Revenue Code of 1939 by corporations which are members of the group during the taxable year (and individuals or corporations which have transferred any mineral property to any such member within the meaning of section 617(g)(2)(B)) for taxable years ending after December 31, 1950 and prior to the taxable year, then the deduction under section 617 with respect to such foreign expenditures and paragraph (c) of § 1.1502-12 for each member shall be no greater than an allocable portion of such amount hereinafter referred to as the “consolidated foreign exploration limitation.” Such allocable portion shall be determined under subparagraph (2) of this paragraph. If the amount of such expenditures exceeds the consolidated foreign exploration limitation, no deduction shall be allowed with respect to such excess.
(2) Allocable portion of limitation. A member's allocable portion of the consolidated foreign exploration limitation for a consolidated return year shall be:
(i) The amount allocated by the common parent pursuant to an allocation plan adopted by the consolidated group, but in no event shall a member be allocated more than the amount it could have deducted had it filed a separate return. Such allocation plan must include a statement which also contains the total foreign exploration expenditures of each member which could have been deducted under section 617 if the member had filed a separate return. Such plan must be attached to a consolidated return filed on or before the due date of such return (including extensions of time), and may not be changed after such date, or
(ii) If no plan is filed in accordance with subdivision (i) of this subparagraph, then the portion of the consolidated foreign exploration limitation allocable to each member incurring such expenditures is an amount equal to such limitation multiplied by a fraction, the numerator of which is the amount of foreign exploration expenditures which could have been deducted under section 617 by such member had it filed a separate return and the denominator of which is the aggregate of such amounts for all members of the group.
(b) Section 615 —(1) In general. If the aggregate amount of the expenditures, to which section 615(a) applies, which are paid or incurred by the members of the group during any consolidated return year exceeds the lesser of:
(i) $100,000, or
(ii) $400,000 minus all such expenditures deducted (or deferred) by corporations which are members of the group during the taxable year (and individuals or corporations which have transferred any mineral property to any such member within the meaning of section 615(c)(2)(B)) for taxable years ending after December 31, 1950, and prior to the taxable year, then the deduction (or amount deferrable) under section 615 and paragraph (c) of § 1.1502-12 for each member shall be no greater than an allocable portion of such lesser amount, hereinafter referred to as the “consolidated exploration limitation”. Such allocable portion shall be determined under subparagraph (2) of this paragraph.
(2) Allocable portion of limitation. A member's allocable portion of the consolidated exploration limitation for a consolidated return year shall be:
(i) The amount allocated by the common parent pursuant to an allocation plan adopted by the consolidated group, but in no event shall a member be allocated more than the amount it could have deducted (or deferred) had it filed a separate return. Such allocation plan must include a statement which also contains the total exploration expenditures of each member for the taxable year, and the expenditures of each member which could have been deducted (or deferred) under section 615 if the member had filed a separate return. Such plan must be attached to a consolidated return filed on or before the due date of such return (including extensions of time), and may not be changed after such date, or
(ii) If no plan is filed in accordance with subdivision (i) of this subparagraph, then the portion of the consolidated exploration limitation allocable to each member incurring such expenditures is an amount equal to such limitation multiplied by a fraction, the numerator of which is the amount which could have been deducted (or deferred) under section 615 by such member had it filed a separate return and the denominator of which is the aggregate of such amounts for all members of the group.
(c) Examples. The provisions of this section may be illustrated by the following examples:
Y = $75,000
Z = $100,000 (maximum amount allowed if filed separately)
§ 1.1502-17   Methods of accounting.
(a) General rule. The method of accounting to be used by each member of the group is determined in accordance with the provisions of section 446 as if such member filed a separate return.
(b) Adjustments required if method of accounting changes —(1) General rule. If a member of a group changes its method of accounting for a consolidated return year, the terms and conditions prescribed by the Commissioner under section 446(e), including section 481(a) where applicable, shall apply to the member. If the requirements of section 481(b) are met because applicable adjustments under section 481(a) are substantial, the increase in tax for any prior year shall be computed upon the basis of a consolidated return or a separate return, whichever was filed for such prior year.
(2) Changes in method of accounting for intercompany transactions. If a member changes its method of accounting for intercompany transactions for a consolidated return year, the change in method generally will be effected on a cut-off basis.
