[Federal Register Volume 69, Number 224 (Monday, November 22, 2004)]
[Proposed Rules]
[Pages 67873-67880]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-25649]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-145535-02]
RIN 1545-BB85


Guidance Regarding Predecessors and Successors Under Section 
355(e); Limitation on Gain Recognition Under Section 355(e)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that define the 
terms predecessor and successor for purposes of section 355(e). These 
proposed regulations provide guidance in determining whether a 
corporation is a predecessor or successor of a distributing or 
controlled corporation, as well as rules to assist taxpayers in 
determining whether an acquisition of an interest in a corporation 
would cause a distributing corporation to recognize gain under section 
355(e). These proposed regulations affect corporations that distribute 
the stock of controlled corporations in distributions described in 
section 355.

DATES: Written or electronic comments and requests for a public hearing 
must be received by February 22, 2005.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-145535-02), room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
145535-02), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the IRS 
Internet site at http://www.irs.gov/regs or via the Federal eRulemaking 
Portal at http://www.regulations.gov (IRS--REG-145535-02).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Krishna P. Vallabhaneni at (202) 622-7550; concerning submissions of 
comments or requests for a hearing, Robin R. Jones, (202) 622-7180 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    This document contains proposed regulations under section 355(e) of 
the Internal Revenue Code of 1986. Section 355(e), enacted as part of 
the Taxpayer Relief Act of 1997 (Pub. L. 105-34, 111 Stat 788 (1997)), 
provides that stock of a controlled corporation (Controlled) generally 
will not be treated as qualified property under section 355(c)(2) or 
361(c)(2) if the Controlled stock is distributed as part of a plan (or 
series of related transactions) pursuant to which one or more persons 
acquire directly or indirectly stock representing a 50-percent or 
greater interest in the distributing corporation (Distributing) or 
Controlled. On April 26, 2002, the Internal Revenue Service (IRS) and 
the Treasury Department published temporary regulations (TD 8988) in 
the Federal Register (67 FR 20632) under section 355(e) providing 
guidance regarding whether a distribution and an acquisition of 
Distributing or Controlled are part of a ``plan (or series of related 
transactions).'' See Treas. Reg. Sec.  1.355-7T. Section 355(e)(4)(D) 
provides that, for purposes of section 355(e), ``any reference to a 
controlled corporation or a distributing corporation shall include a 
reference to any predecessor or successor of such corporation.''
    Practitioners have commented that guidance regarding the 
definitions of predecessor and successor is desirable. Therefore, these 
regulations propose definitions of predecessor and successor, rules for 
determining whether there has been an acquisition of a predecessor of 
Distributing, Distributing, or Controlled in certain

[[Page 67874]]

cases, and rules limiting the amount of gain required to be recognized 
as a result of acquisitions of stock that in the aggregate represent a 
50-percent or greater interest in a predecessor of Distributing.

Predecessors of Distributing

    The definition of a predecessor of Distributing in these proposed 
regulations is intended to reflect the fact that section 355(e) 
generally denies tax-free treatment under sections 355(c)(1) and 
361(c)(1) if there is a division of a corporation's assets to which 
section 355(a) applies that is coupled with planned acquisitions of 
stock representing in the aggregate a 50-percent or greater interest in 
Distributing or Controlled. The proposed regulations generally provide 
that a predecessor of Distributing includes a corporation that, before 
the distribution, transfers property to Distributing in a transaction 
to which section 381 applies if Distributing transfers some (but not 
all) of the acquired property to Controlled (or a predecessor of 
Controlled, as described below) and the basis of such property 
immediately after the transfer to Controlled (or a predecessor of 
Controlled) is determined in whole or in part by reference to the basis 
of the property in the hands of Distributing immediately before the 
transfer. For example, if before the distribution P merges into D in a 
statutory merger under section 368(a)(1)(A) and D transfers some but 
not all of the acquired P assets to C in exchange for C stock in a 
reorganization under section 368(a)(1)(D), then P is a predecessor of 
D.
    The proposed regulations also provide that a predecessor of 
Distributing includes a corporation that, before the distribution, 
transfers property to Distributing in a transaction to which section 
381 applies if some but not all of the property transferred to 
Distributing includes Controlled stock and, after the combining 
transaction, Distributing transfers less than all of the property 
acquired (other than the Controlled stock) to Controlled. In such 
cases, the distribution of Controlled stock, even without a pre-
distribution transfer of acquired assets to Controlled, effects a 
division of the predecessor's assets.
    The definition of a predecessor of Distributing may result in a 
corporation being treated as a predecessor of Distributing even if the 
distribution and the combination of the predecessor and Distributing 
are not part of a plan. Once a predecessor of Distributing is 
identified, it must be determined whether the distribution and any 
acquisitions (deemed or actual) of stock of the predecessor are part of 
a plan.

