2964 Federal Register / Vol. 72, No. 14 / Tuesday, January 23, 2007 / Proposed Rules 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–157711–02] 

RIN 1545–BB61 

Unified Rule for Loss on Subsidiary 

Stock 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations under sections 

358, 362(e)(2) and 1502 of the Internal 

Revenue Code (Code). The regulations 

apply to corporations filing 

consolidated returns. The regulations 

implement aspects of the repeal of the 

General Utilities doctrine by 

redetermining members’ bases in 

subsidiary stock and requiring certain 

reductions in subsidiary stock basis on 

a transfer of the stock. The regulations 

also promote the clear reflection of 

income by redetermining members’ 

bases in subsidiary stock and reducing 

the subsidiary’s attributes to prevent the 

duplication of loss. Additionally, the 

regulations provide guidance limiting 

the application of section 362(e)(2) with 

respect to transactions between 

members of a consolidated group. 

DATES: Written or electronic comments 

or a request for a public hearing must 

be received by April 23, 2007. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–157711–02), room 

5203, Internal Revenue Service, P.O. 

Box 7604, Ben Franklin Station, 

Washington, DC 20044. Submissions 

may be hand-delivered Monday through 

Friday between the hours of 8 a.m. and 

4 p.m. to CC:PA:LPD:PR (REG–157711– 

02), Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC, or sent 

electronically, via the IRS Internet site 

at www.irs.gov/regs or via the Federal 

eRulemaking Portal at 

www.regulations.gov (IRS/REG–157711– 

02). 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

Theresa Abell (202) 622–7700 or Phoebe 

Bennett (202) 622–7770; concerning 

submissions of comments, Richard 

Hurst, 

Richard.A.Hurst@irscounsel.treas.gov, 

(202) 622–7180 (not toll-free numbers). 

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act 

The collection of information 

contained in this notice of proposed 

rulemaking has been submitted to the 

Office of Management and Budget for 

review in accordance with the 

Paperwork Reduction Act of 1995 (44 

U.S.C. 3507(d)). Comments on the 

collection of information should be sent 

to the Office of Management and 

Budget, Attn: Desk Officer for the 

Department of the Treasury, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503, with copies to 

the Internal Revenue Service, Attn: IRS 

Reports Clearance Officer, 

SE:W:CAR:MP:T:T:SP, Washington, DC 

20224. Comments on the collection of 

information should be received by 

March 26, 2007. 

Comments are specifically requested 

concerning: 

Whether the proposed collection of 

information is necessary for the proper 

performance of the functions of the IRS, 

including whether the information will 

have practical utility; 

The accuracy of the estimated burden 

associated with the proposed collection 

of information; 

How the quality, utility, and clarity of 

the information to be collected may be 

enhanced; 

How the burden of complying with 

the proposed collection of information 

may be minimized, including through 

the application of automated collection 

techniques or other forms of information 

technology; and 

Estimates of capital or start-up costs 

and costs of operation, maintenance, 

and purchase of services to provide 

information. 

The collection of information in these 

proposed regulations is in §§ 1.1502– 

13(e)(4)(v) and 1.1502–36(d)(7). The 

respondents are corporations filing 

consolidated returns. The collection of 

information is required to allow a 

corporation to preserve a subsidiary’s 

attributes by foregoing a stock loss. The 

collection of information is required to 

obtain a benefit. 

Estimated total annual reporting and/ 

or recordkeeping burden: 25 hours. 

Estimated average annual burden per 

respondent and/or recordkeeper: 15 

minutes. 

Estimated number of respondents 

and/or recordkeepers: 100. 

Estimated annual frequency of 

responses: Once. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a valid control 

number assigned by the Office of 

Management and Budget. 

Books or records relating to the 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any Internal Revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

Background 

The discussion in this preamble 

begins with an overview of the history 

of the regulatory attempts to address 

both the circumvention of General 

Utilities repeal and the duplication of 

loss by consolidated groups, in 

particular, in § 1.1502–20 (the Loss 

Disallowance Rule, or LDR). The 

discussion then turns to Rite Aid Corp. 

v. United States, 255 F.3d 1357 (2001), 

which rejected the loss duplication rule 

in the LDR. Section A.4 of this preamble 

discusses the immediate administrative 

responses to Rite Aid. Section A.5 of 

this preamble discusses the legislative 

response to Rite Aid. Following the Rite 

Aid decision, the IRS and Treasury 

Department undertook a study to 

reconsider the issues addressed by 

§ 1.1502–20. Section B of this preamble 

discusses the various issues considered 

in that study, including both the 

original noneconomic and duplicated 

stock loss specifically addressed by the 

LDR and certain related issues with 

which the Internal Revenue Service and 

Treasury Department have grown 

concerned since the LDR was 

promulgated. Section C of this preamble 

describes the various approaches that 

were considered to address 

noneconomic stock loss and sets forth 

the conclusions reached regarding each. 

Section D of this preamble describes the 

various approaches that were 

considered to address loss duplication 

and sets forth the conclusions reached 

regarding each. Section E of this 

preamble describes the various 

approaches that were considered to 

address the noneconomic and 

duplicated loss that can arise from the 

general operation of the investment 

adjustment system and sets forth the 

conclusions reached regarding each. 

Section F of this preamble describes the 

specific provisions of this proposed 

regulation § 1.1502–36. Section G of this 

preamble discusses the proposed 

removal of §§ 1.337(d)–1, 1.337(d)–2, 

and 1.1502–35. 

The IRS and Treasury Department are 

also proposing regulations to address 

the application of section 362(e)(2) to 

members of consolidated groups. These 

proposed regulations are described in 

section H of this preamble. 

Finally, the IRS and Treasury 

Department are proposing various 

technical and administrative revisions 

to the consolidated return regulations. 

These proposed regulations are 

described in section I of this preamble. 


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The IRS and Treasury Department 

request comments on the proposed 

regulations and other approaches that 

could be adopted, as well as other issues 

currently under study. See section J of 

this preamble for further discussion of 

comments requested. 

A. History of General Utilities Repeal 

and Loss Disallowance Under § 1.1502– 

20 

1. The Repeal of the General Utilities 

Doctrine 

In 1986, Congress enacted section 

337(d), which directs the Secretary to 

prescribe such regulations as may be 

necessary or appropriate to carry out the 

repeal of the General Utilities doctrine 

(GU repeal). See Tax Reform Act of 

1986, Public Law 99–514 (100 Stat. 2085 

(1986)). The legislative history states 

that Congress was concerned that the 

General Utilities doctrine allowed 

‘‘assets to leave corporate solution and 

to take a stepped-up basis in the hands 

of the transferee without the imposition 

of a corporate-level tax’’ and thus 

‘‘tend[ed] to undermine the corporate 

income tax.’’ H.R. Rep. No. 99–426, 99th 

Cong., 1st Sess. 282 (1985). The General 

Utilities doctrine and GU repeal are 

discussed extensively in the Treasury 

Decisions referenced in this preamble; 

in addition, see generally, H.R. Rep. No. 

99–426 at 274–282 for a discussion of 

the history of the General Utilities 

doctrine; see also General Utilities & 

Operating Co. v. Helvering, 296 U.S. 200 

(1935). 

2. The Administrative Response to GU 

Repeal: § 1.1502–20 

The IRS and Treasury Department 

first responded to GU repeal by issuing 

Notice 87–14 (1987–1 CB 445), which 

set forth the intent to promulgate 

regulations affecting adjustments to 

members’ bases in stock of any 

subsidiary acquired when the subsidiary 

held an appreciated asset. Notice 87–14 

indicated that, in general, adjustments 

to subsidiary stock basis would not 

reflect gains on such assets. Thus, 

Notice 87–14 implied that a tracingbased regime would be adopted to 

determine adjustments to member’s 

bases in shares of subsidiary stock. 

After several years of study, the IRS 

and Treasury Department concluded 

that any approach relying on the 

identification and tracing of 

appreciation on particular assets, while 

theoretically accurate, would impose 

substantial administrative burdens on 

taxpayers and on the government. See 

TD 8294 (1990–1 CB 69), 55 FR 9426, 

9428 (March 14, 1990). As a result, the 

tracing-based approach envisioned in 

Notice 87–14 was implemented only in 

regulations promulgated under section 

337(d). Those regulations applied only 

for the period of time between the 

issuance of Notice 87–14 and the 

effective date of final regulations under 

§ 1.1502–20 (February 1, 1991). See TD 

8364 (1991–2 CB 43), 56 FR 47379 

(September 19, 1991), §§ 1.337(d)–1 and 

1.337(d)–2 (as contained in 26 CFR part 

1 revised as of April 1, 1991). 

In lieu of tracing, the LDR used 

certain operating presumptions to 

determine the extent to which 

investment adjustments would be 

permitted to give rise to allowable stock 

loss. Because the LDR only disallowed 

loss, noneconomic investment 

adjustments were able to increase stock 

basis and thus reduce gain without 

limitation. As a result, the LDR reduced 

the duplication of gain in the tax 

system. The IRS and Treasury 

Department considered the reduction of 

gain duplication an important balance 

to the imprecision inherent in the LDR’s 

use of irrebuttable presumptions. 

The study following the issuance of 

Notice 87–14 led the IRS and Treasury 

Department to consider the issue of loss 

duplication by members of consolidated 

groups. Their conclusion was that loss 

duplication was inappropriate in the 

consolidated setting. Further, the IRS 

and Treasury Department recognized 

that there were administrative 

advantages to addressing both issues in 

a single integrated rule. Thus, unlike the 

regulations under section 337(d), the 

LDR was at once directed at both the 

circumvention of GU repeal through the 

use of noneconomic stock loss and the 

duplication of loss. See TD 8294 and TD 

8364. 

3. The Rite Aid Opinion 

Ten years after the promulgation of 

the LDR, the validity of the duplicated 

loss component of the LDR was 

considered in Rite Aid, supra. Under the 

duplicated loss component of the LDR, 

Rite Aid had been disallowed a 

deduction for an economic loss on 

subsidiary stock solely because the 

stock loss could be duplicated by the 

subsidiary after it left the group. The 

Federal Circuit stated that the 

Secretary’s authority to change the 

application of a Code provision to a 

consolidated group was limited to 

situations in which the change was 

necessary to address a problem created 

by the filing of a consolidated return. 

Because duplicated stock loss occurs 

and is allowable in the separate return 

setting, the court concluded that the 

duplicated loss component of the LDR 

was not addressing a problem arising 

from the filing of a consolidated return. 

Accordingly, the court held that the 

Secretary did not have the authority to 

change the Code rule allowing a 

deduction for the stock loss. 

4. The Administrative Response to Rite 

Aid 

In response to the Rite Aid decision, 

on February 19, 2002, the IRS 

announced that it would not continue to 

litigate the validity of the duplicated 

loss rule in § 1.1502–20. See Notice 

2002–11 (2002–1 CB 526). On March 7, 

2002, the IRS and Treasury Department 

promulgated § 1.1502–20T(i) (to 

suspend the application of the LDR) and 

§ 1.337(d)–2T (to provide an interim 

rule addressing noneconomic stock 

loss). See TD 8984 (2002–1 CB 668), 67 

FR 11034 (March 12, 2002). 

Concurrently with the promulgation of 

§§ 1.337(d)–2T and 1.1502–20T(i), the 

IRS issued Notice 2002–18 (2002–1 CB 

644), announcing that loss duplication 

regulations would also be promulgated. 

Following the publication of TD 8984, 

the IRS and Treasury Department 

undertook a study of the issues 

underlying both noneconomic and 

duplicated loss on subsidiary stock. 

In general, § 1.337(d)–2T disallowed 

stock loss and reduced stock basis (to 

value) upon the disposition or 

deconsolidation of subsidiary stock by a 

member of a consolidated group. 

However, under § 1.337(d)–2T(c)(2), loss 

disallowance and basis reduction were 

avoided to the extent the taxpayer could 

establish that the loss or basis ‘‘is not 

attributable to the recognition of builtin gain on the disposition of an asset.’’

Section 1.337(d)–2T(c)(2) defined the 

term ‘‘built-in gain’’ as gain that is 

‘‘attributable, directly or indirectly, in 

whole or in part, to any excess of value 

over basis that is reflected, before the 

disposition of the asset, in the basis of 

the share, directly or indirectly, in 

whole or in part.’’

On March 14, 2003, the IRS and 

Treasury Department promulgated 

§ 1.1502–35T as an interim measure to 

address the problem of loss duplication 

in consolidated groups. See TD 9048 

(2003–1 CB 644), 68 FR 12287 (March 

14, 2003). In the preamble to TD 9048, 

the IRS and Treasury Department 

announced that the issues addressed in 

§ 1.1502–35T were still under study. 

The provisions of § 1.1502–35 are 

discussed in more detail in section D.1 

of this preamble. 

Further guidance on the interim rules 

was issued August 25, 2004, in the form 

of Notice 2004–58 (2004–2 CB 520). In 

Notice 2004–58, the IRS announced that 

it would accept the ‘‘basis 

disconformity’’ method as an alternative 

approach to determining whether stock 


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loss or basis was attributable to ‘‘builtin gain’’ within the meaning of 

§ 1.337(d)–2T. 

Under the basis disconformity method 

described in Notice 2004–58, stock loss 

or basis is treated as attributable to 

built-in gain to the extent of the least of 

(i) the net positive investment 

adjustment applied to the stock basis 

(disregarding distributions), (ii) the 

aggregate gain (net of directly related 

expenses) recognized on asset 

dispositions by the subsidiary, and (iii) 

the disconformity amount (generally, 

the amount by which the basis of the 

share exceeds the share’s proportionate 

interest in the subsidiary’s net inside 

asset basis; for this purpose, net inside 

asset basis is defined as the excess of the 

sum of the subsidiary’s money, asset 

basis, loss carryforwards, and deferred 

deductions over its liabilities). Notice 

2004–58 also requested comments on 

the general scope of GU repeal and on 

other approaches that could be adopted 

to safeguard the purposes of GU repeal 

in the consolidated return context. 

5. The Legislative Response to Rite Aid 

Congress responded to the Rite Aid 

opinion on October 22, 2004, in the 

American Jobs Creation Act (the AJCA), 

Public Law 108–357 (118 Stat. 1418 

(2004)). In the AJCA, Congress added a 

sentence at the end of section 1502 of 

the Code, so that the section now reads: 

The Secretary shall prescribe such 

regulations as he may deem necessary in 

order that the tax liability of any affiliated 

group of corporations making a consolidated 

return and of each corporation in the group, 

both during and after the period of affiliation, 

may be returned, determined, computed, 

assessed, collected, and adjusted, in such 

manner as clearly to reflect the income tax 

liability and the various factors necessary for 

the determination of such liability, and in 

order to prevent avoidance of such tax 

liability. In carrying out the preceding 

sentence, the Secretary may prescribe rules 

that are different from the provisions of 

chapter 1 that would apply if such 

corporations filed separate returns. 

In the legislative history to the AJCA, 

Congress stated that the Secretary is 

authorized to change the application of 

a Code provision when the Secretary 

determines it is necessary to clearly 

reflect the income tax liability of the 

group and each corporation in the 

group, both during and after the period 

of affiliation. See H.R. Conf. Rep. No. 

108–755, 108th Cong., 2d Sess. 653 

(2004). Congress thus rejected the 

suggestion in the Rite Aid opinion that 

the Secretary’s authority to change the 

general application of the Code is 

limited to promulgating regulations that 

address problems created by the filing of 

a consolidated return. 

In the AJCA legislative history, 

Congress also spoke to the proper scope 

of future regulations. Regarding the 

promulgation of regulations addressing 

noneconomic stock loss, Congress stated 

that ‘‘presumptions and other 

simplifying conventions’’ could be used 

to prevent the circumvention of GU 

repeal. See H.R. Conf. Rep. No. 108–755, 

fn. 595. In addition, Congress indicated 

two acceptable methods for addressing 

loss duplication by group members. The 

first would disallow subsidiary stock 

loss to the extent it duplicates losses 

that remain available to the group. The 

second would reduce the subsidiary’s 

attributes in order to prevent the 

subsidiary from using losses outside the 

group, to the extent the losses duplicate 

stock loss. But Congress also stated its 

intention that the result of the Rite Aid 

decision is to be preserved. The IRS and 

Treasury Department interpret this 

statement to mean that regulations 

addressing loss duplication by 

consolidated groups must not disallow 

a deduction for an economic loss on 

subsidiary stock solely because the 

stock loss duplicates unrecognized or 

unabsorbed losses that later could be 

used outside the group. 

6. Further Administrative Response to 

Rite Aid 

On March 3, 2005, the IRS and 

Treasury Department finalized 

§ 1.337(d)–2. See TD 9187 (2005–13 IRB 

778), 70 FR 10319 (March 3, 2005). In 

TD 9187, the IRS and Treasury 

Department stated that the issues 

addressed in § 1.337(d)–2 were still 

under study and that an alternative 

approach would be proposed. On March 

14, 2006, the IRS and Treasury 

Department finalized § 1.1502–35. See 

TD 9254 (2006–13 IRB 662), 71 FR 

13008 (March 14, 2006). In TD 9254, the 

IRS and Treasury Department stated that 

both noneconomic and duplicated loss 

were still under study, and that 

regulations would be proposed adopting 

a singe integrated approach to 

addressing both issues. The results of 

that study and the proposed integrated 

approach are described below in 

sections D through H of this preamble. 

B. Issues Considered in the Post-Rite 

Aid Study. 

1. GU Repeal and Noneconomic 

Investment Adjustments Under the LDR 

Section 337(d) generally directs the 

Secretary to prescribe regulations to 

prevent the circumvention of GU repeal 

and, in particular, section 337(d)(1) 

directs the Secretary to promulgate 

regulations to prevent the 

circumvention of GU repeal through the 

use of the consolidated return 

regulations. Congress’ concern stems 

from the general operation of the 

investment adjustment system of 

§ 1.1502–32. 

The purpose of the investment 

adjustment system is to promote the 

clear reflection of the group’s income. 

See § 1.1502–32(a)(1). One of the 

principal ways that the investment 

adjustment system promotes clear 

reflection is by preventing a subsidiary’s 

items of income, gain, deduction and 

loss from giving rise to duplicative gain 

or loss on the subsidiary’s stock. To that 

end, the investment adjustment system 

adjusts members’ bases in shares of 

subsidiary stock to reflect such items 

once they have been taken into account 

by the group. See TD 8560 (1994–2 CB 

200), 59 FR 41666 (August 15, 1994). 

Example 1. Economic adjustment to stock 

basis prevents duplication. P, the common 

parent of a consolidated group, purchases all 

100 outstanding shares of S common stock 

for $100 cash, taking a basis of $1 in each 

share. At the time, S owns one asset, A1, 

with a basis and value of $100. Later, the 

value of A1 increases to $150. S sells A1 to 

a nonmember for $150 and recognizes a $50 

gain, which the P group takes into account. 

Under the investment adjustment system, P 

increases its basis in its S stock to reflect the 

$50 taken into account by the group. As a 

result, the basis of each share increases to 

$1.50, its fair market value. P can then sell 

all or any portion of its S stock for its fair 

market value without recognizing duplicative 

gain on the disposition. 

The result in Example 1 is that the 

group takes its economic gain into 

account only once, on the disposition of 

S’s asset, and not again on the 

subsequent disposition of the S stock. 

Thus the group’s income is clearly 

reflected and there is no circumvention 

of GU repeal. 

The investment adjustment system is 

not a tracing regime. Rather, it is a 

presumptive regime based on certain 

operating assumptions. A principal 

assumption is that all of a subsidiary’s 

items taken into account represent 

economic accruals (of gain or loss) to 

the group. Another principal 

assumption is that all such items accrue 

equally to all outstanding shares, at least 

within a class. When these assumptions 

correspond to the facts of a particular 

situation, as in Example 1, the 

investment adjustment system produces 

appropriate results: stock basis, which 

reflects only the investment in the stock, 

increases to reflect economic accrual 

(the group’s return on its stock 

investment), and, as a result, stock basis 

can then shelter that return on the 

group’s investment, protecting it from 

being taken into account again when the 

stock is sold. 


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The assumptions, however, do not 

correspond to the facts of all situations. 

For example, if stock of a subsidiary is 

purchased for its fair market value when 

the subsidiary holds appreciated assets, 

the items of income or gain generated 

when that appreciation is recognized do 

not represent an economic accrual on 

the group’s investment (because the 

appreciation was already reflected in 

the basis of the stock). Nevertheless, the 

presumptive rules of the investment 

adjustment system treat such items as 

economic accruals and include them in 

the investment adjustment to be applied 

to the basis of the stock. 

Example 2. Noneconomic adjustment to 

stock basis creates noneconomic stock loss. 

Assume the same facts as in Example 1 

except that P does not purchase the stock of 

S until the value of A1 has increased to $150. 

Accordingly, P purchases the stock for $150, 

taking a basis of $1.50 in each share. As in 

Example 1, when S sells A1, the investment 

adjustment system again increases P’s basis 

in its S stock to reflect the $50 taken into 

account by the group. As a result, P’s basis 

in each of its shares increases to $2, even 

though the fair market value of each share 

remains $1.50. If P were then to sell all or 

some portion of the S stock for its fair market 

value, P would recognize a $.50 loss on each 

share ($50 loss in the aggregate). 

In this situation, a deduction for the 

stock loss would be inappropriate 

because neither the group nor its 

members have suffered any economic 

loss. If P were allowed to deduct that 

noneconomic loss, the deduction would 

offset the gain recognized on S’s asset 

and, effectively, eliminate the corporatelevel tax on the gain on S’s asset. This 

is the circumvention of GU repeal that 

concerned Congress in 1986. 

At the time Notice 87–14 was issued, 

the IRS and Treasury Department had 

identified the creation of noneconomic 

stock loss in situations similar to those 

illustrated in Example 2. Thus, Notice 

87–14 referred specifically to 

investment adjustments attributable to 

the disposition of assets that, at the time 

of the acquisition of the subsidiary 

stock, had a fair market value in excess 

of adjusted basis. For that reason, 

§ 1.337(d)–1, which implemented 

Notice 87–14, disallowed subsidiary 

stock loss unless the taxpayer could 

show that the loss was not attributable 

to the recognition of appreciation on 

assets owned, directly or indirectly, by 

a subsidiary when it became a member. 

2. Duplicated Loss and the Clear 

Reflection of Group Income Under the 

LDR 

In the study that followed the 

issuance of Notice 87–14, the IRS and 

Treasury Department also considered 

the issue of loss duplication by 

members of a consolidated group. The 

specific concern of the IRS and Treasury 

Department was the loss duplication 

that occurs when an economic loss is 

reflected in both a member’s basis in 

subsidiary stock and in the subsidiary’s 

assets or operations, and the loss is first 

recognized with respect to the stock. 

Example 3. Duplication of loss. P forms S 

by contributing $110 to S in exchange for all 

100 outstanding shares of S stock. S uses the 

cash to purchase an asset, A1. The value of 

A1 later declines to $10. If P were then to sell 

all or some portion of the S stock for its fair 

market value, P would recognize a $1 loss on 

each share. 

In this situation, even though P would 

have recognized the group’s economic 

loss on its disposition of the S stock, the 

loss continues to be reflected in the 

basis of A1. As a result, that loss would 

remain available for use by P (if the 

stock sale did not deconsolidate S) or S 

(if the stock sale deconsolidated S). 

Upon the disposition of A1, the group’s 

single economic loss would thus be 

recognized and taken into account more 

than once by the group and its members 

or former members. 

In contrast, if the duplicated loss had 

first been taken into account with 

respect to A1, the investment 

adjustment system would have 

prevented a duplicative benefit to the 

group and its members by reducing P’s 

basis in S stock by the amount of the 

loss. In that case, the group would have 

enjoyed the tax benefit attributable to 

the loss, but that benefit would not 

remain available for another use by the 

group and its members or former 

members. 

The IRS and Treasury Department 

concluded that the duplication of a 

group’s tax benefit (represented by a 

single economic loss) distorts income 

without regard to whether the 

duplicated loss is taken into account 

first with respect to the subsidiary’s 

stock or first with respect to the 

subsidiary’s assets and operations. The 

IRS and Treasury Department further 

concluded that, even if the duplicated 

loss is used by a former member outside 

the group, that duplicative use distorts 

the income of the group and its 

members. Accordingly, the IRS and 

Treasury Department decided to 

promulgate regulations that would 

complement the investment adjustment 

system by addressing the stock-first 

recognition of a duplicated loss and that 

such regulations would apply to both 

deconsolidating and 

nondeconsolidating dispositions. 

Recognizing the administrative benefits 

of addressing both noneconomic and 

duplicated stock loss in a single 

integrated rule, the IRS and Treasury 

Department promulgated the LDR as a 

single rule with components directed at 

both. 

The method adopted by the LDR to 

address loss duplication was the 

disallowance of stock loss (or reduction 

of stock basis) that duplicated 

unrecognized inside loss, such as that 

illustrated in Example 3. However, 

groups had several mechanisms 

available to recognize or preserve the 

inside loss and thereby avoid loss 

disallowance (by eliminating loss 

duplication). Inside losses could be 

recognized through an actual asset sale 

or a deemed asset sale under section 

338(h)(10), and, following the sale, the 

subsidiary’s unabsorbed losses would be 

available to the group. In addition, the 

LDR allowed the common parent to 

elect to reattribute the subsidiary’s 

losses (to itself) under § 1.1502–20(g). If 

the group chose not to exercise those 

options, then the stock loss was denied, 

but the inside loss was preserved for a 

nonduplicative use by the subsidiary, in 

or out of the group. 

At the time the LDR was promulgated, 

the duplication potential illustrated in 

Example 3 was the principal form of 

loss duplication with which the IRS and 

Treasury Department were concerned. 

Thus it is the only form of loss 

duplication specifically addressed by 

the LDR. The anti-abuse rule in the LDR 

did, however, provide a limited 

mechanism for expanding the scope of 

that provision. 

3. Noneconomic and Duplicated Loss 

Resulting from Investment Adjustments 

Allocated to Shares With Disparate 

Bases 

Since the promulgation of the LDR, 

the IRS and Treasury Department have 

become increasingly concerned with the 

noneconomic and duplicated loss 

potential arising from the interaction of 

§ 1.1502–32 and the disparate reflection 

of gain or loss in members’ bases in 

individual shares of subsidiary stock. 

As discussed in section B.1 of this 

preamble, the investment adjustment 

system is a presumptive regime that 

allocates a subsidiary’s items of income, 

gain, deduction, and loss taken into 

account by the group. It operates in 

accordance with the assumption that all 

such items reflect economic accruals to 

all shares equally within each class. 

When its underlying assumptions 

correspond to the facts of a particular 

situation, the investment adjustment 

system produces appropriate results, as 

illustrated in Example 1. But when its 

underlying assumptions do not 

correspond to the facts of a situation 

because shares held by members have 

disparate bases, the general operation of 


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the investment adjustment system can 

give rise to both noneconomic and 

duplicated loss on individual shares of 

subsidiary stock. 

Example 4. Noneconomic loss. P and M (a 

member of the P group) form S by 

contributing property to S in exchange for all 

100 outstanding shares of S stock. P 

contributes A1, with a basis and value of $80, 

in exchange for 80 shares of S stock. M 

contributes A2, with a basis of $0 and a value 

of $20, to S in exchange for 20 shares of S 

stock. S then sells A2 for $20 and recognizes 

a $20 gain that is taken into account by the 

group. As a result, the basis of each share 

increases by $.20. P’s basis in each of its 

shares is then $1.20 (or, $96 in the aggregate), 

and M’s basis in each of its shares is then 

$.20 (or, $4 in the aggregate), even though the 

value of each share remains $1. P then sells 

all or some portion of its shares to X, a 

nonmember, and, under general principles of 

tax law, recognizes a $.20 noneconomic loss 

on each share, effectively eliminating up to 

$16 of the gain on A2. 

Example 5(a). Duplicated loss, inside 

recognition precedes stock disposition. P 

forms S with $100 and receives all 50 shares 

of S common stock. S uses the $100 to buy 

A1, which then declines in value to $50. P 

contributes another $50 for a second 50 

shares of common stock. S then sells A1 and 

recognizes a loss of $50 that is taken into 

account on the P group return. The 

absorption of the $50 loss results in a $.50 

reduction to the basis of each share (original 

and newly issued). P then sells all or some 

portion of the original shares to X for $1 each 

(each with a basis of $1.50) and recognizes 

a $.50 loss on each share (up to $25 total). 

Although the $50 asset loss and the $25 stock 

loss both reflect an economic loss of the 

group, they are both reflecting the same loss. 

The group has actually experienced only $50 

of economic loss. Therefore, the $.50 loss 

recognized on each of the original shares (up 

to $25 total) is duplicative. 

Example 5(b). Duplicated loss, stock 

disposition precedes inside recognition. The 

facts are the same as in Example 5(a), except 

that, before S sells A1, P sells 20 of its 

original 50 shares to X for $20 (aggregate 

basis $40), recognizing a $20 loss that is 

taken into account on the P group return, and 

S remains a member of the group. S then sells 

A1, recognizing a $50 loss that is taken into 

account on the P group return. Although the 

$50 asset loss and the $20 stock loss both 

reflect an economic loss of the group, they 

are both reflecting the same loss. As in 

Example 5(a), the group has actually 

experienced only $50 of economic loss. 

Therefore, $20 of the recognized loss is 

duplicative. Alternatively, if P sold all its 

original 50 shares, P would recognize a $50 

loss even though the entire $50 group loss 

would remain available to S for a duplicative 

use against its separate year income. 

The IRS and Treasury Department 

recognize that, in each case where the 

disproportionate reflection of an item in 

a particular share causes an 

inappropriate stock loss, whether 

noneconomic or duplicated, that loss is 

offset by unrecognized gain in other 

shares. However, that gain can be 

deferred indefinitely or even eliminated 

by the group. Accordingly, the IRS and 

Treasury Department do not believe that 

the system is appropriately balanced in 

such cases. 

The IRS and Treasury Department 

further recognize that these issues could 

be addressed by adopting a tracingbased approach to the allocation of 

investment adjustments. However, the 

complexity and burden of a tracingbased approach would render such an 

approach generally inadministrable for 

consolidated taxpayers and for the 

government. As a result, the system 

would be prone to error and, in practice, 

inconsistently applied. Moreover, the 

IRS and Treasury Department continue 

to believe that the assumptions on 

which the investment adjustment 

system is based are appropriate for 

typical commercial transactions, as the 

IRS and Treasury Department 

understand that typically subsidiaries 

have only common stock outstanding, 

that their stock is wholly owned by 

group members, and that members’

bases in shares of subsidiary stock are 

uniform, as under the facts of Example 

1. See section E.2 of the preamble of 

CO–30–92 (1992–2 CB 627), 57 FR 

53634, 53639 (November 12, 1992). 

Because a tracing-based approach to 

the allocation of investment adjustments 

would not be administrable, the IRS and 

Treasury Department are not 

considering revising the investment 

adjustment system to adopt such an 

approach. Instead, the IRS and Treasury 

Department have considered various 

presumptive approaches that could be 

adopted to mitigate the creation of 

noneconomic and duplicated loss when 

members hold subsidiary stock with 

disparate bases. The approaches 

considered and decisions reached are 

discussed in section E of this preamble. 

4. Redetermination Events: Changes in 

the Extent That Unrecognized Gain or 

Loss Is Effectively Reflected in the Basis 

of Individual Shares 

Because the investment adjustment 

system adjusts the basis of each share in 

accordance with its proportionate 

interest in S’s assets and operations, the 

relationship between a share’s basis and 

its allocable portion of unrecognized 

appreciation or depreciation determines 

the extent to which such amounts are 

effectively reflected in the basis of the 

share. This relationship, however, is not 

fixed at the time that stock is acquired. 

The reason is that there are many 

transactions, referred to here as 

redetermination events, that alter either 

the basis of a share or the interest it 

represents. These events generally occur 

in one of three types of situations. 

a. Stock basis is reallocated. 

The relationship between the basis of 

a share and the interest represented by 

the share can be altered whenever stock 

basis is reallocated among shares, 

including when it is allocated to shares 

of stock of other members. 

Example 6. Intragroup spin-off. P forms S 

by contributing $100 to S in exchange for all 

the stock of S. S purchases two assets, A1 

and A2, for $50 each. Subsequently, A1 

appreciates to $75 and A2 depreciates to $25. 

In a transaction qualifying under sections 355 

and 368(a)(1)(D), S transfers A2 to C in 

exchange for all of the C stock and S then 

distributes all the C stock to P. Under section 

358 and § 1.358–2, P’s basis in the S stock is 

allocated among the S and C stock in 

proportion to the value of the stock of S and 

C. As a result, P’s basis in its S stock is $75 

(75⁄100 × $100) and P’s basis in its C stock is 

$25 (25⁄100 × $100). S sells A1 for $75, 

recognizing a $25 gain that is taken into 

account on the P group return. P’s basis in 

its S stock increases by $25, from $75 to 

$100. P then sells its S stock for $75 and 

recognizes a $25 loss. 

In this Example 6, after the 

reallocation of stock basis, P’s basis in 

its S stock reflects the unrecognized 

appreciation on A1, just as P’s basis in 

its S stock reflected unrecognized 

appreciation on A1 in Example 2. As a 

result, P’s reallocated S stock basis 

protects the appreciation on A1 from 

being recognized as both asset gain and 

stock gain. Increasing P’s basis in its S 

stock to reflect the recognition of S’s 

gain on A1 is not only unnecessary, it 

inflates stock basis and thereby gives 

rise to either noneconomic loss or 

noneconomic reduction of gain when 

the stock is sold. 

Basis reallocations, and the 

consequences described, can occur for a 

number of reasons, including, for 

example, under rules like § 1.1502– 

32(c)(4) (cumulative redetermination of 

investment adjustments) and § 1.1502– 

35(b) (basis redetermination to reduce 

disparity) and the corresponding 

provision in these proposed regulations. 

b. Capital transactions expand or 

contract the subsidiary’s pool of assets. 

The relationship between the basis of 

a share and the nature of the interest 

represented by the share can also be 

altered by capital transactions that have 

no effect on the basis or value of 

outstanding shares, but that 

nevertheless alter the interest 

represented by those shares. Some 

common examples arise in the context 

of section 351 exchanges, even though, 

as illustrated in Example 7(a), a section 

351 exchange in its simplest form 

cannot give rise to stock basis that 

reflects unrecognized appreciation. 


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Example 7(a). Contribution of appreciated 

asset in section 351 exchange. P forms S by 

contributing an asset, A1, to S in exchange 

for all 80 outstanding shares of S stock. The 

basis of A1 is $40 and its value is $80. S sells 

A1 and recognizes a $40 gain that is taken 

into account by the P group. As a result, P’s 

aggregate basis in its S shares is increased by 

$40, from $40 to $80. Subsequently, P sells 

its S stock for $80, the stock’s fair market 

value and recognizes $0 on the sale. The 

group is thus taxed once on its $40 economic 

gain. 

In Example 7(a), P holds appreciated 

S stock and S holds an appreciated 

asset, but that appreciation is not 

reflected in either P’s basis in its S stock 

or S’s basis in its asset. Each share has 

a basis of $.50 and an interest in 1/80 

of S’s asset, A1, which has $40 of 

unrecognized appreciation (allocable 

$.50 to each share). If this relationship 

between P’s basis in its S shares and the 

interest represented by the shares 

remains constant, as in Example 7(a), 

the investment adjustment system 

produces appropriate results. But if 

there is a change in that relationship, 

the underlying assumptions of the 

investment adjustment system may no 

longer correspond to the facts of the 

situation and, as a result, the general 

operation of the system could produce 

inappropriate results. Such changes can 

occur whenever S acquires property in 

exchange for additional shares of its 

stock. 

Example 7(b). Contribution of appreciated 

asset in subsequent section 351 exchange 

creates disconformity in original shares. The 

facts are the same as in Example 7(a), except 

that, before A1 is sold, P contributes a second 

asset, A2, to S in exchange for an additional 

20 shares of S stock. A2 has a basis of $0 and 

a value of $20. S sells both assets and 

recognizes a $60 gain that is taken into 

account by the P group. As a result, P’s basis 

in its original shares increases by $48 ($.60 

per share), from $40 to $88 (or, from $.50 to 

$1.10 per share), and P’s basis in its new 

shares increases by $12, from $0 to $12 (or, 

from $0 to $.60 per share). P then sells 20 of 

its original shares (basis of $22) for $20, their 

fair market value, and recognizes a $2 loss. 

In Example 7(b), P’s basis in the 

original S stock reflected no 

unrecognized appreciation when the 

stock was issued. After the second 

contribution, however, P’s basis in those 

shares reflects a portion of the 

unrecognized appreciation on A2. The 

reason is that each share represents an 

interest in S’s entire pool of assets. 

When the pool changes, the nature of 

the interest represented by the shares 

changes, even though the share’s basis 

and value remain constant. Thus, in 

Example 7(b), while each original 

share’s basis ($.50) and value ($1) 

remain constant, the interest 

represented by each share changed from 

1/80 of an asset with unrecognized 

appreciation of $40 (or, $.50 per share), 

to 1/100 of assets with unrecognized 

appreciation of $60 (or, $.60 per share). 

This shift causes the basis of each 

original share to reflect $.10 of 

unrecognized appreciation. When the 

gain is recognized, $.10 of the gain 

allocated to each original share under 

the investment adjustment system is a 

noneconomic increase in the share’s 

basis. That increase will give rise to 

noneconomic stock loss or gain 

reduction. Although this (noneconomic) 

allocation of the (economic) item results 

in an offsetting stock gain on the basis 

of the new shares, that gain can be 

indefinitely deferred and even 

eliminated. 

The principles that increase the 

reflection of unrecognized appreciation 

in the original shares in Example 7(b) 

can also cause the reflection of 

unrecognized appreciation in the basis 

of shares that are received in exchange 

for property that is not appreciated, 

including cash. Although such shares 

would have a substituted basis (which 

generally precludes the reflection of 

unrecognized appreciation, as 

illustrated in Example 7(a)), the 

reflection of unrecognized appreciation 

is prevented only if the shares represent, 

wholly and solely, the transferee’s 

interest in its transferred property. If 

there are previously issued shares 

outstanding, or if other shares are issued 

in the exchange, the shares represent an 

interest in a pool of assets that includes 

more than the transferred assets. As a 

result, the interest represented by each 

such share may be significantly different 

from what it would be if the subsidiary 

held only the transferred property. 

Example 7(c). Multiple transferors in single 

section 351 exchange. The facts are the same 

as in Example 7(a), except that, when P 

contributes A1 to S in exchange for 80 shares 

of S stock, M (another member in the group) 

also contributes $20 cash to S in exchange for 

20 shares of S stock. S sells A1 for $80 and 

recognizes a $40 gain that is taken into 

account by the group. Accordingly, P’s 

aggregate basis in its shares increases by $32 

(80⁄100 × $40), from $40 to $72, and M’s 

aggregate basis in its shares increases by $8 

(20⁄100 × $40), from $20 to $28. M then sells 

its shares for $20, their fair market value, and 

recognizes an $8 noneconomic loss. 

Similar changes in the extent to 

which unrecognized amounts are 

reflected in basis can occur whenever 

the subsidiary’s pool of assets is 

increased or decreased by a capital 

transaction. The reason is that the 

interest represented by each share, and 

thus the relationship between a share’s 

basis and the interest represented by the 

share, changes whenever the 

subsidiary’s pool of assets changes. 

Such transactions include acquisitive 

reorganizations (if new shares are 

issued) and redemptions. 

c. Assets are acquired with a basis 

that reflects unrecognized appreciation. 

The relationship between the basis of 

a share and the nature of the interest 

represented by the share can also be 

altered by transactions in which S 

acquires assets with a basis that reflects 

unrecognized appreciation, such as 

stock of a new member. The reason is 

that, after the lower-tier acquisition, the 

S shares have an interest in 

unrecognized appreciation and the 

investment adjustment system will 

increase the basis of the S shares when 

those lower-tier items are recognized. 

Example 8. Acquisition of lower-tier 

subsidiary with appreciated assets. P forms S 

by contributing $100 to S in exchange for all 

the stock of S. S then purchases all the stock 

of T for $100 when T holds one asset, A1, 

with a basis of $0 and a value of $100. T sells 

A1, recognizing a $100 gain that is taken into 

account on the P group return. As a result, 

both S’s basis in its T stock and P’s basis in 

its S stock are increased by $100, from $100 

to $200. P then sells its S stock, recognizing 

a $100 loss. 

The result is the same noneconomic 

loss illustrated in Example 2. 

d. Other redetermination events. 

The IRS and Treasury Department 

expect that other transactions and 

events can alter the extent to which 

unrecognized asset appreciation is 

reflected in stock basis. Accordingly, the 

preceding discussion is not intended to 

present an exhaustive list of possible 

redetermination events. 

e. Conclusions regarding 

redetermination events. 

The IRS and Treasury Department 

recognize that redetermination events 

occur as the result of bona fide business 

transactions engaged in frequently and 

routinely throughout the time a share is 

held by any member of the group, and 

that these transactions are typically not 

tax-structured transactions. Still, these 

events generate a significant potential 

for noneconomic stock loss or gain 

reduction that facilitates the 

circumvention of GU repeal. 

Accordingly, the IRS and Treasury 

Department believe that all such events, 

whether described in this preamble or 

not, must be taken into account in any 

model that is adopted to address the 

circumvention of GU repeal. 

Nevertheless, the IRS and Treasury 

Department recognize, and are 

concerned that, the factual analysis 

necessary to identify all redetermination 

events for all members’ shares would be 

an extensive, complex, difficult, and, 


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therefore, expensive undertaking and, as 

such, would impose a substantial 

burden on both taxpayers and the 

government. Moreover, the nature of the 

undertaking would make it prone to 

error and, as a result, the rule would be 

unevenly administered and similarly 

situated taxpayers would not be 

similarly treated. 

The IRS and Treasury Department 

recognize that redetermination events 

can also create or increase the extent to 

which the basis of an individual share 

duplicates an inside loss. However, 

because duplicated loss is measured at 

the time that a stock loss is either 

recognized or preserved for later use, 

loss duplication rules by their operation 

account for redetermination events. 

Accordingly, regulations addressing loss 

duplication do not generally require 

specific provisions to address 

redetermination events. 

C. Methods Considered To Implement 

GU Repeal 

The IRS and Treasury Department 

considered a number of approaches to 

address the circumvention of GU repeal 

independently from the issue of loss 

duplication. The approaches fall into 

two broad categories: tracing-based and 

presumptive approaches. 

1. Tracing-Based Methods 

Under a tracing-based method, the 

extent to which a member can enjoy the 

benefit of subsidiary stock basis 

attributable to the recognition of an item 

of income or gain is determined by the 

extent to which the recognized item is 

reflected in the basis of the share and 

thus already protected from duplicative 

recognition on a later disposition of the 

stock. The IRS and Treasury Department 

continue to believe that tracing is a 

theoretically correct method for 

implementing GU repeal in the 

consolidated return setting and so 

considered various tracing-based 

proposals. 

a. Pure tracing. 