(c) Anti-avoidance rules —(1) General rule. If one member (B) directly or indirectly acquires an activity of another member (S), or undertakes S's activity, with the principal purpose to avail the group of an accounting method that would be unavailable (or would be unavailable without securing consent from the Commissioner) if S and B were treated as divisions of a single corporation, B must use the accounting method for the acquired or undertaken activity determined under paragraph (c)(2) of this section or must secure consent from the Commissioner under applicable administrative procedures to use a different method.
(2) Treatment as divisions of a single corporation. B must use the method of accounting that would be required if B acquired the activity from S in a transaction to which section 381 applied. Thus, the principles of section 381 (c)(4) and (c)(5) apply to resolve any conflicts between the accounting methods of S and B, and the acquired or undertaken activity is treated as having the accounting method used by S. Appropriate adjustments are made to treat all acquisitions or undertakings that are part of the same plan or arrangement as a single acquisition or undertaking.
(d) Examples. The provisions of this section are illustrated by the following examples:
(b) Under paragraph (c) of this section, S must account for the consulting income under the payment-on-completion contracts on an accrual method rather than adopting the cash method contemplated by P.
(b) Under paragraph (c) of this section, S must maintain two pools (manufacturing and resale) to the same extent that P would be required to maintain those pools under § 1.472-8 if it had not formed S.
(e) Effective dates. Paragraph (b) of this section applies to changes in method of accounting effective for years beginning on or after July 12, 1995. Paragraphs (c) and (d) of this section apply with respect to acquisitions occurring or activities undertaken in years beginning on or after July 12, 1995.
§ 1.1502-19   Excess loss accounts.
(a) In general —(1) Purpose. This section provides rules for a member (M) to include in income its excess loss account in the stock of another member (S). The purpose of the excess loss account is to recapture in consolidated taxable income M's negative adjustments with respect to S's stock (e.g., under § 1.1502-32 from S's deductions, losses, and distributions), to the extent the negative adjustments exceed M's basis in the stock. 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.
(2) Excess loss accounts —(i) In general. M's basis in S's stock is adjusted under the consolidated return regulations and other rules of law. Negative adjustments may exceed M's basis in S's stock. The resulting negative amount is M's excess loss account in S's stock. For example:
(A) Once M's negative adjustments under § 1.1502-32 exceed its basis in S's stock, the excess is M's excess loss account in the S stock. If M has further adjustments, they first increase or decrease the excess loss account.
(B) If M forms S by transferring property subject to liabilities in excess of basis, § 1.1502-80(d) provides for the nonapplicability of section 357(c) and the resulting negative basis under section 358 is M's excess loss account in the S stock.
(ii) Treatment as negative basis. M's excess loss account is treated for all Federal income tax purposes as basis that is a negative amount, and a reference to M's basis in S's stock includes a reference to M's excess loss account.
(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) Excess loss account taken into account as income or gain —(1) Operating rules —(i) General rule. Except as provided in paragraph (b)(1)(ii) of this section, if M is treated under this section as disposing of a share of S's stock, M takes into account its excess loss account in the share as income or gain from the disposition.
(ii) Special limitation on amount taken into account. Notwithstanding paragraph (b)(1)(i) of this section, if M is treated as disposing of a share of S's stock as a result of the application of paragraph (c)(1)(iii)(B) of this section, the aggregate amount of its excess loss account in the shares of S's stock that M takes into account as income or gain from the disposition shall not exceed the amount of S's indebtedness that is discharged that is neither included in gross income nor treated as tax-exempt income under § 1.1502-32(b)(3)(ii)(C)( 1 ). If more than one share of S's stock has an excess loss account, such excess loss accounts shall be taken into account pursuant to the preceding sentence, to the extent possible, in a manner that equalizes the excess loss accounts in S's shares that have an excess loss account.
(iii) Treatment of disposition. Except as provided in paragraph (b)(4) of this section, the disposition is treated as a sale or exchange for purposes of determining the character of the income or gain.
(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.
(2) Nonrecognition or deferral —(i) In general. M's income or gain under paragraph (b)(1) of this section is subject to any nonrecognition or deferral rules applicable to the disposition. For example, if S liquidates and the exchange of M's stock in S is subject to section 332, or M transfers all of its assets (including S's stock) to S in a reorganization to which section 361(a) applies, M's income or gain from the excess loss account is not recognized under these rules.