Predecessors of Controlled

    In the course of developing these regulations, the IRS and Treasury 
Department considered to what extent a corporation's transfer of 
property to Controlled in a transaction to which section 381 applies 
implicates the policies underlying section 355(e). Generally, 
Controlled will not be able to transfer property that it receives in 
such a transaction to Distributing tax-free. One exception is where 
Controlled itself distributes the stock of another corporation in a 
distribution to which section 355 applies. In these cases, however, 
Controlled will functionally be a distributing corporation, and the 
transferor of property to Controlled may be a predecessor of the 
distributing corporation. Therefore, as a general matter, it appears 
that property transferred to Controlled cannot be divided tax-free 
between Distributing and Controlled in the same way that property 
transferred to Distributing can be divided tax-free. Accordingly, the 
policy underlying the definition of a predecessor of Distributing does 
not appear to necessitate a definition of a predecessor of Controlled.
    Nonetheless, solely for purposes of determining whether a 
corporation is a predecessor of Distributing, calculating certain 
limitations on gain recognition described below, and applying a special 
affiliated group rule described below, these proposed regulations 
define a predecessor of Controlled as a corporation that before the 
distribution transfers property to Controlled in a transaction to which 
section 381 applies. Under these proposed regulations, for no other 
purpose can a corporation be a predecessor of Controlled. Thus, 
acquisitions of stock that are part of a plan that includes the 
distribution and that in the aggregate represent a 50-percent or 
greater interest in a predecessor of Controlled will not cause 
Distributing to recognize gain. However, the IRS and Treasury 
Department continue to study whether there may be other situations in 
which a corporation should be treated as a predecessor of Controlled.
    The definition of a predecessor of Controlled ensures that a 
corporation is treated as a predecessor of Distributing in the 
following situation and similar ones. Suppose Distributing acquires all 
the assets of X (including all the outstanding stock of Y) in a 
transaction to which section 381 applies. After the acquisition, 
Distributing causes Y to merge into Controlled, a wholly owned 
subsidiary of Distributing, in a reorganization under section 
368(a)(1)(D). Distributing then distributes the stock of Controlled to 
its shareholders pro rata in a distribution to which section 355(a) 
applies. In this case, there is a separation of the X assets in a 
distribution to which section 355(a) applies. Under the definition of a 
predecessor of Controlled described above, Y will be treated as a 
predecessor of Controlled, and because Distributing acquires in a 
transaction to which section 381 applies stock of a predecessor of 
Controlled from X, X will be treated as a predecessor of Distributing.

Multiple Predecessors

    Under the proposed regulations, more than one corporation may be a 
predecessor of Distributing or Controlled. For example, if more than 
one corporation transfers property to Distributing in transactions to 
which section 381 applies, each of the transferring corporations may be 
a predecessor of Distributing. However, a corporation that transfers 
its assets in a transaction to which section 381 applies to a 
predecessor of Distributing is not also treated as a predecessor of 
Distributing. The IRS and Treasury Department recognize that such 
transfers of assets to a predecessor of Distributing could be part of 
the plan that includes the distribution, but are concerned that 
treating such transferring corporations as predecessors of Distributing 
would add substantial complexity. Nonetheless, the IRS and Treasury 
Department continue to consider whether such corporations should be 
treated as a predecessor of Distributing.

Successors

    The definition of a successor of Distributing or Controlled 
proposed in these regulations is intended to identify corporations that 
are properly viewed as a continuation of Distributing or Controlled for 
purposes of section 355(e). Therefore, the proposed regulations define 
a successor of Distributing as any corporation to which Distributing 
transfers property after the distribution in a transaction to which 
section 381 applies and a successor of Controlled as any corporation to 
which Controlled transfers property after the distribution in a 
transaction to which section 381 applies. More than one corporation may 
be a successor of Distributing or Controlled. For example, if after a 
distribution Distributing transfers property to another corporation (X) 
in a transaction to which section 381 applies, and X

[[Page 67875]]

transfers property to another corporation (Y) in a transaction to which 
section 381 applies, then each of X and Y may be a successor of 
Distributing. In this case, the determination of whether Y is a 
successor of Distributing is made after the determination of whether X 
is a successor of Distributing.

Special Rules for Measuring Certain Acquisitions

    Whether there have been acquisitions of stock that are part of a 
plan that includes a distribution that in the aggregate represent a 50-
percent or greater interest in a predecessor of Distributing is counted 
separately from whether there have been acquisitions of stock that are 
part of a plan that includes a distribution that in the aggregate 
represent a 50-percent or greater interest in Distributing. Therefore, 
Distributing may be required to recognize gain by reason of section 
355(e) with respect to a predecessor of Distributing, but not 
Distributing, and vice versa.
    Because a predecessor of Distributing may no longer exist after it 
combines with Distributing, special rules are necessary to determine 
whether there has been an acquisition of the predecessor in connection 
with and after the combination transaction. These proposed regulations 
provide that each person that owned an interest in Distributing 
immediately before the transaction in which the predecessor of 
Distributing transfers its property to Distributing is treated as 
acquiring stock in the predecessor of Distributing in the combination 
transaction. For example, suppose D acquires the assets of a 
predecessor in a statutory merger under section 368(a)(1)(A) and A, an 
individual, owned stock of D immediately before the merger. A would be 
treated as acquiring stock of the predecessor.
    In addition, an acquisition of Distributing (or a successor of 
Distributing) that occurs after Distributing's combination with a 
predecessor will count not only as an acquisition of Distributing, but 
also as an acquisition of the predecessor. The stock of Distributing 
(or a successor of Distributing) is treated as the stock of all 
predecessors of Distributing. Therefore, if D acquires the assets of a 
predecessor in a statutory merger under section 368(a)(1)(A) and, after 
the merger, A, an individual, acquires 5 percent of the stock of D, A 
is treated as acquiring not only stock of D, but also stock of the 
predecessor of D.
    The proposed regulations provide similar rules for determining 
whether there has been an acquisition of stock of Distributing or 
Controlled if there is an acquisition of stock of a successor of 
Distributing or Controlled. Therefore, acquisitions of a successor of 
Distributing or Controlled and acquisitions of Distributing or 
Controlled (before or after the distribution) pursuant to a plan are 
combined to determine whether there have been acquisitions of stock 
that in the aggregate represent a 50-percent or greater interest in 
Distributing or Controlled that cause section 355(e) to apply.