In general, a tracing approach would 

look solely to the connection between a 

subsidiary’s recognized items and any 

appreciation reflected in stock basis in 

order to determine the extent to which 

the group will be allowed the benefit of 

stock basis attributable to those items. 

However, such an approach would 

require taxpayers to create and maintain 

(and the IRS to examine) records to 

establish: 

• The identity of every ‘‘tainted 

asset,’’ that is, every asset held by the 

subsidiary and any lower-tier 

subsidiaries on every ‘‘measuring date,’’

which includes the date on which the 

member (or its predecessor) purchased 

the share and all subsequent dates on 

which the subsidiary has a 

redetermination event; 

• The ‘‘tainted appreciation,’’ that is, 

the appreciation on each tainted asset 

held by the subsidiary and any lowertier subsidiaries on each measuring 

date; and 

• The extent to which tainted 

appreciation is recognized, whether as 

income or gain, and included in an 

adjustment to the basis of the share. 

In addition, to fully benefit from a 

tracing regime, taxpayers would need to 

create and maintain similar records for 

tainted assets with unrecognized 

depreciation on a measuring date, 

because the recognition of that 

depreciation would be allowed to 

reduce the amount of recognized 

appreciation treated as tainted. 

These records would have to be 

created and maintained for each share of 

stock of each subsidiary and each share 

of lower-tier subsidiary stock held by a 

subsidiary on each measuring date. In 

addition, these records would need to 

be created and maintained not just for 

subsidiaries, but for all corporations the 

stock of which is acquired by a member, 

because the information would be 

necessary if the corporation becomes a 

member at some later date. 

In administering the various 

temporary and final regulations 

promulgated as loss limitation rules 

under § 1.337(d)–1 and § 1.337(d)–2, the 

IRS has found that taxpayers encounter 

substantial difficulty in attempting to 

satisfy these requirements. 

To begin, taxpayers are generally 

unable to accurately identify all of a 

subsidiary’s tainted assets. One reason 

is simply the vast number of assets 

implicated. Another reason is that many 

assets are accounted for in mass 

accounts and thus cannot be separately 

identified. Problems are exacerbated if 

appropriate records are not created 

contemporaneously; taxpayers have 

found this a particular concern when 

subsidiaries have been acquired with 

inadequate records. 

Furthermore, the commonplace 

nature of many redetermination events 

makes it difficult to identify all such 

dates. For example, many taxpayers 

routinely issue stock when a member 

contributes cash or property to a 

subsidiary, even if the issuance of stock 

would not be required for section 351 to 

apply, and each such occurrence is a 

redetermination event. 

Valuation also imposes significant 

financial and administrative burdens on 

both taxpayers and the government. 

These problems are exacerbated because 

the corporation’s assets are not 

themselves the subject of an arms-length 

transaction and, in most cases, the date 

on which the assets are actually valued 

is long after the stock transaction. 

The most problematic aspect of 

tracing, however, has typically been 

establishing the connection, or lack 

thereof, between items taken into 

account by the group and particular 

amounts of tainted appreciation. If 

much time has elapsed between a 

measuring date and the disposition of a 

tainted asset, or if an asset is held in a 

mass account, this can be difficult or 

even impossible. If tainted appreciation 

is recognized as income earned through 

the wasting or consumption of the 

appreciation, instead of as gain on the 

disposition of the asset, there are 

additional difficulties. In those cases, 

tracing is possible only if the tainted 

appreciation generates an identifiable 

stream of income. However, this is 

frequently not the case. For example, 

intangible assets, like patents or 

goodwill, are the source of significant 

tainted appreciation and they typically 

do not generate identifiable income 

streams. 

i. Conclusions regarding tracing. 

For all the reasons set forth in this 

preamble, the IRS and Treasury 

Department have again, as in 1990, 

concluded that tracing is not a viable 

method for preventing the 

circumvention of GU repeal in 

consolidation. This conclusion, while 

arguably based on theoretical concerns 

in 1990, is now based on several years 

of administering § 1.337(d)–2 (in both 

its temporary and final form) as a 

tracing regime. The IRS found that the 

difficulties encountered, by taxpayers 

and the government alike, in 

administering § 1.337(d)–2 as a tracingbased rule were overwhelmingly greater 

than those encountered in administering 

it as a presumption-based rule under the 

basis disconformity method permitted 

under Notice 2004–58. Accordingly, the 

IRS and Treasury Department are not 

proposing to adopt a tracing-based 

approach. 

ii. Tracing in other contexts. 

The IRS and Treasury Department 

recognize that tracing-based regimes are 

used to implement other provisions in 

the Code. For example, section 382(h), 

which prescribes the tax treatment of 

built-in items recognized by a 

corporation that has had an ownership 

change, and section 1374, which 

prescribes the tax treatment of built-in 

items recognized by an S corporation 

that was formerly a C corporation, both 

use tracing-based regimes. Further, the 

IRS and Treasury Department are 

proposing regulations implementing 

section 362(e)(2) in a consolidated 

return context that require certain items 


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to be traced. See section H of this 

preamble. 

The tracing regimes appropriate for 

those sections, however, do not present 

compliance and administrative concerns 

of the scope and magnitude presented 

by a tracing regime appropriate for GU 

repeal in the consolidated setting for at 

least three reasons. 

To begin, both sections 382(h) and 

1374 apply only for a limited period of 

time—five years in the case of section 

382(h) and ten years in the case of 

section 1374—and so whatever burden 

is imposed is more limited in nature. 

More importantly, sections 382(h) and 

1374 are generally concerned only with 

the unrecognized appreciation and 

depreciation in a pool of assets held by 

a corporation on a single date—the date 

the C corporation converts to an S 

corporation or the date the S 

corporation acquires assets of a C 

corporation in the case of section 1374, 

and the date a corporation has an 

ownership change in the case of section 

382(h). Similarly, section 362(e)(2) is 

only concerned net unrecognized 

depreciation in a pool of assets on the 

date of the transaction to which section 

362(e)(2) applies. But the ability to 

circumvent GU repeal using the 

consolidated return provisions can be 

created any time the subsidiary has a 

redetermination event. Thus, any rule 

implementing GU repeal in the 

consolidated context, unlike rules 

implementing sections 362(e)(2), 382(h), 

and 1374, must trace the pool of assets 

held on all measuring dates, and not just 

the pool of assets held when subsidiary 

stock is acquired (or when assets are 

transferred). 

Finally, unlike regulations 

implementing GU repeal, regulations 

implementing those other sections do 

not need to take into account the 

changing relationship between the basis 

in a particular share of stock and the 

unrecognized appreciation and 

depreciation in the corporation’s assets. 

For these reasons, any tracing-based 

regime appropriately implementing GU 

repeal in the consolidated setting would 

be much more expansive and complex, 

and therefore much less administrable, 

than the tracing regimes appropriately 

implementing sections 382(h) or 1374 

(or proposed to implement section 

362(e)(2)). 

b. Modified tracing. 

The IRS and Treasury Department 

considered several approaches that 

could be adopted to modify a tracing 

model by limiting the extent to which 

tracing would be required, in order to 

mitigate the administrative burdens of a 

pure tracing model. 

i. Exclusion for items attributable to 

after-acquired assets. 

Several commentators have suggested 

an approach, generally called the ‘‘afteracquired asset exception,’’ which allows 

taxpayers to identify assets acquired 

after the acquisition of subsidiary stock, 

in order to treat any gain realized on 

those assets as economic to the group. 

In general, all other items of gain and 

income would be deemed to be 

noneconomic, that is, attributable to the 

recognition of appreciation that was 

already reflected in basis. Stock loss 

would be allowed only to the extent that 

stock basis was attributable to the 

amounts deemed economic to the group. 

In response to concerns raised by the 

IRS and Treasury Department about 

redetermination events, the proposal 

was modified to provide that only assets 

acquired after the latest measuring date 

would be treated as giving rise to 

economic amounts. The principal 

advantage of this approach is that it 

identifies some untainted items with no 

need for valuation. 

To begin, the IRS and Treasury 

Department are concerned with the 

burden and error potential presented by 

the need to identify all redetermination 

events. Moreover, because these events 

can occur with considerable frequency 

in the ordinary course of business, it is 

unlikely that a great deal of time will 

typically elapse between the last 

redetermination date and the date of a 

stock disposition. Thus, the amount of 

gain recognized on an asset acquired 

and sold during such periods of time 

will not likely be significant. As a result, 

it appears unlikely that this approach 

would afford much relief to taxpayers 

(in terms of administrative burden or 

reducing the disallowance amount) or to 

the government (in terms of 

administrative burden). 

Furthermore, in order to implement 

GU repeal appropriately, such an 

approach must take into account not 

only gains, but also losses, recognized 

on after-acquired assets. But the 

identification of such losses imposes an 

additional administrative burden that 

taxpayers have no incentive to facilitate. 

In any event, a requirement to take 

losses into account could be easily 

manipulated by the timing and 

structuring of redetermination events. 

ii. Exclusion for items recognized 

after prescribed period of time. 

Several commentators also suggested 

a tracing-based approach that would 

apply to investment adjustments taken 

into account only during a prescribed 

period of time following the acquisition 

of a share. The chief advantage to this 

approach is that, regardless how 

burdensome the administration of the 

rule, it would not extend indefinitely. 

Like the proposed after-acquired-asset 

approach, however, this approach 

would need to take redetermination 

events into account. The tracing period 

would then begin again on the date of 

each redetermination event. Thus, like 

the after-acquired-asset exception, this 

approach is unlikely to afford much 

relief to taxpayers (in terms of 

administrative or tax burden) or the 

government (in terms of administrative 

burden) because the period for tracing 

may never close. 

Moreover, the IRS and Treasury 

Department are concerned that such an 

approach does not adequately respond 

to GU repeal. The reason is that 

noneconomic investment adjustments 

circumvent GU repeal whenever they 

are taken into account. Thus, the IRS 

and Treasury Department continue to 

believe that, in the absence of any 

direction from Congress, such as in the 

case of section 1374, imposing time 

limits on the implementation of GU 

repeal would be inappropriate. See TD 

8294. 

iii. Exclusion for basis conforming 

acquisitions. 

Commentators have also suggested 

adopting a tracing-based approach that 

excepted any stock acquired in either a 

section 351 exchange or a qualified 

stock purchase for which an election 

was made under section 338. The 

rationale for this approach is that, by 

operation of statute, the basis of stock 

acquired in these transactions can 

reflect no unrecognized appreciation. 

The IRS and Treasury Department 

agree that, in certain circumstances, the 

structure of a stock acquisition will, by 

operation of law, preclude the reflection 

of unrecognized appreciation in stock 

basis. The IRS and Treasury Department 

are concerned, however, that many 

acquisitions under section 351 or 

section 338 actually do not preclude the 

reflection of unrecognized asset 

appreciation in stock basis. For 

example, if subsidiary stock is acquired 

in a section 351 exchange in multiple 

transactions or by multiple transferors, 

as illustrated in Example 7(b) and 

Example 7(c), respectively, the basis of 

the shares received can reflect 

unrecognized appreciation. Similarly, 

because only 80 percent of the stock of 

a subsidiary need be acquired to elect 

section 338 treatment, the basis of up to 

20 percent of a subsidiary’s shares may 

reflect unrecognized appreciation. 

Moreover, even if the initial acquisition 

precludes the reflection of unrecognized 

gain, once there is a redetermination 

event, the form of the acquisition no 

longer prevents the reflection of 


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unrecognized appreciation in stock 

basis. Thus, very few, if any, such 

transactions would ultimately qualify 

for this exception. 

Thus, like the two previously 

described approaches to modified 

tracing, this approach has the 

inaccuracy and burden associated with 

identifying redetermination dates and a 

limited potential for relief to either 

taxpayers or the government. 

iv. Conclusions regarding modified 

tracing. 

Each approach considered would 

increase the administrative burden 

significantly without significantly 

increasing precision or relief. 

Accordingly, the IRS and Treasury 

Department are not proposing to adopt 

any of these approaches. 

2. Hybrid Tracing-Presumptive Model: 

Asset Tracing. 

The IRS and Treasury Department 

also considered a hybrid tracingpresumption approach that would 

identify all assets held when a share is 

acquired and on each redetermination 

date thereafter (again, the ‘‘tainted 

assets’’) and then presume all items of 

income, gain, deduction, and loss traced 

to those assets to be tainted. The intent 

was to design an approach that would 

be more precise than either a modified 

tracing or purely presumptive approach, 

while being more administrable than a 

pure tracing-based approach. The chief 

advantages of this approach are that it 

may enhance precision and, like the 

after-acquired asset exception described 

in section C.1.b.i of this preamble, may 

eliminate any need for valuation. 

However, like the modified tracing 

approaches described above, this 

approach would require the 

identification of all redetermination 

events. Furthermore, it would require 

the identification of all assets held at the 

time of each such event and the tracing 

of those assets to particular investment 

adjustments. Thus, it presents even 

more complexity, burden, and expense 

than the modified tracing regimes 

considered. Furthermore, the IRS and 

Treasury Department are concerned that 

this approach could be easily abused, 

either by the manipulation of 

redetermination dates or the use of 

intercompany transactions to make 

valuation elective. (That is, taxpayers 

could selectively engage in 

intercompany transactions so that, in 

effect, some assets would be valued and 

not others.) 

Finally, the IRS and Treasury 

Department are not convinced that the 

approach in fact significantly enhances 

the precision of a pure presumptive 

model in light of the fact that there is 

no actual valuation (and therefore no 

actual determination that there was any 

gain reflected in stock basis). 

For all these reasons, the IRS and 

Treasury Department concluded that the 

potential advantages of this hybrid 

tracing-presumptive approach are 

outweighed by its disadvantages. 

Accordingly, the IRS and Treasury 

Department are not proposing to adopt 

this approach. 

3. Presumption-Based Models 

Recognizing that even the hybrid 

tracing-presumptive model would 

present significant burden and 

imprecision, the IRS and Treasury 

Department considered various 

presumptive models that, like the LDR, 

would eliminate all elements of tracing. 

A principal advantage of such 

approaches is that they are readily 

administrable by both taxpayers and the 

IRS. Thus, the rules can apply 

uniformly and consistently, with the 

result that similarly situated taxpayers 

will be similarly treated, increasing the 

overall fairness of the system. The 

elimination of any tracing element, 

however, increases the importance of 

limitations, where appropriate, on the 

nature and amount of items treated as 

noneconomic to a share. The 

approaches considered are discussed in 

this section C.3 and in section C.4 of 

this preamble. 

a. Basis disconformity under Notice 

2004–58. 

One model considered was the basis 

disconformity model described in 

Notice 2004–58, presently available as a 

method to avoid disallowance under 

§ 1.337(d)–2. As noted in section A.4 of 

this preamble, the basis disconformity 

model treats as built-in gain (within the 

meaning of § 1.337(d)–2) the smallest of 

three amounts. The first is the basis 

disconformity amount (which identifies 

the minimum amount of built-in gain 

that could be reflected in the share), the 

second is the net positive adjustment 

amount (which identifies the actual 

amount of stock basis attributable to the 

consolidated return system), and the 

total gains on property dispositions 

(which responds to the definition of the 

term built-in gain in § 1.337(d)–2). A 

significant advantage of this approach is 

that both taxpayers and the IRS find it 

readily administrable with information 

that taxpayers are already required to 

maintain. 

However, the Notice 2004–58 basis 

disconformity model, because it is an 

interpretation of the current loss 

limitation rule in § 1.337(d)–2, reflects 

limitations that inhibit the extent to 

which the rule addresses the 

circumvention of GU repeal and 

promotes the clear reflection of group 

income. For example, the model did not 

account for the consumption of 

unrecognized appreciation reflected in 

stock basis (the ‘‘wasting asset’’

problem). Thus, if unrealized gain 

reflected in stock basis was recognized 

as income (for example through a lease, 

instead of a disposition of the property), 

the resulting noneconomic stock loss 

was not disallowed under the current 

rule. In addition, the model did not 

address the problem of basis disparity. 

(See for example, Example 4.) 

A more significant concern, however, 

is that the basis disconformity approach 

is underinclusive in that it can only 

address noneconomic stock loss to the 

extent of net appreciation reflected in 

stock basis, which is, by its nature, 

reduced by unrecognized depreciation 

reflected in basis. As a result, a 

potentially significant amount of 

noneconomic stock loss remained 

unaddressed, particularly in 

deconsolidating dispositions of 

subsidiary stock. 

Example 9. Unrecognized loss reflected in 

stock basis. P purchases all the outstanding 

stock of S for $150. At the time, S owns one 

asset, A1, with a basis of $25 and value of 

$100, and one asset, A2, with a basis of $100 

and a value of $50. S sells A1 to a 

nonmember for $100 and recognizes a $75 

gain, which the P group takes into account. 

Under the investment adjustment system, P 

increases its basis in the S stock by $75, to 

$225, to reflect the $75 taken into account by 

the group. If P then sells the S stock for $150 

(its fair market value), P will recognize a $75 

loss. Under the basis disconformity 

approach, only $25, the excess of P’s S stock 

basis ($225) over S’s net inside asset basis 

($100 cash plus S’s $100 basis in A2, or, 

$200), of the $75 gain is treated as a 

noneconomic investment adjustment. Thus, 

although the entire loss is noneconomic, only 

$25 of that loss would be disallowed under 

this approach. 

b. Modified basis disconformity. 

The IRS and Treasury Department 

considered several modifications to the 

basis disconformity model, all of which 

were intended to address the 

underinclusivity of that model. One 

approach suggested by commentators 

would mitigate the wasting assets 

concern by first, for a prescribed period 

of time, treating the sum of all property 

gains and, up to the disconformity 

amount, all income as noneconomic 

(and thus included in the disallowance 

amount). After the prescribed time, all 

gains and income would be treated as 

noneconomic, but only to the extent of 

the disconformity amount. Other 

approaches considered reflected 

variations on this suggestion. 

The IRS and Treasury Department 

recognize that the model described, and 


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any similar models, would be readily 

administrable, but are concerned that 

such a model would not adequately 

preserve the group’s ability to deduct 

economic loss sustained by the group. 

The reason is that stock loss could be 

attributable to economic investment 

adjustments (adjustments attributable to 

the recognition of items of income and 

gain that were not reflected in stock 

basis) that were followed by economic 

loss (attributable to a decline in the 

value of the subsidiary’s assets). For 

example, assume that P contributed an 

asset to S (basis and value of $10), the 

asset appreciated and S sold it for $100 

(recognizing a $90 gain that increased 

P’s basis in S stock to $100), S 

reinvested the $100 in an asset that 

declined in value to $10, and P then 

sold the stock for $10. P would 

recognize a $90 loss that would be 

disallowed because S had a $90 gain on 

the disposition of an asset. Yet the 

entire loss was an economic loss. As a 

result, the IRS and Treasury Department 

are concerned that the result in Rite Aid 

(that the group receive the tax benefit of 

its economic loss) would not be 

adequately protected. 

Ultimately, the IRS and Treasury 

Department concluded that the basis 

disconformity model in Notice 2004–58 

would not be modified, but that 

elements of the model would be 

incorporated in a new approach. 

4. The Presumptions and Simplifying 

Conventions Adopted in These 

Proposed Regulations 

a. Loss limitation model. 

As discussed in section A.2 of this 

preamble, when the IRS and Treasury 

Department rejected a tracing approach 

in favor of the presumptive approach in 

1990, the decision was made to balance 

the use of irrebuttable presumptions by 

adopting a loss limitation model. Under 

a loss limitation model, losses 

attributable to noneconomic investment 

adjustments are disallowed, but gain 

reduction (or elimination) attributable to 

noneconomic investment adjustments is 

not. The IRS and Treasury Department 

believed that allowing noneconomic 

gain reduction not only balanced the 

benefits and burdens of the presumptive 

approach, it also provided the 

considerable advantage of reducing gain 

duplication in consolidated groups. 

Example 10. Noneconomic gain reduction, 

elimination of gain duplication. P purchases 

all the stock of S for $150 when S holds one 

asset, A1, with a basis of $100. S sells A1 for 

$150, recognizing $50 of gain. S uses the 

$150 proceeds from the sale of A1 to 

purchase A2. The value of A2 appreciates to 

$200, and P then sells its S stock for $200. 

If the investment adjustment system 

did not adjust stock basis for items 

attributable to appreciation reflected in 

basis, P’s basis in S stock would remain 

$150 and, when P sells the S stock, P 

would recognize a gain of $50 (reflecting 

the $50 appreciation in A2). When S 

sells A2, S would recognize the same 

$50 of economic gain a second time. 

However, because P’s basis in S is 

increased by the $50 gain recognized on 

the sale of A1, P will recognize no gain 

or loss on its sale of S stock. The gain 

on A2 is therefore taxed once, when 

there is a recognition event with respect 

to A2. 

These proposed regulations adopt a 

loss limitation model for the same 

reasons such a model was adopted in 

1990, in the regulations promulgated 

under section 337(d) and the LDR (to 

balance the use of a presumptive 

approach). 

However, the LDR, as well as 

§§ 1.337(d)–1 and 1.337(d)–2, applied 

the loss limitation model by disallowing 

loss recognized on the disposition of 

subsidiary stock and reducing basis on 

the deconsolidation of subsidiary stock. 

The IRS and Treasury Department 

recognize that the effect of a loss 

disallowance rule can be achieved by 

applying a basis reduction rule 

immediately before the disposition of 

loss stock. Modifying the loss limitation 

model to reduce basis in all cases 

simplifies the structure of the rule by 

avoiding the need for two distinct rules. 

b. Amount of basis reduction. 

The IRS and Treasury Department 

considered two basic approaches to 

determining the amount of basis 

reduction. One would be determined 

with reference to a share’s adjusted 

basis and the other would be 

determined with reference to the 

disconformity between the share’s basis 

and its allocable portion of the 

subsidiary’s attributes. 

i. Adjusted purchase price cap. 

Under this approach, the basis of a 

transferred loss share would be reduced 

by the amount that the subsidiary’s 

items increased the share’s basis, but 

only to the extent of the adjusted 

purchase price. For purposes of this 

rule, the adjusted purchase price would 

be defined as the holder’s original basis 

in the stock, adjusted to take into 

account all redetermination events. The 

rationale for this rule is that the 

adjusted purchase price represents the 

maximum amount of unrecognized gain 

that could be reflected in stock basis. 

However, this cap does not establish 

that, in fact, there was any appreciation 

reflected in stock basis and, therefore, it 

could prove to be substantially 

overinclusive. 

The IRS and Treasury Department 

considered several rules that could be 

combined with the adjusted purchase 

price cap in order to mitigate its 

potential for overinclusiveness. One 

approach would combine this cap with 

the asset tracing model described in this 

preamble. Another approach would 

combine this cap with rules that treat 

income items as included in the basis 

reduction amount under a different rate 

(for example, using a declining 

percentage over time) or amount (for 

example, using an annual income cap, 

perhaps based on a percentage of the 

gross items). The IRS and Treasury 

Department ultimately concluded that 

the limitations either imposed 

unacceptable burdens (because of the 

need to identify redetermination dates 

and trace assets) or did not significantly 

increase the theoretical soundness of the 

approach, and that the potential for 

overinclusiveness prevented the 

approach from responding adequately to 

the Congressional mandate to preserve 

the result in Rite Aid. 

ii. Modified adjusted purchase price 

cap. 

To address the potential 

overinclusivity of the adjusted purchase 

price cap, the IRS and Treasury 

Department considered modifying the 

rule by reducing the cap by the basis of 

any tainted assets sold at a gain. The 

rationale for this modification is that the 

maximum potential amount of 

appreciation reflected in basis is 

reduced by the basis of tainted assets as 

they are sold. While this modification 

reduced the potential for 

overinclusiveness in a theoretically 

sound manner, it exacerbated the 

administrative difficulties by requiring 

not only the identification of all 

redetermination dates, but also of all 

assets held on such dates. Moreover, the 

IRS and Treasury Department ultimately 

concluded that the basic premise (that 

the limitation represented the maximum 

possible noneconomic income) 

remained an inadequate response to the 

Congressional directive that the group 

be allowed to deduct its economic loss. 

iii. Disconformity cap. 

This model would also reduce basis 

by the amount that the subsidiary’s 

items increased the share’s basis, but 

only to the extent of the disconformity 

amount. For this purpose, the 

disconformity amount would generally 

be the same as the basis disconformity 

amount described in Notice 2004–58. 

The rationale for this limitation is that 

the disconformity amount identifies the 

minimum amount of unrecognized 

appreciation actually reflected in the 

basis of a share of subsidiary stock at the 

relevant time. Thus, although the 


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amount of such appreciation could 

actually be considerably greater (as in 

Example 9), and could even be equal to 

the adjusted purchase price (assuming a 

subsidiary was purchased with no basis 

in any of its assets), it is not lower. Not 

only does the disconformity cap have 

the advantage of identifying an amount 

of appreciation actually reflected in 

stock basis, it allows for the 

computation of that amount with 

information taxpayers are already 

required to know. Additionally, it 

avoids the need to identify 

redetermination events because, by 

computing disconformity immediately 

before a transfer, this approach 

automatically takes the effect of all such 

events into account. 

iv. Modified disconformity cap. 

Because the use of a disconformity 

cap raises significant potential for 

underinclusivity, as illustrated in 

Example 9, the IRS and Treasury 

Department considered increasing the 

disconformity cap by the amount of 

unrecognized loss on any tainted assets 

held by the subsidiary. The rationale for 

this increase is that those losses could 

prevent an equal amount of recognized 

tainted appreciation from being treated 

as noneconomic. Thus, the rule would 

not undermine the theoretical 

foundation of the disconformity cap. 

However, this approach would 

require the identification of 

redetermination dates, as well as the 

identification and valuation of all assets 

held on the last such date. Recognizing 

the imprecision inherent in this 

approach, the IRS and Treasury 

Department considered increasing the 

disconformity cap by only a discounted 

portion of those unrecognized losses. 

The IRS and Treasury Department 

concluded that this approach would 

introduce burden and imprecision much 

greater than the potential benefit 

obtained by increasing the cap on basis 

reductions, at least in the majority of 

commercially typical cases. 

The IRS and Treasury Department 

also considered implementing this 

modification not as a general rule, but 

only as an anti-abuse rule, so that it 

would apply only in circumstances that 

indicated a significant amount of tainted 

income or gain might be sheltered by 

unrecognized loss on tainted assets. For 

example, such a rule could require an 

increase to the disconformity cap if 

there was a significant loss in stock, if 

the subsidiary recognized significant 

gain shortly before stock sale, or if the 

stock was held for only a short period 

of time before it was sold. The IRS and 

Treasury Department were concerned, 

however, that the increased uncertainty 

and burden introduced by such an 

approach could not be justified in light 

of the protections against manipulation 

that exist in the Code and other rules of 

law. For example, see sections 269, 

362(e)(2), and 482, as well as various 

anti-avoidance and anti-abuse 

provisions in the regulations, including 

these proposed regulations. 

v. Disconformity cap with duplication 

rule. 

In considering the structural potential 

for underinclusivity in the 

disconformity cap, the IRS and Treasury 

Department observed that the 

recognition of noneconomic gains in 

excess of the disconformity amount 

causes the subsidiary’s unrecognized 

losses to be expressed in stock basis. 

The facts of Example 9 illustrate this 

point. In that example, P purchased S 

for $150 when S held A1 (basis $25, 

value $100) and A2 (basis $100, value 

$50). S sold A1 and recognized $75 

gain, which increased P’s basis in S to 

$225. P then sold the S stock and 

recognized a $75 loss. At the time of the 

stock sale, S’s net asset basis was $200 

(the $100 received for A1 and the basis 

of A2), which exceeds the value of the 

stock by $50. Thus, the basis 

disconformity amount is $25 (the excess 

of the $225 stock basis over the $200 net 

asset basis), and so (although there is a 

$75 recognized gain), only $25 is 

disallowed. However, at that point, S’s 

$200 net asset basis exceeds S’s $150 

value by $50. The $50 of unrecognized 

loss on A2 is reflected in both P’s basis 

in S stock and S’s basis in its assets. 

That is, the loss on A2 has been 

duplicated. As a result, the 

underinclusivity of the disconformity 

cap can be measured and addressed as 

duplicated loss. 

The IRS and Treasury Department 

recognize that addressing this loss as a 

duplicated loss allows taxpayers to 

accelerate the benefit of a subsidiary’s 

unrecognized losses (that is, obtain the 

benefit of the loss without a recognition 

event with respect to its loss assets). 

However, this approach allows 

taxpayers the benefit of their economic 

loss while limiting any arguably 

excessive benefit to the ability to 

accelerate inside loss. In the end, loss 

duplication is prevented. (The IRS and 

Treasury Department have long 

recognized that it is appropriate for a 

group to offset recognized built-in gains 

and losses, see §§ 1.337(d)–1 and 

1.337(d)–2, as promulgated in 1990 and 

again as temporary and final regulations 

following the Rite Aid decision). 

vi. Conclusion. 

In light of the concerns raised by any 

method that would reduce basis beyond 

the disconformity amount, the IRS and 

Treasury Department have concluded 

that the amount of basis reduction 

should be limited to the disconformity 

amount and that combining the 

disconformity cap with a loss 

duplication rule to address its 

underinclusivity provides the most 

appropriate balancing of interests. 

Under this approach, the group’s 

economic loss is appropriately protected 

and neither the group nor its members 

will receive more than one benefit for 

the subsidiary’s economic loss. 

c. Items applied to reduce basis. 

i. Character of items applied to reduce 

basis. 

In general, the IRS and Treasury 

Department have concluded, and 

commentators have generally agreed, 

that all gains on property dispositions, 

as well as various gain equivalents, 

should be fully available to reduce basis 

under a presumptive rule. 

Questions arose, however, regarding 

whether income items should also be 

fully available to reduce basis. The 

reasons for these questions center on the 

general difficulty of tracing income 

items (which is limited in the best of 

circumstances) and the observation that 

the likelihood of a particular income 

item being attributable to tainted 

appreciation generally decreases over 

time. Accordingly, the IRS and Treasury 

Department considered several 

proposals to limit both the amount and 

the rate of inclusion for income items. 

All of these approaches would 

segregate income that could be traced to 

particular appreciation reflected in 

stock basis and treat those amounts in 

the same manner as items of gain. The 

net income remaining would be applied 

to reduce basis according to prescribed 

limits. For example, one proposal would 

apply net income to reduce basis for a 

prescribed period of time following a 

measuring date, but, after that time, net 

income would be so applied only 

according to a declining percentage. 

The IRS and Treasury Department are 

concerned, however, that the 

approaches considered could be readily 

manipulated, for example, by converting 

gain into income that cannot be readily 

traced to particular assets or by delaying 

the recognition of income items until 

after the applicable time period. 

Therefore, any such rule would 

inappropriately influence the structure 

of business transactions and, at the same 

time, fail to provide adequate protection 

for GU repeal. In addition, the need to 

account for redetermination dates 

would add complexity and diminish the 

potential relief afforded under any such 

approach. Moreover, the IRS and 

Treasury Department identified no 

theoretical basis for any particular rule 

and were concerned that the increased 


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precision may be more perceived than 

real. 

ii. Capital transfers. 

Adjustments to reflect transfers of 

capital, whether contributions or 

distributions, are not adjustments 

attributable to the recognition of 

appreciation or depreciation. 

Accordingly, these adjustments do not 

increase or decrease the extent to which 

stock basis is noneconomic or facilitates 

the circumvention of GU repeal. For that 

reason, such amounts are not taken into 

account in determining the extent to 

which subsidiary stock basis is subject 

to reduction. 

Commentators have suggested that the 

nature of an intercompany cancellation 

of indebtedness is similar to that of a 

capital contribution and thus should not 

be taken into account in determining 

basis reduction. The IRS and Treasury 

Department recognize that this may 

often be the case, but are concerned 

that, under some circumstances, this 

may not be the case. Because it will be 

administratively very difficult to 

identify situations in which 

intercompany cancellation of 

indebtedness is not similar to a capital 

contribution, and to distinguish 

intercompany cancellation of 

indebtedness from other arguably 

similar cases, these proposed 

regulations treat items related to 

intercompany cancellation of 

indebtedness like all other items of 

income or loss. However, the IRS and 

Treasury Department continue to study 

the issue and invite further comments. 

d. Netting of items from different tax 

periods. 

Under the LDR, there was no crossyear netting of investment adjustments. 

Positive investment adjustments were 

taken into account in determining the 

loss disallowance amount, negative 

investments were not. The IRS and 

Treasury Department have reconsidered 

whether items from different tax periods 

should be considered together in 

determining basis reduction. 

The IRS and Treasury Department 

recognize that the particular 

circumvention of GU repeal at issue 

here is a product of the manner in 

which the investment adjustment 

system adjusts stock basis to reflect a 

subsidiary’s amounts that are taken into 

account by the group. Thus, IRS and 

Treasury Department have concluded 

that the appropriate measure of the 

concern must take into account the net 

extent to which the basis of a share has 

been increased or decreased by the 

investment adjustment system. Whether 

a loss is taken into account in the same 

year in which a gain is taken into 

account or in a separate year does not 

change the net effect of the investment 

adjustment system. Thus, unlike the 

LDR, these proposed regulations allow 

netting of all investment adjustments 

made to a share for all periods. 

e. Summary and conclusions. 

Only a presumptive approach can 

eliminate the substantial administrative 

burdens imposed by the tracing-based 

and hybrid regimes discussed above. As 

a result, only a presumptive approach 

can be applied consistently among 

taxpayers and thus achieve the overall 

fairness necessary to these regulations. 

Importantly, if presumptions are 

rebuttable, the administrative burdens 

associated with a tracing system are not 

avoided. In fact, they are exacerbated, 

because taxpayers will feel it necessary 

to be prepared to establish, and the 

government will then need to be 

prepared to examine, returns using both 

systems. Accordingly, the proposed 

regulations reflect a presumptive 

approach that does not permit the 

rebuttal of its operating presumptions. 

As noted in section A.5 of this 

preamble, Congress has specifically 

sanctioned the use of presumptions and 

other simplifying conventions to 

address the circumvention of GU repeal. 

To balance the use of irrebuttable 

presumptions, the proposed regulations 

adopt several provisions that are 

intended to enhance their overall 

fairness and theoretical soundness. 

First, the proposed regulations adopt the 

disconformity amount as the maximum 

amount of potential stock basis 

reduction. The reason, as discussed, is 

that only the disconformity amount both 

establishes the fact that the taxpayer had 

unrealized gain reflected in stock basis 

and identifies the minimum amount of 

such gain. Second, the proposed 

regulations include all items taken into 

account, from all years, in the 

determination of the basis reduction 

amount. Thus, basis is not reduced for 

certain amounts (such as capital 

transfers) that cannot be attributable to 

noneconomic investment adjustments. 

In addition, by presuming all items of 

income, gain, deduction and loss as 

attributable to appreciation or 

depreciation reflected in basis, the 

proposed regulations avoid the 

administrative and other concerns 

inherent in various tracing and hybrid 

approaches. Moreover, by presuming all 

items to be reflected in basis, the 

benefits and burdens inherent in the use 

of irrebuttable presumptions are fairly 

balanced between taxpayers and the 

government. Presuming all items of 

income and gain are noneconomic 

favors the fisc, while presuming all 

items of deduction and loss are 

noneconomic favors taxpayers. 

D. Loss Duplication 

The IRS and Treasury Department 

continue to believe that a group’s 

income is distorted when the group 

enjoys more than one tax benefit from 

an economic loss. Further, the IRS and 

Treasury Department believe that a 

subsidiary’s use of a group loss in a 

separate return year, after the group has 

already recognized the benefit of the 

loss, distorts the subsidiary’s separate 

year income. 

Moreover, the IRS and Treasury 

Department do not believe that the 

manner or order in which a group takes 

its losses into account affects the extent 

to which loss duplication is 

inappropriate. Thus, loss duplication is 

inappropriate and must be addressed 

whether arising in situations like that 

illustrated in Example 3 (loss reflected 

in both stock and assets) or in Example 

5 (duplication attributable to disparate 

stock basis). In addition, loss 

duplication is inappropriate and must 

be addressed whether the group chooses 

to recognize loss first as an inside loss, 

on the subsidiary’s assets and 

operations (which is addressed by 

§ 1.1502–32), or as a stock loss (which 

is currently addressed, at least partially, 

by § 1.1502–35). 

Accordingly, the IRS and Treasury 

Department have returned to a 

fundamental premise of the LDR and 

again concluded that a loss duplication 

rule that operates without regard to 

members’ continued affiliation is a 

necessary complement to the 

investment adjustment system. The IRS 

and Treasury Department have also 

concluded that such a rule must also 

address the potential for loss 

duplication presented when loss is 

disproportionately reflected in the bases 

of individual shares. 

Importantly, as noted in section A.5 of 

this preamble, Congress has indicated 

that it, too, views the prevention of loss 

duplication, including in 

deconsolidating stock dispositions, as 

an area that is appropriately addressed 

by regulation. See H.R. Conf. Rep. No. 

108–755 at 652. 

Therefore, the IRS and Treasury 

Department have reviewed the current 

rules and considered alternative 

approaches to address the duplication of 

loss. 

1. Reconsideration of § 1.1502–35 

Loss duplication is currently 

addressed in § 1.1502–35. That rule 

generally applies whenever there is a 

disposition of loss shares of subsidiary 

stock. To address the loss duplication 

problems arising when loss is 

disproportionately reflected in stock 


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basis, the rule first redetermines 

members’ bases to reduce that disparity 

(to address the problems illustrated in 

Example 5). Different rules apply 

depending on the subsidiary’s status as 

a group member following the stock 

disposition. If the subsidiary remains a 

member, the full blending rule of 

§ 1.1502–35(b)(1) applies and all 

members’ bases in shares of the 

subsidiary’s stock are combined and 

then allocated evenly to preferred (to 

value) and then to common (equally). If 

the subsidiary ceases to be a member, 

the basis redetermination rule of 

§ 1.1502–35(b)(2) applies and members’

bases are redetermined to reduce loss on 

all members’ shares. However, this rule 

only redetermines basis to the extent of 

items of deduction and loss included in 

negative adjustments applied to nonloss 

shares. As under the full blending rule, 

redetermination under this rule first 

reduces or eliminates loss on preferred 

shares and then equalizes members’

bases in common shares. 

The potential for loss duplication 

following the redetermination of 

members’ bases is addressed only if the 

subsidiary remains a member of the 

group. In that case, stock loss (to the 

extent of loss duplication) is suspended, 

the suspended loss is reduced as the 

subsidiary’s items of deduction and loss 

are taken into account, and any 

suspended loss remaining when the 

subsidiary ceases to be a member is 

allowed at that time. The regulation 

does not address the duplication of loss 

when the subsidiary ceases to be a 

member, other than to prevent the 

reimportation of duplicated losses back 

into the group. 

The IRS and Treasury Department 

understand that certain administrability 

concerns have arisen under § 1.1502–35. 

For example, taxpayers have 

commented that the rules relating to the 

suspension of loss in 

nondeconsolidating dispositions and 

the treatment of reimported losses 

present substantial compliance issues. 

The experience of the IRS is consistent 

with those comments. 

Moreover, the IRS and Treasury 

Department have reconsidered the 

appropriateness of allowing subsidiaries 

to duplicate group losses after the 

period of consolidation. Under this 

approach, former members can use 

group losses (that have already been 

used by the group) to offset their 

separate year income. This duplicative 

use of group losses distorts the former 

member’s separate income. Under 

section 1502, consolidated return 

regulations are directed to promote the 

clear reflection of not only the income 

of a group, but also of its members, 

including former members. 

Accordingly, as in 1990, the IRS and 

Treasury Department have concluded 

that a group loss, once used by the 

group, should not be available to a 

former member for a second, duplicative 

use outside the group. 

For these reasons, the IRS and 

Treasury Department propose to remove 

§ 1.1502–35 and replace it with a more 

easily administered and more 

comprehensive approach to addressing 

loss duplication among members of a 

consolidated group. 

2. Other Methods Considered for 

Addressing Loss Duplication 

As discussed in section D of this 

preamble, the IRS and Treasury 

Department have concluded that loss 

duplication is an inappropriate 

distortion of income (of either a group 

or its members, including former 

members) regardless of the subsidiary’s 

status after a transfer of its stock. 

Accordingly, these proposed regulations 

address loss duplication in both 

nondeconsolidating and 

deconsolidating stock transfers. Several 

approaches were considered. 

a. Disallowance of stock loss. 

As a general matter, the IRS and 

Treasury Department believe that 

disallowing duplicative stock loss better 

implements single entity principles 

because it results in the recognition of 

the subsidiaries’ economic gain or loss 

on its assets and operations, instead of 

on its stock. However, to preserve the 

result in Rite Aid, stock loss could only 

be disallowed for nondeconsolidating 

transfers and additional rules would be 

necessary to address both the loss 

remaining in the group and the 

duplication of loss in deconsolidating 

transfers (which could not be subject to 

the loss disallowance rule). Thus, a rule 

implementing this approach would 

need to include a provision comparable 

to § 1.1502–35(c), which taxpayers and 

the IRS have found to present 

significant compliance issues. In 

addition, this approach would need to 

include a provision to address loss 

duplication in deconsolidating transfers. 

b. Loss duplication accounts. 

The IRS and Treasury Department 

also considered an approach that would 

allow stock loss, but identify the 

amount of loss duplication and create a 

suspended account to limit the 

deductibility of items as they are taken 

into account. One advantage of this 

approach is that it only requires one set 

of rules to address both 

nondeconsolidating and 

deconsolidating transfers. This 

approach also has the advantage of 

increasing the precision in identifying 

(and disallowing) losses that are 

actually duplicated. 

However, unless the rule were to use 

presumptions to treat items as 

chargeable against the loss duplication 

account, it would present considerable 

tracing issues. In addition, this 

approach raises administrability issues 

comparable to those associated with the 

loss suspension regime in § 1.1502–

35(c). These difficulties are exacerbated 

by the need to have the account follow 

the subsidiary, possibly through 

subsequent acquisitions, until the 

account is eliminated. 

The IRS and Treasury Department are 

also concerned that, because this 

approach would reduce or eliminate 

duplication only when inside losses 

were recognized, taxpayers could avoid 

the effect of the rule by waiting until 

assets appreciated before disposing of 

them. To mitigate this concern, the rule 

could require the subsidiary to take into 

account the duplication account, either 

ratably over time or at some specified 

time, but this could give rise to income 

in the absence of any loss duplication. 

c. Attribute reduction. 

The IRS and Treasury Department 

also considered a presumptive rule that 

would identify the extent of duplicated 

loss and then reduce the subsidiary’s 

attributes by that amount. This 

approach, like the loss duplication 

account, has the advantage of needing 

only one set of rules to govern both 

deconsolidating and 

nondeconsolidating transfers. It has the 

added advantage of being similar to 

regimes that are already familiar to 

taxpayers, such as the attribute 

reduction rules of sections 108 and 

1017, and § 1.1502–28. Although 

attribute reduction could be based on 

valuation, like the rule in section 

362(e)(2), the IRS and Treasury 

Department believe that mandatory 

valuation would present a significant 

administrative burden and expense for 

both taxpayers and the IRS. 

d. Conclusions. 