(ii) Nonrecognition or deferral inapplicable. If M's income or gain under paragraph (b)(1) of this section is from a disposition described in paragraph (c)(1) (ii) or (iii) of this section (relating to deconsolidations and worthlessness), the income or gain is taken into account notwithstanding any nonrecognition or deferral rules (even if the disposition is also described in paragraph (c)(1)(i) of this section). For example, if M transfers S's stock to a nonmember in a transaction to which section 351 applies, M's income or gain from the excess loss account is taken into account.
(3) Tiering up in chains. If the stock of more than one subsidiary is disposed of in the same transaction, the income or gain under this section is taken into account in the order of the tiers, from the lowest to the highest.
(4) Insolvency —(i) In general. Gain under this section is treated as ordinary income to the extent of the amount by which S is insolvent (within the meaning of section 108(d)(3)) immediately before the disposition. For this purpose S's liabilities include any amount to which preferred stock would be entitled if S were liquidated immediately before the disposition, and any former liabilities that were discharged to the extent the discharge was treated as tax-exempt income under § 1.1502-32(b)(3)(ii)(C) (special rule for discharges).
(ii) Reduction for amount of distributions. The amount treated as ordinary income under this paragraph (b)(4) is reduced to the extent it exceeds the amount of M's excess loss account redetermined without taking into account S's distributions to M to which § 1.1502-32(b)(2)(iv) applies.
(c) Disposition of stock. For purposes of this section:
(1) In general. M is treated as disposing of a share of S's stock:
(i) Transfer, cancellation, etc. At the time—
(A) M transfers or otherwise ceases to own the share for Federal income tax purposes, even if no gain or loss is taken into account; or
(B) M takes into account gain or loss (in whole or in part) with respect to the share.
(ii) Deconsolidation. At the time—
(A) M becomes a nonmember, or a nonmember determines its basis in the share (or any other asset) by reference to M's basis in the share, directly or indirectly, in whole or in part (e.g., under section 362); or
(B) S becomes a nonmember, or M's basis in the share is reflected, directly or indirectly, in whole or in part, in the basis of any asset other than member stock (e.g., under section 1071).
(iii) Worthlessness. At the time—
(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);
(B) An indebtedness of S is discharged, if any part of the amount discharged is not included in gross income and is not treated as tax-exempt income under § 1.1502-32(b)(3)(ii)(C); or
(C) A member takes into account a deduction or loss for the uncollectibility of an indebtedness of S, and the deduction or loss is not matched in the same tax year by S's taking into account a corresponding amount of income or gain from the indebtedness in determining consolidated taxable income.
(2) Becoming a nonmember. A member is treated as becoming a nonmember if it has a separate return year (including another group's consolidated return year). For example, S may become a nonmember if it issues additional stock to nonmembers, but S does not become a nonmember as a result of its complete liquidation. A disposition under paragraph (c)(1)(ii) of this section must be taken into account in the consolidated return of the group. For example, if a group ceases under § 1.1502-75(c) to file a consolidated return as of the close of its consolidated return year, the disposition under paragraph (c)(1)(ii) of this section is treated as occurring immediately before the close of the year. If S becomes a nonmember because M sells S's stock to a nonmember, M's sale is a disposition under both paragraphs (c)(1) (i) and (ii) of this section. If a group terminates under § 1.1502-75(d) because the common parent is the only remaining member, the common parent is not treated as having a deconsolidation event under paragraph (c)(1)(ii) of this section.
(3) Exception for acquisition of group —(i) Application. This paragraph (c)(3) applies only if a consolidated group (the terminating group) ceases to exist as a result of—
(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
(B) The application of the principles of § 1.1502-75(d)(2) or (d)(3).
(ii) General rule. Paragraph (c)(1)(ii) of this section does not apply solely by reason of the termination of a group in a transaction to which this paragraph (c)(3) applies, if there is a surviving group that is, immediately thereafter, a consolidated group. Instead, the surviving group is treated as the terminating group for purposes of applying this section to the terminating group. This treatment does not apply, however, to members of the terminating group that are not members of the surviving group immediately after the terminating group ceases to exist (e.g., under section 1504(a)(3) relating to reconsolidation, or section 1504(c) relating to includible insurance companies).