Special Rules for Gain Recognition

    Generally, if a distribution and acquisitions that in the aggregate 
represent a 50-percent or greater interest in a predecessor of 
Distributing or Distributing are part of a plan, section 355(e) 
requires Distributing to recognize the full amount of the gain inherent 
in the Controlled stock on the date of the distribution under section 
355(c)(2) or section 361(c)(2), as applicable. However, if a 
distribution and acquisitions of stock that in the aggregate represent 
a 50-percent or greater interest in a predecessor of Distributing are 
part of a plan but there are not acquisitions of stock that in the 
aggregate represent a 50-percent or greater interest in Distributing 
that are part of that plan, and if the gain inherent in the assets of 
the predecessor of Distributing that are contributed to Controlled is 
small relative to the gain inherent in the Controlled stock on the date 
of the distribution, it may seem inappropriate to require that 
Distributing recognize the full amount of gain inherent in the 
Controlled stock. Similarly, if a distribution and acquisitions of 
stock that in the aggregate represent a 50-percent or greater interest 
in Distributing are part of a plan but there are not acquisitions of 
stock that in the aggregate represent a 50-percent or greater interest 
in the predecessor of Distributing that are part of a plan, and if the 
excess of the gain inherent in the Controlled stock on the date of the 
distribution over the gain attributable to the assets of the 
predecessor is small relative to the full amount of gain inherent in 
the Controlled stock, it may seem inappropriate to require that 
Distributing recognize the full amount of gain inherent in the 
Controlled stock. Therefore, the proposed regulations provide two rules 
limiting the amount of gain that Distributing must recognize in these 
cases.
    The first rule provides that if a distribution and acquisitions of 
stock that in the aggregate represent a 50-percent or greater interest 
in a predecessor of Distributing are part of a plan, then the amount of 
gain that Distributing recognizes by reason of such acquisitions will 
not exceed the amount of gain, if any, that the predecessor of 
Distributing would have recognized if, immediately before the 
distribution, the predecessor had transferred the property that was 
transferred to Controlled and the stock of Controlled that it 
transferred to Distributing to a newly formed, wholly owned corporation 
solely for stock of such corporation in an exchange to which section 
351 applied (even if section 351 would not have actually applied) and 
then sold the stock of that corporation to an unrelated person in 
exchange for cash equal to its fair market value.
    The second rule applies if a distribution and acquisitions of stock 
that in the aggregate represent a 50-percent or greater interest in 
Distributing are part of a plan and the acquisitions occur in the 
section 381 transaction in which a predecessor of Distributing 
transfers its assets to Distributing. In these cases, the proposed 
regulations effectively provide that the amount of gain that 
Distributing recognizes will not exceed the amount of gain that 
Distributing would have recognized had it not transferred assets of the 
predecessor to Controlled and had it not acquired any Controlled stock 
from the predecessor. In particular, the amount of gain that 
Distributing recognizes will not exceed the excess, if any, of the 
amount described in section 355(c)(2) or section 361(c)(2), as 
applicable, over the amount of gain, if any, that Distributing would 
have been required to recognize if there had been acquisitions of stock 
that in the aggregate represent a 50-percent or greater interest in the 
predecessor of Distributing (but not Distributing) involved in the 
combining transfer that were part of a plan that includes the 
distribution, taking into account the limitation in the first rule. For 
example, assume that X, a corporation, merges into Distributing in a 
statutory merger that qualifies as a reorganization under section 
368(a)(1)(A). In the merger, Distributing issues 75 percent of its 
stock to the former shareholders of X. Distributing then forms 
Controlled solely with assets acquired from X in the merger and 
distributes the stock of Controlled pro rata to its shareholders. At 
the time of the distribution, the basis of the Controlled stock is $30 
and the fair market value of that stock is $70. Assume that the 
distribution and the former X shareholders' acquisition of