The IRS and Treasury Department 

have concluded that the complexity, 

administrative burden, and expense of 

the loss disallowance and the loss 

duplication account approaches 

outweighed their respective advantages. 

Accordingly, these proposed regulations 

adopt an attribute reduction rule. The 

IRS and Treasury Department recognize 

that the attribute reduction approach 

allows taxpayers to accelerate economic 

losses of the subsidiary, but believe that 

this approach best preserves the result 

in Rite Aid while addressing loss 

duplication. In general, the approach 

adopted operates as an irrebuttable 

presumption, to avoid the burden of 


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mandatory valuation in all cases, but 

taxpayers continue to have several 

mechanisms available to structure their 

transactions to permit valuation (for 

example, by using actual or deemed 

asset sales). 

3. Gain Duplication 

Notwithstanding the conclusions 

regarding duplication of loss, for the 

reasons set forth in the LDR preambles, 

the IRS and Treasury Department have 

tentatively concluded that adequate 

protections, and the incentive to use 

them, already exist to prevent the 

duplication of gain. See TD 8294, TD 

8364 and TD 8984. For example, see 

sections 332, 336(e) (which is the 

subject of another current guidance 

project), and 338(h)(10). Accordingly, 

the duplication of gain is not addressed 

in these proposed regulations, except as 

a result of the adoption of a loss 

disallowance model. The IRS and 

Treasury Department continue to study 

the issues, however, and invite further 

comment. See section J of this preamble 

for further discussion of the issues on 

which comments are requested. 

E. Noneconomic and Duplicated Loss 

From Investment Adjustment System 

For all the reasons discussed in this 

preamble, IRS and Treasury Department 

believe that the approaches to 

noneconomic and duplicated loss that 

are adopted in these proposed 

regulations represent the best approach 

to the (original) noneconomic and 

duplicated loss concerns described in 

sections B.1 and B.2 of this preamble. 

However, those rules alone do not 

adequately address the problem of 

noneconomic and duplicated loss 

attributable to investment adjustments 

applied to shares of stock with disparate 

bases. This is the concern described in 

section B.3 of this preamble and 

illustrated in Example 4 and Example 5, 

as well as Example 7(b) and Example 

7(c). 

The IRS and Treasury Department 

believe it is essential to address this 

concern. One reason is that stock basis 

would be inappropriately eliminated 

when, in cases like Example 4, there is 

noneconomic loss on one share because 

appreciated assets were contributed to a 

corporation in exchange for other 

shares. In those cases, the noneconomic 

loss should not be allowed, but a rule 

that only prevents that loss does not 

address the problem that there is 

insufficient basis on the shares received 

in the exchange. The result would be 

noneconomic gain on the sale of those 

shares. An equally important reason is 

that loss could otherwise be duplicated 

when, in cases like Example 5, loss is 

disproportionately reflected in the basis 

of some shares. Although regulations 

could prevent duplication in such cases 

(by eliminating inside loss to the full 

extent of duplicated stock loss), 

allowing a deduction for 

disproportionate stock loss in such 

cases permits the acceleration of a 

disproportionate amount of inside loss. 

To the extent that loss is 

disproportionately reflected in the basis 

of an individual share, acceleration is 

generally unwarranted and should be 

prevented to the extent possible. 

Accordingly, the IRS and Treasury 

Department have considered various 

approaches to mitigating these effects. 

1. Revise Investment Adjustment 

System To Adopt a Tracing Approach 

The IRS and Treasury Department 

recognize that one approach to this 

problem would be to revise the 

investment adjustment system so that it 

would allocate subsidiaries’ items of 

income, gain, deduction, and loss to 

their shares in accordance with the 

actual reflection of those items in the 

each share’s basis. This approach would 

be similar to the section 704(c) regime 

applicable to partnerships. However, 

this approach is a tracing model and, as 

discussed in section C of this preamble, 

the IRS and Treasury Department do not 

believe that tracing is administrable in 

the consolidated setting. 

Moreover, as noted above, the IRS and 

Treasury Department continue to 

believe that the presumptive-based rules 

of § 1.1502–32 are not only 

administrable, but appropriate in the 

vast majority of cases because typically 

subsidiary stock is common stock 

owned entirely by members with 

uniform bases. Where subsidiaries have 

issued preferred stock, it is generally 

section 1504(a)(4) stock. In addition, the 

investment adjustment system contains 

some guidance for situations that do not 

reflect the general assumptions on 

which the rules are based (for example, 

the cumulative redetermination rule in 

§ 1.1502–32(c)(4)). In such cases, tracing 

would be unnecessary. Moreover, the 

IRS and Treasury Department do not 

believe that typical commercial 

transactions generally require groups to 

alter a subsidiary’s capital structure in 

a manner that would require tracing. 

Accordingly, the IRS and Treasury 

Department are not considering revising 

the investment adjustment system to 

implement a tracing regime. 

2. Presumptive Approaches To Reduce 

Basis Disparity 

The two presumptive approaches 

considered to reduce basis disparity 

were a full blending rule similar to that 

in § 1.1502–35(b)(1) and a rule that 

would redetermine investment 

adjustments made under § 1.1502–32, 

similar to the rule in § 1.1502–35(b)(2). 

a. Full basis blending. 

Under the full basis blending 

approach, all members’ bases are 

aggregated and then allocated among 

members’ shares in a manner that 

results in the elimination of loss on 

preferred shares and of basis disparity 

on all other shares, at least within each 

class. As a result, members’ bases are 

aligned with the operating premises of 

the investment adjustment system. 

Full basis blending not only mitigates 

the effects of previous noneconomic 

investment adjustments, addressing the 

concern illustrated in Example 4 and 

Example 5(a), it also prevents the 

acceleration of disproportionate 

amounts of unrecognized loss, 

addressing the concern illustrated in 

Example 5(b). 

A full basis blending rule is, however, 

a significant departure from the rules 

generally applicable under the Code. 

Commentators have suggested that this 

departure from generally applicable law 

may be more significant than is 

warranted in light of the extent to which 

the concerns can be addressed under the 

investment adjustment redetermination 

approach described in this preamble. 

b. Redetermination of Investment 

Adjustments Previously Made to Stock 

Basis. 

The investment adjustment 

redetermination approach is less a 

departure from Code provisions as it is 

a departure from the general operation 

of § 1.1502–32. In general, this approach 

would reallocate investment 

adjustments previously applied to 

members’ bases in subsidiary stock with 

the goal of reducing, to the greatest 

extent possible, the disparity in 

members’ bases in subsidiary stock. 

Thus, like the full blending approach, 

this approach would bring members’

bases closer into alignment with the 

assumptions underlying the investment 

adjustment system. However, it would 

do so to a more limited extent than the 

full blending rule and in a manner that 

is less of a departure from general Code 

rules. 

i. Recomputation of individual 

investment adjustments. 

Presently, § 1.1502–35(b)(2) addresses 

duplicated loss by redetermining 

investment adjustments when there is a 

deconsolidating disposition of 

subsidiary stock. To achieve the greatest 

reduction in basis disparity possible, 

§ 1.1502–35(b)(2) in effect deconstructs 

investment adjustments in order to 

remove negative items (that is, items of 

deduction and expense) from 


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adjustments to the bases of gain shares 

and then apply those items to reduce 

members’ bases in loss shares. 

Taxpayers have raised concerns with 

the complexity and administrability of 

this approach. The IRS has observed 

compliance and audit difficulties with 

this approach. 

Accordingly, the IRS and Treasury 

Department have reconsidered whether 

this general approach, redetermining 

investment adjustments, could be 

adopted in a simpler form. The 

principal method considered was a 

presumptive reallocation of entire 

investment adjustments (exclusive of 

distributions), instead of the individual 

items that comprise them. The approach 

is similar to that used in the cumulative 

redetermination rule of § 1.1502–

32(c)(4). A significant advantage to this 

simplified approach is that it is readily 

administered with information that 

taxpayers are already required to know 

(§ 1.1502–32 already requires taxpayers 

to determine investment adjustments 

exclusive of distributions). 

The IRS and Treasury Department 

recognize that this general approach, in 

whichever form adopted, does not 

address the acceleration illustrated in 

Example 5(b) to the extent that full 

blending would. However, this 

approach is less disruptive to the 

general determination of basis. 

ii. Reallocations to loss shares that 

are not transferred. 

Presently, § 1.1502–35(b)(2) 

reallocations can result in the reduction 

of any member’s basis in a loss share of 

subsidiary stock. The IRS and Treasury 

Department have reconsidered whether 

reallocated investment adjustments 

should be applied to reduce loss on 

shares that are not transferred in the 

transaction. 

The IRS and Treasury Department 

have concluded that reallocating 

investment adjustments to reduce the 

basis of only transferred loss shares 

better implements the loss disallowance 

model. The reason is that this approach 

allows subsidiary stock basis to remain 

intact until there is a taxable 

disposition, deconsolidation, or 

worthlessness of the share, thereby 

permitting that basis to enjoy the full 

protection of subsequent appreciation as 

long as it remains in the group and 

otherwise subject to the consolidated 

return system. This approach has the 

added benefit of affording the maximum 

potential to eliminate disparate 

reflection of loss on transferred shares 

because all the reallocations are directed 

to transferred shares. As a result, this 

approach reduces the amount of loss 

that can be accelerated (as illustrated in 

Example 5(b)). 

iii. Reallocations of positive and 

negative investment adjustments. 

Under the basis redetermination rule 

in § 1.1502–35(b)(2), only negative items 

are reallocated. However, the sole 

purpose of § 1.1502–35, and thus the 

basis redetermination rules in § 1.1502–

35(b), is to address the duplication of 

loss. (The full blending approach of 

§ 1.1502–35(b)(1) addresses 

noneconomic loss attributable to basis 

disparity as well as loss duplication, but 

only incidentally as a result of its broad 

operation.) The IRS and Treasury 

Department believe that, although it is 

appropriate for a rule addressing only 

loss duplication to reallocate just 

negative items (or negative investment 

adjustments), a rule addressing both 

noneconomic and duplicated loss must 

reallocate both negative and positive 

items (or investment adjustments). As 

illustrated in Example 4 and Example 5, 

reallocations of both positive and 

negative amounts are necessary to 

prevent the noneconomic and 

duplicated stock loss that results from 

the disparate reflection of unrecognized 

gain and to do so without causing 

inappropriate results to taxpayers 

(specifically, noneconomic gain). 

For the foregoing reasons, the IRS and 

Treasury Department have concluded 

that the reallocation of both positive and 

negative adjustments is appropriate and 

necessary to balance the use of a 

presumptive system. Accordingly, these 

proposed regulations provide for the 

reallocation of both positive and 

negative investment adjustments to 

minimize the potential over- and underapplication of the noneconomic and 

duplicated loss rules. 

Explanation of Provisions 

F. Explanation of the Proposed 

Regulations 

1. Overview 

The proposed regulation consists of 

three principal rules that apply when a 

member transfers a loss share of 

subsidiary stock. The first rule 

redetermines members’ bases in 

subsidiary stock by reallocating 

§ 1.1502–32 adjustments (to adjust for 

disproportionate reflection of gains and 

losses in the bases of members’ shares). 

The second rule reduces members’ bases 

in transferred loss shares (but not below 

value) by the net positive amount of all 

investment adjustments applied to the 

bases of those shares, but only to the 

extent of the share’s disconformity 

amount (to address noneconomic stock 

loss). The third rule reduces the 

subsidiary’s attributes to prevent the 

duplication of a loss recognized on, or 

preserved in the basis of, transferred 

stock. 

The three rules generally apply in the 

order described. If members transfer 

stock of multiple subsidiaries in one 

transaction, the basis redetermination 

and basis reduction rules apply first 

with respect to transfers of loss shares 

of stock of the subsidiaries at the lowest 

tier and then successively to transferred 

shares at each next higher tier. These 

rules are not applied at any tier until 

any gain or loss recognized (even if 

disallowed) on lower-tier transfers and 

any items resulting from lower-tier 

adjustments (whether required by the 

basis redetermination or basis reduction 

rule or otherwise) are taken into account 

and reflected in stock basis. After the 

basis redetermination and reallocation 

rules have applied with respect to all 

transferred loss shares, the attribute 

reduction rule applies with respect to 

the highest-tier transferred loss shares. 

The attribute reduction rule then 

applies successively with respect to 

transferred loss shares at each next 

lower tier. 

For purposes of these proposed 

regulations, a transfer of stock includes 

any event in which gain or loss would 

be recognized (but for these proposed 

regulations), the holder of a share and 

the subsidiary cease to be members of 

the same group, a nonmember acquires 

an outstanding share from a member, or 

the share is treated as worthless. This 

rule allows the proposed regulations to 

prescribe one integrated set of rules that 

implement a loss limitation approach 

and that can be applied to all loss 

shares, regardless of the event giving 

rise to the application of the section. 

2. The Basis Redetermination Rule 

When a member transfers a share of 

subsidiary (S) stock and, after the 

application of all other provisions of the 

Code and regulations, the share is a loss 

share, this rule subjects all members’

shares of S stock to redetermination. 

Under the basis redetermination rule, 

investment adjustments (exclusive of 

distributions) that were previously 

applied to members’ bases in S stock are 

generally reallocated in a manner that, 

to the greatest extent possible, first 

eliminates loss on preferred shares and 

then eliminates basis disparity on all 

shares. The rule moves both positive 

and negative adjustments, and so 

addresses both noneconomic and 

duplicated losses. Because it generally 

requires adjustments to be made to 

reduce disparity, it brings members’

bases closer in line with the 

fundamental principals underlying the 

investment adjustment system. As a 

result, there is less likelihood for later 


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noneconomic or duplicated loss 

attributable to the investment 

adjustment system. 

The rule operates by first removing 

positive investment adjustments (up to 

the amount of the loss) from the bases 

of transferred loss shares. Then, to the 

extent of any remaining loss on the 

transferred shares, negative investment 

adjustments are removed from shares 

that are not transferred loss shares and 

applied to reduce the loss on transferred 

loss shares. The positive adjustments 

removed from the transferred loss shares 

are allocated and applied only after the 

negative items have been reallocated. 

The reason is to preserve the most 

flexibility possible in reallocating 

positive adjustments, in order to 

minimize disparity to the greatest 

extent. Thus, the operation of these 

rules has the effect of removing basis 

from transferred loss shares and using it 

to reduce disparity in members’ bases in 

S shares. 

Redetermination is limited in several 

respects. First, because the premise of 

the rule is that the original allocation of 

an item did not represent the most 

economically appropriate allocation of 

the item, redeterminations under the 

rule are limited to allocations of 

investment adjustments that could have 

been made at the time an item was taken 

into account. Accordingly, no 

adjustments can be reallocated to shares 

that were not held by members in the 

year taken into account, as members’

shares would not have been able to 

receive those adjustments in the original 

allocation. 

A related limitation on reallocation is 

that an investment adjustment cannot be 

reallocated except to the extent that the 

full effect of the reallocation can be 

accomplished. Thus, an investment 

adjustment can not be reallocated to the 

extent the resulting basis has previously 

been taken into account (including at a 

higher tier). This rule guards against 

double benefits from an adjustment (for 

example, by not allowing positive 

adjustments to be moved from, or 

negative adjustments be moved to, 

shares after the item would have 

affected basis that was taken into 

account in recognizing gain or loss). It 

also guards against the loss of a benefit 

(for example, by not allocating positive 

adjustments to previously transferred 

shares that can no longer benefit from 

the basis). 

The principle purpose of the rule is to 

reduce loss on transferred shares. 

However, because its secondary purpose 

is to decrease disconformity to the 

greatest extent possible, in certain fact 

patterns, the application of the rule will 

actually increase loss on some shares. 

Importantly, in no fact patterns will the 

application of the rule create gain on 

shares. Overall, the rule has no effect on 

the aggregate amount of gain or loss on 

members’ bases in subsidiary stock. 

In the basis reallocation rule, and in 

several other provisions of the proposed 

regulations, there is a direction to 

allocate items in a manner that reduces 

disparity to the greatest extent possible. 

The regulations do not, however, 

prescribe the manner in which such 

determinations are to be made. The IRS 

and Treasury Department intend that 

taxpayers have flexibility in choosing 

the methods and formulas to be 

employed in making these 

determinations and the IRS will respect 

any reasonable method or formula so 

employed. 

The IRS and Treasury Department 

recognize that the redetermination of 

basis imposes a certain administrative 

burden. Thus, the rule contains two safe 

harbors that excuse taxpayers from 

reallocating basis in situations in which 

redetermination is deemed unnecessary. 

One safe harbor is for situations in 

which redetermination would have no 

ultimate effect on the basis of any share 

held by a member. This happens, for 

example, if only common stock is 

outstanding and there is no disparity in 

the bases of the shares. In such a case, 

any redetermination would result in the 

same bases the members’ had before 

redetermination. The second safe harbor 

is for situations in which the group 

disposes of its entire interest in the 

subsidiary to an unrelated person in one 

or more fully taxable transactions. In 

such a case, the group recognizes all the 

gains and losses on the shares and so 

obtains no benefit from the disparate 

reflection of gain or loss. Transfers that 

are excepted from basis 

redetermination, like transfers of shares 

that remain loss shares after application 

of the rule, are then subject to the basis 

reduction rule. 

3. The Basis Reduction Rule 

If, after basis redetermination, any 

member’s transferred share is a loss 

share (even if the share only became a 

loss share as a result of the application 

of the basis redetermination rule), the 

basis of that share is subject to reduction 

under this rule. This rule is intended to 

eliminate stock loss that is presumed 

noneconomic. It operates by reducing 

the basis of each transferred loss share 

(but not below value) by the lesser of the 

share’s disconformity amount and its 

net positive adjustment. 

A share’s disconformity amount is the 

excess of its basis over its allocable 

portion of S’s net inside attributes, 

determined at the time of the transfer. 

This amount identifies the net amount 

of unrealized appreciation reflected in 

the basis of the share. Because the 

disconformity amount is computed at 

the time of the transfer, the 

disconformity amount reflects the 

effects of all prior redetermination 

events. 

The term net inside attributes is 

defined as the sum of S’s loss 

carryovers, deferred deductions, cash, 

and asset basis, reduced by S’s 

liabilities. This computation is used in 

both this basis reduction rule and the 

attribute reduction rule described in 

section F.4 of this preamble. Both rules 

do, however, have special provisions 

that modify the computation of net 

inside attributes if S holds lower-tier 

subsidiary stock. See sections F.3.a and 

F.4.a of this preamble for a discussion 

of rules relating to the stock of lowertier subsidiaries for purposes of basis 

reduction and attribute reduction, 

respectively. 

A share’s net positive adjustment is 

computed as the greater of zero and the 

sum of all investment adjustments 

(excluding distributions) applied to the 

basis of the transferred loss share, 

including by reason of prior basis 

reallocations. All items of income, gain, 

deduction, and loss are included fully 

in the net positive adjustment amount. 

This rule identifies the extent to which 

basis has been increased by the 

investment adjustment provisions for 

items of income, gain, deduction and 

loss (whether taxable or not) that have 

been taken into account by the group. 

a. Special rules applicable when S 

holds stock of lower-tier subsidiary. 

For purposes of computing the 

disconformity amount, if S holds stock 

of a lower-tier subsidiary (S1) that was 

not transferred in the transaction, S’s 

net inside attribute amount is computed 

by treating S’s basis in S1 stock as 

‘‘tentatively reduced’’ by the lesser of 

the S1 share’s net positive adjustment 

and its disconformity amount. This 

reduction is made only for purposes of 

determining basis reduction to the S 

share, and has no other effect. The 

purpose of this adjustment is to prevent 

S1’s recognized items from giving rise to 

noneconomic loss in S stock, for 

example, when S1 recognizes gain that 

is already reflected (indirectly) in P’s 

basis in S shares. This problem is 

illustrated in Example 8 (subsidiary 

holding lower-tier subsidiary stock with 

a basis that reflects lower-tier 

unrecognized appreciation). 

When determining the disconformity 

amount of a share of subsidiary stock, 

no tentative reduction is made to the 

basis of lower-tier shares that were 

transferred in the transaction (without 


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regard to whether S retained the shares 

after the transaction, such as when S1 

is transferred because S and S1 cease to 

be members of the same group but S 

continues to hold S1 stock). The reason 

is that the basis reduction rule applies 

directly to each transfer, starting with 

the lowest-tier transfer, and so any 

noneconomic loss in S stock that was 

attributable to S1’s items has been 

eliminated by the time that the basis 

reduction rule applies to the S Stock. In 

addition, the tentative basis reduction 

rule does not apply to shares that are 

lower tier to any shares that were 

transferred in the transaction. The 

application of the rule to those shares is 

unnecessary because, when the basis 

reduction rule applied to S1, it 

eliminated any inappropriate effects 

from items that tiered up from 

subsidiaries that were lower tier to S1. 

4. The Attribute Reduction Rule 

If any transferred share remains a loss 

share after application of the basis 

reduction rule, the subsidiary’s 

attributes (including the consolidated 

attributes attributable to the subsidiary) 

are subject to reduction. The attribute 

reduction rule addresses the duplication 

of loss by members of consolidated 

groups. This rule is intended to insure 

that the group does not recognize more 

than one loss with respect to a single 

economic loss regardless of whether the 

group chooses to dispose of the 

subsidiary stock before or after the 

subsidiary recognizes the loss with 

respect to its assets or operations. 

Under this rule, S’s attributes are 

reduced by the ‘‘attribute reduction 

amount,’’ which is computed as the 

lesser of the net stock loss and the 

aggregate inside loss. This amount 

reflects the total amount of 

unrecognized loss that is reflected in 

both the basis of the S stock and S’s 

attributes. Net stock loss is the excess of 

the sum of the bases (after application 

of the basis reduction rule) of all S 

shares transferred by members in the 

same transaction over the value of such 

shares. S’s aggregate inside loss is the 

excess of S’s net inside attributes over 

the value of all of the S shares. Net 

inside attributes generally has the same 

meaning as in the basis reduction rule, 

subject to special rules for lower-tier 

subsidiaries (see section F.4.a of this 

preamble). 

Unlike comparable provisions in 

§ 1.1502–35 and the LDR, this rule does 

not limit its application to a share’s 

proportionate interest in the 

subsidiary’s aggregate inside loss. The 

reason is that when a member 

recognizes a stock loss, or preserves a 

stock loss for a later recognition (for 

example, when the share is retained but 

deconsolidated), the member enjoys (or 

preserves for later use) the benefit of the 

entire amount of that stock loss. If basis 

is uniform, the amount of stock loss will 

reflect a proportionate interest in the 

subsidiary’s unrecognized loss. But if 

basis is disparate, the loss on a 

particular share can reflect any amount, 

even all, of the subsidiary’s 

unrecognized loss. In either case, the 

potential loss duplication equals the 

entire amount by which the stock loss 

is duplicated in the subsidiary’s 

attributes. Accordingly, the proposed 

regulations reduce attributes to that 

extent. This prevents the duplication 

(but not acceleration) of loss otherwise 

available in situations similar to 

Example 5(b) by reducing S’s attributes 

by the entire amount by which the stock 

loss duplicates the aggregate inside loss. 

A principal goal of this regulation is 

to address the issues of noneconomic 

and duplicated stock loss in a manner 

that is as readily administrable as 

possible, by taxpayers and the 

government. For that reason, the 

proposed regulations generally avoid 

imposing valuation requirements 

whenever possible. However, the 

proposed regulations do, to the extent 

possible, use readily available 

information to identify the location and 

amount of loss, to avoid knowingly 

creating gain. The order in which 

attributes are reduced reflects this 

principle. 

After S’s attribute reduction amount is 

determined, it is first applied to reduce 

or eliminate items that represent actual 

realized losses, such as operating loss 

carryovers, capital loss carryovers, and 

deferred deductions. If S’s attribute 

reduction amount exceeds those items, 

the excess is then applied to reduce or 

eliminate the loss in the basis of 

property that is publicly traded (other 

than subsidiary stock, which is subject 

to special rules). The reason that the 

basis of publicly traded property, unlike 

that of other assets, is only reduced by 

the amount of loss reflected in the basis 

of the property is that such property can 

be readily and easily valued. Finally, if 

any attribute reduction amount remains 

after eliminating those attributes, it is 

applied to reduce or eliminate the basis 

in assets, other than publicly traded 

property (which then reflects no loss) 

and other than cash and equivalents 

(which also reflect no loss). This 

reduction is made proportionately 

according to the basis in each property. 

The proposed regulations provide a 

special rule that applies to the extent a 

subsidiary has liabilities that have not 

been taken into account as of the time 

of the transfer. Under the general rule, 

if the attribute reduction amount 

exceeds attributes available for 

reduction, that excess attribute 

reduction amount has no further effect. 

However, a special rule applies if the 

attribute reduction amount exceeds the 

attributes available for reduction and 

the subsidiary has a liability that has not 

been taken into account. Typically this 

will happen when cash or other liquid 

assets are held to fund future expenses 

related to the liability. Because the 

assets held by S do not reflect attributes 

that can be reduced, loss can be 

duplicated later, when the liability is 

taken into account. To prevent the 

duplication of loss in such cases, the 

excess attribute reduction amount is 

suspended and applied to prevent the 

deduction or capitalization of payments 

later made by S or another person with 

respect to the liability. 

a. Special rules applicable when S 

holds stock of lower-tier subsidiary. 

When S holds stock of lower-tier 

subsidiaries, the attribute reduction 

amount is computed in a manner that 

identifies the maximum potential 

amount of loss duplication and 

attributes are reduced to that extent. 

However, the rule incorporates two 

restrictions to prevent excessive 

reduction of attributes that could 

otherwise result from this approach. 

These rules are set forth in this section 

4.a. 

First, to facilitate the computation of 

S’s attribute reduction amount, all of S’s 

shares of S1 stock are treated as a single 

share (generally referred to as the S1 

stock). To identify the maximum 

potential duplication, the computation 

of the attribute reduction amount is 

made treating S’s basis in S1 stock as its 

‘‘deemed basis’’ in that stock. The 

proposed regulations define deemed 

basis as the greater of S’s actual 

aggregate basis in the S1 shares 

(adjusted for any gain or loss recognized 

on a transfer of the S1 shares) and the 

S1 shares’ allocable portion of S1’s net 

inside attributes. For example, if P owns 

all the stock of S with a basis of $150, 

S owns all the stock of S1 with a basis 

of $100, and S1 owns an asset with a 

basis of $150. S’s deemed basis in S1 

stock is $150, the greater of $100 (S’s 

actual basis in S1 stock) and $150 (the 

S1 shares’ allocable portion of S1’s net 

inside attribute amount), which is the 

maximum amount of inside loss that S 

can recognize. The proposed regulation 

uses deemed basis not only to identify 

the maximum potential amount of loss 

duplication ($150 in the example), but 

also to reduce attributes on the 

assumption that taxpayers will act in 

their best interest when deciding how 

lower-tier attributes will be recognized 


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(subject to certain limits discussed in 

this section F.4.a). 

S’s deemed basis in S1 stock is also 

used for purposes of allocating S’s 

attribute reduction amount between S’s 

S1 stock and S’s other attributes. 

However, for this purpose, deemed basis 

is treated as reduced by certain amounts 

that, by their nature, do not reflect loss. 

These excluded amounts include the 

value of S1 shares transferred in the 

transaction and the portion of S1’s cash, 

S1’s cash equivalents, and the value of 

S1’s publicly traded property (net of 

S1’s liabilities) that is attributable to S’s 

nontransferred shares of S1 stock. The 

excluded amounts also include the 

corresponding amounts with respect to 

all shares of stock of lower-tier 

subsidiaries. These modifications 

prevent nonloss assets from 

inappropriately increasing the 

allocation of attribute reduction to S1 

stock. 

The attribute reduction amount 

allocated to S’s block of S1 stock is then 

apportioned and applied to reduce the 

bases of S’s individual shares of S1 

stock in a manner that, to the greatest 

extent possible, reduces disparity. This 

general rule is subject to two 

modifications. First, no allocated 

amount is apportioned to any 

transferred S1 share if gain or loss is 

recognized on the transfer of that share. 

The reason is that the recognition of 

gain or loss (even if not allowed) 

establishes that the basis of that share 

does not reflect (or no longer reflects) 

unrecognized loss. This modification 

thus directs attribute reduction to other 

shares that are the source of the 

potential duplication. The second 

modification is that no allocated amount 

that is apportioned to any transferred S1 

share is to be applied to reduce the basis 

of the share below its value. This 

modification prevents attribute 

reduction from knowingly creating gain 

on such shares. 

To fully implement the loss 

duplication rule, any portion of S’s 

attribute reduction amount that is 

allocated to S1 stock, whether or not it 

is apportioned or applied to reduce the 

basis of any S1 shares, tiers down and 

becomes an attribute reduction amount 

of S1. The attribute reduction rules then 

apply to reduce S1’s attributes in the 

same manner that they apply S’s 

attribute reduction amount to reduce S’s 

attributes. However, because the 

attribute reduction amount represents 

the maximum potential amount of 

duplication in the lower-tier subsidiary, 

the proposed regulations include two 

modifications to prevent the reduction 

of attributes beyond the amount 

necessary to eliminate duplicated loss. 

The first modification is the 

conforming limit rule, which prevents 

the tier down of attribute reduction from 

reducing S1’s net inside attributes 

below the sum of the value of the S1 

shares transferred by members and the 

aggregate bases that members have in 

nontransferred S1 stock (after any 

reduction to those shares by the direct 

application of S’s attribute reduction 

amount). 

The second modification is the basis 

restoration rule. This rule applies after 

the attribute reduction rule has been 

applied with respect to all transfers and 

all resulting reductions (whether as a 

result of direct or tier-down attribute 

reduction) have been given effect. This 

rule reverses stock basis reductions 

made by the attribute reduction rule, but 

only to the extent necessary to conform 

inside (net inside attributes) and outside 

(stock) basis at each tier, taking into 

account the effect of any prior section 

362(e)(2) transactions. Because net 

inside attributes can be a negative 

number, stock basis may be a negative 

number even after basis restoration. In 

such cases, the basis of the share will 

remain an excess loss account in the 

hands of the owning member after the 

transaction (the regulations specifically 

provide that the excess loss account 

created by this rule is not taken into 

account under § 1.1502–19). Basis 

restoration adjustments are made at 

each tier, but they do not give rise to 

any upper-tier adjustments. 

With these two modifications, the 

attribute reduction rule can reduce 

lower-tier attributes in an amount that 

eliminates the full duplication potential 

reflected in S’s basis in S1 stock and 

S1’s net inside attributes without 

creating a noneconomic gain in the 

corresponding attribute. 

b. Election to reduce stock basis and/ 

or reattribute loss. 

Finally, the attribute reduction rule 

contains an elective provision under 

which groups can reduce the potential 

for loss duplication and thereby reduce 

or completely avoid attribute reduction 

under these regulations. Under this rule, 

the common parent of a group can elect 

to reduce stock basis, reattribute 

attributes, or do some combination of 

basis reduction and attribute 

reattribution in order to prevent the 

reduction of attributes otherwise 

required under these proposed 

regulations. The total amount that can 

be the subject of the election is limited 

to the amount that S’s attributes would 

otherwise be subject to reduction. 

The election to reattribute attributes 

can only be made if S ceases to be a 

member of the P group as a result of the 

transfer. The reason is that the election 

is not intended to be merely a 

mechanism for changing location of 

items within a group (and its continuing 

members). The election can be made 

with respect to loss carryforwards and 

deferred deductions of S or any of S’s 

lower-tier subsidiaries, but only to the 

extent and in the order that such 

attributes would otherwise have been 

reduced under the attribute reduction 

rule. However, P may only reattribute 

attributes of lower-tier subsidiaries that 

would otherwise be reduced as a result 

of tier-down attribute reduction to the 

extent that the reattribution does not 

create an excess loss account in the 

stock of any lower-tier subsidiary. When 

this election is made, P is treated as 

succeeding to the attributes as though it 

had acquired them in a section 381(a) 

transaction. Proposed regulations under 

§ 1.1502–32 treat the reattributed 

attributes as absorbed and tiering up to 

reduce the basis of shares such that the 

full amount tiers up through the 

transferred S shares for which the 

election is made. This amount is 

allocated to shares in the chain with 

positive basis in a manner that reduces 

the disparity in the basis of the shares 

to the greatest extent possible. However, 

this amount is not allocated to any 

lower-tier subsidiary shares that were 

transferred in a transfer in which gain 

or loss was recognized. The IRS and 

Treasury Department recognize and are 

concerned with the potential 

complexity of this election and request 

comments regarding both the 

administrability and the benefit of the 

election, particularly as it relates to 

attributes of lower-tier subsidiaries. 

Although the maximum amount of the 

election is computed by tentatively 

applying the attribute reduction rule to 

S, the election is actually given effect 

immediately before the application of 

the attribute reduction rule. Thus, to the 

extent loss duplication has not been 

eliminated by the election, the attribute 

reduction rules apply in their general 

manner. 

5. Over-Ride Provisions 

These proposed regulations contain 

two over-ride provisions. One, found in 

the general introductory provisions of 

the proposed regulation, requires that 

the provisions of these proposed 

regulations be interpreted and applied 

in accordance with their stated 

purposes. The other, an anti-abuse and 

anti-avoidance rule, provides that 

‘‘appropriate adjustments’’ will be made 

if a taxpayer acts with a view to avoid 

the purposes of this section or use this 

section to avoid another rule of law. The 

anti-abuse rule includes several 

examples that illustrate general 


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principles. The examples are not 

intended to specify particular 

transactions that will be treated as 

abusive in all cases or to prevent the IRS 

from treating other transactions as 

abusive. This rule is an important 

safeguard to ensure that only transfers 

made in the ordinary course of business 

enjoy the benefits and avoid the burdens 

arising from the principles adopted in 

these proposed regulations. 

6. Special Rules for Section 362(e)(2) 

Transactions 

The IRS and Treasury Department 

recognize that adjustments made 

pursuant to section 362(e)(2) (see 

discussion in section H of this 

preamble) alter the extent to which 

comparisons of stock basis, net inside 

attributes, and value can identify both 

the amount of unrecognized 

appreciation reflected in stock basis and 

the amount of duplicated loss. For 

example, a reduction to asset basis 

under section 362(e)(2)(A) increases the 

disconformity amount of the shares 

received in the transaction subject to 

section 362(e)(2), but this amount does 

not represent unrealized appreciation 

reflected in stock basis. Further, the 

reduction to asset basis under section 

362(e)(2)(A) decreases the amount of 

loss duplication that can exist with 

respect to the shares received in the 

transaction subject to section 362(e)(2). 

Similarly, if stock basis is reduced 

pursuant to an election under section 

362(e)(2)(C), there is an increase in the 

subsidiary’s net inside attribute amount 

that reduces the disconformity amount 

of all shares and increases aggregate 

inside loss, even though there has been 

neither a decrease in the amount of 

unrealized appreciation reflected in 

stock basis nor an increase in duplicated 

loss. 

Accordingly, to adjust for distortions 

resulting from basis reduction under 

section 362(e)(2)(A), the proposed 

regulations adjust the disconformity 

amount of the shares received in the 

transaction to which section 362(e)(2) 

applied by an amount equal to the 

amount the basis of such shares would 

have been reduced had an election 

under section 362(e)(2)(C) been made. 

Further, for purposes of computing the 

attribute reduction amount on a transfer 

of any shares received in the section 

362(e)(2) transaction, and applying the 

conforming limitation on the 

application of tier-down attribute 

reduction, the basis in such shares is 

reduced by an amount equal to the 

amount the basis of such shares would 

have been reduced had an election 

under section 362(e)(2)(C) been made 

Similarly, to adjust for distortions 

resulting from basis reduction under 

section 362(e)(2)(C), for purposes of 

computing any share’s disconformity 

amount or the subsidiary’s aggregate 

inside loss, and for purposes of 

determining any stock basis restoration, 

the proposed regulations reduce S’s net 

inside attribute amount by an amount 

equal to the amount S’s attributes would 

have been reduced under section 

362(e)(2)(A) had no election under 

section 362(e)(2)(C) been made. Further, 

the regulations indicate that the special 

application of section 362(e)(2) to 

intercompany transactions must be 

taken into account, so these adjustments 

only apply to the extent section 

362(e)(2) has actually resulted in some 

basis reduction. 

The IRS and Treasury Department 

recognize that the computations in these 

proposed regulations may need to take 

other items into account. Accordingly, 

the proposed regulations provide that 

the Commissioner will make 

appropriate adjustments to account for 

changes in the relationship between 

stock basis and net inside attributes that 

are not the result of either § 1.1502–32 

or these proposed regulations and that 

are not otherwise adjusted under these 

proposed regulations. In addition, the 

proposed regulations provide that 

taxpayers may seek a written 

determination regarding the treatment of 

comparable items or adjustments. 

7. Special Rules Considered But Not 

Adopted 

a. Discounting of losses that are 

limited by section 382 or other 

provisions. 

The IRS and Treasury Department 

considered whether losses could be 

included in the computation of the net 

inside attribute amount at a reduced rate 

if their use was limited, for example, by 

section 382. Ultimately no 

administrable and precise method was 

identified for determining the extent to 

which losses could be considered 

properly excluded (or included at a 

reduced rate), except in the most 

extreme cases. Accordingly, the 

proposed regulations do not provide 

special rules for limited losses. As a 

result, losses are fully included in net 

inside attributes. 

The IRS and Treasury Department 

recognize that this approach is 

extremely favorable to taxpayers as it 

reduces the disconformity amount (and 

thus the extent to which stock basis may 

be reduced) with the only potential cost 

being the elimination of the losses 

under the attribute reduction rule. The 

IRS and Treasury Department believe 

that this taxpayer-favorable result, when 

produced in the ordinary course of 

business, is not an inappropriate result 

as part of the overall balance reached by 

these regulations. Taxpayers that engage 

in transactions that have no bona fide 

purpose other than to acquire limited 

losses to avoid the purposes of the 

proposed regulations, however, will be 

subject to the anti-avoidance rule and 

the benefits of the transaction will be 

eliminated. 

b. Exceptions for basis conforming 

acquisitions. 

Practitioners had suggested that any 

proposed regulations addressing 

noneconomic loss contain an exception 

for transactions such as section 351 

exchanges and acquisitions subject to a 

section 338 election. These proposed 

regulations do not explicitly contain 

such an exception. One reason is that 

such an exception would introduce the 

complexity and burden of identifying all 

redetermination events. A more 

important reason, however, is that such 

an exception is unnecessary under the 

basis disconformity model because, by 

measuring disconformity immediately 

before the transfer of loss shares, this 

rule automatically excludes situations 

from basis reduction when there is 

inside/outside conformity. Thus, the 

effect of this suggestion is accomplished 

and no special rules are necessary. 

c. Shadow account for reduced basis. 

The proposed regulations do not 

contain a mechanism, suggested by 

practitioners, for restoring basis to 

transferred shares that are retained by a 

member and later sold at a gain (for 

example, when a member retains S 

shares but S ceases to be a member). The 

IRS and Treasury Department are 

concerned that such a rule would add 

undue complexity to the regulatory 

scheme. Moreover, such a rule would be 

inconsistent with a fundamental 

principle underlying these proposed 

regulations, specifically, that a transfer 

(as defined in these proposed 

regulations) is the appropriate time for 

these proposed regulations to apply. 

Thus, the basis reduction rules do not 

permanently reduce the basis of lowertier subsidiary stock unless the stock is 

transferred in the transaction. And, 

moreover, similar to the general 

application of other provisions of the 

Code and regulations, subsequent events 

should not reverse the effects of such 

application. 

8. Effective Date 

The proposed regulations would be 

applicable as of the date they are 

published as final regulations in the 

Federal Register. 


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G. Sections 1.337(d)–1, 1.337(d)–2, and 

1.1502–35 

Because proposed § 1.1502–36 

addresses both noneconomic and 

duplicated loss on subsidiary stock, the 

IRS and Treasury Department are also 

proposing the removal of §§ 1.337(d)–1, 

1.337(d)–2, and 1.1502–35, except to the 

extent necessary to address losses 

suspended under § 1.1502–35(c) and 

losses reimported under § 1.1502–

35(g)(3). 

Additionally, the IRS and Treasury 

Department intend to publish temporary 

regulations that will modify the antiabuse provisions of § 1.1502–35. First, 

the temporary regulations will restate 

the loss reimportation rule as a 

principle-based rule. This change 

responds to comments received about 

the administrability of the current 

provision. Second, the temporary 

regulations will modify the loss 

reimportation rule to provide that a 

duplicated loss on subsidiary stock is 

subject to the loss reimportation rule 

even if the group deconsolidates the 

subsidiary before selling loss shares of 

the subsidiary stock. These 

modifications are reflected in these 

proposed regulations. 

These proposed regulations also 

revise several regulations solely to 

reflect the removal of §§ 1.337(d)–1, 

1.337(d)–2, and 1.1502–35 (other than 

with respect to loss suspension and loss 

reimportation), and the addition of 

§ 1.1502–36. 

The proposed regulations described in 

this section G would be applicable as of 

the date they are published as final 

regulations in the Federal Register. 

H. Suspension of Section 362(e)(2) in 

Consolidation 

1. Background 

As part of the AJCA, Congress enacted 

section 362(e)(2) to address certain 

instances of loss duplication. Very 

generally, that provision provides that if 

loss property is transferred to a 

corporation in a section 351 exchange 

(or as a capital contribution or paid-in 

surplus), the transferee’s aggregate basis 

in the assets will be limited to the 

properties’ fair market value. However, 

section 362(e)(2) also permits the parties 

to elect to limit the basis of the stock 

received (or treated as received) in the 

exchange to its fair market value, so that 

the loss is preserved in the basis of the 

transferred property. Section 

362(e)(2)(C). See REG–110405–05 

(2006–48 IRB 1004), 71 FR 62067 

(October 23, 2006), (‘‘the 2006 

proposal’’) for a more detailed 

explanation of the general application of 

section 362(e)(2). 

Practitioners have questioned whether 

it is necessary to apply section 362(e)(2) 

to intercompany transactions where 

there is a consolidated return rule 

addressing loss duplication. The IRS 

and Treasury Department recognize that 

loss duplication in consolidated groups 

is generally addressed by § 1.1502–32 

(when losses are recognized on a 

subsidiary’s assets or operations) and, 

currently, by § 1.1502–35 (or by this 

proposed § 1.1502–36 when it is 

finalized). In general, the IRS and 

Treasury believe that these regulations 

together address loss duplication in a 

manner that is most consistent with 

single entity principles. Nevertheless, 

the IRS and Treasury Department are 

concerned that, if section 362(e)(2) were 

not to apply to intercompany transfers, 

members of consolidated groups may be 

able to reduce gain under circumstances 

that separate taxpayers could not. 