(d) Special allocation of basis in connection with an adjustment or determination —(1) Excess loss account in original shares. If a member has an excess loss account in shares of a class of S's stock at the time of a basis adjustment or determination under the Internal Revenue Code with respect to shares of the same class of S's stock owned by the member, the adjustment or determination is allocated first to equalize and eliminate that member's excess loss account. See § 1.1502-32(c) for similar allocations of investment adjustments to prevent or eliminate excess loss accounts.
(2) Excess loss account in new S shares. If a member would otherwise determine shares of a class of S's stock (new shares) to have an excess loss account and such member owns one or more other shares of the same class of S's stock, the basis of such other shares is allocated to eliminate and equalize any excess loss account that would otherwise be in the new shares.
(e) Anti-avoidance rule. If any person acts with a principal purpose contrary to the purposes of this section, to avoid the effect of the rules of this section or apply the rules of this section to avoid the effect of any other provision of the consolidated return regulations, adjustments must be made as necessary to carry out the purposes of this section.
(f) Predecessors and successors. For purposes of this section, any reference to a corporation (or to a share of the corporation's stock) includes a reference to a successor or predecessor (or to a share of stock of a predecessor or successor), as the context may require.
(g) Examples. For purposes of the examples in this section, unless otherwise stated, M owns all 100 shares of the only class of S's stock and S owns all 100 shares of the only class of T's stock, the stock is owned for the entire year, T owns no stock of lower-tier members, the tax year of all persons is the calendar year, all persons use the accrual method of accounting, the facts set forth the only corporate activity, all transactions are between unrelated persons, and tax liabilities are disregarded. The principles of this section are illustrated by the following examples.
(b) Analysis. Under paragraph (c) of this section, the sale is a disposition of T's stock at the close of Year 1 (the day of the sale). Under § 1.1502-32(b), T's loss results in S having a $100 excess loss account in T's stock immediately before the sale. Under paragraph (b)(1) of this section, S takes into account the $100 excess loss account as an additional $100 of gain from the sale. Consequently, S takes into account a $160 gain from the sale in determining the group's consolidated taxable income. Under § 1.1502-32(b), T's $200 loss and S's $160 gain result in a net $40 decrease in M's basis in S's stock as of the close of Year 1, from $150 to $110.
(c) Intercompany sale followed by sale to nonmember. The facts are the same as in paragraph (a) of this Example 1, except that S sells T's stock to M for $60 at the close of Year 1, and M sells T's stock to a nonmember at a gain at the beginning of Year 5. Under paragraph (c) of this section, S's sale is treated as a disposition of T's stock at the close of Year 1 (the day of the sale). Under § 1.1502-13 and paragraph (b)(2) of this section, S's $160 gain from the sale is deferred and taken into account in Year 5 as a result of M's sale of the T stock. Under § 1.1502-32(b), the absorption of T's $200 loss in Year 1 results in M having a $50 excess loss account in S's stock at the close of Year 1. In Year 5, S's $160 gain taken into account eliminates M's excess loss account in S's stock and increases M's basis in the stock to $110.
(d) Intercompany distribution followed by sale to a nonmember. The facts are the same as in paragraph (a) of this Example 1, except that the value of the T stock is $60 and S declares and distributes a dividend of all of the T stock to M at the close of Year 1, and M sells the T stock to a nonmember at a gain at the beginning of Year 5. Under paragraph (c) of this section, S's distribution is treated as a disposition of T's stock at the close of Year 1 (the day of the distribution). S's $100 excess loss account in T's stock is treated as additional gain under section 311(b) from the distribution. Under section 301(d), M's basis in the T stock is $60. Under § 1.1502-13, and paragraph (b)(2) of this section, S's $160 gain from the distribution is deferred and taken into account in Year 5 as a result of M's sale of the T stock. Under § 1.1502-32(b), T's $200 loss and S's $60 distribution result in M having a $110 excess loss account in S's stock at the close of Year 1. In Year 5, S's $160 gain taken into account eliminates M's excess loss account in S's stock and increases M's basis in the stock to $50.