[[Page 67876]]

stock of Distributing are part of a plan. Furthermore, assume that, 
other than the deemed acquisition of stock of X by the pre-merger 
shareholders of Distributing, there are no other acquisitions of the 
stock of X that are part of a plan that includes the distribution. By 
reason of the second limitation, Distributing's gain recognized under 
section 361(c)(2) would be zero because all of the gain inherent in the 
Controlled stock at the time of the distribution is attributable to 
assets acquired from X in the merger.
    In order to ensure that in appropriate cases these limitations do 
not ultimately prevent recognition of gain in the full amount described 
in section 355(c)(2) or 361(c)(2), as applicable, these proposed 
regulations provide that if there are acquisitions of stock that in the 
aggregate represent a 50-percent or greater interest in more than one 
corporation (for example, two predecessors of Distributing) that are 
pursuant to a plan that includes the distribution, Distributing must 
recognize gain in the amount described in section 355(c)(2) or 
361(c)(2), as applicable, subject to the limitations described above, 
with respect to each such corporation. However, because this rule could 
cause Distributing to recognize a total amount of gain in excess of 
that amount described in section 355(c)(2) or 361(c)(2), as applicable, 
these regulations include an overall limitation on gain recognition. 
That rule provides that the sum of the amounts required to be 
recognized by Distributing under section 355(e) and the regulations 
promulgated thereunder will not exceed the amount described in section 
355(c)(2) or section 361(c)(2), as applicable.
    As described above, the rule for determining whether a corporation 
is a predecessor of Distributing references the assets of the 
predecessor at the time it combines with Distributing while the rule 
for calculating the limitation on gain recognition references the basis 
and value of the predecessor's assets at the time of the distribution. 
The IRS and Treasury Department believe that determining whether a 
corporation is a predecessor of Distributing by reference to its assets 
at the time it combines with Distributing (and not later) is 
appropriate because, in that transaction, the predecessor will likely 
cease to exist. However, the division of the predecessor's assets does 
not occur until the distribution. In addition, the gain required to be 
recognized by reason of section 355(e) is measured as of the date of 
the distribution. Therefore, the IRS and Treasury Department believe 
that it is appropriate to measure the basis and value of the 
predecessor's assets on the date of the distribution for purposes of 
determining the amount of gain required to be recognized when there 
have been acquisitions of a 50-percent or greater interest in the 
predecessor that are part of a plan that includes the distribution.

Special Rule for Affiliated Groups

    The proposed regulations include a special rule that relates to the 
application of section 355(e)(2)(C). Section 355(e)(2)(C) provides that 
a plan (or series of related transactions) will not result in stock or 
securities in the controlled corporation not being treated as qualified 
property for purposes of section 355(c)(2) or section 361(c)(2) if, 
immediately after the completion of such plan or transactions, the 
distributing corporation and all controlled corporations are members of 
a single affiliated group (as defined in section 1504 without regard to 
subsection (b) thereof). These proposed regulations provide that, for 
purposes of section 355(e)(2)(C), a predecessor of Distributing or 
Controlled is treated as continuing in existence following its transfer 
of property to Distributing or Controlled, and Distributing or 
Controlled is treated as continuing in existence following a transfer 
of property to a successor.

Request for Comments

    The IRS and Treasury Department are concerned that certain 
transfers of assets to a partnership or a corporation by Distributing 
or Controlled may facilitate an acquisition of an interest in 
Distributing's or Controlled's assets that is functionally equivalent 
to an acquisition of Distributing or Controlled. The IRS and Treasury 
Department are also concerned that certain acquisitions by persons 
unrelated to Distributing or Controlled of an interest in a corporation 
or partnership in which Distributing or Controlled directly or 
indirectly owns an interest may also be an acquisition that is 
functionally equivalent to an acquisition of Distributing or 
Controlled. If such transfers and acquisitions are part of a plan that 
includes the distribution, they could be used to circumvent the 
purposes of section 355(e). Accordingly, the IRS and Treasury 
Department are studying how section 355(e) might apply to such 
transfers and acquisitions. Comments are requested in this regard.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and, because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The IRS and Treasury Department specifically request 
comments on the clarity of the proposed rules and how they may be made 
easier to understand. All comments will be available for public 
inspection and copying.
    A public hearing will be scheduled if requested in writing by any 
person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Krishna P. 
Vallabhaneni of the Office of Associate Chief Counsel (Corporate). 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.355-8 also issued under 26 U.S.C. 355(e)(5). * * *

    Par. 2. Section 1.355-8 is added to read as follows:

[[Page 67877]]

Sec.  1.355-8  Definition of predecessors and successors and 
limitations on gain recognition.