Accordingly, the IRS and Treasury 

Department have tentatively concluded 

that section 362(e)(2) should be applied 

to intercompany transactions. However, 

the IRS and Treasury are concerned 

with the administrative burden imposed 

by section 362(e)(2) and are continuing 

to study whether its provisions should 

be applicable to such transfers. 

Comments are invited on this issue. 

2. Suspension of Section 362(e)(2) for 

Intercompany Transactions. 

Although the IRS and Treasury 

Department have tentatively concluded 

that section 362(e)(2) should remain 

applicable to transfers between 

members of a consolidated group, as 

noted, the IRS and Treasury Department 

are concerned with the significant 

complexity and administrative burden 

that section 362(e)(2) adds in the 

consolidated return context. For 

example, if an election is made to 

reduce stock basis under section 

362(e)(2)(C), a portion of the items 

attributable to the transferred loss assets 

can produce duplicative reductions 

unless traced and treated as duplicative 

of the section 362(e)(2) reduction to 

stock basis. 

Moreover, the IRS and Treasury 

Department recognize that basis 

reductions are not necessary in 

intercompany section 362(e)(2) 

transactions as long as duplication can 

effectively be eliminated by the general 

operation of the investment adjustment 

system. Accordingly, these proposed 

regulations would suspend application 

of section 362(e)(2) until the occurrence 

of a ‘‘section 362(e)(2) application 

event,’’ and then apply the principles of 

section 362(e)(2) only to the extent the 

investment adjustment system has not 

and can no longer effectively eliminate 

any remaining duplication. The IRS and 

Treasury Department expect that this 

suspension will often effectively 

eliminate the application of section 

362(e)(2) to most intercompany 

transactions. 

Nevertheless, in order to apply 

section 362(e)(2) upon the occurrence of 

a section 362(e)(2) application event, the 

group must determine the extent to 

which an intercompany transaction 

resulted in loss duplication that would 

have been prevented by section 

362(e)(2), and track the extent to which 

this duplication is effectively eliminated 

while the transferor and the transferee 

are members. Accordingly, these 

proposed regulations require the group 

to identify the amount and location of 

basis in the transferred assets that 

would have been eliminated had section 

362(e)(2)(A) applied at the time of the 

intercompany transaction. This is the 

amount of the net built-in loss that is 

duplicated as a result of the section 

362(e)(2) transaction. The regulations 

refer to this amount of duplication as 

the ‘‘section 362(e)(2) amount.’’

The duplicated loss is reflected in 

both the transferor’s basis in the 

transferee stock (or securities), and in 

the transferee’s basis in the property 

received. The duplication is initially 

reflected in the basis of the transferee 

stock (or securities) to the extent the 

basis would have been reduced under 

section 362(e)(2)(C), if such an election 

was made and section 362(e)(2) was not 

suspended by these temporary 

regulations. The duplication is also 

initially reflected in the transferee’s 

basis in the property received to the 

extent the basis of such property would 

have been reduced under section 

362(e)(2)(A) if no election was made 

under section 362(e)(2)(C) and section 

362(e)(2) was not suspended by these 

temporary regulations. Over time this 

amount can be reflected in other 

attributes of the transferee (such as 

unabsorbed losses) to the extent such 

attributes are attributable to the 

transferee’s basis in the property 

received. 

3. Elimination of the Section 362(e)(2) 

Amount 

Because the investment adjustment 

system reduces stock basis as a 

subsidiary’s attributes are taken into 

account, the duplication is eliminated to 

this extent, and the section 362(e)(2) 

amount must be eliminated to this 

extent. Further, if the basis of the stock 

(or securities) received in the 

intercompany section 362(e)(2) 

transaction is reduced as the result of a 

section 362(e)(2)(C) election, as a result 

of attribute reduction under these 


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proposed regulations, or is otherwise 

eliminated without the recognition of 

gain or loss, the duplication is similarly 

eliminated. Accordingly, these types of 

basis reductions result in an elimination 

of all or a portion of the section 

362(e)(2) amount. The proposed 

regulations provide specific guidance 

regarding how much of any remaining 

section 362(e)(2) amount is reflected in 

the basis of the subsidiary’s stock (or 

securities) or the subsidiary’s attributes 

as the section 362(e)(2) amount is 

eliminated. 

4. Application of Section 362(e)(2) to 

Intercompany Transactions 

Upon the occurrence of a section 

362(e)(2) application event, the 

regulations apply section 362(e)(2) only 

to the extent necessary. A section 

362(e)(2) application event occurs when 

all or a portion of the duplicated 

amount can no longer be effectively 

eliminated by the operation of the 

investment adjustment system, and can 

involve either the stock (or securities) of 

the transferee or the assets transferred in 

the intercompany section 362(e)(2) 

transaction. Such an event is defined to 

include any transfer (as defined in 

proposed § 1.1502–36) of the 

transferee’s stock received in the 

exchange, any satisfaction of a security 

received in the exchange, any 

transaction in which a nonmember 

acquires any of the transferred assets 

with substituted basis or succeeds to 

any attributes attributable to such basis, 

or any other transaction the result of 

which prevents all or a portion of any 

remaining section 362(e)(2) amount 

reflected in stock basis and attributes 

from being effectively eliminated by the 

operation of the investment adjustment 

system when taken into account. 

Further, if the transferor and the 

transferee in the intercompany section 

362(e)(2) transaction continue to be 

members of the same group (including 

as members of another group), the 

investment adjustment system can 

continue to effectively eliminate the 

duplication. Accordingly, these 

proposed regulations provide a 

subgroup exception implicit in the 

definition of section 362(e)(2) 

application events that allows the 

transferor and transferee to become 

members of a new group without 

triggering the application of section 

362(e)(2). In such a case, the transferor 

and transferee will continue to track the 

section 362(e)(2) amount reflected in 

stock basis and attributes, and apply 

these provisions upon the occurrence of 

a section 362(e)(2) event. 

Given the fact that section 362(e)(2) is 

applied in this context only to the 

extent necessary, the scope of its 

application varies slightly depending 

upon the type of section 362(e)(2) 

application event that occurs. If the 

application event involves a transaction 

in which a nonmember acquires some or 

all of the transferee’s attributes that 

reflect a section 362(e)(2) amount, 

section 362(e)(2) applies to the extent 

such attributes reflect all or part of any 

remaining section 362(e)(2) amount. In 

such a case, the resulting reduction in 

attributes is applied to the attributes 

involved in the application event that 

reflect the section 362(e)(2) amount. If 

the application event involves all or part 

of the transferee stock (or securities) 

received in the section 362(e)(2) 

transaction, section 362(e)(2) applies to 

the extent such stock (or securities) 

reflect all or part of any remaining 

section 362(e)(2) amount. Further, in 

this case, the resulting reduction in 

attributes is applied to proportionately 

to the transferee’s attributes that reflect 

the section 362(e)(2) amount (based on 

the relative section 362(e)(2) amount 

reflected). The reduction in the 

transferee’s attributes is not a 

noncapital, nondeductible expense. 

As is provided in section 362(e)(2)(C), 

the transferor and transferee may elect 

to reduce the basis in the transferee 

stock (or securities) received in the 

intercompany section 362(e)(2) 

transaction instead of reducing the 

transferee’s attributes. Similar to the 

provisions of the proposed regulations 

under section 362(e)(2), the reduction in 

the basis of the transferee stock (or 

securities) received in the intercompany 

section 362(e)(2) transaction is equal to 

the amount of the reduction in the 

transferee’s attributes absent the 

election. Further, if this election is 

made, the type of section 362(e)(2) 

application event dictates which shares 

(or securities) receive the basis 

reduction. If the application event 

involves a transaction in which a 

nonmember acquires some or all of the 

transferee’s attributes, the reduction is 

applied proportionately to all of the 

transferee stock (or securities) held by 

members immediately before the 

application event (based on the relative 

section 362(e)(2) amount reflected). 

However, if the application event 

involves all or a part of the transferee 

stock (or securities) received in the 

intercompany section 362(e)(2) 

transaction, the reduction is applied 

proportionately to the stock (or 

securities) so involved (based on the 

relative section 362(e)(2) amount 

reflected). The reduction in the basis of 

the stock of the transferee as a result of 

this election is treated as a 

nondeductible basis recovery item. 

Under the proposed regulations, the 

election to reduce stock basis (in lieu of 

attributes) under section 362(e)(2)(C) 

may be made for the intercompany 

transaction on either the group return 

for the year of the intercompany section 

362(e)(2) transaction or the year in 

which the first section 362(e)(2) 

application event occurs. In either case, 

the election has effect only if and to the 

extent there is a section 362(e)(2) 

application event, is irrevocable once 

made, and applies to all section 

362(e)(2) application events with 

respect to such intercompany section 

362(e)(2) transaction (even if the 

application event occurs at a time when 

the transferor and transferee are 

members of another consolidated 

group). 

5. Special Allocations Under § 1.1502–

32 

The proposed regulations also include 

a special allocation provision in 

§ 1.1502–32 that requires all items taken 

into account by a group (including tierups of such amounts) that reflect a 

section 362(e)(2) amount to be allocated 

entirely to member’s shares. In other 

words, such items are allocated as if any 

shares held by nonmembers were not 

outstanding. The reason for these 

special allocation rules is to prevent the 

general § 1.1502–32 allocation of items 

to dilute the elimination of duplication 

where shares of subsidiary stock are 

held by nonmembers. 

6. Other Considerations 

In the 2006 proposal, the IRS and 

Treasury Department proposed 

regulations that would provide that the 

tracing rules in § 1.358–2(a)(2) will not 

apply to stock received in a section 

362(e)(2) transaction if the transferor 

and transferee elect to apply section 

362(e)(2)(C). The IRS and Treasury 

requested comments regarding whether 

that treatment is appropriate. As noted 

in section H.4 of this preamble, these 

proposed regulations would allow the 

making of a section 362(e)(2)(C) election 

to be deferred until the year of the first 

section 362(e)(2) application event. The 

IRS and Treasury Department are aware 

of the potential difficulty and 

administrative burden associated with 

retroactively not applying the 

provisions of § 1.358–2(a)(2). The IRS 

and Treasury Department continue to 

study this issue, and invite comments 

regarding whether the proposed revision 

to § 1.358–2(a)(2)(viii) regarding section 

362(e)(2)(C) elections should apply to 

intercompany transactions. 


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These proposed regulations would be 

applicable as of the date they are 

published as final regulations in the 

Federal Register. 

I. Other Revisions to the Consolidated 

Return Regulations 

The IRS and Treasury Department are 

also proposing various technical and 

administrative revisions to the 

consolidated return regulations. 

1. Removal of § 1.1502–13(f)(6)(ii) 

Section 1.1502–13(f)(6)(ii) prevents a 

member from recognizing gain on the 

qualified disposition of parent stock. 

However, § 1.1502–13(f)(6)(ii) only 

applies to dispositions of parent stock 

occurring prior to May 16, 2000. Thus, 

the provision has no current 

applicability. Nevertheless, gain on 

dispositions of parent stock occurring 

on or after May 16, 2000 may qualify to 

be prevented by § 1.1032–3, which has 

fewer conditions to its application than 

did § 1.1502–13(f)(6)(ii). To avoid 

confusion, the IRS and Treasury 

Department propose replacing the 

current provisions in § 1.1502–

13(f)(6)(ii) (and references to that 

provision) with a reference to § 1.1032–

3. 

2. Modification of Exception to 

Definition of Deconsolidation in 

§ 1.1502–19 

Section 1.1502–19 provides rules for 

the determination and recapture of 

excess loss accounts. In general, an 

excess loss account is recaptured (taken 

into account) when there is a 

disposition of the stock to which the 

account relates. Section 1.1502–19(c) 

defines the term disposition for 

purposes of § 1.1502–19. Under that 

section, the term disposition includes 

transfers, cancellations, 

deconsolidations, and worthlessness. 

The term deconsolidation is defined in 

§ 1.1502–19(c)(1)(ii). 

In general, the termination of a 

consolidated group will give rise to the 

deconsolidation of the members of the 

group. However, § 1.1502–19(c)(3)(i)(A) 

provides that, if a group terminates 

because a member of another group has 

acquired 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, the members of the acquired 

group that become members of the 

acquiror’s group are not treated as 

deconsolidated. Thus, there is no 

recapture of excess loss accounts in the 

shares of stock of subsidiaries of the 

acquired group that, after the 

acquisition, are held by a member of the 

acquiring group. 

The exception to deconsolidation 

treatment in § 1.1502–19(c)(3)(i)(A) (and 

therefore to the recapture of excess loss 

accounts) is warranted because its 

conditions ensure that the consolidated 

return provisions will continue to apply 

to the members of the acquired group. 

Thus, the provisions of § 1.1502–19 are 

able to continue to regulate the 

determination and recapture of the 

excess loss accounts. However, for the 

continued application of the 

consolidated return provisions to the 

acquired group, it is only necessary that 

the acquiror be a member of a group 

following the acquisition. Its status prior 

to the acquisition is immaterial. The IRS 

and Treasury Department have therefore 

decided to revise the rule in § 1.1502–

19(c)(3)(i)(A) to require only that the 

acquiror be a member of a group 

following the qualified acquisition. 

Thus, under the proposed regulations, 

the exception to deconsolidation 

treatment provided in § 1.1502–

19(c)(3)(i)(A) would be available when 

the acquisition is by a stand-alone 

corporation or a member of an affiliated, 

nonconsolidated group. 

3. Clarification of ‘‘Substantially All’’

Standard in § 1.1502–19(c)(1)(iii)(A) 

Section 1.1502–19(c)(1)(iii) defines 

the term ‘‘worthless’’ for purposes of 

excess loss account recapture (resulting 

in the inclusion of the excess loss 

account in income). The definition of 

worthlessness in § 1.1502–19(c)(1)(iii) is 

adopted for determining the time when 

subsidiary stock with positive basis may 

be treated as worthless (and therefore 

deductible). See § 1.1502–80(c). 

Section 1.1502–19(c)(1)(iii)(A) 

generally provides that a share of 

subsidiary stock will be treated as 

worthless when substantially all the 

subsidiary’s assets are treated as 

disposed of, abandoned, or destroyed 

for federal tax purposes. This provision 

prevents an excess loss account from 

being included in income (and a 

worthless stock deduction from being 

taken) until the subsidiary’s activities 

have been taken into account by the 

group. As a result, the group’s income 

is clearly reflected and single entity 

treatment is promoted. 

The current regulations do not, 

however, define the term ‘‘substantially 

all’’ for purposes of § 1.1502–

19(c)(1)(iii)(A). Particular concerns have 

arisen because the term is used in many 

other areas of tax law, most notably in 

the area of corporate reorganizations. 

Because different policies are operative 

in those areas, the thresholds 

appropriate in those areas are not 

necessarily appropriate for purposes of 

§ 1.1502–19(c)(1)(iii)(A) and the 

consolidated return provisions that 

incorporate it. 

The IRS and Treasury Department 

believe that the single entity purpose of 

these consolidated return provisions is 

best effected by treating a subsidiary’s 

stock as worthless only once the 

subsidiary has recognized all items of 

income, gain, deduction, and loss 

attributable to its assets and operations. 

Accordingly, these proposed regulations 

clarify § 1.1502–19(c)(1)(iii)(A) by 

providing that stock of a subsidiary will 

be treated as worthless when the 

subsidiary has disposed of, abandoned, 

or destroyed (for Federal tax purposes) 

all its assets other than its corporate 

charter and those assets, if any, that are 

necessary to satisfy state law minimum 

capital requirements to maintain 

corporate existence. 

4. Triangular Reorganizations That Are 

Also Group Structure Changes 

Sections 1.1502–30 and 1.1502–31 

provide special rules for determining 

the basis of stock following, 

respectively, a triangular reorganization 

and group structure change. The 

provisions both generally adopt net 

asset basis rules, but, in the case of a 

triangular reorganization, taxpayers can 

elect other rules in certain transactions. 

The regulations do not specify whether 

a group structure change that is also a 

triangular reorganization is subject to 

the basis rules applicable to group 

structure changes (under § 1.1502–31) or 

to triangular reorganizations (under 

§ 1.1502–30). Because it is appropriate 

to conform the basis of the stock of the 

former common parent to its net asset 

basis in the case of any group structure 

change, the IRS and Treasury 

Department intend the rules of 

§ 1.1502–31 to control the determination 

of stock basis when a transaction is a 

group structure change, without regard 

to whether the transaction is also a 

triangular reorganization. Accordingly, 

the proposed regulations add a rule to 

clarify that § 1.1502–31 governs the 

determination of basis in all cases to 

which it applies, even those that also 

qualify as triangular reorganizations. 

5. Allocations of Investment 

Adjustments To Prevent or Minimize 

Excess Loss Accounts 

Under § 1.1502–32(c)(2)(i), positive 

investment adjustments allocated to a 

member’s shares of a class of common 

stock are allocated first to equalize and 

eliminate excess loss accounts and then 

equally to all the member’s other shares 

in that class. In the case of a negative 

adjustment, that section provides for the 

reduction of a member’s positive basis 

in shares of a class of common stock 


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before the creation or increase of an 

excess loss account in any such share. 

However, the current rule does not 

require that negative adjustments must 

be made first to equalize excess loss 

accounts before applying them equally 

to all shares. The proposed regulations 

add such a provision in order to better 

reflect the member’s investment in its 

shares of subsidiary stock. 

6. Expired Losses and Attribute 

Reduction Under § 1.1502–28. 

Section 1.1502–32(b)(3)(ii)(C)(2) 

provides that, if the amount of a 

discharge of indebtedness exceeds the 

amount of the related attribute 

reduction under § 1.1502–28, that 

excess is treated as applying to reduce 

attributes to the extent of certain 

expired losses. In general, this section 

only applies to losses that expired 

without tax benefit, that were taken into 

account as noncapital, nondeductible 

expenses when they expired, and that 

would have been reduced had they not 

expired. The effect of this rule is to 

create a positive adjustment to the 

extent of the expired losses. The 

purpose of the rule, as stated in TD 

8560, is to more fully integrate expired 

losses into the investment adjustment 

system. 

As currently written, however, the 

rule does not explicitly state whether 

this special treatment of expired losses 

is available to all members’ expired 

losses or only to the debtor-subsidiary’s 

expired losses. Allowing such treatment 

for all members’ expired losses is 

beyond the intended scope of relief and 

undermines the purpose of sections 108 

and 1017, and § 1.1502–28. 

Accordingly, § 1.1502–32(b)(3)(ii)(C)(2) 

is revised to state explicitly that such 

treatment is intended only for the 

debtor-subsidiary’s expired losses. The 

regulation is also revised to clarify that 

all available attributes, not just those of 

the debtor-subsidiary, must be reduced 

before this special rule for certain 

expired losses can apply. 

7. Applicability of Other Rules of Law, 

Anti-Duplicative Adjustments Rules 

Many of the consolidated return rules 

include provisions stating that other 

rules of law continue to apply. These 

provisions are generally unnecessary in 

light of § 1.1502–80(a), which provides 

that the provisions of the Code continue 

to apply to taxpayers filing a 

consolidated return unless specifically 

provided otherwise in the consolidated 

return regulations. However, these 

provisions often also contain statements 

that the consolidated return provisions 

modify other rules of law and that 

duplicative adjustments should not be 

made as a result of the consolidated 

return provisions. To simplify the 

regulations and remove any potential 

negative implication from the absence of 

such a provision in a particular 

provision, these proposed regulations 

incorporate all of these principles in 

§ 1.1502–80(a) and remove similar 

provisions from other sections of the 

consolidated return regulations. 

8. Retention of, and Nonsubstantive 

Revisions to, § 1.1502–80(c) 

Section 1.1502–80(c) provides that 

subsidiary stock is not treated as 

worthless until the earlier of the time 

that the subsidiary ceases to be a 

member of the group and the time that 

the stock is worthless within the 

meaning of § 1.1502–19(c)(1)(iii). This 

rule, with its companion rule 

postponing the inclusion in income of 

excess loss accounts, prevents a group 

from recognizing any amount (whether 

loss or gain) on subsidiary stock until 

the subsidiary has taken into account all 

of its operating income, gain, deduction, 

and loss. Thus, the rule promotes single 

entity treatment by enabling the group 

to continue treating its investment in 

subsidiary stock as an investment in the 

subsidiary’s assets and operations until 

the subsidiary has either taken all of its 

items into account or ceased to be a 

member of the group. 

Following the Rite Aid decision, 

practitioners have submitted comments 

suggesting that § 1.1502–80(c) should be 

removed from the consolidated return 

regulations. The suggestion was based 

on the observation that § 1.1502–80(c) 

prevented inappropriate disallowance 

under the LDR and, since LDR no longer 

applies to stock dispositions, § 1.1502–

80(c) is no longer necessary. While it is 

correct that there is no longer an LDRbased justification for the rule in 

§ 1.1502–80(c), the LDR was neither the 

only nor the principal purpose for the 

rule. The principal purpose of the rule 

was, and is, to promote single entity 

treatment. And, with its companion rule 

governing the inclusion of excess loss 

accounts, this rule continues to do that. 

In addition, the IRS and Treasury 

Department recognize that, to the extent 

a subsidiary’s attributes would survive a 

worthlessness event (for example, when 

a subsidiary survives and is owned by 

its creditors following a bankruptcy), 

§ 1.1502–80(c) benefits the group by 

postponing the time that the 

subsidiary’s stock is treated as 

worthless. Because section 382(g)(4)(D) 

could subject S’s losses to a zero section 

382 limitation if P were to treat S’s stock 

as worthless during bankruptcy, a court 

might prevent P from treating S’s stock 

as worthless in an earlier year, 

effectively denying P any worthlessness 

deduction. See, In re Prudential Lines, 

Inc., 928 F.2d 565 (2d Cir. 1991), cert. 

denied, 112 S.Ct. 82 (1991). 

Accordingly, the IRS and Treasury 

Department have rejected the suggestion 

to remove § 1.1502–80(c). The proposed 

regulations do, however, revise the 

language of the current rule solely for 

the purpose of clarifying its operation. 

No substantive change is intended. 

9. Effective Dates 

The proposed regulations described in 

this section I would be applicable as of 

the date they are published as final 

regulations in the Federal Register. 

J. Request for Comments 

As described in this preamble, many 

approaches and combinations of 

approaches were considered with 

respect to both noneconomic and 

duplicated loss and, although the IRS 

and Treasury Department believe the 

approach adopted in these proposed 

regulations best responds to and 

balances the Congressional mandates, 

comments are requested concerning 

both the approach adopted in these 

proposed regulations and other possible 

approaches. 

As noted in section D of this 

preamble, the IRS and Treasury 

Department are continuing to study, and 

invite comments on, the issue of gain 

duplication by consolidated groups. 

Comments are specifically requested 

concerning the circumstances under 

which gain duplication should be 

addressed and the mechanisms that 

could be adopted to do so. For example, 

comments could address whether a gain 

duplication rule could or should 

parallel the approach to loss duplication 

suggested in the proposed regulations, 

or whether some other approach would 

be more appropriate or administrable. 

Comments are also requested regarding 

limitations that may be necessary or 

appropriate to address concerns such as 

attribute churning and conversion. In 

addition, comments are requested 

concerning the noneconomic reduction 

of stock gain (that is, the 

appropriateness of the continued use of 

a loss disallowance model) and the 

reduction of noneconomic stock gain 

(that is, the reduction of basis through 

the absorption of built-in losses or net 

built-in losses), and the extent to which 

it would be appropriate to address gain 

duplication without addressing these 

issues. 

As noted in section H of this 

preamble, the IRS and Treasury 

Department are continuing to study the 

application of section 362(e)(2) in the 

consolidated setting. Comments are 


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specifically requested concerning the 

general application of section 362(e)(2) 

to intercompany transactions, as well as 

the administrability and 

appropriateness of the proposed rules 

suspending the application of section 

362(e)(2) to intercompany transactions 

and specially allocating items 

attributable to intercompany section 

362(e)(2) transactions. 

Although these regulations are 

generally proposed to be applicable 

when published as final regulations in 

the Federal Register, the IRS and 

Treasury Department invite comments 

regarding the extent to which it would 

be appropriate and desirable to allow 

taxpayers to elect to apply these 

provisions retroactively. 

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 

is hereby certified that these regulations 

will not have a significant economic 

impact on a substantial number of small 

entities. This certification is based on 

the fact that these regulations primarily 

will affect affiliated groups of 

corporations that have elected to file 

consolidated returns, which tend to be 

larger entities. Therefore, a Regulatory 

Flexibility Analysis under the 

Regulatory Flexibility Act (5 U.S.C. 

chapter 6) is not required. Pursuant to 

section 7805(f), this regulation has been 

submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on its 

impact on small business. 

Comments and Requests for Public 

Hearing 

Before these proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

written (a signed original and eight (8) 

copies) or electronic comments that are 

submitted timely to the IRS. The IRS 

and Treasury Department request 

comments on the clarity of the proposed 

regulations and how they can 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 authors of these 

regulations are Theresa Abell and 

Phoebe Bennett 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 1.1502–36 also issued under 26 

U.S.C. 1502 * * * 

Section 1.1502–36 also issued under 26 

U.S.C. 337(d). * * * 

§ 1.337(d)–1 [Removed] 

Par. 2. Section 1.337(d)–1 is removed. 

§ 1.337(d)–2 [Removed] 

Par. 3. Section 1.337(d)–2 is removed. 

Par. 4. Section 1.358–6 is amended 

by: 

1. Revising paragraph (e). 

2. Adding new paragraph (f)(3). 

The revision and addition reads as 

follows: 

§ 1.358–6 Stock basis in certain triangular 

reorganizations. 

* * * * * 

(e) Cross-reference regarding 

triangular reorganizations involving 

members of a consolidated group. For 

rules relating to stock basis adjustments 

made as a result of a triangular 

reorganization in which P and S, or P 

and T, as applicable, are, or become, 

members of a consolidated group, see 

§ 1.1502–30. However, if a transaction is 

a group structure change, even if it is 

also a triangular reorganization, stock 

basis adjustments are determined under 

§ 1.1502–31. 

* * * * * 

(f) * * * 

(3) Special rule for triangular 

reorganizations involving members of a 

consolidated group. Paragraph (e) of this 

section shall apply to all transfers on or 

after the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 5. Section 1.1502–13 is amended 

by: 

1. Revising paragraphs (a)(4), (f)(6)(ii), 

and (j)(5)(i)(A). 

2. Adding new paragraph (e)(4). 

3. Revising the last sentence of 

paragraph (f)(6)(iv)(A). 

4. Removing the second sentence in 

paragraph (f)(6)(v). 

5. Adding a new last sentence to 

paragraph (l)(1). 

The revisions and additions read as 

follows: 

§ 1.1502–13 Intercompany transactions. 

(a) * * * 

(4) Application of other rules of law. 

See § 1.1502–80(a) regarding the general 

applicability of other rules of law and a 

limitation on duplicative adjustments. 

* * * * * 

(e) * * * 

(4) Intercompany section 362(e)(2) 

transactions—(i) Purpose and scope. 

This paragraph (e)(4) provides 

simplifying rules for intercompany 

transactions that are subject to section 

362(e)(2) (intercompany section 

362(e)(2) transactions). The purpose of 

this paragraph (e)(4) is to suspend the 

application of section 362(e)(2) during 

the period of time that the duplication 

resulting from the intercompany section 

362(e)(2) transaction (the section 

362(e)(2) amount, as defined in 

paragraph (e)(4)(ii)(A) of this section) 

can effectively be eliminated by the 

operation of the investment adjustment 

provisions of § 1.1502–32. The amount 

and location of this duplication is 

identified and tracked while in the 

consolidated group. When this 

duplication can no longer effectively be 

eliminated by the investment 

adjustment provisions, the principles of 

section 362(e)(2) apply to the extent 

necessary to eliminate all or a portion of 

any remaining section 362(e)(2) amount 

(as defined in paragraph (e)(4)(ii)(B) of 

this section) reflected in B’s attributes or 

stock. For purposes of this paragraph 

(e)(4), any reference to B stock received 

in an intercompany section 362(e)(2) 

transaction refers to B stock or B 

securities received (or deemed received) 

without the recognition of gain or loss. 

(ii) Identification and elimination of 

section 362(e)(2) amount—(A) Section 

362(e)(2) amount. The section 362(e)(2) 

amount is the amount of duplication 

resulting from an intercompany section 

362(e)(2) transaction, and is equal to the 

amount by which B’s basis in the assets 

received in an intercompany section 

362(e)(2) transaction would have, but 

for the application of this paragraph 

(e)(4), been eliminated under section 

362(e)(2)(A) (absent an election under 

section 362(e)(2)(C)). Such amount is 

initially reflected in both the basis of the 

B stock received in the transaction and 

B’s basis in the assets received. Each 

share of B stock initially reflects the 

section 362(e)(2) amount to the extent 

the basis would have been reduced 

under section 362(e)(2)(C) if such an 


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election was made and this paragraph 

(e)(4) did not apply. B’s basis in each 

asset received initially reflects the 

section 362(e)(2) amount to the extent 

the basis in such asset would have been 

reduced under section 362(e)(2)(A) if no 

election was made under section 

362(e)(2)(C) and this paragraph (e)(4) 

did not apply. However, over time the 

section 362(e)(2) amount may be 

reflected in B’s basis in assets, deferred 

items, or other unabsorbed losses (B’s 

attributes). 

(B) Remaining section 362(e)(2) 

amount. The remaining section 

362(e)(2) amount is the portion of the 

section 362(e)(2) amount that has not 

been eliminated. 

(C) Elimination of section 362(e)(2) 

amount—(1) Elimination caused by 

reduction in B’s attributes. The section 

362(e)(2) amount is eliminated as B’s 

attributes that reflect the section 

362(e)(2) amount are taken into account 

by the group (including as a result of 

attribute reduction under paragraph 

(e)(4)(iv) of this section, or § 1.1502–

36(d) to the extent it did not reduce the 

basis in B stock that reflects the section 

362(e)(2) amount). The portions of B’s 

attributes that reflect a section 362(e)(2) 

amount are generally taken into account 

by the group proportionately. However, 

because any reduction in B’s attributes 

under paragraph (e)(4)(iv) of this section 

is applied to reduce attributes that 

reflect the section 362(e)(2) amount, the 

section 362(e)(2) amount is eliminated 

to the extent of the full amount of such 

reduction. If the section 362(e)(2) 

amount is eliminated because B’s 

attributes that reflect the section 

362(e)(2) amount are taken into account, 

each share of B stock received in the 

intercompany section 362(e)(2) 

transaction that is held by a member is 

treated as proportionately reflecting the 

remaining section 362(e)(2) amount 

(based on the section 362(e)(2) amount 

reflected before the elimination). 

(2) Elimination caused by reduction in 

basis in B stock. The section 362(e)(2) 

amount is also eliminated to the extent 

the basis in B stock that reflects the 

section 362(e)(2) amount is reduced 

under paragraph (e)(4)(v) of this section, 

is reduced under § 1.1502–36(d), or is 

otherwise is eliminated (other than 

under § 1.1502–32) without the 

recognition of gain or loss. The portion 

of the basis in a share of B stock that 

reflects a section 362(e)(2) amount is so 

reduced or eliminated before any other 

portion of the basis in such a share. If 

the section 362(e)(2) amount is 

eliminated as provided in this 

paragraph (e)(4)(ii)(C)(2), each of B’s 

attributes that reflected the section 

362(e)(2) amount is treated as 

proportionately reflecting the remaining 

section 362(e)(2) amount (based on the 

section 362(e)(2) amount reflected 

before the elimination). 

(iii) Section 362(e)(2) application 

event. A section 362(e)(2) application 

event is any transaction or event that 

results in—

(A) A transfer (within the meaning of 

§ 1.1502–36(f)(11)) of any of the B stock 

that was received in the intercompany 

section 362(e)(2) transaction; 

(B) Any satisfaction (actual or 

deemed) of a security received in an 

intercompany section 362(e)(2) 

transaction without the recognition of 

gain or loss; 

(C) Any nonmember holding an asset 

with a substituted basis that reflects all 

or a portion of the remaining section 

362(e)(2) amount or succeeding to an 

attribute that reflects all or a portion of 

the remaining section 362(e)(2) amount; 

or 

(D) Any other transaction the result of 

which prevents all or a portion of any 

remaining section 362(e)(2) amount 

reflected in stock basis or attributes 

from being effectively eliminated by the 

operation of the investment adjustment 

provisions of § 1.1502–32 when taken 

into account. 

(iv) General rule. In the case of an 

intercompany section 362(e)(2) 

transaction, no adjustment to B’s 

attributes shall be made under section 

362(e)(2) until immediately before a 

section 362(e)(2) application event (as 

defined in paragraph (e)(4)(iii) of this 

section). At that time, unless an election 

is made under paragraph (e)(4)(v) of this 

section, B reduces its attributes that 

reflect the remaining section 362(e)(2) 

amount as provided in this paragraph 

(e)(4)(iv). 

(A) Amount of reduction. If the 

application event involves B’s attributes 

that reflect all or a portion of the 

remaining section 362(e)(2) amount, the 

amount of the reduction is equal to the 

remaining section 362(e)(2) amount 

reflected in the attributes so involved. If 

the application event involves all or a 

portion of the B stock received in the 

intercompany section 362(e)(2) 

transaction, the amount of the reduction 

is equal to the remaining section 

362(e)(2) amount reflected in the B stock 

so involved. 

(B) Application of reduction. If the 

application event involves B’s attributes 

that reflect all or a portion of the 

remaining section 362(e)(2) amount, the 

reduction is applied to reduce each 

attribute so involved by the full amount 

of the remaining section 362(e)(2) 

amount reflected in each such attribute. 

If the application event involves all or 

a portion of the B stock received in the 

intercompany section 362(e)(2) 

transaction, the reduction is applied 

proportionately (based on the remaining 

section 362(e)(2) amount reflected in 

each attribute prior to reduction) to all 

of B’s attributes that reflect the 

remaining section 362(e)(2) amount. 

(C) Effect of the reduction. Any 

reduction to B’s attributes under this 

paragraph (e)(4)(iv) is not a noncapital, 

nondeductible expense described in 

§ 1.1502–32(b)(2)(iii). 

(v) Election to reduce the basis in B 

stock. In lieu of reducing B’s attributes 

as provided in paragraph (e)(4)(iv) of 

this section, S and B may elect to reduce 

the basis in the B stock received in the 

intercompany section 362(e)(2) 

transaction as provided in this 

paragraph (e)(4)(v). 

(A) Amount of reduction. The basis in 

the B stock is reduced by an amount 

equal to the amount B would otherwise 

be required to reduce its attributes 

under paragraph (e)(4)(iv) of this 

section. 

(B) Application of reduction. If the 

application event involves B’s attributes 

that reflect all or a portion of the 

remaining section 362(e)(2) amount, the 

reduction is applied proportionately 

(based on the remaining section 

362(e)(2) amount reflected in the B stock 

prior to reduction) to all of the B stock 

received in the intercompany section 

362(e)(2) transaction that is held by 

members immediately before the 

application event. If the application 

event involves all or a portion of the B 

stock received in the intercompany 

section 362(e)(2) transaction, the 

reduction is applied proportionately 

(based on the remaining section 

362(e)(2) amount reflected in the B stock 

prior to reduction) to the B stock so 

involved. Any reduction in the basis of 

the B stock under this paragraph 

(e)(4)(v) is applied immediately before 

the section 362(e)(2) application event. 

(C) Effect of the reduction. Any 

reduction to the basis of the B stock 

under this paragraph (e)(4)(v) is a 

nondeductible basis recovery item 

described in § 1.1502–32(b)(3)(iii)(B). 

(D) Election. The election is made in 

the manner described in regulations 

implementing section 362(e)(2). The 

election must be made for an 

intercompany section 362(e)(2) 

transaction on or with the group return 

for either the year in which the 

intercompany section 362(e)(2) 

transaction or the first section 362(e)(2) 

application event occurs. The election is 

irrevocable and applicable for all 

section 362(e)(2) application events 

with respect to such intercompany 

section 362(e)(2) transaction (even if the 

event occurs while S and B are members 


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of another consolidated group). If the 

election is made on or with the return 

for the year of the intercompany section 

362(e)(2) transaction, it has effect only 

if and to the extent there is a remaining 

section 362(e)(2) amount when there is 

a section 362(e)(2) application event. 

(vi) Examples. The application of this 

paragraph (e)(4) is illustrated by the 

following examples: 

Example 1. Section 362(e)(2) amount 

reflected in asset basis. (i) Facts. P owns the 

sole outstanding share of S stock. S owns 

Asset 1 with a basis of $100 and a value of 

$20. On January 1, year 1, S contributes Asset 

1 to newly formed B in exchange for 10 

shares of B stock in a transaction to which 

section 351 applies. At the end of year 1, B’s 

only item is a $10 depreciation deduction 

with respect to Asset 1, which gives rise to 

a $10 loss that is absorbed by the group. On 

January 1, year 2, S sells all 10 shares of B 

stock for $18. After applying and giving effect 

to all generally applicable rules of law, S’s 

basis in each share of B stock is $9 (the 

original $10 basis reduced by $1 loss 

attributable to the depreciation on Asset 1). 

No election is made under section 

362(e)(2)(C). 

(ii) Suspension of section 362(e)(2) in year 

1. S’s contribution of Asset 1 to B is an 

intercompany transaction to which section 

362(e)(2) applies. Under the general rules of 

section 362(e)(2)(A), B’s basis in Asset 1 

would be reduced by $80 to its value, $20. 

However, as described in this paragraph 

(e)(4), the transfer is an intercompany section 

362(e)(2) transaction and therefore, under 

paragraph (e)(4)(iv) of this section, no 

adjustment is made under section 362(e)(2) 

until there is a section 362(e)(2) application 

event. The $80 reduction that B would have 

had in its basis in Asset 1 is a section 

362(e)(2) amount described in paragraph 

(e)(4)(ii)(A) of this section. This amount is 

reflected ratably in S’s basis in the 10 shares 

of B stock, and in B’s basis in Asset 1. There 

is no section 362(e)(2) application event in 

year 1 and so there is no section 362(e)(2) 

adjustment in year 1. 

(iii) Application of section 362(e)(2) on sale 

of B stock. S’s sale of the B stock is a transfer 

within the meaning of § 1.1502–36(f)(11) and 

therefore a section 362(e)(2) application 

event under paragraph (e)(4)(iii)(A) of this 

section. Accordingly, under paragraphs 

(e)(4)(iv)(A) and (e)(4)(iv)(B) of this section, 

because the section 362(e)(2) application 

event was caused by the transfer of B stock 

received in the intercompany section 

362(e)(2) transaction, B must reduce its basis 

in Asset 1 that reflects the remaining section 

362(e)(2) amount by an amount equal to the 

remaining section 362(e)(2) amount reflected 

in the B stock involved in the application 

event. Because S sold all of the B stock 

received in the intercompany section 

362(e)(2) transaction and this stock reflects 

all of the section 362(e)(2) amount, B must 

reduce its basis in Asset 1 by the full amount 

of the remaining section 362(e)(2) amount 

immediately before the application event. 

Although there was originally an $80 section 

362(e)(2) amount, $8 of that amount ($80/ 

$100 × $10) was eliminated under paragraph 

(e)(4)(ii)(C)(1) of this section when the loss 

attributable to the depreciation deduction on 

Asset 1 was absorbed in year 1. Thus, at the 

time of the sale, the remaining section 

362(e)(2) amount is only $72 ($80 less $8), 

and B’s basis in Asset 1 is reduced by such 

amount, to $18. Under paragraph (e)(4)(iv)(C) 

of this section, the reduction in the basis of 

Asset 1 is not a noncapital, nondeductible 

expense described in § 1.1502–32(b)(2)(iii) 

and so has no effect on S’s basis in its B 

shares. See § 1.1502–36 for additional rules 

relating to loss on shares of subsidiary stock. 

Example 2. Section 362(e)(2) amount 

reflected in unabsorbed loss. (i) Facts. The 

facts are the same as in Example 1, except 

that during year 1 B sells Asset 1 to an 

unrelated nonmember for $20, and 

recognizes an $80 loss that is not absorbed 

by the group. 

(ii) Suspension of section 362(e)(2) in year 

1. As in paragraph (ii) of Example 1, S’s 

contribution of Asset 1 to B is an 

intercompany section 362(e)(2) transaction, 

the section 362(e)(2) amount is $80, and there 

is no section 362(e)(2) adjustment in year 1. 

This amount is reflected ratably in S’s basis 

in the 10 shares of B stock, and initially in 

B’s basis in Asset 1. Further, because the $80 

loss recognized on the sale of Asset 1 is not 

absorbed by the group, at the end of year 1 

the remaining section 362(e)(2) amount is 

$80, reflected ratably in S’s basis in the 10 

shares of B stock, and in B’s unabsorbed $80 

loss. 

(iii) Application of section 362(e)(2) on sale 

of B stock. As in paragraph (iii) of Example 

1, S’s sale of the 10 shares of B stock is a 

section 362(e)(2) application event that 

involves all of the B stock received in the 

intercompany section 362(e)(2) transaction. 

Accordingly, immediately before the 

application event, B must reduce the 

unabsorbed loss carryover that reflects the 

remaining section 362(e)(2) amount by an 

amount equal to the remaining section 

362(e)(2) amount reflected in the B stock 

involved in the application event, $80 (all of 

the remaining section 362(e)(2) amount). The 

reduction of the loss carryover is not a 

noncapital, nondeductible expense described 

in § 1.1502–32(b)(2)(iii) and so has no effect 

on S’s basis in its B shares. See § 1.1502–36 

for additional rules relating to loss on shares 

of subsidiary stock. 

Example 3. Section 362(e)(2) amount 

reflected in unabsorbed loss, partial 

application. (i) Facts. The facts are the same 

as in Example 2, except that on January 1, 

year 2, S only sells two shares of the B stock 

to an unrelated nonmember for $4. 

(ii) Suspension of section 362(e)(2) in year 

1. S’s contribution of Asset 1 to B is an 

intercompany section 362(e)(2) transaction, 

the section 362(e)(2) amount is $80, and there 

is no section 362(e)(2) adjustment in year 1. 

This amount is reflected ratably in S’s basis 

in the 10 shares of B stock, and initially in 

B’s basis in Asset 1. Further, because the $80 

loss recognized on the sale of Asset 1 is not 

absorbed by the group, at the end of year 1 

the remaining section 362(e)(2) amount is 

$80, reflected ratably in S’s basis in the 10 

shares of B stock, and in B’s unabsorbed $80 

loss. 

(iii) Application of section 362(e)(2) on sale 

of B stock. S’s sale of two of the shares of B 

stock is a section 362(e)(2) application event 

that involves two shares of the B stock 

received in the intercompany section 

362(e)(2) transaction. Accordingly, 

immediately before the application event, B 

must reduce the unabsorbed loss carryover 

that reflects the remaining section 362(e)(2) 

amount by an amount equal to the remaining 

section 362(e)(2) amount reflected in the B 

stock involved in the application event, $16 

($8 of the remaining section 362(e)(2) amount 

reflected in each share). The loss carryover is 

reduced from $80 to $64. This reduction is 

not a noncapital, nondeductible expense 

described in § 1.1502–32(b)(2)(iii) and so has 

no effect on S’s basis in its B shares. 