(ii) Analysis. Under sections 351 and 354, M does not recognize gain in connection with the transfer. Under § 1.358-2(a)(2)(iii), M is deemed to receive 150 shares of T stock of the same class. Without regard to the application of paragraph (d) of this section, under section 358 and § 1.358-2(a)(2)(i), M would have a $1 basis in each such share. However, because the basis of the additional shares of T stock will be determined when M has an excess loss account in its original shares of T stock, under paragraph (d)(1) of this section, the basis that M would otherwise have in such additional shares will eliminate the excess loss account in M's original shares of T stock such that each original share of T stock will have a basis of $0 and each share of T stock deemed received will have a basis of $0.20. Then, under § 1.358-2(a)(2)(iii), the T stock is deemed to be recapitalized in a reorganization under section 368(a)(1)(E) in which M receives 100 shares of T stock (those shares M actually owns immediately after the transfer) in exchange for those 100 shares of T stock that M held immediately prior to the transfer and those 150 shares of T stock M is deemed to receive in the transfer. Under § 1.358-2(a)(2)(i), immediately after the transfer, M holds 100 shares of T stock, 60 of which take a basis of $0.50 each and 40 of which take a basis of $0 each. In addition, T takes a $1 basis in each share of S stock under section 362. (If M had actually received an additional 150 shares of T stock of the same class, paragraph (d)(1) of this section would apply to shift basis from such additional T shares to M's original T shares because the basis of the additional T stock would be determined when M had an excess loss account in its original T shares. M would have a basis of $0 in each of the original T shares and a basis of $0.20 in each of the additional T shares.)
(iii) Transfer of shares with an excess loss account. The facts are the same as in paragraph (i) of this Example 2 , except that M transfers T's stock to S without receiving additional S stock. The transfer is an exchange described in both section 351 and section 354. Under paragraph (c) of this section, M's transfer is treated as a disposition of T's stock. Under sections 351 and 354 and paragraph (b)(2) of this section, M does not recognize gain from the disposition. Under § 1.358-2(a)(2)(iii), M is deemed to have received 100 shares of S stock of the same class. Without regard to the application of paragraph (d) of this section, M would have a $1.20 excess loss account in each such share. However, because M will have an excess loss account in such shares and M owns other shares of S stock of the same class, under paragraph (d)(2) of this section, the excess loss account that M would otherwise have in such shares will decrease M's basis in its original shares of S's stock such that each such original share will have a basis of $0.20 and each share deemed received will have a basis of $0. Then, under § 1.358-2(a)(2)(iii), the S stock is deemed to be recapitalized in a reorganization under section 368(a)(1)(E) in which M receives 150 shares of S stock (those shares M actually owns immediately after the transfer) in exchange for those 150 shares of S stock that M held immediately prior to the transfer and those 100 shares of S stock that M is deemed to receive in connection with the transfer. Under § 1.358-2(a)(2)(i), immediately after the transfer, M holds 150 shares of S stock, 90 of which take a basis of $0.33 each and 60 of which take a basis of $0 each. In addition, S takes an excess loss account of $1.20 in each share of T stock under section 362. (If M had actually received 100 additional shares of S stock of the same class, paragraph (d)(2) of this section would apply to shift basis from M's original S stock because M would have otherwise had an excess loss account in such additional shares and M owned other shares of S stock of the same class. The excess loss account that M would have otherwise had in such additional shares would have decreased M's basis in its original shares of S's stock. M would have had a basis of $0.20 in each of the original shares and a basis of $0 in each of the additional shares.)
(iv) Intercompany merger—shares with excess loss account retained. The facts are the same as in paragraph (i) of this Example 2 , except that S merges into T in a reorganization described in section 368(a)(1)(A) (and in section 368(a)(1)(D)), and M receives 150 additional shares of T stock of the same class in the reorganization. Under section 354, M does not recognize gain. Without regard to the application of paragraph (d) of this section, under section 358 and § 1.358-2(a)(2)(i), M would have a $1 basis in each such share. However, because the basis of the additional shares of T stock will be determined when M has an excess loss account in its original shares of T stock, under paragraph (d)(1) of this section, the basis that M would otherwise have in such additional shares eliminates the excess loss account in M's original shares of T stock such that each original share of T stock has a basis of $0 and each additional share of T stock has a basis of $0.20.