    (a) References to a distributing or controlled corporation. For 
purposes of section 355(e) and the regulations promulgated thereunder, 
except as otherwise provided, any reference to a distributing 
corporation (Distributing) or a controlled corporation (Controlled) 
shall include a reference to any predecessor or successor of such 
corporation, as such terms are defined in this section.
    (b) Definition of predecessor--(1) Predecessor of a distributing 
corporation. A predecessor of Distributing is a corporation (the first 
corporation) that before the distribution transfers property to 
Distributing in a transaction to which section 381 applies (the 
combining transfer), but only if either--
    (i) Distributing transfers some but not all of the property 
acquired from the first corporation to Controlled (the separating 
transfer) and the basis of such property immediately after the 
separating transfer is determined in whole or in part by reference to 
the basis of the property in the hands of Distributing immediately 
before the separating transfer; or
    (ii) In the combining transfer, some but not all of the property 
transferred to Distributing includes Controlled stock and, after the 
combining transfer, Distributing does not transfer all of the property 
acquired from the first corporation (other than the Controlled stock) 
to Controlled.
    (2) Predecessor of a controlled corporation. Solely for purposes of 
paragraphs (b)(1), (e)(2), and (f) of this section, a corporation is a 
predecessor of Controlled if, before the distribution, it transfers 
property to Controlled in a transaction to which section 381 applies. 
Other than for the purposes described in the preceding sentence, no 
corporation can be a predecessor of Controlled.
    (3) References to a distributing or controlled corporation. For 
purposes of paragraph (b)(1) of this section, a reference to 
Distributing shall not include a reference to a predecessor of 
Distributing. Therefore, a corporation that transfers property to a 
predecessor of Distributing in a transaction to which section 381 
applies is not also a predecessor of Distributing. For purposes of 
paragraph (b)(2) of this section, a reference to Controlled shall not 
include a reference to a predecessor of Controlled. Therefore, a 
corporation that transfers property to a predecessor of Controlled in a 
transaction to which section 381 applies is not also a predecessor of 
Controlled.
    (4) Determination of predecessor status--(i) Substitute assets. For 
purposes of determining whether a corporation is a predecessor of 
Distributing, if after the combining transfer Distributing transfers 
any property it received in the combining transfer in a transaction in 
which gain or loss is not recognized in whole, the property received by 
Distributing in exchange for such property shall be treated as 
transferred to Distributing in the combining transfer.
    (ii) Reorganizations under section 368(a)(1)(F). For purposes of 
determining whether a corporation is a predecessor of Distributing or 
Controlled, if a corporation engages in a reorganization under section 
368(a)(1)(F), then the resulting corporation shall be treated as the 
same corporation that engaged in the reorganization. Therefore, if a 
corporation (X) transfers property to another corporation (Y) in a 
reorganization under section 368(a)(1)(A), and then Y transfers 
property to Distributing in a reorganization under section 
368(a)(1)(F), Y and Distributing will be treated as the same 
corporation and X may be a predecessor of Distributing.
    (iii) Multiple predecessors. More than one corporation may be a 
predecessor of Distributing or Controlled. Therefore, if more than one 
corporation transfers property to Distributing or Controlled in 
transactions to which section 381 applies, each of the transferring 
corporations may be a predecessor of Distributing or Controlled, 
respectively.
    (c) Definition of successor--(1) In general. A successor of 
Distributing or Controlled, respectively, is a corporation to which 
Distributing or Controlled transfers property after the distribution in 
a transaction to which section 381 applies (a successor transaction).
    (2) Determination of successor status. More than one corporation 
may be a successor of Distributing or Controlled. Therefore, if 
Distributing transfers property to another corporation (X) in a 
transaction to which section 381 applies, and X transfers property to 
another corporation (Y) in a transaction to which section 381 applies, 
then each of X and Y may be a successor of Distributing. In this case, 
the determination of whether Y is a successor of Distributing is made 
after the determination of whether X is a successor of Distributing.
    (d) Special acquisition rules--(1) Deemed acquisitions of a 
predecessor of a distributing corporation. If there is a predecessor of 
Distributing, the following rules shall apply.
    (i) Each person that owned an interest in Distributing immediately 
before the combining transfer involving the predecessor of Distributing 
shall be treated as acquiring in the combining transfer stock 
representing an interest in the predecessor of Distributing.
    (ii) If stock of Distributing is acquired after the combining 
transfer involving the predecessor of Distributing, the stock of 
Distributing shall be treated as the stock of the predecessor of 
Distributing. Therefore, an acquisition of the stock of Distributing 
that occurs after the combining transfer shall be treated as not only 
an acquisition of the stock of Distributing, but also an acquisition of 
the stock of the predecessor of Distributing.
    (2) Deemed acquisitions of a distributing corporation. If there is 
a successor of Distributing, the following rules shall apply.
    (i) Each person that owned an interest in the successor of 
Distributing immediately before the successor transaction involving the 
successor of Distributing shall be treated as acquiring in the 
successor transaction stock representing an interest in Distributing.
    (ii) If stock of the successor of Distributing is acquired after 
the successor transaction, the stock of the successor of Distributing 
shall be treated as stock of Distributing. Therefore, acquisitions of 
the stock of a successor of Distributing that occur after the successor 
transaction shall be treated as acquisitions of the stock of 
Distributing.
    (3) Deemed acquisitions of a controlled corporation. If there is a 
successor of Controlled, the following rules shall apply.
    (i) Each person that owned an interest in the successor of 
Controlled immediately before the successor transaction involving the 
successor of Controlled shall be treated as acquiring in the successor 
transaction stock representing an interest in Controlled.
    (ii) If stock of the successor of Controlled is acquired after the 
successor transaction, the stock of the successor of Controlled shall 
be treated as stock of Controlled. Therefore, acquisitions of the stock 
of a successor of Controlled that occur after the successor transaction 
shall be treated as acquisitions of stock of Controlled.
    (4) Separate counting for distributing corporations and their 
predecessors. The measurement of whether one or more persons have 
acquired stock that in the aggregate represents a 50-percent or greater 
interest in either a predecessor of Distributing or Distributing that 
is part of the plan that