Additionally, under paragraph (e)(4)(ii)(C)(1) 

of this section, $16 of the remaining section 

362(e)(2) amount is eliminated, and, 

thereafter, the $64 remaining section 

362(e)(2) amount is ratably reflected in S’s 

basis in the remaining 8 shares of B stock and 

in B’s $64 loss carryover. Because no election 

is made under section 362(e)(2)(C) in the year 

of the intercompany section 362(e)(2) 

transaction or in the year of the stock sale, 

the first section 362(e)(2) application event, 

no such election can be made with respect 

to the remaining shares received in the 

intercompany section 362(e)(2)(C) 

transaction. See § 1.1502–36 for additional 

rules relating to loss on shares of subsidiary 

stock. 

(iv) Application of section 362(e)(2) on sale 

of B stock, section 362(e)(2)(C) election. If S 

and B elect under paragraph (e)(4)(v) of this 

section to reduce S’s basis in the B stock 

received in the intercompany section 

362(e)(2) transaction, under paragraph 

(e)(4)(v)(A) of this section S will reduce its 

basis in the B stock by $16 (an amount equal 

to the amount that B would otherwise be 

required to reduce its loss carryover, or the 

remaining section 362(e)(2) amount reflected 

in the two shares of B stock sold). Under 

paragraph (e)(4)(v)(B) of this section, this $16 

reduction is applied proportionately to the 

two shares of B stock sold immediately 

before the application event, reducing the 

basis of each share to $2. The reduction in 

the basis of the two B shares sold is a 

nondeductible basis recovery item described 

in § 1.1502–32(b)(3)(iii)(B), and will effect P’s 

basis in its share of S stock. Additionally, 

under paragraph (e)(4)(ii)(C)(2) of this 

section, $16 of the remaining section 

362(e)(2) amount is eliminated, and, 

thereafter, the $64 remaining section 

362(e)(2) amount is ratably reflected in S’s 

basis in the remaining 8 shares of B stock and 

in B’s $80 loss carryover. S recognizes no 

gain or loss on the sale of these two shares 

of B stock. Under paragraph (e)(4)(v)(D) of 

this section, S and B’s election to reduce S’s 

basis in the B stock is irrevocable and 

applicable to all future section 362(e)(2) 

application events with respect to this 

intercompany section 362(e)(2) transaction, 

such as subsequent dispositions of B stock to 

an unrelated nonmember. 

Example 4. Section 362(e)(2) amount 

reflected in unabsorbed loss, subgroup 

exception. (i) Facts. The facts are the same as 

in Example 3, except that S does not sell any 

shares of B stock, and on January 1, year 2, 

P sells the sole share of the S stock to P1, the 


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common parent of another consolidated 

group. 

(ii) Suspension of section 362(e)(2) in year 

1. S’s contribution of Asset 1 to B is an 

intercompany section 362(e)(2) transaction, 

the section 362(e)(2) amount is $80, and there 

is no section 362(e)(2) adjustment in year 1. 

This amount is reflected ratably in S’s basis 

in the 10 shares of B stock, and initially in 

B’s basis in Asset 1. Further, because the $80 

loss recognized on the sale of Asset 1 is not 

absorbed by the group, at the end of year 1 

the remaining section 362(e)(2) amount is 

$80, reflected ratably in S’s basis in the 10 

shares of B stock, and in B’s unabsorbed $80 

loss. 

(iii) No section 362(e)(2) application event 

on sale of S stock. P’s sale of the S stock is 

not an application event described in 

paragraph (e)(4)(iii) of this section. Further, 

because S and B continue to be members of 

the same consolidated group, there is no 

transfer (within the meaning of § 1.1502–

36(f)(11)) of the 10 shares of B stock. 

Accordingly, there is no application event 

and, under paragraph (e)(4)(iv) of this 

section, no section 362(e)(2) adjustment is 

required. However, adjustments will be 

required if a section 362(e)(2) application 

event occurs at a time when there is a 

remaining section 362(e)(2) amount. 

* * * * * 

(f) * * * 

(6) * * * 

(ii) Gain stock. For dispositions of P 

stock occurring before May 16, 2000, see 

§ 1.1502–13(f)(6)(ii) as contained in 26 

CFR part 1 in effect on April 1, 2000. 

For dispositions of P stock occurring on 

or after May 16, 2000, see § 1.1032–3. 

* * * * * 

(iv) * * * (A) * * * If P grants M an 

option to acquire P stock in a 

transaction meeting the requirements of 

§ 1.1032–3, M is treated as having 

purchased the option from P for fair 

market value with cash contributed to M 

by P. 

* * * * * 

(j) * * * 

(5) * * * (i) * * * 

(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 

* * * * * 

(l) * * * (1) * * * Paragraphs (a)(4), 

(e)(4), (f)(6)(ii), (f)(6)(iv)(A), and 

(j)(5)(i)(A) of this section apply to all 

transfers on or after the date these 

regulations are published as final 

regulations in the Federal Register. 

* * * * * 

Par. 6. Section 1.1502–19 is amended 

by: 

1. Revising paragraphs (a)(3), 

(c)(1)(iii)(A), and (c)(3)(i)(A). 

2. Adding a new last sentence to 

paragraph (h)(1). 

The revisions and addition reads as 

follows: 

§ 1.1502–19 Excess loss accounts. 

(a) * * * 

(3) Application of other rules of law. 

See § 1.1502–80(a) regarding the general 

applicability of other rules of law and a 

limitation on duplicative adjustments. 

In addition, for purposes of this section, 

the definitions in § 1.1502–32 apply. 

* * * * * 

(c) * * * 

(1) * * * 

(iii) * * * 

(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 in satisfaction 

of indebtedness); 

* * * * * 

(3) * * * (i) * * * 

(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 

* * * * * 

(h) * * * (1) * * * Paragraphs (a)(3), 

(c)(1)(iii)(A), and (c)(3)(i)(A) of this 

section apply to all transfers on or after 

the date these regulations are published 

as final regulations in the Federal 

Register. 

* * * * * 

§ 1.1502–20 [Removed] 

Par. 7. Section 1.1502–20 is removed. 

Par. 8. Section 1.1502–21 is amended 

by: 

1. Removing the last sentence of 

paragraph (b)(1). 

2. Removing paragraph (b)(3)(v). 

3. Revising paragraphs (b)(2)(ii)(A), 

(b)(2)(iv)(B)(2), (h)(6), and (h)(8). 

4. Adding new paragraph (h)(1)(iii). 

The revisions and addition reads as 

follows: 

§ 1.1502–21 Net operating losses. 

* * * * * 

(b) * * * 

(2) * * * 

(ii) Special rules—(A) Year of 

departure from group. If a corporation 

ceases to be a member during a 

consolidated return year, net operating 

loss carryovers attributable to the 

corporation are first carried to the 

consolidated return year, then are 

subject to reduction under section 108 

and § 1.1502–28 (regarding discharge of 

indebtedness income that is excluded 

from gross income under section 

108(a)), and then are subject to 

reduction under § 1.1502–36 (regarding 

transfers of loss shares of subsidiary 

stock). Only the amount that is neither 

absorbed nor reduced under section 108 

and § 1.1502–28 or under § 1.1502–36 

may be carried to the corporation’s first 

separate return year. For rules 

concerning a member departing a 

subgroup, see paragraph (c)(2)(vii) of 

this section. 

* * * * * 

(iv) * * * 

(B) * * * 

(2) Special rules—(i) Carryback to a 

separate return year. If a portion of the 

CNOL attributable to a member for a 

taxable year is carried back to a separate 

return year, the percentage of the CNOL 

attributable to each member, as of 

immediately after such portion of the 

CNOL is carried back, is recomputed 

pursuant to paragraph (b)(2)(iv)(B)(2)(v) 

of this section. 

(ii) Excluded discharge of 

indebtedness income. If during a taxable 

year a member realizes discharge of 

indebtedness income that is excluded 

from gross income under section 108(a) 

and such amount reduces any portion of 

the CNOL attributable to any member 

pursuant to section 108 and § 1.1502–

28, the percentage of the CNOL 

attributable to each member as of 

immediately after the reduction of 

attributes pursuant to sections 108 and 

1017, and § 1.1502–28, shall be 

recomputed pursuant to paragraph 

(b)(2)(iv)(B)(2)(v) of this section. 

(iii) Departing member. If during a 

taxable year a member that had a 

separate net operating loss for the year 

of the CNOL ceases to be a member, the 

percentage of the CNOL attributable to 

each member as of the first day of the 

following consolidated return year shall 

be recomputed pursuant to paragraph 

(b)(2)(iv)(B)(2)(v) of this section. 

(iv) Reduction of attributes for stock 

loss. If during a taxable year a member 

does not cease to be a member of the 

group and any portion of the CNOL 

attributable to any member is reduced 

pursuant to § 1.1502–36, the percentage 

of the CNOL attributable to each 

member immediately after the reduction 

of attributes pursuant to § 1.1502–36 

shall be recomputed pursuant to 

paragraph (b)(2)(iv)(B)(2)(v) of this 

section. 


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(v) Recomputed percentage. The 

recomputed percentage of the CNOL 

attributable to each member shall equal 

the unabsorbed CNOL attributable to the 

member at the time of the 

recomputation divided by the sum of 

the unabsorbed CNOL attributable to all 

of the members at the time of the 

recomputation. For purposes of the 

preceding sentence, a CNOL that is 

reduced pursuant to section 108 and 

§ 1.1502–28, or under § 1.1502–36, or 

that is otherwise permanently 

disallowed or eliminated, shall be 

treated as absorbed. 

(vi) 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. * * * 

* * * * * 

(h) * * * (1) * * * 

(iii) Paragraphs (b)(2)(ii)(A) and 

(b)(2)(iv)(B)(2) of this section apply to 

taxable years the original return for 

which the due date (without regard to 

extensions) is on or after the date these 

regulations are published as final 

regulations in the Federal Register. 

* * * * * 

(6) Certain prior periods. Paragraphs 

(b)(1), (b)(2)(iv)(A), (b)(2)(iv)(B)(1), and 

(c)(2)(vii) of this section shall apply to 

taxable years for which the due date of 

the original return (without regard to 

extensions) is after March 21, 2005. 

Sections 1.1502–21T(b)(1), (b)(2)(iv), 

and (c)(2)(vii), as contained in 26 CFR 

part 1 revised as of April 1, 2004, shall 

apply to taxable years for which the due 

date of the original return (without 

regard to extensions) is on or before 

March 21, 2005, and after August 29, 

2003. For taxable years for which the 

due date of the original return (without 

regard to extensions) is on or before 

August 29, 2003, see paragraphs (b)(1), 

(b)(2)(ii)(A), (b)(2)(iv), and (c)(2)(vii) of 

this section and § 1.1502–21T(b)(1) as 

contained in 26 CFR part 1 revised as of 

April 1, 2003. 

* * * * * 

(8) Losses treated as expired under 

§ 1.1502–35(f)(1). For rules regarding 

losses treated as expired under 

§ 1.1502–35(f) on and after March 10, 

2006, see § 1.1502–21(b)(3)(v) as 

contained in 26 CFR part 1 in effect on 

April 1, 2006. For rules regarding losses 

treated as expired before March 10, 

2006, see § 1.1502–21T(h)(8) as 

contained in 26 CFR part 1 in effect on 

April 1, 2005. 

Par. 9. Section 1.1502–30 is amended 

by: 

1. Revising paragraph (b)(4). 

2. Adding a new second sentence to 

paragraph (c). 

The revision and addition reads as 

follows: 

§ 1.1502–30 Stock basis after certain 

triangular reorganizations. 

* * * * * 

(b) * * * 

(4) Application of other rules of law. 

If a transaction otherwise subject to this 

section is also a group structure change 

subject to § 1.1502–31, the provisions of 

§ 1.1502–31 and not this section apply 

to determine stock basis. See § 1.1502–

80(a) regarding the general applicability 

of other rules of law and a limitation on 

duplicative adjustments. See § 1.1502–

80(d) for the non-application of section 

357(c) to P. 

* * * * * 

(c) * * * However, paragraph (b)(4) of 

this section applies to reorganizations 

occurring on or after the date these 

regulations are published as final 

regulations in the Federal Register. 

* * * * * 

Par. 10. Section 1.1502–31 is 

amended by: 

1. Revising paragraph (a)(2). 

2. Adding a new last sentence to 

paragraph (h)(1). 

The revision and addition reads as 

follows: 

§ 1.1502–31 Stock basis after a group 

structure change. 

(a) * * * 

(2) Application of other rules of law. 

If a transaction subject to this section is 

also a triangular reorganization 

otherwise subject to § 1.1502–30, the 

provisions of this section and not those 

of § 1.1502–30 apply to determine stock 

basis. See § 1.1502–80(a) regarding the 

general applicability of other rules of 

law and a limitation on duplicative 

adjustments. 

* * * * * 

(h) * * * (1) * * * In addition, 

paragraph (a)(2) of this section applies 

to group structure changes that occurred 

on or after the date these regulations are 

published as final regulations in the 

Federal Register. 

* * * * * 

Par. 11. Section 1.1502–32 is 

amended by: 

1. Revising paragraphs (a)(2), 

(b)(3)(ii)(C)(2), (b)(3)(iii)(C), (b)(3)(iii)(D), 

(c)(1), (c)(2)(i), the first sentence in 

paragraph (c)(2)(ii)(A) introductory text, 

the first sentence in paragraph (c)(3), 

and the first sentence in paragraph 

(c)(4)(i) introductory text. 

2. Adding new paragraph (h)(9). 

The revisions and addition read as 

follows: 

§ 1.1502–32 Investment adjustments. 

(a) * * * 

(2) Application of other rules of law. 

See § 1.1502–80(a) regarding the general 

applicability of other rules of law and a 

limitation on duplicative adjustments. 

* * * * * 

(b) * * * 

(3) * * * 

(ii) * * * 

(C) * * * 

(2) Expired loss carryovers. If the 

amount of the discharge exceeds the 

amount of the attribute reduction under 

sections 108 and 1017, and § 1.1502–28, 

the excess nevertheless is treated as 

applied to reduce tax attributes to the 

extent a loss carryover attributable to S 

expired without tax benefit, the 

expiration was taken into account as a 

noncapital, nondeductible expense 

under paragraph (b)(3)(iii) of this 

section, and the loss carryover would 

have been reduced had it not expired. 

* * * * * 

(iii) * * * 

(C) Loss suspended under § 1.1502–

35(c). For losses suspended by § 1.1502–

35(c) prior to the date these regulations 

are published as final regulations in the 

Federal Register, see 1.1502–

32(b)(3)(iii)(C) as contained in 26 CFR 

part 1 revised as of April 1, 2006. 

(D) Reimported losses disallowed 

under § 1.1502–35. Any loss or 

deduction the use of which is 

disallowed pursuant to § 1.1502–35(b) 

(other than duplicating items that are 

carried back to a consolidated return 

year of the group), and with respect to 

which no waiver described in paragraph 

(b)(4) of this section is filed, is treated 

as a noncapital, nondeductible expense 

incurred during the taxable year that 

such loss would otherwise be absorbed. 

For losses or deductions disallowed 

under § 1.1502–35(g)(3)(iii) prior to the 

date these regulations are published as 

final regulations in the Federal Register, 

see 1.1502–32(b)(3)(iii)(D) as contained 

in 26 CFR part 1 revised as of April 1, 

2006. 

* * * * * 

(c) Allocation of adjustments among 

shares of stock—(1) In general—(i) 

Distributions. The portion of the 

adjustment under paragraph (b) of this 

section that is described in paragraph 

(b)(2)(iv) of this section (negative 

adjustments for distributions) is 

allocated to the shares of S’s stock to 

which the distribution relates. 


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(ii) Special allocations in the case of 

certain loss transfers and reallocations 

of investment adjustments subject to 

prior use limitation—(A) Losses 

attributable to transfers subject to 

section 362(e)(2)–(1) In general. If a 

nonmember holds shares of S stock, any 

amounts that directly or indirectly 

reflect a section 362(e)(2) amount (as 

defined in § 1.1502–13(e)(4)(ii)(A)) are 

allocated to members’ shares of S stock 

under the general principles of this 

paragraph (c), except that such 

allocations are made as though the 

shares of S stock held by nonmembers 

were not outstanding. 

(2) Example. The application of this 

paragraph (c) is illustrated by the 

following example: 

Example. (i) Facts. P owns four of the five 

outstanding shares of the stock of M. X, a 

nonmember, owns the remaining outstanding 

share of M stock. On January 1, year 1, M 

contributes Asset 1 to S, a newly formed 

subsidiary, in exchange for five shares of S 

stock in a transaction to which section 351 

applies. At the time of the transfer, M’s basis 

in Asset 1 is $100 and its value is $20. At 

the end of year 1, S’s only item is a $10 

depreciation deduction with respect to Asset 

1, which gives rise to a $10 loss that is 

absorbed by the group. At the beginning of 

year 2, M sells one of its S shares to X for 

$3.60, and M and S elect to reduce M’s basis 

in the S stock under § 1.1502–13(e)(4)(v) by 

the amount of the remaining section 362(e)(2) 

amount ($72) (computed in paragraph (iii)(C) 

of this Example) reflected in the share. See, 

§ 1.1502–13(e)(4). Accordingly, M’s basis in 

the S share is reduced by $14.40 (the portion 

of the $72 remaining section 362(e)(2) 

amount reflected in the share (computed in 

paragraph (iii)(C) of this Example)), to $3.60. 

M recognizes no gain or loss on the sale of 

the S share. At the end of year 2, S’s only 

item is an additional $10 depreciation 

deduction with respect to Asset 1, which 

gives rise to an additional $10 loss that is 

absorbed by the group. At the end of year 2, 

M’s only item is a $14.40 nondeductible basis 

recovery item resulting from the election to 

reduce its basis in the S share. See § 1.1502–

13(e)(4)(v)(C). 

(ii) Application of section 362(e)(2) and 

§ 1.1502–13(e)(4) to the transfer of Asset 1. 

M’s contribution of Asset 1 to S is a 

transaction described in section 362(e)(2). 

Under the general rules of section 

362(e)(2)(A), S’s basis in Asset 1 would be 

limited to its value ($20) and would thus be 

reduced by $80, from $100 to $20. However, 

the transfer is an intercompany section 

362(e)(2) transaction and therefore, under 

§ 1.1502–13(e)(4)(iv), no adjustment is made 

to S’s basis in Asset 1 under section 362(e)(2) 

until there is a section 362(e)(2) application 

event (within the meaning of § 1.1502–

13(e)(4)(iii)). There is no section 362(e)(2) 

application event in year 1 and so there is no 

section 362(e)(2) adjustment in year 1. The 

$80 reduction that S would have had in its 

basis in Asset 1 is a section 362(e)(2) amount 

described in § 1.1502–13(e)(4)(ii)(A). This 

$80 section 362(e)(2) amount is initially 

reflected ratably ($16 per share) in M’s basis 

in each of the five shares of S stock received 

in the transaction, and in S’s basis in Asset 

1. Further, under § 1.1502–13(e)(4)(ii)(C)(1), 

the section 362(e)(2) amount reflected in an 

attribute is generally eliminated 

proportionately as the attribute is taken into 

account. Accordingly, $8 ($80/$100 × $10) of 

the year 1 Asset 1 depreciation deduction is 

attributable to the section 362(e)(2) amount. 

(iii) Treatment of year 1 item. (A) 

Allocation of item among shares of S stock. 

Although no adjustment is made under 

section 362(e)(2) during year 1, if any shares 

of S stock are held by nonmembers, any 

items taken into account that are attributable 

to the section 362(e)(2) amount must be 

specially allocated under the rules of this 

paragraph (c)(1)(ii). Because M owns all the 

shares of S stock, the special allocation rules 

of this paragraph (c)(1)(ii) have no 

application to the allocation of S’s 

depreciation deduction to M’s shares. 

Accordingly, the entire $10 of depreciation 

on Asset 1 is included in the remaining 

adjustment to the S shares under the general 

rules in paragraphs (c)(2) through (c)(4) of 

this section. As a result, $2 is allocated to, 

and decreases the basis in, each share of S 

stock held by M from $20 to $18. 

(B) Allocation of tiered-up item among 

shares of M stock. Under paragraph (a)(3)(iii) 

of this section, adjustments to M’s basis in S 

stock tier up and are taken into account in 

determining adjustments to higher-tier stock. 

However, because X, a nonmember, holds a 

share of M stock, any portion of the tieringup adjustment that is attributable to a section 

362(e)(2) amount is specially allocated under 

this paragraph (c)(1)(ii). In this case, $8 of the 

adjustment to M’s basis in S stock (80⁄100 × 

$10) is attributable to a section 362(e)(2) 

amount and thus $8 of the tiered-up 

adjustment is indirectly attributable to a 

section 362(e)(2) amount. As a result, $8 of 

the tiered-up adjustment must be allocated as 

though X’s share of M stock was not 

outstanding. Accordingly, $2 (1⁄4) of the $8 of 

the tiered-up adjustment is allocated to each 

of P’s four shares of M stock and no portion 

of that amount is allocated to X’s share of M 

stock. However, the remaining $2 of the 

tiered-up adjustment not attributable to a 

section 362(e)(2) amount is included in the 

remaining adjustment allocated to all 

outstanding shares under the general rules in 

paragraphs (c)(2) through (c)(4) of this 

section. Thus, $.40 (1⁄5) of the $2 of the 

tiered-up adjustment is allocated to each 

outstanding share. (Although $.40 is 

allocated to X’s share of M stock, that 

allocation does not affect X’s basis in the 

share because X is not a member of the 

group. See paragraph (c)(1)(iv) of this 

section.) The allocation of the tiered up year 

1 item is thus: 

Item 

Allocation 

P’s shares of M stock 

(4⁄5) 

X’s share of M stock 

(1⁄5) 

Tiered-up section 362(e)(2) amount ($8 of the $10 depreciation on Asset 1) ............. $8.00 ($2.00 per share) ..... N/A. 

Tiered-up non-section 362(e)(2) amount ($2 of the $10 depreciation on Asset 1) ...... $1.60 ($.40 per share) ....... $.40 ($.40 per share). 

Total allocation ....................................................................................................... $9.60 ($2.40 per share) ..... $.40 ($.40 per share). 

(C) Remaining section 362(e)(2) amount. 

After the year 1 items have been taken into 

account, the remaining section 362(e)(2) 

amount with respect to the S shares is $72 

($80 less $8 eliminated due to Asset 1 

depreciation being taken into account). 

Under § 1.1502–13(e)(4)(ii)(C)(1), this $72 

remaining section 362(e)(2) amount is 

reflected proportionately in the five S shares 

held by M, or $14.40 per share. 

(iv) Treatment of year 2 items. (A) 

Elimination of a portion of the section 

362(e)(2) amount. Under § 1.1502–

13(e)(4)(ii)(C)(2), S’s remaining section 

362(e)(2) amount is eliminated to the extent 

of the reduction in M’s basis in the S stock 

under § 1.1502–13(e)(4)(v). Accordingly, S’s 

remaining section 362(e)(2) amount is 

reduced by $14.40, to $57.60. This remaining 

section 362(e)(2) amount is reflected 

proportionately in the four remaining S 

shares held by M, or $14.40 per share. 

(B) Allocation of item among shares of S 

stock. Because X owns a share of S stock in 

year 2, the special allocation rule in 

paragraph (c)(1)(ii) of this section applies to 

the allocation of the portion of the year 2 

depreciation deduction attributable to a 

section 362(e)(2) amount. Under that rule, 

$6.40 (57.60/90 × $10) of the item attributable 

to a section 362(e)(2) amount must be 

allocated as though only the four shares of S 

stock held by M were outstanding. 

Accordingly, $1.60 (1⁄4) of the $6.40 of the 

$10 depreciation deduction is allocated to 

each of M’s four shares of S stock and no 

portion of that amount is allocated to X’s 

share of S stock. However, the remaining 

$3.60 of the $10 depreciation deduction not 

attributable to a section 362(e)(2) amount is 

included in the remaining adjustment 

allocated to all outstanding shares under the 

general rules in paragraphs (c)(2) through 

(c)(4) of this section. Thus, $.72 (1⁄5) of the 

$3.60 of the $10 depreciation deduction is 

allocated to each outstanding S share. 

(Although $.72 is allocated to X’s share of S 

stock, that allocation does not affect X’s basis 


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in the share because X is not a member of the 

group. See paragraph (c)(1)(iv) of this 

section.) The allocation of S’s year 2 item is 

thus: 

Item 

Allocation 

M’s shares of S stock 

(4⁄5) 

X’s share of S stock 

(1⁄5) 

Section 362(e)(2) amount ($6.40 of the $10 depreciation on Asset 1) ........................ $6.40 ($1.60 per share) ..... N/A. 

Non-section 362(e)(2) amount ($3.60 of the $10 depreciation on Asset 1) ................. $2.88 ($.72 per share) ....... $.72 ($.72 per share). 

Total allocation: ...................................................................................................... $9.28 ($2.32 per share) ..... $.72 ($.72 per share). 

(C) Adjustments to the basis of shares of M 

stock. The adjustment to the basis of M stock 

includes two items: M’s $14.40 

nondeductible basis recovery item resulting 

from the reduction in M’s basis in the S stock 

under § 1.1502–13(e)(4)(v); and $9.28 tieredup adjustment from the adjustment made to 

its basis in the S stock. The full amount of 

the $14.40 nondeductible basis recovery 

item, and $6.40 of the $9.28 tiered-up 

adjustment is attributable to the section 

362(e)(2) amount. Therefore $20.80 ($14.40 

plus $6.40) must be allocated entirely to P’s 

shares of M stock. Accordingly, $5.20 (1⁄4) of 

the $20.80 is allocated to each of P’s four 

shares of M stock. The remaining $2.88 of the 

tiered-up adjustment not attributable to a 

section 362(e)(2) amount is included in the 

remaining adjustment allocated to all 

outstanding shares under the general rules in 

paragraphs (c)(2) through (c)(4) of this 

section. Thus, approximately $.58 (1⁄5) of the 

$2.88 of the tiered-up adjustment is allocated 

to each outstanding share. (Although 

approximately $.58 is allocated to X’s share 

of M stock, that allocation does not affect X’s 

basis in the share because X is not a member 

of the group. See paragraph (c)(1)(iv) of this 

section.) The allocation of M’s year 2 items 

is thus: 

Item 

Allocation 

P’s shares of M stock 

(4⁄5) 

X’s share of M stock 

(1⁄5) 

.

Nondeductible basis recovery ($14.40 reduction in S stock basis) .............................. $14.40 ($3.60 per share) ... N/A. 

Tiered-up section 362(e)(2) amount ($6.40 of the $9.28 tiered-up adjustment) .......... $6.40 ($1.60 per share) ..... N/A. 

Tiered-up non-section 362(e)(2) amount ($2.88 of the $9.28 tiered-up adjustment) ... $2.30 (approx. $.58 per 

share).

$.58 (approx. $.58 per 

share). 

Total allocation: ...................................................................................................... $23.10 (approx. $5.78 per 

share).

$.58 (approx. $.58 per 

share). 

(D) No duplicative adjustments to the basis 

of shares of M stock. A portion of the $2.88 

of the tiered-up adjustment not attributable to 

a section 362(e)(2) amount duplicates a 

portion of the $14.40 nondeductible basis 

recovery item resulting from the reduction in 

M’s basis in the S stock under § 1.1502–

13(e)(4)(v). Consequently, under § 1.1502–

80(a), such portion of the tiered-up 

adjustment is not applied to reduce P’s basis 

in its shares of M stock. The election to 

reduce M’s basis in the S stock eliminated 

$14.40 of the remaining section 362(e)(2) 

amount. Accordingly, at the S level, $1.60 

($14.40/$90 × $10) of the Asset 1 year 2 

depreciation deduction is associated with 

this amount. This portion was allocated to all 

outstanding shares of S stock under the 

general rules in paragraphs (c)(2) through 

(c)(4) of this section ($.32 per share ($1.60/ 

5)). At the M level, $1.28 (4 × $.32) of the 

tiered-up non-section 362(e)(2) amount 

reflects depreciation on this $14.40 of Asset 

1 basis. So, at the M level, approximately 

$.26 ($1.28/5) of this tiered-up amount is 

allocated to each outstanding share. This 

approximately $.26 per share amount would 

duplicate a portion of the $14.40 

nondeductible basis recovery item if it is 

applied to reduce P’s basis in the M shares. 

Accordingly, although approximately $5.78 

of the items are allocated to each M share 

held by P, P’s basis in each share of M stock 

is only reduced by approximately $5.52 

($5.78 less $.26). 

(B) Losses reattributed pursuant to an 

election under § 1.1502–36(d)(6). If a 

member transfers (within the meaning 

of § 1.1502–36(f)(11)) loss shares of S 

stock and the common parent elects 

under § 1.1502–36(d)(6) to reattribute S 

attributes, the resulting noncapital, 

nondeductible expense is allocated to 

all loss shares of S stock transferred by 

members in the transaction in 

proportion to the loss in the shares, and 

such amount tiers up to any higher tiers 

under the general rules of this section. 

If lower-tier subsidiary attributes that 

would otherwise be reduced as a result 

of tier-down attribute reduction under 

§ 1.1502–36(d)(5)(ii)(D) are reattributed, 

the resulting noncapital, nondeductible 

expense is allocated to the shares of the 

lower-tier subsidiary (and any tier up of 

such amount is allocated to the shares 

of higher tier subsidiaries) that will 

cause the full amount of this expense to 

be applied to reduce the basis of the loss 

shares of S stock transferred by 

members in the transaction. However, 

this noncapital, nondeductible expense 

(and any tier up of such amount) is not 

allocated to shares (other than S shares) 

transferred in a transfer in which gain 

or loss was recognized. Further, this 

noncapital, nondeductible expense (and 

any tier up of such amount) is allocated 

among lower-tier shares with positive 

basis in a manner that reduces the 

disparity in the basis of the shares to the 

greatest extent possible. The tier up of 

this amount is allocated to the loss 

shares of S stock transferred by 

members in the transaction in 

proportion to the loss in the shares, and 

such amount tiers up to any higher tiers 

under the general rules of this section. 

For example, suppose P owns M1, P and 

M1 own M2, M2 owns S, M1 and S own 

S1, and M1 and S1 own S2. If S sells 

a portion of the S1 shares at a gain and 

M2 sells all of the S stock at a net loss 

(after adjusting the basis for the gain 

recognized by S on the sale of the S1 

shares), and P elects under § 1.1502–

36(d)(6) to reattribute attributes of S2, 

the resulting noncapital, nondeductible 

expense is allocated entirely to the S2 

shares held by S1, the tier up of this 

amount is allocated entirely to the S1 

shares held by S (excluding the S1 

shares sold), and the tier up of this 

amount is allocated to the loss shares of 

S stock sold by M2. This amount then 

tiers up from M2 to M1 and P, and from 

M1 to P under the general rules of this 

section. 


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(C) Reallocations of investment 

adjustments subject to prior use 

limitation. If the reallocation of an 

investment adjustment under § 1.1502–

36(b)(2) is subject to the limitation in 

§ 1.1502–36(b)(2)(iii)(B)(2) due to prior 

use, no amount of such reallocation 

(including as a tiered-up amount) shall 

be allocated to any share whose prior 

use resulted in the application of the 

limitation. 

(iii) Remaining adjustment. The 

remaining adjustment is that portion of 

the adjustment described in paragraphs 

(b)(2)(i) through (b)(2)(iii) of this section 

(adjustments for taxable income or loss, 

tax-exempt income, and noncapital, 

nondeductible expenses) that is not 

specially allocated under paragraph 

(c)(1)(ii) of this section. The remaining 

adjustment is allocated among the 

shares of S stock as provided in 

paragraphs (c)(2) through (c)(4) of this 

section. If the remaining adjustment is 

positive, it is allocated first to any 

preferred stock to the extent provided in 

paragraph (c)(3) of this section, and then 

to the common stock as provided in 

paragraph (c)(2) of this section. If the 

remaining adjustment is negative, it is 

allocated only to common stock as 

provided in paragraph (c)(2) of this 

section. 

(iv) Nonmember shares. No 

adjustment under this section that is 

allocated to a share for the period it is 

owned by a nonmember affects the basis 

of the share. 

(v) Cross-references. See paragraph 

(c)(4) of this section for the reallocation 

of adjustments, and paragraph (d) of this 

section for definitions. See § 1.1502–

19(d) for special allocations of basis 

determined or adjusted under the Code 

with respect to excess loss accounts. 

(2) Common stock—(i) Allocation 

within a class. The remaining 

adjustment described in paragraph 

(c)(1)(iii) of this section that is allocable 

to a class of common stock generally is 

allocated equally to each share within 

the class. However, if a member has an 

excess loss account in shares of a class 

of common stock at the time of a 

positive remaining adjustment, the 

portion of the adjustment allocable to 

the member with respect to the class is 

allocated first to equalize and eliminate 

that member’s excess loss accounts and 

then to increase equally its basis in the 

shares of that class. Similarly, any 

negative remaining adjustment is 

allocated first to reduce the member’s 

positive basis in shares of the class 

before creating or increasing its excess 

loss account. After positive basis is 

eliminated, any remaining portion of the 

negative adjustment is allocated first to 

equalize, to the greatest extent possible, 

and then to increase equally, the 

member’s excess loss accounts in the 

shares of that class. Distributions and 

any adjustments or determinations 

under the Internal Revenue Code (for 

example, under section 358, including 

any modifications under § 1.1502–19(d)) 

are taken into account before the 

allocation is made under this paragraph 

(c)(2)(i). 

(ii) Allocation among classes—(A) 

General rule. If S has more than one 

class of common stock, the extent to 

which the remaining adjustment 

described in paragraph (c)(1)(iii) of this 

section is allocated to each class is 

determined, based on consistently 

applied assumptions, by taking into 

account the terms of each class and all 

other facts and circumstances relating to 

the overall economic arrangement. 

* * * 

* * * * * 

(3) Preferred stock. If the remaining 

adjustment described in paragraph 

(c)(1)(iii) of this section is positive, it is 

allocated to preferred stock to the extent 

required (when aggregated with prior 

allocations to the preferred stock during 

the period that S is a member of the 

consolidated group) to reflect 

distributions described in section 301 

(and all other distributions treated as 

dividends) to which the preferred stock 

becomes entitled, and arrearages arising, 

during the period that S is a member of 

the consolidated group. * * * 

* * * * * 

(4) Cumulative redetermination—(i) 

General rule. A member’s basis in each 

share of S’s preferred and common stock 

must be redetermined whenever 

necessary to determine the tax liability 

of any person. See paragraph (b)(1) of 

this section. The redetermination is 

made by reallocating S’s adjustments 

described in paragraphs (c)(1)(ii) and 

(c)(1)(iii) of this section (adjustments for 

specially allocated losses and remaining 

adjustments, respectively) for each 

consolidated return year (or other 

applicable period) of the group by 

taking into account all of the facts and 

circumstances affecting allocations 

under this paragraph (c) as of the 

redetermination date with respect to all 

of S’s shares. * * * 

* * * * * 

(h) * * * 

(9) Allocations of investment 

adjustments, including adjustments 

attributable to certain loss transfers; 

certain conforming amendments. 

Paragraphs (a)(2), (b)(3)(ii)(C)(2), 

(b)(3)(iii)(C), (b)(3)(iii)(D), (c)(1), (c)(2)(i), 

(c)(2)(ii)(A), (c)(3), and (c)(4)(i) of this 

section are applicable on or after the 

date these regulations are published as 

final regulations in the Federal Register. 

* * * * * 

Par. 12. Section 1.1502–33 is 

amended by: 

1. Revising paragraph (a)(2). 

2. Adding a new last sentence to 

paragraph (j)(1). 

The revision and addition reads as 

follows: 

§ 1.1502–33 Earnings and profits. 

(a) * * * 

(2) Application of other rules of law. 

See § 1.1502–80(a) regarding the general 

applicability of other rules of law and a 

limitation on duplicative adjustments. 

* * * * * 

(j) * * * (1) * * * However, 

paragraph (a)(2) of this section applies 

with respect to determinations of the 

earnings and profits of a member in 

consolidated return years beginning on 

or after the date these regulations are 

published as final regulations in the 

Federal Register. 

* * * * * 

Par. 13. Section 1.1502–35 is 

amended by: 

1. Revising paragraphs (a), (b), and 

(h). 

2. Removing and reserving paragraphs 

(f) and (g). 

3. Adding new paragraph (l). 

The revisions and addition read as 

follows: 

§ 1.1502–35 Transfers of subsidiary stock 

and deconsolidations of subsidiaries. 

(a) Losses on subsidiary stock 

transferred or deconsolidated prior to 

the date that these regulations are 

published as final regulations in the 

Federal Register. If a member disposed 

of a loss share of stock of a subsidiary 

(S), or if S ceased to be a member 

(deconsolidated) when any member 

held loss shares of S stock, and if the 

disposition or deconsolidation occurred 

prior to the date that these regulations 

are published as final regulations in the 

Federal Register, see § 1.1502–35, as 

contained in 26 CFR part 1, revised as 

of April 1, 2006. For transfers and 

deconsolidations on or after the date 

that these regulations are published as 

final regulations in the Federal Register, 

see § 1.1502–36. 

(b) Anti-loss reimportation rule 

applicable on or after the date that these 

regulations are published as final 

regulations in the Federal Register—(1) 

Conditions for application. This 

paragraph (b) applies when—

(i) A member of a group (the selling 

group) recognized and was allowed a 

loss with respect to a share of stock of 

S, a subsidiary or former subsidiary in 

the selling group; 


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(ii) That stock loss was duplicated (in 

whole or in part) in S’s attributes 

(duplicating items) at the earlier of the 

time that the loss was recognized or that 

S ceased to be a member; and 

(iii) Within ten years of the date that 

S ceased to be a member, there is a 

reimportation event. For this purpose, a 

reimportation event is any event after 

which a duplicating item becomes 

directly or indirectly reflected in the 

attributes of any member of the selling 

group, including S, or, if not reflected in 

the attributes, would be properly taken 

into account by any member of the 

selling group (for example, as the result 

of a carryback) (reimported items). 

(2) Effect of application. Immediately 

before the time that a reimported item 

(or any portion of a reimported item) 

would be properly taken into account 

(but for the application of this paragraph 

(b)), such item (or such portion of the 

item) is reduced to zero and no 

deduction or loss is allowed, directly or 

indirectly, with respect to that item. 

(3) Operating rules. For purposes of 

this paragraph (b)—

(i) The terms ‘‘member’’, 

‘‘subsidiary’’, and ‘‘group’’ include their 

predecessors and successors to the 

extent necessary to effectuate the 

purposes of this section; 

(ii) The determination of whether a 

loss is duplicative is made under the 

principles of § 1.1502–35, as contained 

in 26 CFR part 1, revised as of April 1, 

2006; and 

(iii) The reduction of a reimported 

item (other than duplicating items that 

are carried back to a consolidated return 

year of the group) is a noncapital, 

nondeductible expense within the 

meaning of § 1.1502–32(b)(2)(iii). 

(4) Period of applicability. The 

provisions of this paragraph (b) apply to 

a reimported item if its related stock 

loss is recognized on or after the date 

that these regulations are published as 

final regulations in the Federal Register. 

The provisions of this paragraph (b) 

(other than paragraph (b)(1)(i)) also 

apply to a reimportation event if its 

related stock loss is recognized on or 

after March 7, 2002, and is recognized 

in either a disposition (described in 

paragraph (g)(3)(i)(A) of this section, as 

contained in 26 CFR part 1, revised as 

of January 1, 2007) or a disposition 

otherwise subject to this section. For 

prior law, see paragraph (g)(3) of this 

section, as contained in 26 CFR part 1, 

revised as of January 1, 2007. 

* * * * * 

(h) Application of other rules of law. 

See § 1.1502–80(a) regarding the general 

applicability of other rules of law and a 

limitation on duplicative adjustments. 

* * * * * 

(l) Effective date. Paragraphs (a), (b), 

and (h) of this section apply with 

respect to stock transfers, 

deconsolidations of subsidiaries, 

determinations of worthlessness, and 

stock dispositions on or after the date 

these regulations are published as final 

regulations in the Federal Register. For 

rules applicable prior to the date these 

regulations are published as final 

regulations in the Federal Register, see 

§ 1.1502–35 as contained in 26 CFR part 

1 in effect on April 1, 2007. 

§ 1.1502–35T [Removed] 

Par. 14. Section 1.1502–35T is 

removed. 

Par. 15. Section 1.1502–36 is added to 

read as follows: 

§ 1.1502–36 Loss on subsidiary stock. 

(a) In general—(1) Scope. This section 

provides rules for adjusting members’

bases in stock of a subsidiary (S) and for 

reducing S’s attributes when a member 

(M) transfers a loss share of S stock. See 

paragraph (f) of this section for 

definitions of the terms used in this 

section, including transfer and loss 

share. 

(2) Purpose. The rules in this section 

have two principal purposes. The first is 

to prevent the consolidated return 

provisions from reducing a group’s 

consolidated taxable income through 

the creation of noneconomic loss on S 

stock. The second is to prevent members 

(including former members) of the 

group from collectively obtaining more 

than one tax benefit from a single 

economic loss. Additional purposes are 

set forth in other paragraphs of this 

section. The rules of this section must 

be interpreted and applied in a manner 

that is consistent with and reasonably 

carries out the purposes of this section. 

(3) Overview—(i) General application 

of section. This section applies when M 

transfers a share of S stock and, after 

giving effect to all applicable rules of 

law other than this section, the share is 

a loss share. Paragraph (b) of this section 

applies first to require certain 

redeterminations of all members’ bases 

in shares of S stock. If the transferred 

share is a loss share after any basis 

redetermination required by paragraph 

(b) of this section, paragraph (c) of this 

section applies to require certain 

reductions in M’s basis in the 

transferred loss share. If the transferred 

share is a loss share after any reduction 

required by paragraph (c) of this section, 

paragraph (d) of this section applies to 

require certain reductions in S’s 

attributes. Paragraphs (e), (f), and (g) of 

this section provide general operating 

rules (predecessor/successor rules, 

effects of prior section 362(e)(2) 

transactions), definitions, and an antiabuse rule, respectively. 

(ii) Stock of multiple subsidiaries 

transferred in the transaction—(A) 

Order of application—(1) Transferred 

shares in lowest tier. If shares of stock 

of more than one subsidiary are 

transferred in a transaction and no 

transferred shares of stock of the lowesttier subsidiary (S2) are loss shares, any 

gain recognized with respect to the S2 

shares immediately adjusts members’

bases in subsidiary stock under the 

principles of § 1.1502–32. However, if 

any of the transferred S2 shares are loss 

shares, first paragraph (b) of this section 

and then paragraph (c) of this section 

apply with respect to the S2 shares. 