(v) Intercompany merger—shares with excess loss account surrendered. The facts are the same as in paragraph (i) of this Example 2 , except that T merges into S in a reorganization described in section 368(a)(1)(A) (and in section 368(a)(1)(D)), and M receives 100 additional shares of S stock of the same class in the reorganization. Under section 354 and paragraph (b)(2) of this section, M does not recognize gain from the disposition. Without regard to the application of paragraph (d) of this section, under section 358 and § 1.358-2(a)(2)(i), M would have a $1.20 excess loss account in each additional share of S stock received. However, because M would have an excess loss account in such shares and M owns other shares of S stock of the same class, under paragraph (d)(2) of this section, the excess loss account that M would otherwise have in such shares decreases M's basis in its original shares of S's stock such that each original share of S stock has a basis of $0.20 and each additional share of S stock has a basis of $0.
(b) Analysis. Under paragraph (c) of this section, S's distribution of the T stock is treated as a disposition. Under section 355(c) and paragraph (b)(2) of this section, S does not recognize any gain from the distribution. Under section 358, S's excess loss account in the T stock is eliminated, and M's $30 excess loss account in the S stock is treated as basis allocated between the S stock and the T stock based on their relative values. Consequently, M has a $20 excess loss account in the S stock and a $10 excess loss account in the T stock. (If M had a $30 basis rather than a $30 excess loss account in the S stock, S would not recognize gain, its excess loss account in the T stock would be eliminated, and M's basis in the stock of S and T would be $20 and $10, respectively.)
(c) Section 355 distribution to nonmember. The facts are the same as in paragraph (a) of this Example 3, except that M also distributes the T stock to its shareholders in a transaction to which section 355 applies. Under paragraph (c) of this section, M's distribution is treated as a disposition of T's stock. Under paragraph (b)(2) of this section, because M's disposition is described in paragraph (c)(1)(ii) of this section, M's $10 excess loss account in the T stock must be taken into account at the time of the distribution, notwithstanding the nonrecognition rules of section 355(c).
(b) Analysis. Under paragraph (c)(2) of this section, S is treated as disposing of each of its shares of T's stock immediately before T becomes a nonmember. Under paragraph (b)(1) of this section, S takes into account its $100 excess loss account as gain from the sale or exchange of T's stock. Under § 1.1502-32(b) of this section, S's $100 gain eliminates M's excess loss account in S's stock and increases M's basis in S's stock to $50.
(c) Deconsolidation of a higher-tier member. The facts are the same as in paragraph (a) of this Example 4, except that S (rather than T) issues the stock and, as a consequence, both S and T become nonmembers. Under paragraph (c)(2) of this section, M is treated as disposing of S's stock and S is treated as disposing of T's stock immediately before S and T become nonmembers. Under § 1.1502-32(b) and paragraph (b)(3) of this section, because S and T become nonmembers in the same transaction and T is the lower-tier member, S is first treated under paragraph (b)(1) of this section as taking into account its $100 excess loss account as gain from the sale or exchange of T's stock. Under § 1.1502-32(b), S's $100 gain eliminates M's excess loss account in S's stock and increases M's basis in S's stock to $50 immediately before S becomes a nonmember. Thus, only S's $100 gain is taken into account in the determination of the group's consolidated taxable income.
(d) Intercompany gain and deconsolidation. The facts are the same as in paragraph (c) of this Example 4, except that T has $30 of gain that is deferred under § 1.1502-13 and taken into account in determining consolidated taxable income immediately before T becomes a nonmember. Under § 1.1502-32(b), T's $30 gain decreases S's excess loss account in T's stock from $100 to $70 immediately before S is treated as disposing of T's stock. Under paragraph (b)(1) of this section, S is treated as taking into account its $70 excess loss account as gain from the disposition of T's stock. Under § 1.1502-32(b), S's $70 gain from the excess loss account and T's $30 deferred gain that is taken into account eliminate M's $50 excess loss account in S's stock and increase M's basis in S's stock to $50 immediately before S becomes a nonmember.
(b) Analysis. Under paragraph (c)(1)(iii)(A) of this section, M is not treated as disposing of S's stock in Year 3 solely because S's stock becomes worthless within the meaning of section 165(g) (taking S's liabilities into account). In addition, because S's stock is not treated as worthless, section 382(g)(4)(D) does not prevent the Year 1 consolidated net operating loss carryover from offsetting S's $10 of income in Year 4.