[[Page 67878]]

includes the distribution shall be made separately. Therefore, there 
may be acquisitions of stock that in the aggregate represent a 50-
percent or greater interest in a predecessor of Distributing that are 
part of a plan that includes a distribution where there are not 
acquisitions of stock that in the aggregate represent a 50-percent or 
greater interest in Distributing that are part of a plan that includes 
a distribution. In addition, there may be acquisitions of stock that in 
the aggregate represent a 50-percent or greater interest in 
Distributing that are part of a plan that includes a distribution where 
there are not acquisitions of stock that in the aggregate represent a 
50-percent or greater interest in a predecessor of Distributing that 
are part of a plan that includes a distribution.
    (e) Special rules for gain recognition--(1) In general. If there 
are acquisitions of stock that in the aggregate represent a 50-percent 
or greater interest in more than one corporation (for example, two 
predecessors of Distributing) that are pursuant to a plan that includes 
the distribution, Distributing must recognize gain in the amount 
described in section 355(c)(2) or 361(c)(2), as applicable, with 
respect to each such corporation, subject to the limitations in 
paragraphs (e)(2) and (3) of this section if applicable. The 
limitations in paragraphs (e)(2) and (3) of this section are applied 
separately to each such corporation to determine the amount of gain 
required to be recognized. Paragraph (e)(4) of this section sets forth 
an overall limitation that is computed taking into account all of the 
gain recognized by Distributing by reason of section 355(e).
    (2) Acquisition of a predecessor of a distributing corporation--(i) 
In general. If a distribution and acquisitions of stock that in the 
aggregate represent a 50-percent or greater interest in a predecessor 
of Distributing are part of a plan, the amount of gain recognized by 
Distributing by reason of section 355(e) as a result of the 
acquisitions shall not exceed the amount of gain, if any, that the 
predecessor of Distributing would have recognized if, immediately 
before the distribution, the predecessor of Distributing had 
transferred the property that was transferred to Controlled in the 
separating transfer and stock of Controlled that the predecessor of 
Distributing transferred to Distributing in the combining transfer to a 
newly formed, wholly owned corporation in exchange solely for stock of 
such corporation in an exchange to which section 351 applied and then 
sold the stock of that corporation to an unrelated person in exchange 
for cash equal to its fair market value.
    (ii) Operating rules. For purposes of applying paragraph (e)(2)(i) 
of this section, the following rules shall apply.
    (A) If before the distribution Distributing transfers any property 
it received from the predecessor of Distributing in the combining 
transfer in a transaction in which gain or loss is not recognized in 
whole, the property received by Distributing in exchange for such 
property shall be treated as transferred to Distributing in the 
combining transfer.
    (B) The basis of the property other than stock of Controlled 
treated as transferred to the newly formed, wholly owned corporation by 
the predecessor of Distributing shall equal the basis of such property 
in the hands of Controlled immediately before the distribution.
    (C) Only property (other than stock of Controlled) owned by 
Controlled at the time of the distribution shall be taken into account 
in computing the amount pursuant to paragraph (e)(2)(i) of this 
section. However, if before the distribution Controlled transfers any 
property it received in the separating transfer in a transaction in 
which gain or loss is not recognized in whole, the property received by 
Controlled in exchange for such property shall be treated as 
transferred to Controlled in the separating transfer.
    (D) The basis and fair market value of the stock of Controlled 
treated as transferred to the newly formed, wholly owned corporation 
shall equal the basis and fair market value, respectively, of such 
stock immediately before the combining transfer in which the 
predecessor of Distributing transferred such stock to Distributing.
    (3) Acquisitions of a distributing corporation. If a distribution 
and acquisitions of stock that in the aggregate represent a 50-percent 
or greater interest in Distributing are part of a plan and the 
acquisitions occur in a combining transfer, the amount of gain 
recognized by Distributing by reason of section 355(e) as a result of 
the acquisitions shall not exceed the excess, if any, of the amount 
described in section 355(c)(2) or section 361(c)(2), as applicable, 
over the amount of gain, if any, that Distributing would have been 
required to recognize if there had been acquisitions of stock that in 
the aggregate represent a 50-percent or greater interest in the 
predecessor of Distributing (but not Distributing) involved in the 
combining transfer that were part of a plan that includes the 
distribution, taking into account the limitation in paragraph (e)(2) of 
this section. For purposes of this paragraph (e)(3), references to 
Distributing shall not include a reference to a predecessor of 
Distributing.
    (4) Overall limitation on gain recognition. The sum of the amounts 
required to be recognized by Distributing under section 355(e) and the 
regulations promulgated thereunder (taking into account paragraphs 
(e)(2) and (3) of this section) shall not exceed the amount described 
in section 355(c)(2) or section 361(c)(2), as applicable.
    (f) Predecessor or successor as a member of the affiliated group. 
For purposes of section 355(e)(2)(C), a predecessor of Distributing 
shall be treated as continuing in existence following the combining 
transfer to which section 381 applies described in paragraph (b)(1) of 
this section, a predecessor of Controlled shall be treated as 
continuing in existence following the transaction to which section 381 
applies described in paragraph (b)(2) of this section, and Distributing 
or Controlled shall be treated as continuing in existence following a 
successor transaction.
    (g) Examples. The following examples illustrate the principles of 
this section. Unless otherwise stated, assume throughout these examples 
that Distributing (D) owns all the stock of Controlled (C) and that D 
distributes the stock of C in a distribution to which section 355 
applies, but to which section 355(d) does not apply. In addition, 
assume that X, Y, and Z are individuals, and that D, C, P, Q, and R are 
corporations and none of them is a member of a consolidated group. No 
inference should be drawn from any example concerning whether any 
requirements of section 355 other than those of section 355(e) are 
satisfied. The examples are as follows:

    Example 1. Predecessor of distributing--(i) Facts. X owns 100 
percent of the stock of P and Y owns 100 percent of the stock of D. 
P merges into D in a reorganization under section 368(a)(1)(A). 
Immediately after the merger, X and Y own 10 percent and 90 percent, 
respectively, of the stock of D. D then contributes to C one of the 
assets acquired from P in the merger. At the time of the 
contribution, the asset has a basis of $40x and a fair market value 
of $110x. In exchange for the asset, D receives additional C stock 
and $10x. D distributes the stock of C (but not the cash) to X and Y 
pro rata. The contribution is described in section 368(a)(1)(D) and 
D recognizes $10x of gain under section 361(b) in the contribution. 
Immediately before the distribution, the asset contributed to C has 
a basis of $50x and a fair market value of $110x, and the stock of C 
held by D has a basis of $100x and a fair market value of $200x.

[[Page 67879]]

    (ii) Analysis. Under paragraph (b)(1) of this section, P is a 
predecessor of D because before the distribution P transferred 
property to D in a transaction to which section 381 applies, D 
transferred some but not all of the acquired property to C, and 
immediately after its transfer to C, the property has a basis 
determined in whole or in part by reference to the basis of the 
property in the hands of D immediately before the transfer to C.
    (iii) Under paragraph (d)(1)(i) of this section, Y is treated as 
acquiring stock representing 90 percent of the voting power and 
value of P.
    (iv) If the distribution and Y's deemed acquisition of a 90-
percent interest in P were part of a plan, D would recognize gain in 
the amount described in section 361(c)(2). Without regard to the 
limitations in paragraph (e) of this section, D would be required to 
recognize $100x of gain. Under paragraph (e)(2) of this section, 
however, D's gain recognized by reason of the acquisition of P would 
not exceed $60x, the gain P would have recognized if, immediately 
before the distribution, it had transferred the former P property 
transferred by D to C to a newly formed, wholly owned corporation 
solely for stock of such corporation in an exchange to which section 
351 applied and then sold that stock to an unrelated person for cash 
equal to its fair market value. Therefore, D would recognize $60x of 
gain.
    Example 2. Distributing's predecessor owns controlled stock--(i) 
Facts. X owns 100 percent of the stock of P, and Y owns 100 percent 
of the stock of D. P owns 35 percent of the stock of C with a basis 
of $40x and a fair market value of $35x. D owns the remaining 65 
percent of the C stock with a basis of $10x and a fair market value 
of $65x. P merges into D in a reorganization under section 
368(a)(1)(A). Immediately after the merger, X and Y own 10 percent 
and 90 percent, respectively, of the D stock, and D owns 100 percent 
of the C stock with a basis of $50x and a fair market value of 
$100x. D then contributes to C one of the assets it acquired from P 
in the merger in exchange for additional shares of C. The 
contribution qualifies as a reorganization under section 
368(a)(1)(D). After the contribution, D distributes all of the C 
stock to X and Y pro rata. Immediately before the distribution, the 
asset contributed to C has a basis of $40x and a fair market value 
of $100x, and the C stock held by D has a basis of $90x and a fair 
market value of $200x.
    (ii) Analysis. Under paragraph (b)(1) of this section, P is a 
predecessor of D because before the distribution P transferred 
property to D in a transaction to which section 381 applies, D 
transferred some but not all of the acquired property to C, and 
immediately after its transfer to C, the property has a basis 
determined in whole or in part by reference to the basis of the 
property in the hands of D immediately before the transfer to C. P 
is also a predecessor of D under paragraph (b)(1) of this section 
because some but not all of the property transferred to D includes C 
stock and, after the merger, D does not transfer all of the property 
acquired from P to C.
    (iii) Under paragraph (d)(1)(i) of this section, Y is treated as 
acquiring stock representing 90 percent of the voting power and 
value of P.
    (iv) If the distribution and Y's deemed acquisition of a 90-
percent interest in P were part of a plan, D would recognize gain in 
the amount described in section 361(c)(2). Without regard to the 
limitations in paragraph (e) of this section, D would be required to 
recognize $110x of gain. Under paragraph (e)(2) of this section, 
however, D's gain recognized by reason of the acquisition of P would 
not exceed $55x, the gain P would have recognized if, immediately 
before the distribution, it had transferred the former P property 
that was transferred by D to C and the stock of C acquired from P to 
a newly formed, wholly owned corporation solely for stock of such 
corporation in an exchange to which section 351 applies and then 
sold that stock to an unrelated person for cash equal to its fair 
market value. For this purpose, the basis and fair market value of 
the C stock is treated as its basis and fair market value, 
respectively, immediately before the merger. Therefore, D would 
recognize $55x of gain.
    Example 3. Predecessor of controlled--(i) Facts. X owns 100 
percent of the stock of P and P owns various assets including 100 
percent of the stock of R. Y owns 100 percent of the stock of D and 
D owns 100 percent of the stock of C. P merges into D in a 
reorganization under section 368(a)(1)(A). Immediately after the 
merger, X and Y own 10 percent and 90 percent, respectively, of the 
stock of D. D then causes R to merge into C in a reorganization 
under section 368(a)(1)(D). At the time of the P-D merger, the R 