After giving effect to any adjustments 

required under paragraphs (b) and (c) of 

this section, gain or loss is computed on 

all transferred S2 shares. Any 

adjustments under paragraphs (b) and 

(c) of this section, any gain or loss 

recognized on transferred S2 shares 

(whether allowed or disallowed), and 

any other related or resulting 

adjustments are then applied to adjust 

members’ bases in subsidiary stock 

under the principles of § 1.1502–32. 

(2) Application of paragraphs (b) and 

(c) of this section to higher-tier stock. 

After giving effect to any lower-tier 

adjustments described in paragraph 

(a)(3)(ii)(A)(1) of this section, transfers 

in the next higher tier in which shares 

are transferred, and then in each next 

higher tier successively, are subject to 

the treatment described in paragraph 

(a)(3)(ii)(A)(1). 

(3) Application of paragraph (d) of 

this section. After paragraphs (b) and (c) 

of this section have been applied with 

respect to all transferred loss shares and 

after giving effect to all adjustments 

(whether required by paragraphs (b) and 

(c) of this section, by the recognition of 

gain on a transfer, or otherwise), 

paragraph (d) of this section applies 

with respect to the highest-tier shares 

that are then transferred loss shares. 

Paragraph (d) then applies with respect 

to transferred loss shares in each next 

lower tier successively. 

(B) Example. The rules of this 

paragraph (a)(3) are illustrated by the 

following example: 

Example. M owns all the outstanding 

shares of S stock and one of the two 

outstanding shares of S2 stock, S owns all the 

outstanding shares of S1 stock, and S1 owns 

the other outstanding share of S2 stock. As 

part of one transaction, M sells all the S 

shares and its S2 share, and S1 sells its S2 

share. The sales are to unrelated individuals, 

S and S1 do not elect to file a consolidated 

return after the transaction, the S and S1 

shares are loss shares and the S2 shares are 

gain shares. Each share is transferred within 


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the meaning of this section, the S and S2 

shares because S and S2 cease to be owned 

by M, and M and S1, respectively, as a result 

of taxable dispositions, and the S1 shares 

because S and S1 cease to be members of the 

same group. This section applies to the 

transfer of the S and S1 (loss) shares, but not 

to the transfer of the S2 (gain) shares. 

Accordingly, immediately before the 

transaction, after giving effect to other rules 

of law, the following occurs. First, the gain 

recognized on the transferred S2 shares tiers 

up to adjust members’ bases in all upper-tier 

subsidiary shares under the principles of 

§ 1.1502–32. Then, if S’s transferred S1 

shares are still loss shares, paragraphs (b) and 

(c) of this section apply to those shares. The 

loss on the S1 shares is not recognized in the 

transfer (because there is no taxable 

disposition of the shares) and so only the 

adjustments to the bases of the S1 shares 

required by paragraphs (b) and (c) of this 

section tier up to adjust M’s basis in the S 

stock. Then, if M’s transferred shares of S 

stock are still loss shares, paragraphs (b) and 

(c) of this section apply with respect to those 

shares. If, after giving effect to any 

adjustments under paragraphs (b) and (c) of 

this section, any of the S shares are still loss 

shares, paragraph (d) of this section applies 

with respect to the transfer of those shares. 

If any transferred S1 shares are still loss 

shares after the application of paragraph (d) 

of this section with respect to the transfer of 

S shares, paragraph (d) applies with respect 

to the transfer of the S1 shares. 

(4) Other rules of law and 

coordination with deferral and 

disallowance provisions. This section 

applies and has effect immediately upon 

the transfer of a loss share even if the 

loss is deferred, disallowed, or 

otherwise not taken into account under 

any other applicable rules of law. For 

example, if M sells loss shares of S stock 

to another member in an intercompany 

transaction, every member’s bases in 

shares of S stock and all of S’s attributes 

may be adjusted under this section even 

though M’s loss is deferred under 

§§ 1.267(f)–1 and 1.1502–13, and S 

remains a member. See § 1.1502–80(a) 

regarding the general applicability of 

other rules of law and a limitation on 

duplicative adjustments. 

(5) Nomenclature, factual 

assumptions adopted in this section. 

Unless otherwise stated, for purposes of 

this section, the following nomenclature 

and assumptions are adopted. P is the 

common parent of a consolidated group 

and X is a nonmember of the P group. 

If a corporation has preferred stock 

outstanding, it is stock described in 

section 1504(a)(4). The examples set 

forth the only facts and activities 

relevant to the example. All transactions 

are between unrelated persons and are 

independent of each other. Tax 

liabilities and their effect, and the 

application of any loss disallowance or 

deferral provision of the Code or 

regulations, including but not limited to 

section 267, are disregarded. All persons 

report on a calendar year basis and use 

the accrual method of accounting. All 

parties comply with filing and other 

requirements of this section and all 

other provisions of the Code and 

regulations. 

(b) Basis redetermination to reduce 

disparity—(1) In general—(i) Purpose 

and scope. The rules of this paragraph 

(b) reduce the extent to which there is 

disparity in members’ bases in shares of 

S stock. These rules are intended to 

prevent the operation of the investment 

adjustment system from creating 

noneconomic or duplicated loss when 

members hold S shares with disparate 

bases, and they operate by reallocating 

previously applied investment 

adjustments. The provisions of this 

paragraph (b) do not alter the aggregate 

amount of basis in shares of S stock held 

by members or the aggregate amount of 

investment adjustments applied to 

shares of S stock. 

(ii) Exemptions from basis 

redetermination—(A) No potential for 

redetermination. Notwithstanding the 

general rule in paragraph (b)(2) of this 

section, basis redetermination will not 

be required if redetermination would 

not result in a change to any member’s 

basis in any share of S stock. For 

example, if S has only one class of stock 

outstanding and there is no disparity in 

members’ bases in S shares, no 

member’s basis would be changed by 

the application of this paragraph (b). 

Accordingly, under this paragraph 

(b)(1)(ii)(A), no redetermination would 

be required. Similarly, if S has preferred 

and common stock outstanding, there is 

no gain or loss on any member’s 

preferred shares, and there is no 

disparity in members’ bases in the 

common stock, no member’s basis 

would be changed by the application of 

this paragraph (b). Accordingly, under 

this paragraph (b)(1)(ii)(A), no 

redetermination would be required. 

(B) Disposition of entire interest. 

Notwithstanding the general rule in 

paragraph (b)(2) of this section, basis 

redetermination will not be required if, 

within the group’s taxable year in which 

the transfer occurs, every share of S 

stock held by a member is transferred to 

a nonmember in one or more fully 

taxable transactions. 

(iii) Transfers of stock of subsidiaries 

at multiple tiers. If stock of subsidiaries 

at multiple tiers is transferred in a 

transaction, see paragraph (a)(3)(ii) of 

this section regarding the order of 

application of this section. 

(iv) Investment adjustment. For 

purposes of this paragraph (b), the term 

investment adjustment means the 

adjustment for items described in 

§ 1.1502–32(b)(2), excluding § 1.1502–

32(b)(2)(iv) (distributions). The term 

includes all such adjustments reflected 

in the basis of the share, whether 

originally applied directly by § 1.1502–

32 or otherwise. The term therefore 

includes investment adjustments 

reallocated to the share, and it does not 

include investment adjustments 

reallocated from the share, whether 

pursuant to this section or any other 

provision of law. It also includes the 

proportionate amount of investment 

adjustments reflected in the basis of a 

share after the basis is apportioned 

among shares, for example in a 

transaction qualifying under section 

355. 

(2) Basis redetermination rule. If M 

transfers a loss share of S stock, all 

members’ bases in all their shares of S 

stock are subject to redetermination 

under this paragraph (b). The 

adjustments are made in accordance 

with the following: 

(i) Decreasing the bases of transferred 

loss shares—(A) Removing positive 

investment adjustments from 

transferred loss shares. M’s basis in each 

of its transferred loss shares of S stock 

is first reduced, but not below value, by 

removing positive investment 

adjustments previously applied to the 

basis of the share. The positive 

investment adjustments removed from 

transferred loss shares are reallocated 

under paragraph (b)(2)(ii) of this section 

after negative investment adjustments 

are reallocated under paragraph 

(b)(2)(i)(B) of this section. 

(B) Reallocating negative investment 

adjustments. If a transferred share is 

still a loss share after applying 

paragraph (b)(2)(i)(A) of this section, 

M’s basis in the share is reduced, but 

not below value, by reallocating and 

applying negative investment 

adjustments to the transferred loss share 

from shares held by members that are 

not transferred loss shares. Reductions 

under this paragraph (b)(2)(i)(B) are 

made first to M’s bases in transferred 

loss shares of S preferred stock and then 

to M’s bases in transferred loss shares of 

S common stock. 

(ii) Increasing the bases of gain 

preferred and all common shares—(A) 

Preferred stock. After the application of 

paragraph (b)(2)(i) of this section, the 

positive investment adjustments 

removed from transferred loss shares are 

reallocated and applied to increase, but 

not above value, members’ bases in gain 

shares of S preferred stock. 

(B) Common stock. Any positive 

investment adjustments removed from 

transferred loss shares and not applied 

to S preferred shares are then 


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reallocated and applied to increase 

members’ bases in shares of S common 

stock. Reallocations are made to shares 

of common stock without regard to 

whether a particular share is a loss share 

or a transferred share, and without 

regard to the share’s value. 

(iii) Operating rules—(A) In general. 

Reallocations are made in a manner that 

reduces basis disparity among shares of 

preferred stock and among shares of 

common stock to the greatest extent 

possible (that is, causes the ratio of the 

basis to the value of each member’s 

share to be as equal as possible). 

(B) Limits on reallocation—(1) 

Restriction to outstanding shares. 

Investment adjustments can only be 

reallocated to shares that were held by 

members in the period to which the 

adjustment is attributable. 

(2) Limitation by prior use of 

allocation—(i) In general. In order to 

prevent the reallocation of investment 

adjustments from either increasing or 

decreasing members’ aggregate bases in 

subsidiary stock, no investment 

adjustment (positive or negative) may be 

reallocated under this paragraph (b)(2) 

to the extent that it was (or would have 

been) used prior to the time that it 

would otherwise be reallocated under 

this paragraph (b)(2). For this purpose, 

an investment adjustment was used (or 

would have been used) to the extent that 

it was reflected in (or would have been 

reflected in) the basis of a share of 

subsidiary stock and the basis of that 

share has already been taken into 

account, directly or indirectly, in 

determining income, gain, deduction, or 

loss (including by affecting the 

application of this section to a prior 

transfer of subsidiary stock) or in 

determining the basis of any property 

that is not subject to § 1.1502–32. 

However, notwithstanding the general 

rule, if the prior use was in an 

intercompany transaction, an 

investment adjustment may be 

reallocated to the extent that § 1.1502–

13 has prevented the gain or loss on the 

transaction from being taken into 

account. (In that case, appropriate 

adjustments must be made to the prior 

intercompany transaction.) Further, if 

an investment adjustment was reflected 

in (or would have been reflected in) the 

basis of a share that has been taken into 

account, but the basis of that share 

would not change as a result of the 

reallocation (for example, because the 

reallocation would be among shares that 

are all lower-tier to the share with the 

previously used basis), the investment 

adjustment may be reallocated. See 

§ 1.1502–32(c)(1)(ii)(C) regarding special 

allocations applicable if the reallocation 

of an investment adjustment is limited 

under this paragraph (b)(2)(iii)(B)(2). 

(ii) Example. The application of this 

paragraph (b)(2)(iii)(B)(2) is illustrated 

by the following example: 

Example. (i) Facts. P owns all 20 shares of 

M stock, and 10 shares of S stock. M owns 

the remaining 10 shares of S stock. In year 

1, S recognizes $200 of income that results 

in a $10 positive investment adjustment 

being allocated to each share of S stock. The 

group does not recognize any other items. 

The $100 positive adjustment to M’s basis in 

the S stock tiers up, and results in a $5 

positive adjustment to each share of M stock. 

In year 2, P sells one share of M stock and 

recognizes a gain. In year 3, M sells one loss 

share of S stock, and paragraph (b) of this 

section applies and requires a reallocation of 

the year 1 positive investment adjustment. 

(ii) Application of limitation by prior use. 

M’s basis in the transferred loss share of S 

stock reflects a $10 positive investment 

adjustment attributable to S’s year 1 income. 

Under the general rule of this paragraph (b), 

that $10 would be subject to reallocation to 

reduce basis disparity. However, that $10 

adjustment had originally tiered up to adjust 

P’s basis in its M shares and, as a result, $.50 

of that adjustment was reflected in P’s basis 

in each share of M stock. When P sold the 

share of M stock, the basis of that share 

(including the tiered up $.50) was used in 

determining the gain on the sale. 

Accordingly, $.50 of the $10 investment 

adjustment originally allocated to the S share 

that tiered-up to the M share was previously 

used and therefore cannot be reallocated in 

a manner that would (if it were the original 

allocation) affect the basis of the sold share. 

Thus, taking into account the special 

allocations in § 1.1502–32(c)(1)(ii)(C), up to 

$9.50 of the adjustment to M’s transferred S 

share could be allocated to P’s shares of S 

stock (leaving $.50 on M’s transferred S 

share, all of which would be treated as tiered 

up to P’s transferred M share). Alternatively, 

all $10 could be reallocated to M’s other S 

shares (because the tier up to P’s M shares 

would have been the same regardless which 

of M’s shares of S stock were adjusted.) 

(iii) Application of limitation where 

adjustment would have been used. The facts 

are the same as in paragraph (i) of this 

Example except that M does not sell any 

shares of S stock and, in year 3, P sells a loss 

share of S stock. As in paragraph (i) of this 

Example, when P sold the share of M stock, 

the basis of that share was used in 

determining the gain on the share. When P 

sells the loss share of S stock, the $10 

positive investment adjustment from S’s year 

1 income cannot be reallocated in a manner 

that, if it were the original adjustment, would 

have caused any amount to be reflected in 

the basis of the transferred share. If this $10 

positive investment adjustment had 

originally been allocated to the S shares held 

by M, $.50 of the $10 investment adjustment 

would have tiered up to the M share P sold, 

would have been reflected in P’s basis, and 

would have been used in determining the 

gain or loss on the sale. Accordingly, taking 

into account the special allocations in 

§ 1.1502–32(c)(1)(ii)(C), up to $9.50 of the 

$10 adjustment to P’s transferred S share 

could be allocated to M’s shares of S stock 

(all of which would tier up to P’s 19 retained 

M shares). Alternatively, all $10 could be 

reallocated to P’s other S shares. 

(C) Order of reallocation. In general, 

reallocations are made first with respect 

to the earliest available adjustments. 

However, the overall application of this 

paragraph (b) to a transaction must be 

made in a manner that reduces basis 

disparity to the greatest extent possible. 

(3) Examples. The general application 

of this paragraph (b) is illustrated by the 

following examples: 

Example 1. Transfer of stock received in 

section 351 exchange. (i) Redetermination to 

prevent noneconomic loss. (A) Facts. For 

many years, P has owned two assets, Asset 

1 and Asset 2. On January 1, year 1, P 

receives four shares of S common stock (the 

Block 1 shares) in exchange for Asset 1, 

which has a basis and value of $80. The 

exchange qualifies under section 351 and, 

therefore, under section 358, P’s aggregate 

basis in the Block 1 shares is $80 ($20 per 

share). On July 1, year 1, P receives another 

share of S common stock (the Block 2 share) 

in exchange for Asset 2, which has a basis 

of $0 and value of $20. This exchange also 

qualifies as a section 351 exchange and, 

under section 358, P’s basis in the Block 2 

share is $0. P’s Block 1 and Block 2 shares 

are the only outstanding shares of S stock. On 

October 1, year 1, S sells Asset 2 for $20. On 

December 31, year 1, P sells one of its Block 

1 shares for $20. After applying and giving 

effect to all generally applicable rules of law 

(other than this section), P’s basis in each 

Block 1 share is $24 (P’s original $20 basis 

increased under § 1.1502–32 by $4 (the 

share’s allocable portion of the $20 gain 

recognized on the sale of Asset 2)). In 

addition, P’s basis in its Block 2 share is $4 

(P’s original $0 basis increased under 

§ 1.1502–32 by $4 (the share’s allocable 

portion of the $20 gain recognized on the sale 

of Asset 2)). P’s sale of the Block 1 share is 

a transfer of a loss share and therefore subject 

to the provisions of this section. 

(B) Basis redetermination under this 

paragraph (b). Under this paragraph (b), P’s 

bases in all its shares of S stock are subject 

to redetermination. First, paragraph 

(b)(2)(i)(A) of this section applies to reduce 

P’s basis in the transferred loss share, but not 

below value, by removing positive 

investment adjustments applied to the basis 

of the share. Accordingly, P’s basis in the 

transferred Block 1 share is reduced by $4 

(the amount of the positive investment 

adjustment applied to the share), from $24 to 

$20. No further reduction to the basis of the 

share is required under this paragraph (b) 

because the basis of the share is then equal 

to value. Under paragraph (b)(2)(ii)(B) of this 

section, the positive investment adjustment 

removed from the transferred loss share is 

reallocated and applied to increase P’s bases 

in its S shares in a manner that reduces basis 

disparity to the greatest extent possible. 

Accordingly, the $4 positive investment 

adjustment removed from the Block 1 share 

is reallocated and applied to the basis of the 

Block 2 share, increasing it from $4 to $8. 


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(C) Application of paragraphs (c) and (d) 

of this section. Because P’s sale of the Block 

1 share is no longer a transfer of a loss share 

after the application of this paragraph (b), 

paragraphs (c) and (d) of this section do not 

apply. 

(ii) Redetermination to prevent duplicated 

loss. (A) Facts. The facts are the same as in 

paragraph (i)(A) of this Example 1, except 

that, at the time of the second contribution, 

the value of Asset 1 had declined to $20 and 

so, instead of contributing Asset 2, P 

contributed Asset 3 to S in exchange for the 

Block 2 share. At the time of that exchange, 

Asset 3 had a basis and value of $5. On 

October 1, year 1, S sells Asset 1 for $20, 

recognizing a $60 loss that is absorbed by the 

group. On December 31, year 1, P sells one 

of its Block 1 shares for $5. After applying 

and giving effect to all generally applicable 

rules of law (other than this section), P’s 

basis in each Block 1 share is $8 (P’s original 

$20 basis decreased under § 1.1502–32 by 

$12 (the share’s allocable portion of the $60 

loss recognized on the sale of Asset 1)). P’s 

basis in its Block 2 share is an excess loss 

account of $7 (its original basis of $5 reduced 

by $12, the share’s portion of the loss 

recognized on Asset 1). P’s sale of the Block 

1 share is a transfer of a loss share and 

therefore subject to the provisions of this 

section. 

(B) Basis redetermination under this 

paragraph (b). Under this paragraph (b), P’s 

bases in all its shares of S stock are subject 

to redetermination. There are no positive 

investment adjustments and so there is no 

adjustment under paragraph (b)(2)(i)(A) of 

this section. However, under paragraph 

(b)(2)(i)(B) of this section, P’s basis in the 

transferred Block 1 share is reduced, but not 

below value, by reallocating negative 

investment adjustments from shares that are 

not transferred loss shares. In total, there 

were $48 of negative investment adjustments 

applied to shares that are not transferred loss 

shares. Accordingly, P’s basis in the Block 1 

share is reduced by $3, from $8 to its value 

of $5. Under paragraph (b)(2)(i)(B) of this 

section, the negative investment adjustments 

applied to the transferred share are 

reallocated from (and therefore cause an 

increase in the basis of) S shares that are not 

transferred loss shares in a manner that 

reduces basis disparity to the greatest extent 

possible. Accordingly, the $3 negative 

investment adjustment reallocated and 

applied to the transferred Block 1 share is 

reallocated entirely from the Block 2 share, 

increasing the basis in the Block 2 share from 

an excess loss account of $7 to an excess loss 

account of $4. 

(C) Application of paragraphs (c) and (d) 

of this section. Because P’s sale of the Block 

1 share is no longer a transfer of a loss share 

after the application of this paragraph (b), 

paragraphs (c) and (d) of this section do not 

apply. 

(iii) Nonapplicability of redetermination 

rule to sale of entire interest. The facts are the 

same as in paragraph (ii)(A) of this Example 

1, except that, on December 31, year 1, P sells 

all its shares of S stock for $25. Under 

paragraph (b)(1)(ii)(B) of this section, this 

paragraph (b) does not apply to redetermine 

P’s basis in its S shares because every S share 

held by a member is transferred to a 

nonmember in a fully taxable transaction. 

However, the sale of the Block 1 shares is a 

transfer of loss shares and therefore subject 

to paragraphs (c) and (d) of this section. 

Paragraphs (c)(7) and (d)(3)(i)(A) of this 

section apply netting principles to prevent 

adjustments under either paragraph (c) or 

paragraph (d) of this section. 

Example 2. Redetermination increases 

basis of transferred loss share. (i) Facts. On 

January 1, year 1, P owns all 10 outstanding 

shares of S common stock. Five of the shares 

have a basis of $20 per share (the Block 1 

shares) and five of the shares have a basis of 

$10 per share (the Block 2 shares). S’s only 

asset, Asset 1, has a basis of $50. S has no 

other attributes. On October 1, year 1, S sells 

Asset 1 for $100. On December 31, year 2, S 

sells one Block 1 share and one Block 2 share 

to X for $10 per share. After applying and 

giving effect to all generally applicable rules 

of law (other than this section), P’s basis in 

each Block 1 share is $25 (P’s original $20 

basis increased under § 1.1502–32 by $5 (the 

share’s allocable portion of the $50 gain 

recognized on the sale of Asset 1)), and P’s 

basis in each Block 2 share is $15 (P’s 

original $10 basis increased by $5). P’s sale 

of the Block 1 and Block 2 shares is a transfer 

of loss shares and therefore subject to the 

provisions of this section. 

(ii) Basis redetermination under this 

paragraph (b). Under this paragraph (b), P’s 

bases in all its shares of S stock are subject 

to redetermination. First, paragraph 

(b)(2)(i)(A) of this section applies to reduce 

P’s basis in the transferred Block 1 and Block 

2 shares, but not below value, by removing 

the positive investment adjustments applied 

to the bases of the transferred loss shares. 

Accordingly, the basis of the Block 1 share 

is reduced by $5, from $25 to $20. The basis 

of the Block 2 share is also reduced by $5, 

from $15 to $10. (Although the Block 1 share 

is still a loss share, there is no reduction to 

its basis under paragraph (b)(2)(i)(B) of this 

section because there were no negative 

investment adjustments to shares that are not 

transferred loss shares.) Next, paragraph 

(b)(2)(ii)(B) of this section applies to 

reallocate and apply the $10 of positive 

investment adjustments removed from the 

transferred loss shares to increase P’s bases 

in its S shares in a manner that reduces basis 

disparity to the greatest extent possible. 

Accordingly, of the $10 positive investment 

adjustments to be reallocated, $6 is 

reallocated and applied to the basis of the 

Block 2 share (increasing it from $10 to $16) 

and $4 is reallocated and applied equally to 

the basis of each of the four retained Block 

2 shares (increasing the basis of each from 

$15 to $16). After giving effect to the 

reallocations under this paragraph (b), P’s 

basis in each retained Block 1 share is $25, 

P’s basis in the transferred Block 1 share is 

$20, and P’s basis in each Block 2 share is 

$16. 

(iii) Application of paragraph (c) of this 

section. After the application of this 

paragraph (b), P’s sale of the Block 1 and 

Block 2 shares is still a transfer of loss shares 

and, accordingly, subject to paragraph (c) of 

this section. No adjustment is required to the 

basis of the Block 1 share under paragraph 

(c) of this section because, after its basis is 

redetermined under this paragraph (b), the 

net positive adjustment to the basis of the 

share is $0. See paragraph (c)(3) of this 

section. However, paragraph (c) of this 

section reduces P’s basis in the transferred 

Block 2 share (by the lesser of its net positive 

adjustment and its disconformity amount, or 

$6, from $16 to $10, its value). 

(iv) Application of paragraph (d) of this 

section. After the application of paragraph (c) 

of this section, P’s sale of the Block 1 share 

is still a transfer of a loss share and, 

accordingly, subject to paragraph (d) of this 

section. No adjustment is required under 

paragraph (d) of this section because there is 

no aggregate inside loss. See paragraph 

(d)(3)(iii) of this section. Because P’s sale of 

the Block 2 share is no longer a transfer of 

a loss share after the application of paragraph 

(c) of this section, paragraph (d) of this 

section does not apply to the transfer of the 

Block 2 share. 

Example 3. Application to outstanding 

common and preferred shares. (i) Facts. P 

owns all the stock of M and all eight 

outstanding shares of S common stock. S also 

has two shares of nonvoting preferred stock 

outstanding; the preferred shares have a $100 

annual, cumulative preference as to 

dividends (per share). M owns one of the 

preferred shares (PS1) and P owns the other 

(PS2). On January 1, year 1, the bases and 

values of the outstanding S shares are: 

Preferred Common 

PS1 

(M) 

PS2 

(P) 

CS1 

(P) 

CS2 

(P) 

CS3 

(P) 

CS4 

(P) 

CS5 

(P) 

CS6 

(P) 

CS7 

(P) 

CS8 

(P) 

Basis ................................................................. 1250 975 1025 710 550 400 375 250 215 100 

Value ................................................................ 1000 1000 375 375 375 375 375 375 375 375 

As of January 1, year 1, there are no 

arrearages on the preferred stock. In year 1, 

S has a $1100 capital loss and $100 of 

ordinary income. The loss is absorbed by the 

group and the resulting negative adjustment 

of $1000 is allocable entirely to the common 

stock. See § 1.1502–32(c)(1). 


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In year 2, S has $700 of ordinary income 

and a $100 ordinary loss. Also, on October 

1, year 2, S declares a dividend of $200 ($100 

with respect to each of the preferred shares). 

Thus, there is a net positive investment 

adjustment for year 2 of $400. See § 1.1502–

32(b)(2). Under § 1.1502–32(c)(1), a negative 

adjustment of $100 is first allocated to each 

of the preferred shares to reflect the dividend 

declaration. Then, $400 of the $600 

remaining adjustment (the adjustment 

computed without taking distributions into 

account) is allocated $200 to each of the 

preferred shares to reflect their entitlement to 

dividends accruing in year 1 and year 2. See 

§ 1.1502–32(c)(3). (The year 2 investment 

adjustment to each preferred share is 

therefore a positive $100.) Finally, under 

§ 1.1502–32(c)(2), the remaining $200 of the 

investment adjustment is allocated to the 

common stock, equally to all outstanding 

shares. After applying and giving effect to all 

generally applicable rules of law (other than 

this section), the adjusted bases and the 

values of the shares as of January 1, year 3, 

are: 

Preferred Common 

PS1 

(M) 

PS2 

(P) 

CS1 

(P) 

CS2 

(P) 

CS3 

(P) 

CS4 

(P) 

CS5 

(P) 

CS6 

(P) 

CS7 

(P) 

CS8 

(P) 

Basis ................................................................. 1250 975 1025 710 550 400 375 250 215 100 

Year 1 § 1.1502–32 adjustments ..................... N/A N/A ¥125 ¥125 ¥125 ¥125 ¥125 ¥125 ¥125 ¥125 

Year 2 § 1.1502–32 adjustments ..................... +100 +100 +25 +25 +25 +25 +25 +25 +25 +25 

Adjusted basis .................................................. 1350 1075 925 610 450 300 275 150 115 0 

Value ......................................................... 1100 1100 275 275 275 275 275 275 275 275 

Unrecognized gain/(loss) ................................. (250) 25 (650) (335) (175) (25) 0 125 160 275 

On January 1, year 3, M sells PS1 for $1100 

and P sells CS2 for $275. The sales of PS1 

and CS2 are transfers of loss shares and 

therefore subject to the provisions of this 

section. 

(ii) Basis redetermination under this 

paragraph (b). Under this paragraph (b), all 

members’ bases in shares of S stock are 

subject to redetermination in accordance 

with the following: 

(A) Removing positive investment 

adjustments from transferred loss shares. 

First, paragraph (b)(2)(i)(A) of this section 

applies to reduce M’s basis in PS1 and P’s 

basis in CS2, but not below value, by 

removing the positive investment 

adjustments applied to the bases of the 

shares. Accordingly, M’s basis in PS1 is 

reduced by $200 (the investment adjustment 

applied to the share without regard to the 

distribution), from $1350 to $1150, and P’s 

basis in CS2 is reduced by $25, from $610 to 

$585. 

(B) Reallocating negative investment 

adjustments from shares that are not 

transferred loss shares. Because the 

transferred shares remain loss shares after the 

removal of positive investment adjustments, 

their bases are further reduced under 

paragraph (b)(2)(i)(B) of this section, but not 

below value, by negative investment 

adjustments applied to shares that are not 

transferred loss shares. Reallocations are 

made first to preferred shares and then to the 

common shares, in a manner that reduces 

basis disparity to the greatest extent possible. 

The remaining loss on PS1 is $50, the 

remaining loss on CS2 is $310, and the total 

amount of negative investment adjustments 

applied to shares that are not transferred loss 

shares is $875 (the sum of the adjustments 

made to all common shares other than CS2). 

Thus, $50 of negative investment 

adjustments are reallocated to the basis of 

PS1 and $310 of negative investment 

adjustments are reallocated to the basis of 

CS2, reducing each to its value ($1100 and 

$275, respectively). The negative investment 

adjustments are reallocated from the shares 

that are not transferred loss shares in a 

manner that reduces basis disparity to the 

greatest extent possible. Accordingly, of the 

$360 reallocated negative investment 

adjustments, $125 is reallocated from each of 

CS7 and CS8, and $110 is reallocated from 

CS6. As a result, the basis of CS6 increases 

to $260, the basis of CS7 increases to $240, 

and the basis of CS8 increases to $125. 

(C) Increasing basis by reallocated positive 

investment adjustments. Under paragraph 

(b)(2)(ii)(A) of this section, the $225 of 

positive investment adjustments removed 

from the transferred loss shares are then 

reallocated and applied to increase the basis 

of preferred shares, but not above value. 

Accordingly $25 of that amount is reallocated 

to PS2, increasing its basis from $1075 to 

$1100, its value. The remaining $200 is 

allocated among the common shares in a 

manner that reduces basis disparity to the 

greatest extent possible. Accordingly, of the 

$200 positive investment adjustment that is 

reallocated to common shares, $150 is 

reallocated to CS8, $35 is reallocated to CS7, 

and $15 is reallocated to CS6, increasing the 

basis of each to $275. 

(D) Summary of reallocation adjustments. 

The adjustments made under this paragraph 

(b) are therefore: 

Preferred Common 

PS1 

(M) 

PS2 

(P) 

CS1 

(P) 

CS2 

(P) 

CS3 

(P) 

CS4 

(P) 

CS5 

(P) 

CS6 

(P) 

CS7 

(P) 

CS8 

(P) 

Adjusted basis Before redetermination ............ 1350 1075 925 610 450 300 275 150 115 0 

Removing positive adjustments from transferred loss shares ......................................... ¥200 ............ ............ ¥25 ............ ............ ............ ............ ............ ............

Reallocating negative adjustments .................. ¥50 ............ ............ ¥310 ............ ............ ............ +110 +125 +125 

Applying positive adjustments removed from 

transferred shares ........................................ ............ +25 ............ ............ ............ ............ ............ +15 +35 +150 

Basis after redetermination ....................... 1100 1100 925 275 450 300 275 275 275 275 

Value ......................................................... 1100 1100 275 275 275 275 275 275 275 275 

Gain/(loss) ........................................................ 0 0 (650) 0 (175) (25) 0 0 0 0 

(iii) Application of paragraphs (c) and (d) 

of this section. Because M’s sale of PS1 and 

P’s sale of CS2 are no longer transfers of loss 

shares after the application of this paragraph 

(b), paragraphs (c) and (d) of this section do 

not apply. 

(iv) Higher-tier effects. The adjustments 

made to PS1 give rise to a $250 

nondeductible basis recovery item (a 

noncapital, nondeductible expense under 

§ 1.1502–32(b)(3)(iii)(B)) that will be 

included in the year 3 investment adjustment 


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to be applied to reduce P’s basis in its M 

stock. 

(c) Stock basis reduction to prevent 

noneconomic loss—(1) In general. The 

rules of this paragraph (c) reduce M’s 

basis in a transferred share of S stock in 

order to prevent noneconomic stock loss 

and thereby promote the clear reflection 

of the group’s income. The effect of 

these rules is to limit the reduction to 

M’s basis in the S share to the amount 

of net unrealized appreciation reflected 

in the share’s basis immediately before 

the transfer. These rules also limit the 

reduction to M’s basis in the S share to 

the portion of the share’s basis that is 

attributable to investment adjustments 

made pursuant to the consolidated 

return regulations. 

(2) Basis reduction rule—(i) In 

general. If M transfers a share of S stock 

and, after the application of paragraph 

(b) of this section, the share is a loss 

share, M’s basis in the share is reduced, 

but not below value, by the lesser of—

(A) The share’s net positive 

adjustment (see paragraph (c)(3) of this 

section); and 

(B) The share’s disconformity amount 

(see paragraph (c)(4) of this section). 

(ii) Transactions that adjusted stock 

or asset basis. See paragraph (e)(2) of 

this section for special rules that may 

apply if a prior transaction, such as an 

exchange subject to section 362(e)(2), 

adjusted the basis in any share of S 

stock or S’s attributes in a manner that 

altered a share’s disconformity amount. 

(iii) Transfers of stock of subsidiaries 

at multiple tiers. If stock of subsidiaries 

at multiple tiers is transferred in a 

transaction, see paragraph (a)(3)(ii) of 

this section regarding the order of 

application of this section. 

(3) Net positive adjustment. A share’s 

net positive adjustment is the greater 

of—

(i) Zero; and 

(ii) The sum of all investment 

adjustments reflected in the basis of the 

share. The term investment adjustment 

has the same meaning as in paragraph 

(b)(1)(iv) of this section. 

(4) Disconformity amount. A share’s 

disconformity amount is the excess, if 

any, of—

(i) M’s basis in the share; over 

(ii) The share’s allocable portion of S’s 

net inside attribute amount (as defined 

in paragraph (c)(5) of this section). 

(5) Net inside attribute amount. S’s 

net inside attribute amount is 

determined as of the time immediately 

before the transfer, taking into account 

all applicable rules of law other than 

this section (except as specifically 

provided otherwise in this section). S’s 

net inside attribute amount is the sum 

of S’s net operating and capital loss 

carryovers, deferred deductions, money, 

and basis in assets other than money 

(for this purpose, S’s basis in any share 

of lower-tier subsidiary stock is S’s basis 

in that share, adjusted to reflect any gain 

or loss recognized in the transaction and 

any other related or resulting 

adjustments), reduced by the amount of 

S’s liabilities. See paragraph (f) of this 

section for definitions of the terms 

‘‘allocable portion’’, ‘‘deferred 

deduction’’, ‘‘liability’’, and ‘‘loss 

carryover’’. See paragraph (c)(6) of this 

section for special rules regarding the 

computation of S’s net inside attribute 

amount for purposes of this paragraph 

(c) if S holds stock of a subsidiary. 

(6) Determination of S’s net inside 

attribute amount if S owns stock of a 

lower-tier subsidiary—(i) Overview. If a 

loss share of S stock is transferred when 

S holds a share of stock of another 

subsidiary (S1) and the S1 share is not 

transferred in the same transaction, S’s 

net inside attribute amount is 

determined by treating S’s basis in its S1 

share as tentatively reduced under this 

paragraph (c)(6). The purpose of this 

rule is to reduce the extent to which 

S1’s investment adjustments increased 

noneconomic loss on S stock (as a result 

of S1’s recognition of items that are 

indirectly reflected in members’ bases in 

S stock). 

(ii) General rule for nontransferred 

shares of lower-tier subsidiary. Solely 

for purposes of determining the 

disconformity amount of a share of S 

stock, S’s basis in a share of S1 stock is 

treated as reduced by the share’s 

tentative reduction amount. The 

tentative reduction amount is the lesser 

of the S1 share’s net positive adjustment 

and the S1 share’s disconformity 

amount, computed under the principles 

of paragraphs (c)(3) and (c)(4) of this 

section, respectively. 

(iii) Multiple tiers of nontransferred 

shares. If S directly or indirectly owns 

non-transferred shares of stock of 

subsidiaries in multiple tiers, then, 

subject to the limitations in paragraph 

(c)(6)(iv) of this section (regarding 

nontransferred shares that are lower-tier 

to transferred shares), the rules of this 

paragraph (c)(6) first apply to determine 

the tentatively reduced basis of stock of 

the subsidiary at the lowest tier. These 

rules then apply successively to 

determine the tentatively reduced basis 

of nontransferred shares of stock of 

subsidiaries at each next higher tier that 

is lower tier to S. The tentative 

reductions are treated as noncapital, 

nondeductible expenses that tier up 

under the principles of § 1.1502–32, 

tentatively reducing the basis of stock 

and the net positive adjustments of 

subsidiaries that are lower tier to S. 

(iv) Nonapplicability of tentative basis 

reduction rule to transferred shares. The 

tentative basis reduction rule in this 

paragraph (c)(6) does not apply to any 

share of stock of a lower-tier subsidiary 

(S1) that is transferred in the same 

transaction in which the S share is 

transferred. Further, for purposes of 

determining the S share’s disconformity 

amount, the tentative basis reduction 

rule in this paragraph (c)(6) does not 

apply with respect to stock of any other 

subsidiary (S2) to the extent it is lower 

tier to the transferred S1 share. 

However, the tentative basis reduction 

rule may apply to S2 stock for purposes 

of computing the disconformity amount 

of the transferred S1 share. The purpose 

of this rule is to prevent tentative 

adjustments under this paragraph (c)(6) 

to the extent that this paragraph (c) has 

already applied to shares of subsidiary 

stock, without regard to whether the 

basis of those shares was reduced under 

this paragraph (c). 

(v) Example. The rules of this 

paragraph (c)(6) are illustrated by the 

following example: 

Example. (i) Facts. P owns the sole 

outstanding share of S stock, S owns the sole 

outstanding share of S1 stock, S1 owns the 

sole outstanding share of S2 stock, S2 owns 

the sole outstanding share of S3 stock, and 

S3 owns the sole outstanding share of S4 

stock. The S and S1 shares are loss shares, 

and the S3 share is a gain share. In one 

transaction, P sells its S share to X, S1 issues 

new shares in an amount that prevents S and 

S1 from being members of the same group, 

and S2 sells the S3 share to an unrelated 

individual. S1 and S2 elect to file a 

consolidated return following the 

transaction, as do S3 and S4. 

(ii) General applicability of section. The 

transaction is a transfer of the S and S3 

shares (by reason of the sales) and of the S1 

share (because S and S1 cease to be members 

of the same group). The transfer of the S3 

share is not a transfer of a loss share and so 

this section does not apply to that transfer. 

This section does, however, apply to the 

transfer of the S and S1 loss shares. Under 

paragraph (a)(3)(ii)(A) of this section, the 

application of this section begins with the 

application of paragraph (b) to the transfer of 

the loss share stock of S1, the lowest-tier 

subsidiary the stock of which is transferred 

in the transaction. 

(iii) Application of paragraphs (b) and (c) 

to transfer of S1 stock. First, the gain 

recognized on the transfer of S3 tiers up to 

adjust the basis of each upper-tier share. 

Then, because the transferred S1 share is still 

a loss share under these facts, paragraph (b) 

of this section applies to S’s transfer of S1 

stock. However, no adjustment is required 

under paragraph (b) of this section because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S1 stock). See paragraph (b)(1)(ii)(A) 


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of this section. The S1 share is still a loss 

share and so it is then subject to the 

provisions of this paragraph (c). In 

determining basis reduction under this 

paragraph (c), the disconformity amount of 

the S1 share is computed by treating S1’s 

basis in S2 stock as tentatively reduced under 

this paragraph (c)(6). In determining the 

disconformity amount of the S1 share, this 

tentative reduction rule has no application 

with respect to S2’s basis in the S3 share 

(because the S3 share is transferred in the 

transaction) or with respect to S3’s basis in 

the S4 share (because the S4 stock is lower 

tier to the transferred S3 share). After the 

application of this paragraph (c) to the 

transfer of the S1 share, paragraph (b) of this 

section applies to P’s transfer of the S share 

if the share is still a loss share. 

(iv) Application of section to transfer of S 

stock. First, assuming the S share has 

remained a loss share, paragraph (b) of this 

section applies to P’s transfer of S stock. 

However, no adjustment is required under 

paragraph (b) of this section, either because 

there is no potential for redetermination 

(members hold only one share of S stock) or 

because P transfers the group’s entire interest 

in S to a nonmember in a fully taxable 

transaction. See, respectively, paragraphs 

(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. 

The transferred share is still a loss share and 

therefore subject to the provisions of this 

paragraph (c). In determining the 

disconformity amount of the S share, S’s net 

inside attributes are determined by taking 

into account S’s actual basis in the S1 stock. 

The tentative reduction rule of this paragraph 

(c)(6) does not apply to S’s basis in the S1 

share because the S1 share is transferred in 

the transaction. All other shares are lower 

tier to the transferred S1 share and are 

therefore not subject to tentative reduction 

for purposes of determining the 

disconformity amount of the S share. 

(7) Netting of gains and losses taken 

into account—(i) General rule. Solely 

for purposes of computing the basis 

reduction required under this paragraph 

(c), the basis of each transferred loss 

share of S stock is treated as reduced 

proportionately (as to loss) by the 

amount of gain taken into account by 

members with respect to all transferred 

gain shares of S stock, provided that—

(A) The gain and loss shares are 

transferred in the same transaction; and 

(B) The gain is taken into account in 

the year of the transaction. 

(ii) Example. The netting rule of this 

paragraph (c)(7) is illustrated by the 

following example: 

Example. Disposition of gain and loss 

shares. (i) Facts. P owns the only two 

outstanding shares of S common stock. Share 

A has a basis of $54 and Share B has a basis 

of $100. In the same transaction, P sells the 

two S shares to X for $60 each. P realizes a 

gain of $6 on Share A and a loss of $40 on 

Share B. P’s sale of Share B is a transfer of 

a loss share and therefore subject to the 

provisions of this section. (No adjustment is 

required under paragraph (b) of this section 

because P transfers the group’s entire interest 

in S to a nonmember in a fully taxable 

transaction. See paragraph (b)(1)(ii)(B) of this 

section.) The transfer is then subject to the 

provisions of this paragraph (c). However, for 

this purpose, P treats its basis in Share B as 

reduced by the $6 gain taken into account 

with respect to Share A. Thus, solely for 

purposes of computing the basis reduction 

required with respect to P’s basis in Share B, 

P’s basis in Share B is treated as $94 ($100 

less $6). If, after the application of this 

paragraph (c), the sale of Share B is still a 

transfer of a loss share, then the transfer is 

subject to paragraph (d) of this section. 

(Although the basis of Share B is not reduced 

by gain for purposes of paragraph (d) of this 

section, paragraph (d)(3)(i)(A) of this section 

applies netting principles to limit 

adjustments under paragraph (d) of this 

section.) 