(c) Discharge of indebtedness. The facts are the same as in paragraph (a) of this Example 5, except that, instead of S's stock becoming worthless within the meaning of section 165(g), S's creditor discharges $40 of S's indebtedness during Year 3, S is insolvent by more than $40 before the discharge, the discharge is excluded from the M group's gross income under section 108(a), and $40 of the $50 consolidated net operating loss carryover attributable to S is eliminated under section 108(b). Under § 1.1502- 32(b)(3)(ii)(C), S's $40 of discharge income is treated as tax-exempt income because there is a corresponding decrease under § 1.1502-32(b)(3)(iii) for elimination of the loss carryover. Under paragraph (c)(1)(iii)(B) of this section, M is treated as disposing of S's stock if the amount discharged is not included in gross income and is not treated as tax-exempt income under § 1.1502-32(b)(3)(ii)(C). Because the discharge is treated as tax-exempt income, M is not treated as disposing of S's stock by reason of the discharge.
(b) Analysis. Under paragraph (c)(1)(iii)(A) of this section, M's excess loss account on each of its shares of S's stock ordinarily is taken into account at the time substantially all of S's assets are treated as disposed of, abandoned, or destroyed for Federal income tax purposes. Under paragraph (e) of this section, however, S's assets are not taken into account at the beginning of Year 6 for purposes of applying paragraph (c)(1)(iii)(A) of this section. Consequently, S is treated as worthless at the beginning of Year 6, and M's $110 excess loss account is taken into account.
(h) Effective/applicability dates —(1) Application. This section applies with respect to determinations of the basis of (including an excess loss account in) the stock of a member in consolidated return years beginning on or after January 1, 1995. However, taxpayers may apply paragraph (c)(3)(i)(A) of this section to transactions that occurred prior to September 17, 2008. Any such determination or redetermination does not, however, affect any prior period. 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.
(2) Dispositions of stock —(i) Dispositions of stock before effective date. If M was treated as disposing of stock of S in a tax year beginning before January 1, 1995 (including, for example, a deemed disposition because S was worthless) under the rules of this section then in effect, the amount of M's income, gain, deduction, or loss, and the stock basis reflected in that amount, are not redetermined under paragraph (h)(1) of this section. See paragraph (h)(3) of this section for the applicable rules.
(ii) Application of special limitation. If M was treated as disposing of stock of S because S was treated as worthless as a result of the application of paragraph (c)(1)(iii)(B) of this section after August 29, 2003, the amount of M's income, gain, deduction, or loss, and the stock basis reflected in that amount, are determined or redetermined with regard to paragraph (b)(1)(ii) of this section. If M was treated as disposing of stock of S because S was treated as worthless as a result of the application of paragraph (c)(1)(iii)(B) of this section on or before August 29, 2003, the group may determine or redetermine the amount of M's income, gain, deduction, or loss, and the stock basis reflected in that amount with regard to paragraph (b)(1)(ii) of this section.
(iii) Intercompany amounts. For purposes of this paragraph (h)(2), a disposition does not include a transaction to which § 1.1502-13, § 1.1502-13T, § 1.1502-14, or § 1.1502-14T applies. Instead, the transaction is deemed to occur as the income, gain, deduction, or loss (if any) is taken into account.
(iv) Intercompany reorganizations. Paragraphs (d) and (g) Example 2 of this section apply to transactions occurring on or after July 18, 2007. For transactions occurring on or after January 23, 2006, and before July 18, 2007, see § 1.1502-19T as contained in 26 CFR part 1 in effect April 1, 2007. For transactions occurring before January 23, 2006, see § 1.1502-19 as contained in 26 CFR part 1 in effect April 1, 2005.
(3) Prior law. For prior determinations, see prior regulations under section 1502 as in effect with respect to the determination. See, e.g., § 1.1502-19 as contained in the 26 CFR part 1 edition revised as of April 1, 1994. For guidance regarding determinations of the basis of the stock of a subsidiary acquired in an intercompany reorganization before January 23, 2006, see paragraph (d) and (g) Example 2 of § 1.1502-19 as contained in the 26 CFR part 1 edition revised as of April 1, 2005.