stock has a basis of $40x and a fair market value of $110x. D 
distributes the stock of C to X and Y pro rata. Immediately before 
the distribution, the stock of C held by D has a basis of $100x and 
a fair market value of $200x.
    (ii) Analysis. Under paragraph (b)(2) of this section, R is a 
predecessor of C because before the distribution R transferred 
property to C in a transaction to which section 381 applies. Under 
paragraph (b)(1) of this section, P is a predecessor of D because 
some but not all of the property transferred to D includes stock of 
R, a predecessor of C and, after the merger, D does not transfer all 
of the property acquired from P to C.
    (iii) Under paragraph (d)(1)(i) of this section, Y is treated as 
acquiring stock representing 90 percent of the voting power and 
value of P.
    (iv) If the distribution and Y's deemed acquisition of a 90-
percent interest in P were part of a plan, D would recognize gain in 
the amount described in section 361(c)(2). Without regard to the 
limitations in paragraph (e) of this section, D would be required to 
recognize $100x of gain. Under paragraph (e)(2) of this section, 
however, D's gain recognized by reason of the acquisition of P would 
not exceed $70x, the gain P would have recognized if, immediately 
before the distribution, it had transferred the stock of R to a 
newly formed, wholly owned corporation solely for stock of such 
corporation in an exchange to which section 351 applied and then 
sold that stock to an unrelated person for cash equal to its fair 
market value. For this purpose, the basis and fair market value of 
the R stock is treated as its basis and fair market value, 
respectively, immediately before the P-D merger. Therefore, D would 
recognize $70x of gain.
    Example 4. Acquisition of a distributing corporation. (i) Facts. 
X owns 100 percent of the stock of P and Y owns 100 percent of the 
stock of D. P merges into D in a reorganization under section 
368(a)(1)(A). In the merger, X acquires 60 percent of the D stock. 
After the merger, therefore, X and Y own 60 percent and 40 percent, 
respectively, of the stock of D. D then contributes to C, a newly 
formed corporation, some of the assets acquired from P in the merger 
and one asset that it owned prior to the merger, in exchange for C 
stock in a transfer that qualifies as a reorganization under section 
368(a)(1)(D). After the contribution, D distributes the C stock to 
its shareholders pro rata. Immediately before the distribution, the 
contributed asset that D had owned prior to the merger has a basis 
of $3x and a fair market value of $10x and the contributed assets 
acquired from P have an aggregate basis of $1x and an aggregate 
value of $30x. Finally, immediately before the distribution, D's C 
stock has a basis of $4x and a fair market value of $40x.
    (ii) Analysis. Under paragraph (b)(1) of this section, P is a 
predecessor of D because before the distribution P transferred 
property to D in a transaction to which section 381 applies, D 
transferred some but not all of the acquired property to C, and 
immediately after its transfer to C, the property has a basis 
determined in whole or in part by reference to the basis of the 
property in the hands of D immediately before the transfer to C.
    (iii) Under paragraph (d)(1)(i) of this section, Y is treated as 
acquiring stock representing 40 percent of the voting power and 
value of P. There are not acquisitions that in the aggregate 
represent a 50-percent or greater interest in P in the merger that 
is pursuant to a plan that includes a distribution. However, there 
is an acquisition by X of a 60-percent interest in D in the merger. 
If that acquisition were pursuant to a plan that includes the 
distribution, D would be required to recognize gain in the amount 
described in section 361(c)(2). Without regard to the limitations in 
paragraph (e) of this section, D would be required to recognize $36x 
of gain. Under paragraph (e)(3) of this section, however, because 
that acquisition occurred in connection with P's merger into D, the 
amount of gain recognized by D would not exceed $7x, the excess of 
the gain described in section 361(c)(2) ($36x) over the gain that D 
would have been required to recognize if there had been an 
acquisition of stock representing a 50-percent or greater interest 
in P (but not D) that was part of a plan involving the distribution 
($29x). Therefore, D would recognize $7x of gain.
    Example 5. Successor of a controlled corporation--(i) Facts. X 
owns 100 percent of the stock of each of D and R. D owns 100 percent 
of the C stock. D's C stock has a basis of $10x and a fair market 
value of $30x. D distributes all of its C stock to X. Immediately 
after the distribution, C merges into R in a reorganization under 
section 368(a)(1)(D). Immediately after the merger, X owns all of

[[Page 67880]]

the R stock. Subsequently, Z purchases 60 percent of the stock of R 
from X.
    (ii) Analysis. Under paragraph (c) of this section, R is a 
successor of C because after the distribution C transfers property 
to R in a transaction to which section 381 applies. Accordingly, Z 
acquired an interest in a successor of C. In addition, under 
paragraph (d)(3)(ii) of this section, the stock of R is treated as 
stock of C such that Z is treated as acquiring 60 percent of the 
voting power and value of C.
    (iii) If the distribution and Z's acquisition of a 60-percent 
interest in R were part of a plan, D would be required to recognize 
gain in the amount of $20x, the amount described in section 
355(c)(2).
    (h) Effective date. This section applies to distributions 
occurring after the date these regulations are published as final 
regulations in the Federal Register.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-25649 Filed 11-19-04; 8:45 am]
BILLING CODE 4830-01-P