(ii) Allocation of gain amount to determine 

net loss. The facts are the same as in 

paragraph (i) of this Example, except that, in 

addition to Share A and Share B, a third 

share of S stock, Share C, is outstanding. P’s 

basis in Share C is $80. P sells all three 

shares of S stock to X for $60 each. P’s sales 

of Share B and Share C are transfers of loss 

shares and therefore subject to the provisions 

of this section. (No adjustment is required 

under paragraph (b) of this section because 

P transfers the group’s entire interest in S to 

a nonmember in a fully taxable transaction. 

See paragraph (b)(1)(ii)(B) of this section.) 

The transfer is then subject to the provisions 

of this paragraph (c). However, for this 

purpose, P treats its bases in Share B and 

Share C as reduced by the $6 gain taken into 

account on Share A. The gain is allocated to 

Share B and Share C proportionately based 

on the amount of loss in each share. Thus, 

$4 of gain ($40/$60 × $6) is treated as 

allocated to Share B and $2 of gain ($20/$60 

× $6) is treated as allocated to Share C. 

Accordingly, P computes the basis reduction 

required under this paragraph (c) by treating 

its basis in Share B as $96 ($100 less $4) and 

its basis in Share C as $78 ($80 less $2). If, 

after the application of this paragraph (c), the 

sales of Share B and Share C are still transfers 

of loss shares, then the transfers are subject 

to paragraph (d) of this section. (Although the 

bases of Share B and Share C are not reduced 

by gain for purposes of paragraph (d) of this 

section, paragraph (d)(3)(i)(A) of this section 

applies netting principles to limit 

adjustments under paragraph (d) of this 

section.) 

(iii) Disposition of stock with deferred gain. 

The facts are the same as in paragraph (i) of 

this Example, except that P sells the gain 

share to a member. Under § 1.1502–13, P’s 

gain recognized on Share A is not taken into 

account in the taxable year of the transfer and 

therefore cannot be treated as reducing P’s 

loss recognized on Share B. 

(8) Examples. The application of this 

paragraph (c) is illustrated by the 

following examples. 

Example 1. Appreciation reflected in stock 

basis at acquisition. (i) Appreciation 

recognized as gain. (A) Facts. On January 1, 

year 1, P purchases the sole outstanding 

share of S stock for $100. At that time, S 

owns two assets, Asset 1 with a basis of $0 

and a value of $40, and Asset 2 with a basis 

and value of $60. In year 1, S sells Asset 1 

for $40. On December 31, year 1, P sells its 

S share for $100. After applying and giving 

effect to all generally applicable rules of law 

(other than this section), P’s basis in the S 

share is $140 (P’s original $100 basis 

increased under § 1.1502–32 to reflect the 

$40 gain recognized on the sale of Asset 1). 

P’s sale of the S share is a transfer of a loss 

share and therefore subject to the provisions 

of this section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share is reduced, but not below value, by 

the lesser of the share’s net positive 

adjustment and disconformity amount. The 

share’s net positive adjustment is the greater 

of zero and the sum of all investment 

adjustments applied to the basis of the share, 

computed without taking distributions into 

account. There are no distributions. The only 

investment adjustment to the share is the $40 

adjustment attributable to the gain 

recognized on the sale of Asset 1. Thus the 

share’s net positive adjustment is $40. The 

share’s disconformity amount is the excess, 

if any, of its basis ($140) over its allocable 

portion of S’s net inside attribute amount. S’s 

net inside attribute amount is the sum of S’s 

money ($40 from the sale of Asset 1) and S’s 

basis in Asset 2 ($60), or $100. The share is 

the only outstanding S share and so its 

allocable portion of the $100 net inside 

attribute amount is the entire $100. Thus, the 

share’s disconformity amount is $40, the 

excess of $140 over $100. The lesser of the 

net positive adjustment ($40) and the share’s 

disconformity amount ($40) is $40. 

Accordingly, the basis in the share is reduced 

by $40, from $140 to $100, immediately 

before the sale. 

(D) Application of paragraph (d) of this 

section. Because P’s sale of the S share is no 

longer a transfer of a loss share after the 

application of this paragraph (c), paragraph 

(d) of this section does not apply. 

(ii) Appreciation recognized as income 

(instead of gain). The facts are the same as 

in paragraph (i)(A) of this Example 1, except 

that, instead of selling Asset 1, the value of 

Asset 1 is consumed in the production of $40 

of income in year 1 (reducing the value of 

Asset 1 to $0) Because the net positive 

adjustment includes items of income as well 

as items of gain, the results are the same as 

those described in paragraph (i) of this 

Example 1. 

(iii) Post-acquisition appreciation 

eliminates stock loss. The facts are the same 

as in paragraph (i)(A) of this Example 1 


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3002 Federal Register / Vol. 72, No. 14 / Tuesday, January 23, 2007 / Proposed Rules 

except that, in addition, the value of Asset 2 

increases to $100 before the stock is sold. As 

a result, P sells the S share for $140. Because 

P’s sale of the S share is not a transfer of a 

loss share, this section does not apply to the 

transfer, notwithstanding that P’s basis in the 

S share was increased by the gain recognized 

on Asset 1. 

(iv) Distributions. (A) Facts. The facts are 

the same as in paragraph (i)(A) of this 

Example 1 except that, in addition, S 

distributes a $10 dividend before the end of 

year 1. As a result, the value of the share 

decreases and P sells the share for $90. After 

applying and giving effect to all generally 

applicable rules of law (other than this 

section), P’s basis in the S share is $130 (P’s 

original $100 basis increased by $30 under 

§ 1.1502–32 (the net of the $40 gain 

recognized on the sale of Asset 1 and the $10 

dividend declared and distributed)). P’s sale 

of the S share is a transfer of a loss share and 

therefore subject to the provisions of this 

section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

there redetermination would change no 

member’s basis in a share (members hold 

only one share of S stock) or because P 

transfers the group’s entire interest in S to a 

nonmember in a fully taxable transaction. 

See, respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share is reduced, but not below value, by 

the lesser of the share’s net positive 

adjustment and disconformity amount. The 

share’s net positive adjustment is $40 (the 

sum of all investment adjustments applied to 

the basis of the share, computed without 

taking distributions into account). The 

share’s disconformity amount is the excess of 

its basis ($130) over its allocable portion of 

S’s net inside attribute amount. S’s net inside 

attribute amount is the sum of S’s money 

($30, the $40 sale proceeds minus the $10 

distribution) and S’s basis in Asset 2 ($60), 

or $90. The share is the only outstanding S 

share and so its allocable portion of the $90 

net inside attribute amount is the entire $90. 

The lesser of the share’s net positive 

adjustment ($40) and its disconformity 

amount ($40) is $40. Accordingly, the basis 

in the share is reduced by $40, from $130 to 

$90, immediately before the sale. 

(D) Application of paragraph (d) of this 

section. Because P’s sale of the S share is no 

longer a transfer of a loss share after the 

application of this paragraph (c), paragraph 

(d) of this section does not apply. 

Example 2. Loss of appreciation reflected 

in basis. (i) Facts. On January 1, year 1, P 

purchases the sole outstanding share of S 

stock for $100. At that time, S owns two 

assets, Asset 1 with a basis of $0 and a value 

of $40, and Asset 2 with a basis and value 

of $60. The value of Asset 1 declines to $0 

and P sells its S share for $60. After applying 

and giving effect to all generally applicable 

rules of law (other than this section), P’s 

basis in the S share remains $100. P’s sale of 

the S share is a transfer of a loss share and 

therefore subject to the provisions of this 

section. 

(ii) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(iii) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share ($100) is reduced immediately before 

the sale, but not below value ($60), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. There were no 

adjustments to P’s basis in the share and so 

the share’s net positive adjustment is $0. 

Thus, although the share’s disconformity 

amount is $40 (the excess of P’s basis in the 

share ($100) over the share’s allocable 

portion of S’s net inside attribute amount 

($60)), no basis reduction is required under 

this paragraph (c). 

(iv) Application of paragraph (d) of this 

section. After the application of this 

paragraph (c), P’s sale of the S share is still 

a transfer of a loss share, and, accordingly, 

subject to paragraph (d) of this section. No 

adjustment is required under paragraph (d) of 

this section because there is no aggregate 

inside loss. See paragraph (d)(3)(iii) of this 

section. 

Example 3. Items accruing after S becomes 

a member. (i) Recognition of loss accruing 

after S becomes a member. (A) Facts. On 

January 1, year 1, P purchases the sole 

outstanding share of S stock for $100. At that 

time, S owns two assets, Asset 1, with a basis 

of $0 and a value of $40, and Asset 2, with 

a basis and value of $60. In year 1, S sells 

Asset 1 for $40. Also in year 1, the value of 

Asset 2 declines and S sells Asset 2 for $20. 

On December 31, year 1, P sells its S share 

for $60. After applying and giving effect to 

all generally applicable rules of law (other 

than this section), P’s basis in the S share is 

$100 (P’s original $100 basis, unadjusted 

under § 1.1502–32 because the $40 gain 

recognized on the sale of Asset 1 offsets the 

$40 loss on the sale of Asset 2). P’s sale of 

the S share is a transfer of a loss share and 

therefore subject to the provisions of this 

section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share ($100) is reduced immediately before 

the sale, but not below value ($60), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. The share’s net 

positive adjustment is $0. Thus, although the 

share has a disconformity amount of $40 (the 

excess of P’s basis in the share ($100) over 

the share’s allocable portion of S’s net inside 

attribute amount ($60)), no basis reduction is 

required under this paragraph (c). 

(D) Application of paragraph (d) of this 

section. After the application of this 

paragraph (c), P’s sale of the S share is still 

a transfer of a loss share, and, accordingly, 

subject to paragraph (d) of this section. No 

adjustment is required under paragraph (d) of 

this section because there is no aggregate 

inside loss. See paragraph (d)(3)(iii) of this 

section. 

(ii) Recognition of gain accruing after S 

becomes a member. (A) Facts. The facts are 

the same as in paragraph (i)(A) of this 

Example 3, except that neither P nor S sells 

anything in year 1. In addition, in year 2, the 

value of Asset 1 declines to $0, the value of 

Asset 2 returns to $60, and S creates Asset 

3 (with a basis of $0). In year 3, S sells Asset 

3 for $40. On December 31, year 3, P sells 

its S share for $100. After applying and 

giving effect to all generally applicable rules 

of law (other than this section), P’s basis in 

the S share is $140 (P’s original $100 basis 

increased under § 1.1502–32 to reflect the 

$40 gain recognized on the sale of Asset 3 in 

year 3). 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share ($140) is reduced immediately before 

the sale, but not below value ($100), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. The share’s net 

positive adjustment is $40 (the year 3 

investment adjustment). The share’s 

disconformity amount is the excess of its 

basis ($140) over its allocable portion of S’s 

net inside attribute amount. S’s net inside 

attribute amount is $100, the sum of S’s 

money ($40 from the sale of Asset 3) and its 

basis in its assets ($60 (the sum of Asset 1’s 

basis of $0 and Asset 2’s basis of $60)). S’s 

$100 net inside attribute amount is allocable 

entirely to the sole outstanding S share. 

Thus, the share’s disconformity amount is 

the excess of $140 over $100, or $40. The 

lesser of the share’s net positive adjustment 

($40) and its disconformity amount ($40) is 

$40. Accordingly, the basis in the share is 

reduced by $40, from $140 to $100, 

immediately before the sale. 

(D) Application of paragraph (d) of this 

section. Because P’s sale of the S share is no 


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Federal Register / Vol. 72, No. 14 / Tuesday, January 23, 2007 / Proposed Rules 3003 

longer a transfer of a loss share after the 

application of this paragraph (c), paragraph 

(d) of this section does not apply. 

(iii) Recognition of income earned after S 

becomes a member. The facts are the same 

as in paragraph (ii)(A) of this Example 3, 

except that instead of creating Asset 3, S 

earns $40 of income from services provided 

in year 3. Because the net positive 

adjustment includes items of income as well 

as items of gain, the results are the same as 

those described in paragraph (ii) of this 

Example 3. 

Example 4. Computing the disconformity 

amount. (i) Unrecognized loss reflected in 

stock basis. (A) Facts. P owns the sole 

outstanding share of S stock with a basis of 

$100. S owns two assets, Asset 1 with a basis 

of $20 and a value of $60, and Asset 2 with 

a basis of $60 and a value of $40. In year 1, 

S sells Asset 1 for $60. On December 31, year 

1, P sells the S share for $100. After applying 

and giving effect to all generally applicable 

rules of law (other than this section), P’s 

basis in the S share is $140 (P’s original $100 

basis increased under § 1.1502–32 to reflect 

the $40 gain recognized on the sale of Asset 

1). P’s sale of the S share is a transfer of a 

loss share and therefore subject to the 

provisions of this section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share ($140) is reduced immediately before 

the sale, but not below value ($100), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. The share’s net 

positive adjustment is $40 (the year 1 

investment adjustment). The share’s 

disconformity amount is the excess of its 

basis ($140) over its allocable portion of S’s 

net inside attribute amount. S’s net inside 

attribute amount is the sum of S’s money 

($60 from the sale of Asset 1) and S’s basis 

in Asset 2 ($60), or $120. S’s net inside 

attribute amount is allocable entirely to the 

sole outstanding S share. Thus, the share’s 

disconformity amount is the excess of $140 

over $120, or $20. The lesser of the share’s 

net positive adjustment ($40) and its 

disconformity amount ($20) is $20. 

Accordingly, the basis in the share is reduced 

by $20, from $140 to $120, immediately 

before the sale. 

(D) Application of paragraph (d) of this 

section. After the application of this 

paragraph (c), P’s sale of the S share is still 

a transfer of a loss share, and, accordingly, 

subject to paragraph (d) of this section. 

Paragraph (d) of this section reduces the basis 

of Asset 2 by $20 because the loss is 

duplicated. 

(ii) Loss carryover. The facts are the same 

as in paragraph (i)(A) of this Example 4, 

except that Asset 2 has a basis of $0 (rather 

than $60) and S has a $60 loss carryover (as 

defined in paragraph (f)(6) of this section). 

Because the net positive adjustment includes 

items of income (and not just gain), the 

analysis of the application of this paragraph 

(c) is the same here as in paragraph (i)(C) of 

this Example 4. Furthermore, the analysis of 

the application of this paragraph (C) would 

also be the same if the $60 loss carryover 

were subject to a section 382 limitation from 

a prior ownership change, and if, instead, it 

would subject to the limitation in § 1.1502–

21(c) on losses carried from separate return 

limitation years. However, under each 

alternative fact pattern, paragraph (d) of this 

section reduces the loss carryover by $20 

because the loss is duplicated. 

(iii) Liabilities. The facts are the same as in 

paragraph (i)(A) of this Example 4, except 

that S borrows $100 before P sells the S 

share. S’s net inside attribute amount 

remains $120, computed as the sum of S’s 

money ($160 ($60 from the sale of Asset 1 

plus the $100 borrowed cash)) plus S’s basis 

in Asset 2 ($60), minus its liabilities ($100). 

Thus, the S share’s disconformity amount 

remains the excess of $140 over $120, or $20. 

The results are the same as in paragraph (i) 

of this Example 4. 

Example 5. Computing the allocable 

portion of the net inside attribute amount. (i) 

Facts. On January 1, year 1, P owns all five 

outstanding shares of S stock with a basis of 

$20 per share. S owns Asset with a basis of 

$0. In year 1, S sells Asset for $100. On 

December 31, year 1, P sells one of its shares, 

Share 1, for $20. After applying and giving 

effect to all generally applicable rules of law 

(other than this section), P’s basis in its Share 

1 is $40 (P’s original $20 basis increased by 

$20 under § 1.1502–32 to reflect the share’s 

allocable portion of the $100 gain recognized 

on the sale of Asset). P’s sale of Share 1 is 

a transfer of a loss share and therefore subject 

to the provisions of this section. 

(ii) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section because 

redetermination would change no member’s 

basis in a share (S has only one class of stock 

outstanding and there is no disparity in the 

basis of the shares). See paragraph 

(b)(1)(ii)(A) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of Share 1 is still a transfer of a loss 

share and therefore subject to this paragraph 

(c). 

(iii) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in 

Share 1 ($40) is reduced immediately before 

the sale, but not below value ($20), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. Share 1’s net 

positive adjustment is $20 (the year 1 

investment adjustment). Share 1’s 

disconformity amount is the excess of its 

basis ($40) over its allocable portion of S’s 

net inside attribute amount. S’s net inside 

attribute amount is the sum of S’s money 

($100 from the sale of the asset), and Share 

1’s allocable portion of S’s net inside 

attribute amount is $20 (1⁄5 × $100). Thus, 

Share 1’s disconformity amount is the excess 

of $40 over $20, or $20. The lesser of the 

share’s net positive adjustment ($20) and its 

disconformity amount ($20) is $20. 

Accordingly, the basis in the share is reduced 

by $20, from $40 to $20, immediately before 

the sale. 

(iv) Application of paragraph (d) of this 

section. Because P’s sale of Share 1 is no 

longer a transfer of a loss share after the 

application of this paragraph (c), paragraph 

(d) of this section does not apply. 

Example 6. Liabilities. (i) In general. (A) 

Facts. On January 1, year 1, P purchases the 

sole outstanding share of S stock for $100. At 

that time, S owns Asset, with a basis of $0 

and value of $100, and $100 cash. S also has 

a $100 liability. In year 1, S distributes $60 

to P and earns $20. The value of Asset 

declines to $60 and, on December 31, year 1, 

P sells the S share for $20. After applying and 

giving effect to all generally applicable rules 

of law (other than this section), P’s basis in 

the S share is $60 (P’s original $100 basis 

decreased under § 1.1502–32 by $40 (the net 

of the $60 distribution and the $20 income 

earned)). P’s sale of the S share is a transfer 

of a loss share and therefore subject to the 

provisions of this section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share ($60) is reduced immediately before 

the sale, but not below value ($20), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. The share’s net 

positive adjustment is $20 (the year 1 

investment adjustment computed without 

taking the distribution into account). The 

share’s disconformity amount is the excess of 

its basis ($60) over its allocable portion of S’s 

net inside attribute amount. S’s net inside 

attribute amount is negative $40, computed 

as the sum of S’s money ($60 ($100 minus 

the $60 distribution plus the $20 income 

earned)) plus S’s basis in Asset ($0), minus 

S’s liability ($100). S’s net inside attribute 

amount is allocable entirely to the sole 

outstanding S share. Thus, the share’s 

disconformity amount is the excess of $60 

over negative $40, or $100. The lesser of the 

share’s net positive adjustment ($20) and its 

disconformity amount ($100) is $20. 

Accordingly, the basis in the share is reduced 

by $20, from $60 to $40, immediately before 

the sale. 

(D) Application of paragraph (d) of this 

section. After the application of this 

paragraph (c), the S share is still a loss share 

and, accordingly, S’s attributes are subject to 

reduction under paragraph (d) of this section. 

No adjustment is required under paragraph 

(d) of this section, however, because there is 

no aggregate inside loss. See paragraph 

(d)(3)(iii) of this section. 

(ii) Excluded cancellation of indebtedness 

income—insufficient attributes available for 


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3004 Federal Register / Vol. 72, No. 14 / Tuesday, January 23, 2007 / Proposed Rules 

reduction required by sections 108 and 1017, 

and § 1.1502–28. (A) Facts. The facts are the 

same as in paragraph (i)(A) of this Example 

6, except that P does not sell the S share. 

Instead, in year 4, Asset is destroyed in a fire 

and S spends its $60 on deductible expenses 

that are not absorbed by the group. S’s loss 

becomes part of the consolidated net 

operating loss (CNOL). In year 5, S becomes 

insolvent and S’s debt is discharged. Because 

of S’s insolvency, S’s discharge of 

indebtedness income is excluded under 

section 108 and, as a result, S’s attributes are 

subject to reduction under sections 108 and 

1017, and § 1.1502–28. S’s only attribute is 

the portion of the CNOL attributable to S 

($60) and it is reduced to $0. There are no 

other consolidated attributes. In year 5, the 

S stock becomes worthless under section 

165(g), taking into account the provisions of 

§ 1.1502–80(c). After applying and giving 

effect to all generally applicable rules of law 

(other than this section), P’s basis in the S 

share is $60 (P’s original $100 basis 

decreased under § 1.1502–32 by the year 1 

investment adjustment of $40 (the net of the 

$60 distribution and the $20 income earned). 

The investment adjustment for year 5 is $0 

($60 tax exempt income from the excluded 

COD applied to reduce attributes minus $60 

noncapital, nondeductible expense from the 

reduction of S’s portion of the CNOL). Under 

paragraph (f)(11)(i)(D) of this section, a share 

is transferred on the last day of the taxable 

year during which it becomes worthless 

under section 165(g), taking into account the 

provisions of § 1.1502–80(c). Accordingly, P 

transfers a loss share of S stock on December 

31, year 5, and the transfer is therefore 

subject to the provisions of this section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section because 

redetermination would change no member’s 

basis in a share. See paragraph (b)(1)(ii)(A) of 

this section. After the application of 

paragraph (b) of this section, P’s transfer of 

the S share is still a transfer of a loss share 

and therefore subject to this paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in its 

S share ($60) is reduced immediately before 

the sale, but not below value ($0), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. The share’s net 

positive adjustment is $20 (the year 1 

investment adjustment computed without 

taking the distribution into account). The 

share’s disconformity amount is the excess of 

its basis ($60) over its allocable portion of S’s 

net inside attribute amount. S’s net inside 

attribute amount is $0 (S’s basis in Asset). 

(The attribute reduction required under 

sections 108 and 1017 and § 1.1502–28 is 

given effect before the application of this 

section; therefore, S’s portion of the CNOL 

was eliminated under section 108 and 

§ 1.1502–28.) S’s net inside attribute amount 

is allocable entirely to the sole outstanding 

S share. Thus, the share’s disconformity 

amount is the excess of $60 over $0, or $60. 

The lesser of the share’s net positive 

adjustment ($20) and its disconformity 

amount ($60) is $20. Accordingly, the basis 

in the share is reduced by $20, from $60 to 

$40, immediately before the transfer. 

(D) Application of paragraph (d) of this 

section. After the application of this 

paragraph (c), the S share is still a loss share, 

and, accordingly, S’s attributes are subject to 

reduction under paragraph (d) of this section. 

No adjustment is required under paragraph 

(d) of this section, however, because there is 

no aggregate inside loss. See paragraph 

(d)(3)(iii) of this section. 

(iii) Excluded cancellation of indebtedness 

income—full attribute reduction under 

sections 108 and 1017, and § 1.1502–28 

(using attributes attributable to another 

member). (A) Facts. The facts are the same as 

in paragraph (ii)(A) of this Example 6 except 

that P loses the $60 distributed in year 1 and 

the loss is not absorbed by the group. Thus, 

as of December 31, year 5, the CNOL is $120, 

attributable $60 to S and $60 to P. As a result, 

under § 1.1502–28(a)(4), after the portion of 

the CNOL attributable to S is reduced to $0, 

the remaining $40 of excluded COD applies 

to the portion of the CNOL attributable to P, 

reducing it from $60 to $20. After applying 

and giving effect to all generally applicable 

rules of law (other than this section), P’s 

basis in the S share at the end of year 5 is 

$100 (P’s original $100 basis decreased under 

§ 1.1502–32 by $40 at the end of year 1 and 

then increased under § 1.1502–32 by $40 at 

the end of year 5 ($100 tax exempt income 

from the excluded COD applied to reduce 

attributes minus $60 noncapital, 

nondeductible expense from the reduction of 

S’s portion of the CNOL). Under paragraph 

(f)(11)(i)(D) of this section, a share is 

transferred on the last day of the taxable year 

during which it becomes worthless under 

section 165(g), taking into account the 

provisions of § 1.1502–80(c). Accordingly, P 

transfers a loss share of S stock on December 

31, year 5, and the transfer is therefore 

subject to the provisions of this section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section because 

redetermination would change no member’s 

basis in a share. See paragraph (b)(1)(ii)(A) of 

this section. After the application of 

paragraph (b) of this section, P’s transfer of 

the S share is still a transfer of a loss share 

and therefore subject to this paragraph (c). 

(C) Basis reduction under this paragraph 

(c). Under this paragraph (c), P’s basis in the 

S share ($100) is reduced immediately before 

the sale, but not below value ($0), by the 

lesser of the share’s net positive adjustment 

and disconformity amount. The share’s net 

positive adjustment is $60 (the sum of the 

year 1 investment adjustment computed 

without taking the distribution into account 

($20) and the year 5 investment adjustment 

($40)). The share’s disconformity amount is 

the excess of its basis ($100) over its allocable 

portion of S’s net inside attribute amount. S’s 

net inside attribute amount is $0 (S’s basis in 

Asset). S’s net inside attribute amount is 

allocable entirely to the sole outstanding S 

share. The share’s disconformity amount is 

therefore $100. The lesser of the share’s net 

positive adjustment ($60) and its 

disconformity amount ($100) is $60. 

Accordingly, P’s basis in the share is reduced 

by $60, from $100 to $40, immediately before 

the transfer. 

(D) Application of paragraph (d) of this 

section. After the application of this 

paragraph (c), the S share is still a loss share, 

and, accordingly, S’s attributes are subject to 

reduction under paragraph (d) of this section. 

No adjustment is required under paragraph 

(d) of this section, however, because there is 

no aggregate inside loss. See paragraph 

(d)(3)(iii) of this section. 

Example 7. Lower-tier subsidiary (no 

transfer of lower-tier stock). (i) Facts. P owns 

the sole outstanding share of S stock with a 

basis of $160. S owns two assets, Asset A 

with a basis and value of $100, and the sole 

outstanding share of S1 stock with a basis of 

$60. S1 owns one asset, Asset 1, with a basis 

of $20 and value of $60. In year 1, S1 sells 

Asset 1 to X for $60, recognizing $40 of gain. 

On December 31, year 1, P sells its S share 

to Y, a member of another consolidated 

group, for $160. After applying and giving 

effect to all generally applicable rules of law 

(other than this section), P’s basis in the S 

share is $200 (P’s original $160 basis 

increased under § 1.1502–32 by $40 (to 

reflect the tiering up of the increase to S’s 

basis in S1 under § 1.1502–32 by $40 (to 

reflect the gain recognized on S1’s sale of 

Asset 1)). P’s sale of the S share is a transfer 

of a loss share and therefore subject to the 

provisions of this section. (S does not transfer 

the S1 share because S and S1 are members 

of the same group following the transfer. See 

paragraph (f)(11) of this section.) 

(ii) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. After the 

application of paragraph (b) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and therefore subject to this 

paragraph (c). 

(iii) Basis reduction under this paragraph 

(c). (A) In general. Under this paragraph (c), 

P’s basis in the S share ($200) is reduced 

immediately before the sale, but not below 

value ($160), by the lesser of the share’s net 

positive adjustment and disconformity 

amount. The S share’s net positive 

adjustment is $40. The share’s disconformity 

amount is the excess, if any, of the basis of 

the share ($200) over the share’s allocable 

portion of S’s net inside attribute amount. S’s 

net inside attribute amount is the sum of S’s 

basis in Asset A ($100) plus S’s basis in the 

S1 share. 

(B) S’s basis in the S1 share. Although S’s 

actual basis in the S1 share is $100 (S’s 

original $60 basis increased by S1’s year 1 

positive $40 investment adjustment), for 

purposes of computing the S share’s 

disconformity amount, S’s basis in the S1 

share is tentatively reduced by the lesser of 

the S1 share’s net positive adjustment and its 

disconformity amount. The S1 share’s net 

positive adjustment is $40 (the year 1 

investment adjustment). The S1 share’s 

disconformity amount is the excess, if any, of 

its basis ($100) over its allocable portion of 

S1’s net inside attribute amount. S1’s net 

inside attribute amount is $60 (its cash 

received on the sale of Asset 1) and it is 


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entirely attributable to S’s S1 share. The S1 

share’s disconformity amount is therefore the 

excess of $100 over $60, or $40. The lesser 

of the S1 share’s net positive adjustment 

($40) and its disconformity amount ($40) is 

$40. Accordingly, for purposes of computing 

the disconformity amount of the S share, S’s 

basis in its S1 share is tentatively reduced by 

$40, from $100 to $60. 

(C) The disconformity amount of P’s S 

share. S’s net inside attribute amount is 

treated as the sum of its basis in Asset A 

($100) and its (tentatively reduced) basis in 

its S1 share ($60), or $160. S’s net inside 

attribute amount is allocable entirely to P’s 

S share. Thus, the S share’s disconformity 

amount is the excess of $200 over $160, or 

$40. 

(D) Amount of reduction. P’s basis in its S 

share is reduced by the lesser of the S share’s 

net positive adjustment ($40) and 

disconformity amount ($40), or $40. 

Accordingly, P’s basis in the S share is 

reduced by $40, from $200 to $160, 

immediately before the sale. 

(E) Effect on S’s basis in its S1 share. The 

transaction has no effect on S’s basis in the 

S1 share. Thus, S owns the S1 share with a 

basis of $100, S’s original $60 basis in the 

share plus the $40 adjustment for the gain 

recognized on the sale of Asset 1 in year 1. 

(iv) Application of paragraph (d) of this 

section. Because P’s sale of the S share is no 

longer a transfer of a loss share after the 

application of this paragraph (c), paragraph 

(d) of this section does not apply. 

(d) Attribute reduction to prevent 

duplication of loss—(1) In general. The 

rules of this paragraph (d) reduce S’s 

attributes to the extent they duplicate a 

net loss on shares of S stock transferred 

by members in a single transaction. This 

rule furthers single entity principles by 

preventing S from using deductions and 

losses to the extent that the group or its 

members (including former members) 

have either used, or preserved for later 

use, a corresponding loss in S shares. 

This rule applies without regard to 

whether S ceases to be a member after 

the transfer of its shares. 

(2) Attribute reduction rule—(i) 

General. If a transferred share is a loss 

share after the application of paragraph 

(c) of this section, S’s attributes are 

reduced by S’s attribute reduction 

amount. S’s attribute reduction amount 

is determined under paragraph (d)(3) of 

this section and applied in accordance 

with the provisions of paragraphs (d)(4), 

(d)(5), and (d)(6) of this section. 

(ii) Transfers of stock of subsidiaries 

at multiple tiers. If stock of subsidiaries 

at multiple tiers is transferred in a 

transaction, this paragraph (d) (other 

than paragraph (d)(6) to the extent 

necessary to make the election to 

reattribute attributes) applies only after 

paragraphs (b) and (c) of this section 

have applied with respect to all 

transfers of loss shares. See paragraph 

(a)(3)(ii) of this section regarding the 

order of application of this section. 

(3) Attribute reduction amount—(i) 

General. S’s attribute reduction amount 

is the lesser of—

(A) The net stock loss (see paragraph 

(d)(3)(ii) of this section); and 

(B) S’s aggregate inside loss (see 

paragraph (d)(3)(iii) of this section). 

(ii) Net stock loss. The net stock loss 

is the excess, if any, of—

(A) The aggregate basis of all shares of 

S stock transferred by members in the 

transaction (taking into account any 

adjustments required under paragraphs 

(b) and (c) of this section, any gain or 

loss recognized at lower tiers, and any 

other related or resulting adjustments); 

over 

(B) The aggregate value of those 

shares. 

(iii) Aggregate inside loss—(A) 

General. S’s aggregate inside loss is the 

excess, if any, of—

(1) S’s net inside attribute amount; 

over 

(2) The value of all outstanding shares 

of S stock. 

(B) Net inside attribute amount. S’s 

net inside attribute amount generally 

has the same meaning as in paragraph 

(c)(5) of this section. However, if S 

holds stock of a lower-tier subsidiary, 

the provisions of paragraph (d)(5) of this 

section (and not the provisions of 

paragraph (c)(6) of this section) modify 

the computation of S’s net inside 

attribute amount for purposes of this 

paragraph (d). 

(iv) Transactions that adjusted stock 

or asset basis. See paragraph (e)(2) of 

this section for special rules that may 

apply if a prior transaction, such as an 

exchange subject to section 362(e)(2), 

adjusted the basis in any share of S 

stock or S’s attributes in a manner that 

altered the potential for loss 

duplication. 

(v) Lower-tier subsidiaries. See 

paragraph (d)(5) of this section for 

special rules relating to the application 

of this paragraph (d) if S owns shares of 

stock of a subsidiary. 

(4) Application of attribute 

reduction—(i) Attributes available for 

reduction. S’s attributes available for 

reduction under this paragraph (d) are—

(A) Category A. Net operating loss 

carryovers; 

(B) Category B. Capital loss 

carryovers; 

(C) Category C. Deferred deductions; 

(D) Category D. Basis in publicly 

traded property (other than stock of a 

subsidiary), but only to the extent of the 

amount, if any, that each such 

property’s basis exceeds its value; and 

(E) Category E. Basis of assets 

excluding—

(1) Money and cash equivalents, and 

(2) The basis of publicly traded 

property (other than stock of a 

subsidiary). 

(ii) Rules of application—(A) In 

general. S’s attribute reduction amount 

is allocated and applied to reduce the 

attributes in each category in the order 

that the categories are set forth in 

paragraph (d)(4)(i) of this section. If the 

amount to be allocated and applied to 

any category equals or exceeds the 

amount of attributes in the category, the 

attributes in that category are reduced to 

zero and any excess is then allocated 

and applied to the attributes in the next 

category. If the amount to be allocated 

and applied is less than the amount of 

attributes in any category other than 

Category A or Category B, it is allocated 

and applied proportionately to all 

attributes in the category based on the 

amount of each attribute. If the amount 

to be allocated and applied to attributes 

in Category E exceeds the amount of 

attributes in that category, then—

(1) To the extent of any liabilities of 

S (or a lower-tier subsidiary) that are not 

taken into account for tax purposes 

before the transfer, such excess is 

suspended and allocated and applied 

proportionately to reduce any amounts 

that would be deductible or 

capitalizable as a result of such 

liabilities later being taken into account 

by S or another person; solely for 

purposes of this paragraph 

(d)(4)(ii)(A)(1), liability means any 

liability or obligation that would be 

required to be capitalized as an assumed 

liability by a person that purchased all 

of S’s assets and assumed all of S’s 

liabilities in a single transaction; and 

(2) To the extent such excess is greater 

than any amount suspended by 

paragraph (d)(4)(ii)(A)(1) of this section, 

it is disregarded and has no further 

effect. 

(B) Order of reduction of loss 

carryovers. With respect to attributes in 

Category A and Category B, the attribute 

reduction amount is applied first to 

reduce losses carried from the first 

taxable year in which a loss carryover 

arose, and then to reduce loss carryovers 

that arose in each next successive year. 

(C) Time and effect of attribute 

reduction. In general, the reduction of 

attributes is effective immediately 

before the transaction in which there is 

a transfer of a loss share of S stock. If 

the reduction to a member’s basis in a 

share of S stock exceeds the basis of that 

share, the excess is an excess loss 

account to which the member owning 

the share succeeds (and such excess loss 

account is not taken into account under 

§ 1.1502–19 or otherwise as a result of 

the transaction). The reductions to 


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attributes required under this paragraph 

(d)(4), including by reason of paragraph 

(d)(5)(ii)(D) of this section (tier down of 

attribute reduction amounts to lowertier subsidiaries), are not noncapital, 

nondeductible expenses described in 

§ 1.1502–32(b)(2)(iii). Accordingly, such 

reductions have no effect on the basis of 

stock of upper-tier subsidiaries. 

(5) Special rules applicable if S holds 

stock of a lower-tier subsidiary (S1) 

immediately before a transfer of loss 

shares of S stock—(i) Computation of 

S’s attribute reduction amount. For 

purposes of determining S’s attribute 

reduction amount under paragraph 

(d)(3) of this section—

(A) Single share. All of S’s shares of 

S1 stock held immediately before the 

transaction (whether or not transferred 

in, or held by S immediately after, the 

transaction) are treated as a single share 

(generally referred to as the S1 stock); 

and 

(B) Deemed basis. S’s basis in its S1 

stock is treated as its deemed basis in 

the stock, which is equal to the greater 

of—

(1) The sum of S’s basis in each share 

of S1 stock (adjusted to reflect any gain 

or loss recognized on the transfer of any 

S1 shares in the transaction, whether 

allowed or disallowed); and 

(2) The portion of S1’s net inside 

attribute amount allocable to S’s shares 

of S1 stock. 

(C) Multiple tiers. If S owns (directly 

or indirectly) stock of subsidiaries in 

multiple tiers (whether or not 

transferred in, or held by S, directly or 

indirectly, immediately after, the 

transaction), S’s deemed basis in such 

stock is determined first with respect to 

shares of stock of the lowest-tier 

subsidiary or subsidiaries. Deemed basis 

is then determined with respect to the 

basis of stock of subsidiaries in each 

next higher tier. 

(ii) Allocation and application of S’s 

attribute reduction amount—(A) 

Allocation of attribute reduction 

amount between S1 stock and other 

assets. For purposes of allocating S’s 

attribute reduction amount, S’s basis in 

S1 stock is treated as equal to its 

deemed basis in the S1 stock 

(determined under paragraph (d)(5)(i)(B) 

of this section), reduced by—

(1) The value of S’s transferred shares 

of S1 stock, 

(2) The excess of the sum of S1’s 

money, S1’s cash equivalents, the value 

of S1’s publicly traded property (other 

than stock of a subsidiary) and S1’s 

transferred shares of lower-tier 

subsidiary (S2) stock, and all 

corresponding S2 amounts (net of S2’s 

liabilities) that are allocable to S1’s 

nontransferred shares of S2 stock, over 

the total amount of S1’s liabilities, to the 

extent that such excess is allocable to 

S’s nontransferred shares of S1 stock, 

and 

(3) The corresponding amounts with 

respect to shares of stock of all lower 

tier subsidiaries. 

(B) Application of attribute reduction 

amount to S’s S1 stock. The attribute 

reduction amount allocated to S’s S1 

stock (the allocated amount) is 

apportioned among, and applied to 

reduce S’s bases in, S’s individual S1 

shares in accordance with the 

following—

(1) No allocated amount is 

apportioned to a share of transferred S1 

stock if gain or loss is recognized on its 

transfer; 

(2) The allocated amount is 

apportioned among all of S’s other 

shares of S1 stock in a manner that, 

when applied to those shares, reduces 

the disparity in S’s bases in the S1 

shares to the greatest extent possible; 

(3) The allocated amount that is 

apportioned to any S1 share transferred 

in a transfer in which no gain or loss 

was recognized is applied only to the 

extent necessary to reduce the bases of 

that share to, but not below, the value 

of the share; and 

(4) The allocated amount that is 

apportioned to S1 shares not transferred 

in the transaction is applied to reduce 

the basis of such shares without 

limitation. 

(C) Further effects of allocated 

amount. Any portion of the allocated 

amount that is not applied to reduce S’s 

basis in a share of S1 stock has no effect 

on any other attributes of S, it is not a 

noncapital, nondeductible expense of S, 

and it does not cause S to recognize 

income or gain. However, as provided in 

paragraph (d)(5)(ii)(D) of this section, 

such amounts continue to be part of the 

allocated amount for purposes of the tier 

down rule in paragraph (d)(5)(ii)(D) of 

this section. 

(D) Tier down of attribute reduction 

amount—(1) General rule. The portion 

of S’s attribute reduction amount that is 

allocated to S1 stock (the allocated 

amount) is an attribute reduction 

amount of S1. Thus, subject to the basis 

conforming limitation in paragraph 

(d)(5)(ii)(D)(2) of this section, the 

allocated amount applies to reduce S1’s 

attributes under the provisions of this 

paragraph (d). The allocated amount is 

an attribute reduction amount of S1 that 

must be allocated to S1’s assets even if 

its application to S’s basis in S1 stock 

is limited under paragraph (d)(5)(ii)(B) 

of this section and even if its 

application to S1’s attributes is limited 

under paragraph (d)(5)(ii)(D)(2) of this 

section. 

(2) Conforming limitation on 

reduction of lower-tier subsidiary’s 

attributes. Notwithstanding the general 

rule in paragraph (d)(5)(ii)(D)(1) of this 

section, and subject to any modification 

in paragraph (e)(2) of this section, the 

application of S’s attribute reduction 

amount to S1’s attributes (the tier down 

amount) is limited such that, when 

combined with any attribute reduction 

amount computed with respect to a 

transfer of S1 stock, the total amount of 

reduction to S1’s attributes does not 

exceed the excess of—

(i) The portion of S1’s net inside 

attributes that is allocable to all S1 

shares held by members immediately 

before the transaction; over 

(ii) The sum of the value of all S1 

shares transferred by members in the 

transaction and the sum of all members’

bases in any other shares of S1 stock 

held immediately before the transaction 

(after any reduction under this section, 

including this paragraph (d)). 

(iii) Stock basis restoration. After this 

paragraph (d) has applied with respect 

to all shares of subsidiary stock 

transferred in the transaction, basis is 

restored under this paragraph (d)(5)(iii). 

In general, under this paragraph 

(d)(5)(iii), reductions otherwise required 

under paragraph (d)(5)(ii)(B) of this 

section are reversed to the extent 

necessary to restore members’ bases in 

subsidiary stock to conform the basis of 

each member’s share of subsidiary stock 

to the share’s allocable portion of the 

subsidiary’s net inside attribute amount 

as defined in paragraph (c)(5) of this 

section, without regard to paragraph 

(c)(6) of this section. The restoration 

adjustments are first made at the lowest 

tier and then at each next higher tier 

successively. Restoration adjustments 

do not tier up to affect the bases of 

higher-tier shares. Rather, restoration is 

computed and applied separately at 

each tier. For purposes of this rule—

(A) A subsidiary’s net inside attribute 

amount is determined by treating the 

basis in stock of a lower-tier subsidiary 

as the actual basis of the stock, as 

adjusted under this section; 

(B) The net inside attribute amount is 

treated as decreased by any attribute 

reduction amount suspended under 

paragraph (d)(4)(ii)(A)(1) of this section 

(liabilities not taken into account); and 

(C) If a subsidiary received property 

in a prior intercompany section 

362(e)(2) transaction and the stock of 

such subsidiary was reduced as the 

result of an election under section 

362(e)(2)(C) (taking into account the 

provisions of § 1.1502–13(e)(4)), the net 

inside attribute amount must be reduced 

as provided in paragraph (e)(2) of this 

section. 


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(6) Elections to reduce the potential 

for loss duplication—(i) In general. 

Notwithstanding the general operation 

of this paragraph (d), the common 

parent of the group of which S is a 

member immediately before the 

transaction (P) may make an irrevocable 

election to reduce the potential for loss 

duplication, and thereby avoid or 

reduce attribute reduction. Under this 

paragraph (d)(6), P may elect to reduce 

members’ bases in transferred loss 

shares of S stock, or reattribute S’s 

attributes (including attributes of lowertier subsidiaries) to the extent such 

attributes would otherwise be subject to 

reduction under this paragraph (d), or 

both. The combined amount of stock 

basis reduction and reattribution of 

attributes may not exceed S’s attribute 

reduction amount, tentatively computed 

without regard to any election under 

this paragraph (d)(6). 

(ii) Order of application—(A) Stock of 

one subsidiary transferred in the 

transaction. If shares of stock of only 

one subsidiary are transferred in the 

transaction, any stock basis reduction 

and reattribution of attributes (including 

from lower-tier subsidiaries) is deemed 

to occur immediately before the 

application of this paragraph (d), based 

on the tentatively computed attribute 

reduction amount. If a transferred share 

is still a loss share after giving effect to 

this election, the provisions of this 

paragraph (d) then apply with respect to 

that share. 

(B) Stock of multiple subsidiaries 

transferred in the transaction. If shares 

of stock of more than one subsidiary are 

transferred in the transaction and 

elections under this paragraph (d)(6) are 

made with respect to transfers of stock 

of subsidiaries in multiple tiers, effect is 

given to the elections from the lowest 

tier to the highest tier in the manner 

provided in this paragraph (d)(6)(ii)(B). 

The scope of the election for the transfer 

at the lowest tier is determined by 

tentatively applying paragraph (d) with 

respect to the transferred loss shares of 

this lowest-tier subsidiary immediately 

after applying paragraphs (b) and (c) of 

this section to the stock of such 

subsidiary. The effect of any stock basis 

reduction or reattribution of losses 

immediately tier up (under the 

principles of § 1.1502–32) to adjust 

members’ bases in all higher-tier shares. 

The process is repeated for elections for 

each next higher-tier transfer. 

(iii) Special rules for reattribution 

elections—(A) In general. Because the 

reattribution election is intended to 

provide the group a means to retain 

certain S attributes, and not to change 

the location of attributes where S 

continues to be a member, the election 

to reattribute attributes may only be 

made if S becomes a nonmember 

(within the meaning of § 1.1502–

19(c)(2)) as a result of the transaction. 

The election to reattribute S’s attributes 

can only be made for attributes in 

Category A, Category B, and Category C. 

Attributes subject to the election will be 

reattributed to P in the same order, 

manner, and amount that they would 

otherwise be reduced under paragraph 

(d)(4) of this section. P succeeds to 

reattributed attributes as if such 

attributes were succeeded to in a 

transaction described in section 381(a). 

Any owner shift of the subsidiary 

(including any deemed owner shift 

resulting from section 382(g)(4)(D) or 

section 382(l)(3)) in connection with the 

transaction is not taken into account 

under section 382 with respect to the 

reattributed attributes. The reattribution 

of S’s attributes is a noncapital, 

nondeductible expense described in 

§ 1.1502–32(b)(2)(iii). See § 1.1502–

32(c)(1)(ii)(B) regarding special 

allocations applicable to such 

noncapital, nondeductible expense. If P 

elects to reattribute S attributes 

(including attributes of a lower-tier 

subsidiary) and reduce S stock basis, the 

reattribution is given effect before the 

stock basis reduction. 

(B) Insolvency limitation. If S, or any 

higher-tier subsidiary, is insolvent 

within the meaning of section 108(d)(3) 

at the time of the transfer, S’s losses may 

be reattributed only to the extent they 

exceed the sum of the separate 

insolvencies of any subsidiaries (taking 

into account only S and its higher-tier 

subsidiaries) that are insolvent. For 

purposes of determining insolvency, 

liabilities owed to higher-tier members 

are not taken into account, and stock of 

a subsidiary that is limited and 

preferred as to dividends and that is not 

owned by higher-tier members is treated 

as a liability to the extent of the amount 

of preferred distributions to which the 

stock would be entitled if the subsidiary 

were liquidated on the date of the 

disposition. 

(C) Limitation on reattribution from 

lower-tier subsidiaries. P’s ability to 

reattribute attributes of lower-tier 

subsidiaries is limited under this 

paragraph (d)(6)(iii)(C) in order to 

prevent circular computations of the 

attribute reduction amount. 

Accordingly, attributes that would 

otherwise be reduced as a result of tier 

down attribute reduction under 

paragraph (d)(5)(ii)(D) of this section 

may only be reattributed to the extent 

that the reduction in the basis of any 

lower-tier subsidiary stock resulting 

from the noncapital, nondeductible 

expense (as allocated under § 1.1502–

32(c)(1)(ii)(B)) will not create an excess 

loss account in any such stock. 

(iv) Special rules for stock basis 

reduction elections. An election to 

reduce basis in S stock is effective for 

all members’ basis in loss shares of S 

stock that are transferred in the 

transaction. The reduction is allocated 

among all such shares in proportion to 

the amount of loss on each share. This 

reduction in S stock basis is a 

noncapital, nondeductible expense of 

the transferring member. The attribute 

reduction amount (determined under 

paragraph (d)(3)(i) of this section) is 

treated as reduced by the amount of any 

reduction in the basis of the S stock 

under this paragraph (d)(6). 

Accordingly, the election to reduce 

stock basis under this paragraph (d)(6) 

is treated as reducing or eliminating the 

duplication even if the shares of S stock 

are loss shares after giving effect to the 

election. 

(v) Form and manner of election. An 

election under this paragraph (d)(6) is 

made in the form of a statement titled 

‘‘Section 1.1502–36 Election to 

Reattribute Attributes,’’ ‘‘Section 

1.1502–36 Election to Reduce Stock 

Basis,’’ or ‘‘Section 1.1502–36 Election 

to Reattribute Attributes and Reduce 

Stock Basis,’’ as applicable. The 

statement must include the name and 

employer identification number of the 

subsidiary the stock of which is 

transferred, the name and employer 

identification number of any lower-tier 

subsidiary whose attributes are 

reattributed, and the amount by which 

the group is electing to reattribute 

attributes and/or reduce stock basis. The 

statement must be included on or with 

the group’s timely filed original return 

for the taxable year of the transfer of the 

subsidiary stock to which the election 

relates. 

(7) Examples. The application of this 

paragraph (d) is illustrated by the 

following examples: 

Example 1. Computation of attribute 

reduction amount. (i) Transfer of all S shares. 

(A) Facts. P owns all 100 of the outstanding 

shares of S stock with a basis of $2 per share. 

S owns land with a basis of $100, has a $120 

loss carryover, and has no liabilities. Each 

share has a value of $1. P sells 30 of the S 

shares to X for $30. As a result of the sale, 

P and S cease to be members of the same 

group. Accordingly, P transfers all 100 S 

shares. See paragraphs (f)(11)(i)(A) and 

(f)(11)(i)(B) of this section. P’s transfer of the 

S shares is a transfer of loss shares and 

therefore subject to the provisions of this 

section. 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) of this section either 

redetermination would not change any 

member’s basis in an S share (there is only 


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one class of stock outstanding and there is no 

disparity in the basis of the shares). See 

paragraph (b)(1)(ii)(A) of this section. No 

adjustment is required under paragraph (c) of 

this section because the net positive 

adjustment is $0. See paragraph (c)(3) of this 

section. Thus, after the application of 

paragraph (c) of this section, P’s transfer of 

the S shares is still a transfer of loss shares 

and, accordingly, subject to this paragraph 

(d). 

(C) Attribute reduction under this 

paragraph (d). Under this paragraph (d), S’s 

attributes are reduced by S’s attribute 

reduction amount. Paragraph (d)(3) of this 

section 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 aggregate bases of the 

transferred shares ($200) over the aggregate 

value of the transferred shares ($100), or 

$100. S’s aggregate inside loss is the excess 

of its net inside attribute amount ($220, the 

sum of the $100 basis of the land and the 

$120 loss carryover) over the value of all 

outstanding S shares ($100), or $120. The 

attribute reduction amount is therefore the 

lesser of the net stock loss ($100) and the 

aggregate inside loss ($120), or $100. Under 

paragraph (d)(4) of this section, S’s $100 

attribute reduction amount is allocated and 

applied to reduce S’s $120 loss carryover to 

$20. Under paragraph (d)(4)(ii)(C) of this 

section, the reduction of the loss carryover is 

not a noncapital, nondeductible expense and 

has no effect on P’s basis in the S stock. 

(ii) Transfer of less than all S shares. (A) 

Facts. The facts are the same as in paragraph 

(i)(A) of this Example 1, except that P only 

sells 20 S shares to X. P’s sale of the 20 S 

shares is a transfer of loss shares and 

therefore subject to the provisions of this 

section. 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) or paragraph (c) of this 

section for the reasons set forth in paragraph 

(i)(B) of this Example 1. Thus, after the 

application of paragraph (c) of this section, 

P’s transfer of the S shares is still a transfer 

of loss shares and, accordingly, subject to this 

paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). Under this paragraph (d), S’s 

attributes are reduced by S’s attribute 

reduction amount. Paragraph (d)(3) of this 

section 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 aggregate bases of the 

transferred shares ($40) over the aggregate 

value of the transferred shares ($20), or $20. 

S’s aggregate inside loss is the excess of its 

net inside attribute amount ($220) over the 

value of all outstanding S shares ($100), or 

$120. The attribute reduction amount is 

therefore the lesser of the net stock loss ($20) 

and the aggregate inside loss ($120), or $20. 

Under paragraph (d)(4) of this section, S’s 

$20 attribute reduction amount is allocated 

and applied to reduce S’s $120 loss carryover 

to $100. Under paragraph (d)(4)(ii)(C) of this 

section, the reduction of the loss carryover is 

not a noncapital, nondeductible expense and 

has no effect on P’s basis in the S stock. 

Example 2. Proportionate allocation of 

attribute reduction amount. (i) Facts. P owns 

the sole outstanding share of S stock with a 

basis of $150. S owns land with a basis of 

$100, a factory with a basis of $20, and rental 

property with a basis of $30. P sells its S 

share for $90. P’s sale of the S share is a 

transfer of a loss share and therefore subject 

to the provisions of this section. 

(ii) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) of this section, either 

because redetermination would not change 

any member’s basis in a share (members hold 

only one share of S stock) or because P 

transfers the group’s entire interest in S to a 

nonmember in a fully taxable transaction. 

See, respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. No adjustment is 

required under paragraph (c) of this section 

because the net positive adjustment is $0. See 

paragraph (c)(3) of this section. Thus, after 

the application of paragraph (c) of this 

section, P’s sale of the S share is still a 

transfer of a loss share and, accordingly, 

subject to this paragraph (d). 

(iii) Attribute reduction under this 

paragraph (d). Under paragraph (d)(3) of this 

section, S’s attribute reduction amount is 

determined to be $60, the lesser of the net 

stock loss ($60) and S’s aggregate inside loss 

($60, the excess of S’s $150 net inside 

attribute amount (the $100 basis of the land 

plus the $20 basis of the factory plus the $30 

basis of the rental property) over the $90 

value of the S share). Under paragraph (d)(4) 

of this section, the $60 attribute reduction 

amount is allocated and applied 

proportionately to reduce S’s attributes as 

follows: 

Available attributes Attribute 

amount 

Allocable portion of attribute reduction amount 

Adjusted 

attributes 

amount 

Category E: 

Basis of land ......................................................................................................... $100 (100/150 × $60) $40 $60 

Basis of factory ..................................................................................................... 20 (20/150 × $60) $8 12 

Basis of rental property ........................................................................................ 30 (30/150 × $60) $12 18 

Total attributes ............................................................................................... 150 $60 90 

Example 3. Publicly traded property. (i) 

Facts. The facts are the same as in paragraph 

(i) of Example 2, except that, instead of the 

factory and rental property, S holds two 

shares of publicly traded stock, Share X 

(basis and value of $20) and Share Y (basis 

of $30 and value of $5). P’s sale of the S share 

is a transfer of a loss share and therefore 

subject to the provisions of this section. 

(ii) Application of paragraphs (b) and (c) 

of this section. No adjustment is made under 

paragraph (b) or paragraph (c) of this section 

for the reasons set forth in paragraph (ii) of 

Example 2. Thus, after the application of 

paragraph (c) of this section, P’s sale of the 

S share is still a transfer of a loss share and, 

accordingly, subject to this paragraph (d). 

(iii) Attribute reduction under this 

paragraph (d). Under paragraph (d)(3) of this 

section, S’s attribute reduction amount is 

determined to be $60, the lesser of the net 

stock loss ($60) and S’s aggregate inside loss 

($60, the excess of S’s $150 net inside 

attribute amount (the $20 basis of Share X 

plus the $30 basis of Share Y plus the $100 

basis of the land) over the $90 value of the 

S share). Although S has $150 of attributes, 

S’s attributes available for reduction include 

the basis of publicly traded property only to 

the extent it exceeds the value of the 

property. That loss on publicly traded 

property is a Category D attribute. S’s 

attribute reduction amount is allocated and 

applied to reduce S’s attributes as follows: 

Available attributes Attribute 

amount 

Application of 

attribute 

reduction 

amount 

Adjusted 

attribute 

amount 

Category D: 

Loss in Share Y .................................................................................................................... $25 $25 $0 

Category E: 

Basis of land ......................................................................................................................... 100 35 65 

Total attributes ............................................................................................................... 125 60 65 


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ATTRIBUTES AFTER APPLICATION OF PARAGRAPH (D) 

Attribute Amount 

Basis of Share X .................................................................................................................................................................................. $20 

Basis of Share Y .................................................................................................................................................................................. 5 

Basis of land ........................................................................................................................................................................................ 65 

Example 4. Attributes attributable to 

liability not taken into account. (i) S operates 

one business. (A) Facts. On January 1, year 

1, P forms S by exchanging $100 and land 

with a basis of $50 for the sole outstanding 

share of S stock. In year 1, S earns $500, 

spends $100 to build a factory on its land, 

and purchases $450 of publicly traded 

property. S also earns a section 38 general 

business credit of $50. However, pollution 

generated by S’s business gives rise to a 

substantial environmental remediation 

liability under Federal law. Before any 

amounts have been taken into account with 

respect to the environmental remediation 

liability, P sells its S share to X for $150. At 

the time of the sale, the value of the publicly 

traded property was $450. If X had purchased 

S’s assets and assumed S’s liabilities directly, 

X would have been required to capitalize any 

expenses related to environmental 

remediation. After giving effect to all other 

provisions of law, P’s basis in the S share is 

$650 (the original basis of $150 increased by 

the $500 income earned). The sale is 

therefore a transfer of a loss share of 

subsidiary stock and subject to this section. 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) of this section, either 

because redetermination would not change 

any member’s basis in a share (P holds only 

one share of S stock) or because P transfers 

the group’s entire interest in S to a 

nonmember in a fully taxable transaction. 

See, respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. No adjustment to 

basis is made under paragraph (c) of this 

section because, although the net positive 

adjustment is $500, the disconformity 

amount is $0. See paragraph (c)(3) of this 

section. Thus, after the application of 

paragraph (c) of this section, P’s sale of the 

S share is still a transfer of a loss share and, 

accordingly, subject to this paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). Under paragraph (d)(3) of this 

section, S’s attribute reduction amount is the 

lesser of the net stock loss ($500) and the 

aggregate inside loss. The aggregate inside 

loss is $500, computed as the excess of S’s 

net inside attribute amount ($650, the sum of 

$100 (basis in factory), $50 (basis in land), 

$450 (basis in publicly traded property), and 

$50 (cash remaining after purchases)) over 

the value of the S share ($150). Thus, S’s 

attribute reduction amount is $500, the lesser 

of the net stock loss ($500) and the aggregate 

inside loss ($500). Under paragraph (d)(4) of 

this section, S’s $500 attribute reduction 

amount is allocated and applied to reduce S’s 

attributes as follows: 

Available attributes Attribute 

amount 

Allocable portion of attribute 

reduction 

amount 

Adjusted attribute amount 

Category D: 

Loss on publicly traded property .......................................................................................... $0 $0 $0 

Category E: 

Basis of factory ..................................................................................................................... 100 100 0 

Basis of land ......................................................................................................................... 50 50 0 

Under the general rule of this paragraph 

(d), the remaining $350 attribute reduction 

amount would have no further effect (and 

would not be applied to reduce S’s general 

business tax credit). However, S has a 

liability that has not been taken into account, 

and, therefore, under paragraph 

(d)(4)(ii)(A)(1) of this section, the remaining 

$350 attribute reduction amount is 

suspended and allocated and applied to 

reduce any amounts that would be 

deductible or capitalizable as a result of the 

liability later being taken into account. If the 

liability is satisfied for an amount that is less 

than $350, under paragraph (d)(4)(ii)(A)(2) 

the remaining portion of that $350 is 

disregarded and has no further effect. 

(ii) S operates more than one business. (A) 

Facts. The facts are the same as in paragraph 

(i)(A) of Example 4, except that S operates a 

business providing environmental 

remediation services. Prior to P’s sale of the 

S share, S transfers its environmental 

remediation services business and its $50 of 

cash to S1 in exchange for the sole 

outstanding share of S1 stock. (S’s basis in 

the assets transferred in connection with the 

environmental remediation business is $0.) 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is made under 

paragraph (b) or paragraph (c) of this section 

for the reasons set forth in paragraph (i)(B) 

of this Example 4. Thus, after the application 

of paragraph (c) of this section, P’s sale of the 

S share is still a transfer of a loss share and, 

accordingly, subject to this paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of the net stock loss ($500) and the 

aggregate inside loss. The aggregate inside 

loss is the excess of S’s net inside attribute 

amount over the value of the S share. Under 

paragraph (d)(5)(i)(B) of this section, S’s net 

inside attribute amount is determined by 

using S’s deemed basis in the S1 share ($50, 

the greater of its basis ($50) and S1’s net 

inside attribute amount ($50)). Accordingly, 

S’s net inside attribute amount is $650 (the 

sum of $100 (basis in factory), $50 (basis in 

land), $450 (basis in publicly traded 

property), and $50 (deemed basis in S1 

stock)). The aggregate inside loss is $500, 

computed as the excess of S’s net inside 

attribute amount ($650) over the value of the 

S share ($150). Thus, S’s attribute reduction 

amount is $500, computed as the lesser of the 

net stock loss ($500) and the aggregate inside 

loss ($500). 

(2) Allocation, apportionment, and 

application of attribute reduction amount. 

Under paragraphs (d)(4) and (d)(5)(ii) of this 

section, S’s $500 attribute reduction amount 

is allocated proportionately (by basis) 

between its assets and the S1 share. Under 

paragraph (d)(5)(ii)(A) of this section, for this 

purpose, S’s basis in its S1 share is its 

deemed basis ($50) reduced by S1’s cash 

($50), or, $0. As a result, no portion of S’s 

attribute reduction amount is allocated to the 

S1 share and the entire attribute reduction 

amount is allocated as set forth in paragraph 

(i)(C) of this Example 4. In addition, as in 

paragraph (i)(C) of this Example 4, under 

paragraph (d)(4)(ii)(A)(1) of this section, the 

remaining $350 excess attribute reduction 

amount is suspended and applied to the 

extent of S’s environmental remediation 

liability to reduce any amounts that would be 

deductible or capitalizable as a result of such 

liability later being taken into account. 

Alternatively, assume that S1 had liabilities 

for employee medical expenses that had not 

been taken into account for tax purposes, the 

$350 excess attribute reduction amount 

would be suspended and then allocated and 

applied as S’s and S1’s liabilities are taken 

into account. In either case, under paragraph 

(d)(4)(ii)(A)(2) of this section, to the extent 

the suspended amount exceeds the liabilities 

taken into account, that excess is disregarded 

and has no further effect. 

Example 5. Wholly owned lower-tier 

subsidiary (no lower-tier transfer). (i) 

Application of conforming limitation. (A) 


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Facts. P owns the sole outstanding share of 

S stock with a basis of $250. S owns Asset 

with a basis of $100 and the only two 

outstanding shares of S1 stock (Share A has 

a basis of $40 and Share B has a basis of $60). 

S1 owns Asset 1 with a basis of $50. P sells 

its S share to P1, the common parent of 

another consolidated group, for $50. The sale 

is a transfer of a loss share and therefore 

subject to this section. 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) of this section, either 

because redetermination would not change 

any member’s basis in a share (members hold 

only one share of S stock) or because P 

transfers the group’s entire interest in S to a 

nonmember in a fully taxable transaction. 

See, respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. No adjustment is 

required under paragraph (c) of this section 

because, although there is a $50 

disconformity amount, the net positive 

adjustment is $0. See paragraph (c)(3) of this 

section. Thus, after the application of 

paragraph (c) of this section, P’s sale of the 

S share is still a transfer of a loss share and, 

accordingly, subject to this paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of P’s net stock loss and S’s 

aggregate inside loss. P’s net stock loss is 

$200 ($250 basis minus $50 value). S’s 

aggregate inside loss is the excess of S’s net 

inside attribute amount over the value of the 

S share. Under paragraphs (d)(3)(iii)(B) and 

(d)(5)(i) of this section, S’s net inside 

attribute amount is $200, computed as the 

sum of S’s basis in Asset ($100) and its 

deemed basis in the S1 stock (treated as a 

single share) ($100, computed as the greater 

of S’s $100 total basis in the S1 shares and 

S1’s $50 basis in Asset 1). S’s aggregate 

inside loss is therefore $150 ($200 net inside 

attribute amount minus $50 value of the S 

share). Accordingly, S’s attribute reduction 

amount is $150, the lesser of the net stock 

loss ($200) and the aggregate inside loss 

($150). 

(2) Allocation, apportionment, and 

application of S’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii) of this section, S’s $150 attribute 

reduction amount is allocated 

proportionately (by basis) between Asset 

(basis $100) and the S1 stock (treated as a 

single share) (deemed basis $100). 

Accordingly, $75 of the attribute reduction 

amount ($100/$200 × $150) is allocated to 

Asset and $75 of the attribute reduction 

amount ($100/$200 × $150) is allocated to the 

S1 stock. The $75 allocated to Asset is 

applied to reduce S’s basis in Asset to $25. 

The $75 allocated to the S1 stock is first 

apportioned between the shares in a manner 

that reduces disparity to the greatest extent 

possible. Thus, of the total $75 allocated to 

the S1 stock, $27.50 is apportioned to Share 

A and $47.50 is apportioned to Share B. The 

application of the apportioned amounts 

reduces the basis of each share to $12.50. As 

a result, immediately after the allocation, 

apportionment, and application of S’s 

attribute reduction amount, S’s basis in Asset 

is $25 and S’s basis in each of the S1 shares 

is $12.50. 

(3) Tier down of S’s attribute reduction 

amount, application of conforming 

limitation. Under paragraph (d)(5)(ii)(D) of 

this section, any portion of S’s attribute 

reduction amount allocated to S1 stock is an 

attribute reduction amount of S1 (regardless 

of the extent, if any, to which it is 

apportioned and applied to reduce the basis 

of any shares of S1 stock). Under the general 

rules of this paragraph (d), the $75 allocated 

to the S1 stock would be applied to reduce 

S1’s basis in Asset 1 to $0. However, under 

paragraph (d)(5)(ii)(D)(2) of this section, S1’s 

attributes can be reduced by only $25 as a 

result of tier down attribute reduction, the 

excess of the portion of S1’s net inside 

attribute amount that is allocable to all S1 

shares held by members immediately before 

the transaction ($50) over the sum of 

aggregate value of S1 shares transferred by 

members in the transaction (none) and the 

aggregate amount of members’ bases in 

nontransferred S1 shares, after reduction 

under this paragraph ($25). Thus, of S1’s $75 

tier down attribute reduction amount, only 

$25 is applied to reduce S1’s basis in Asset 

1, from $50 to $25. The remaining $50 of 

allocated amount has no further effect. 

(4) Basis restoration. Under paragraph 

(d)(5)(iii) of this section, after this paragraph 

(d) has been applied with respect to all 

transfers of subsidiary stock, any reduction 

made to the basis of a share of subsidiary 

stock under paragraph (d)(5)(ii)(B) of this 

section is reversed to the extent necessary to 

conform the basis of that share to the share’s 

allocable portion of the subsidiary’s net 

inside attribute amount. S1’s net inside 

attribute amount after the application of this 

paragraph (d) is $25 and thus each of the two 

S1 share’s allocable portion of S1’s net inside 

attribute amount is $12.50. Accordingly, the 

basis of each share (as reduced by this 

paragraph (d)) is already conformed with its 

allocable portion of S1’s net inside attribute 

amount and no restoration will be required 

or permitted under paragraph (d)(5)(iii) of 

this section. 

(ii) Application of basis restoration rule. 

(A) Facts. The facts are the same as in 

paragraph (i)(A) of this Example 5, except 

that S’s basis in Share A is $15 and S’s basis 

in Share B is $35, and S1’s basis in Asset 1 

is $100. 

(B) Basis redetermination and basis 

reduction under paragraphs (b) and (c) of 

this section. No adjustment is required under 

paragraph (b) or paragraph (c) of this section 

for the reasons set forth in paragraph (i)(B) 

of this Example 5. Thus, after the application 

of paragraph (c) of this section, P’s transfer 

of the S share is still a transfer of a loss share 

and, accordingly, subject to this paragraph 

(d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of P’s net stock loss and S’s 

aggregate inside loss. P’s net stock loss is 

$200 ($250 basis minus $50 value). S’s 

aggregate inside loss is the excess of S’s net 

inside attribute amount over the value of the 

S share. Under paragraphs (d)(3)(iii)(B) and 

(d)(5)(i) of this section, S’s net inside 

attribute amount is $200, computed as the 

sum of S’s basis in Asset ($100) and its 

deemed basis in the S1 stock (treated as a 

single share) ($100, computed as the greater 

of S’s $50 total basis in the S1 shares and 

S1’s $100 basis in Asset 1). S’s aggregate 

inside loss is therefore $150 ($200 net inside 

attribute amount minus $50 value of the S 

share). Accordingly, S’s attribute reduction 

amount is $150, the lesser of the net stock 

loss ($200) and the aggregate inside loss 

($150). 

(2) Allocation, apportionment, and 

application of S’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii) of this section, S’s $150 attribute 

reduction amount is allocated 

proportionately (by basis) between Asset 

(basis $100) and the S1 stock (treated as a 

single share) (deemed basis $100). 

Accordingly, $75 of the attribute reduction 

amount ($100/$200 × $150) is allocated to 

Asset and $75 of the attribute reduction 

amount ($100/$200 × $150) is allocated to the 

S1 stock. The $75 allocated to Asset is 

applied to reduce S’s basis in Asset to $25. 

The $75 allocated to the S1 stock is first 

apportioned between the shares in a manner 

that reduces disparity to the greatest extent 

possible. Thus, of the total $75 allocated to 

the S1 stock, $27.50 is apportioned to Share 

A and $47.50 is apportioned to Share B. The 

application of the apportioned amounts 

reduces the basis of each share to an excess 

loss account of $12.50. As a result, 

immediately after the allocation, 

apportionment, and application of S’s 

attribute reduction amount, S’s basis in Asset 

is $25 and S’s basis in each of the S1 shares 

is an excess loss account of $12.50. 

(3) Tier down of S’s attribute reduction 

amount, application of limitation. Under 

paragraph (d)(5)(ii)(D) of this section, any 

portion of S’s attribute reduction amount 

allocated to S1 stock is an attribute reduction 

amount of S1 (regardless of the extent, if any, 

to which it is apportioned and applied to 

reduce the basis of any shares of S1 stock). 

Accordingly, under the general rules of this 

paragraph (d), the $75 allocated to the S1 

stock is applied to reduce S1’s basis in Asset 

1 from $100 to $25. 

(4) Basis restoration. Under paragraph 

(d)(5)(iii) of this section, after this paragraph 

(d) has been applied with respect to all 

transfers of subsidiary stock, any reduction 

made to the basis of a share of subsidiary 

stock under paragraph (d)(5)(ii)(B) of this 

section is reversed to the extent necessary to 

conform the basis of that share to the share’s 

allocable portion of the subsidiary’s net 

inside attribute amount. S1’s net inside 

attribute amount after the application of this 

paragraph (d) is $25 and thus each of the two 

S1 share’s allocable portion of S1’s net inside 

attribute amount is $12.50. Accordingly, the 

reductions to share A and to share B under 

this paragraph (d) are reversed to restore the 

basis of each share to $12.50. Thus, $25 of 

the $27.50 attribute reduction applied to 

reduce the basis of share A and $25 of the 

$47.50 attribute reduction applied to reduce 

the basis of share B are reversed, restoring the 

basis of each share to $12.50. 

Example 6. Multiple blocks of lower-tier 

subsidiary stock outstanding. (i) Excess loss 


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account taken into account (transfer of 

upper-tier share causes disposition within 

the meaning of § 1.1502–19(c)(1)(ii)(B)). (A) 

Facts. P owns the sole outstanding share of 

S stock with a basis of $200. S holds all five 

outstanding shares of S1 common stock 

(shares A, B, C, D, and E). S has an excess 

loss account of $20 in share A and a positive 

basis of $20 in each of the other shares. The 

only investment adjustment applied to any 

S1 share was a negative $20 investment 

adjustment applied to share A when it was 

the only outstanding share, and this amount 

tiered up and adjusted P’s basis in the S 

share. S1 owns one asset with a basis of $250. 

P sells its S share to P1, the common parent 

of a consolidated group, for $20. The sale of 

the S share is a disposition of share A under 

§ 1.1502–19(c)(1)(ii)(B) (after the transaction, 

S1 will no longer be a member of the P 

group). Under paragraph (a)(3)(i) of this 

section, before the application of this section, 

S’s excess loss account in share A is taken 

into account, increasing S’s basis in share A 

to $0 and P’s basis in its S share to $220. 

After giving effect to the recognition of the 

excess loss account, P’s sale of the S share 

is a transfer of a loss share and therefore 

subject to the provisions of this section. 

(B) Basis redetermination and basis 

reduction under paragraphs (b) and (c) of 

this section. No adjustment is made under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. No adjustment is 

made under paragraph (c) of this section 

because, even though there is a disconformity 

amount of $120, the net positive adjustment 

is zero. See paragraph (c)(3) of this section. 

Thus, after the application of paragraph (c) of 

this section, P’s sale of the S share remains 

a transfer of a loss share and, accordingly, 

subject to this paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of P’s net stock loss and S’s 

aggregate inside loss. P’s net stock loss is 

$200 (the S share’s $220 basis minus its $20 

value). S’s aggregate inside loss is the excess 

of S’s net inside attribute amount over the 

value of the S share. Under paragraphs 

(d)(3)(iii)(B) and (d)(5)(i) of this section, S’s 

net inside attribute amount is $250, S’s 

deemed basis in the S1 stock (treated as a 

single share) ($250, computed as the greater 

of S’s $80 total basis in the S1 shares ($0 

basis of share A plus $20 of basis in each of 

the four other shares) and S1’s $250 basis in 

its asset). S’s aggregate inside loss is therefore 

$230 ($250 net inside attribute amount minus 

$20 value of the S share). Accordingly, S’s 

attribute reduction amount is $200, the lesser 

of the net stock loss ($200) and the aggregate 

inside loss ($230). 

(2) Allocation, apportionment, and 

application of S’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii) of this section, S’s $200 attribute 

reduction amount is allocated entirely to the 

S1 stock (treated as a single share) and then 

apportioned among the shares in a manner 

that reduces disparity to the greatest extent 

possible. Thus, $24 is apportioned to share 

A and $44 is apportioned to each of the other 

shares. Because there is no transfer of the S1 

shares, the apportioned amounts are applied 

fully to reduce the basis of each share to an 

excess loss account of $24. 

(3) Tier down of S’s attribute reduction 

amount. Under paragraph (d)(5)(ii)(D) of this 

section, the $200 of S’s attribute reduction 

amount allocated to the S1 shares is an 

attribute reduction amount of S1 (regardless 

of the extent, if any, to which it is 

apportioned and applied to reduce the basis 

of any shares of S1 stock). Accordingly, 

under the general rules of this paragraph (d), 

S1’s $200 attribute reduction amount is 

allocated and applied to reduce S1’s basis in 

its asset from $250 to $50. 

(4) Basis restoration. Under paragraph 

(d)(5)(iii) of this section, after this paragraph 

(d) has been applied with respect to all 

transfers of subsidiary stock, any reduction 

made to the basis of a share of subsidiary 

stock under paragraph (d)(5)(ii)(B) of this 

section is reversed to the extent necessary to 

conform the basis of that share to the share’s 

allocable portion of the subsidiary’s net 

inside attribute amount. S1’s net inside 

attribute amount after the application of this 

paragraph (d) is $50 and thus each of the five 

S1 share’s allocable portion of S1’s net inside 

attribute amount is $10. Accordingly, the 

reductions to the bases of S1 stock under this 

paragraph (d) are reversed to restore (to the 

extent possible) the basis of each share to 

$10. Thus, $24 of the $24 attribute reduction 

applied to reduce the basis of share A is 

reversed, restoring the basis of share A to $0, 

and $34 of the $44 attribute reduction 

applied to reduce the basis of each other 

share is reversed, restoring the basis of each 

of those shares to $10. 

(ii) Sale of gain share to member. (A) Facts. 

The facts are the same as in paragraph (i)(A) 

of this Example 6, except that P owns shares 

A, B, C, and D, S owns share E, S has a 

liability of $20, and S1’s basis in its asset is 

$500. Also, as part of the transaction, S sells 

share E to P for $40. Unlike under the facts 

of paragraph (i)(A) of this Example 6, there 

is no disposition of share A within the 

meaning of § 1.1502–19(c)(1)(ii)(B) (because 

the share continues to be held by P, and S1 

continues to be a member of the P group). As 

a result, the share A excess loss account is 

not taken into account. Although S’s sale of 

share E is a transfer of that share, the share 

is not a loss share and thus the transfer is not 

subject to this section. P’s sale of the S share, 

however, is a transfer of a loss share and 

therefore subject to the provisions of this 

section. 

(B) Transfer in lowest tier (gain share). S’s 

sale of share E is the lowest tier transfer in 

the transaction. Under paragraph 

(a)(3)(ii)(A)(1) of this section, because there 

are no transfers of loss shares at that tier, no 

adjustments are required under paragraphs 

(b) and (c) of this section. However, S’s gain 

recognized on the transfer of share E is 

computed and immediately adjusts members 

basis in subsidiary stock under the principles 

of § 1.1502–32 (because P and S are not 

members of the same group immediately after 

the transaction the sale is not subject to 

§ 1.1502–13). Accordingly, P’s basis in its S 

share is increased by $20, from $200 to $220. 

(C) Transfers in next higher (the highest) 

tier (application of paragraphs (b) and (c) of 

this section). The next highest tier transfer is 

P’s sale of the S stock. Because the sale is a 

transfer of a loss share, first paragraph (b) of 

this section and then paragraph (c) of this 

section apply to the transfer. No adjustments 

are required under paragraph (b), either 

because there is no potential for 

redetermination (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. Under paragraph 

(c) of this section, P’s basis in its S share is 

decreased by $20, the lesser of the 

disconformity amount ($200, computed as 

the excess of stock basis ($220) over S’s net 

inside attribute amount ($20, the $40 value 

of the transferred Share E minus the $20 

liability)) and the net positive adjustment 

($20). Thus, after the application of 

paragraph (c) of this section, P’s basis in the 

S share is $200, and the sale remains a 

transfer of a loss share. There are no higher 

tier transfers and, therefore, P’s transfer of the 

S share is then subject to this paragraph (d). 

(D) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of P’s net stock loss and S’s 

aggregate inside loss. After the application of 

paragraph (c) of this section, P’s net stock 

loss is $180 (the S share’s $200 basis minus 

its $20 value). S’s aggregate inside loss is the 

excess of S’s net inside attribute amount over 

the value of the S share. Under paragraphs 

(d)(3)(iii)(B) and (d)(5)(i) of this section, S’s 

net inside attribute amount is $80, computed 

as $100 (S’s deemed basis in share E (the 

greater of S’s basis in share E, adjusted for 

the gain recognized, ($40) and share E’s 

allocable portion of S1’s net inside attribute 

amount ($100, representing 1/5 of S1’s $500 

basis in its asset)) minus S’s liability ($20). 

Accordingly, S’s net aggregate inside loss is 

$60 ($80 net inside attribute amount minus 

$20 value of the S stock). S’s attribute 

reduction amount is therefore the lesser of 

$180 and $60, or $60. 

(2) Allocation, apportionment, and 

application of S’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii) of this section, S’s $60 attribute 

reduction amount is allocated entirely to its 

S1 stock, share E. However, under paragraph 

(d)(5)(ii)(B)(1) of this section, none of the 

allocated amount is apportioned to, or 

applied to reduce the basis of share E because 

share E was transferred in a transaction in 

which gain or loss was recognized. Under 

paragraph (d)(5)(ii)(C) of this section, the $60 

allocated amount not apportioned to share E 

has no effect on S or S’s attributes. 

(3) Tier down of S’s attribute reduction 

amount. Notwithstanding the fact that no 

portion of the allocated amount was 

apportioned to or applied to reduced the 

basis of share E, the entire $60 allocated 

amount tiers down and is an attribute 


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reduction amount of S1. See paragraphs 

(d)(5)(ii)(C) and (d)(5)(ii)(D) of this section. 

Under the general rules of this paragraph (d), 

S1’s $60 attribute reduction amount is 

allocated and applied to reduce S1’s basis in 

its asset from $500 to $440. 

(4) Basis restoration. Under paragraph 

(d)(5)(iii) of this section, after this paragraph 

(d) has been applied with respect to all 

transfers of subsidiary stock, any reduction 

made to the basis of a share of subsidiary 

stock under paragraph (d)(5)(ii)(B) of this 

section is reversed to the extent necessary to 

conform the basis of that share to the share’s 

allocable portion of the subsidiary’s net 

inside attribute amount. No reduction was 

made to the basis of any share of subsidiary 

stock under paragraph (d)(5)(ii)(B) of this 

section. Therefore, no stock basis is increased 

under the basis restoration rule in paragraph 

(d)(5)(iii) of this section. 

Example 7. Allocation of attribute 

reduction if lower-tier subsidiary has nonloss 

assets or liabilities. (i) S1 holds cash. (A) 

Facts. P owns the sole outstanding share of 

S stock with a basis of $800. S owns Asset 

1 with a basis of $400 and the sole 

outstanding share of S1 stock with a basis of 

$300. S1 holds Asset 2 with a basis of $50, 

and $100 cash. P sells its S share to P1, the 

common parent of a consolidated group, for 

$100. 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) of this section, either 

because redetermination would change no 

member’s basis in a share (members hold 

only one share of S stock) or because P 

transfers the group’s entire interest in S to a 

nonmember in a fully taxable transaction. 

See, respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. No adjustment is 

required under paragraph (c) of this section 

because the net positive adjustment is $0. See 

paragraph (c)(3) of this section. Thus, after 

the application of paragraph (c) of this 

section, P’s sale of the S share is still a 

transfer of a loss share and, accordingly, 

subject to this paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of P’s net stock loss and S’s 

aggregate inside loss. P’s net stock loss is 

$700 (the S share’s $800 basis minus its $100 

value). S’s aggregate inside loss is the excess 

of S’s net inside attribute amount over the 

value of the S share. Under paragraphs 

(d)(3)(iii)(B) and (d)(5)(i) of this section, S’s 

net inside attribute amount is the sum of its 

basis in Asset 1 of $400 and its deemed basis 

in the S1 share. S’s deemed basis in the S1 

share is $300, the greater of S’s basis in the 

S1 share ($300) and S1’s net inside attribute 

amount ($150, S1’s $50 basis in Asset 2 plus 

S1’s $100 cash). Therefore, S’s net inside 

attribute amount is $700 and S’s aggregate 

inside loss is $600 ($700 net inside attribute 

amount less $100 value). S’s attribute 

reduction amount is $600, the lesser of the 

net stock loss ($700) and the aggregate inside 

loss ($600). 

(2) Allocation, apportionment, and 

application of S’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii)(A) of this section, S’s $600 attribute 

reduction amount is allocated 

proportionately (by basis) between S’s basis 

in Asset 1 ($400) and its deemed basis in the 

S1 share. For purposes of allocating the 

attribute reduction amount, S’s deemed basis 

in the S1 share is reduced by S1’s $100 cash 

(from $300 to $200). Thus, the $600 is 

allocated $400 to Asset 1 ($400/$600 × $600) 

and $200 to the S1 share ($200/$600 × $600). 

The $400 allocated to Asset 1 is applied to 

reduce S’s basis in Asset 1 to $0. The $200 

allocated to the S1 share is apportioned and 

applied to reduce S’s basis in the S1 share 

to $100. 

(3) Tier down of S’s attribute reduction 

amount. Under paragraph (d)(5)(ii)(D) of this 

section, any portion of S’s attribute reduction 

amount allocated to the S1 stock is an 

attribute reduction amount of S1 (regardless 

of the extent, if any, to which it is 

apportioned and applied to reduce the basis 

of any shares of S1 stock). Accordingly, 

under the general rules of this paragraph (d), 

the $200 allocated to the S1 share is an 

attribute reduction amount of S1 that is 

allocated and applied entirely to reduce S1’s 

basis in Asset 2 from $50 to $0. The 

remaining $150 S1 attribute reduction 

amount is disregarded and has no further 

effect. 

(4) Basis restoration. Under paragraph 

(d)(5)(iii) of this section, after this paragraph 

(d) has been applied with respect to all 

transfers of subsidiary stock, any reduction 

made to the basis of a share of subsidiary 

stock under paragraph (d)(5)(ii)(B) of this 

section is reversed to the extent necessary to 

conform the basis of that share to the share’s 

allocable portion of the subsidiary’s net 

inside attribute amount. S1’s net inside 

attribute amount after the application of this 

paragraph (d) is $100 and thus the S1 share’s 

allocable portion of S1’s net inside attribute 

amount is $100. Accordingly, the basis of the 

share (as reduced by this paragraph (d)) is 

already conformed with its allocable portion 

of S1’s net inside attribute amount and no 

restoration will be required or permitted 

under paragraph (d)(5)(iii) of this section. 

(ii) S1 borrows cash. The facts are the same 

as in paragraph (i)(A) of this Example 7 

except that S1 borrows $50 from X, an 

unrelated person, immediately before P sells 

the S share. The computation of the attribute 

reduction amount is the same as in paragraph 

(i)(C) of this Example 7 (because the $50 cash 

from the loan proceeds and the $50 liability 

offset in the computation of S’s net inside 

attribute amount). However, under paragraph 

(d)(5)(ii)(A) of this section, for purposes of 

allocating the attribute reduction amount, 

deemed basis is reduced by the amount of 

S1’s cash, but only to the extent it exceeds 

S1’s liabilities. S1’s cash ($150, the original 

$100 plus the $50 loan proceeds) exceeds its 

liability ($50) by $100, so S’s deemed basis 

in the S1 share is reduced by $100 (from 

$300 to $200) for allocation purposes. The 

results are the same as in paragraph (i) of this 

Example 7. 

(iii) S1 borrows cash and invests in nonpublicly traded property. (A) Facts. The facts 

are the same as in paragraph (ii) of this 

Example 7 except that S1 uses its $150 (the 

original $100 plus the $50 loan proceeds) to 

purchase Asset 3, an asset that is not publicly 

traded. 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) or paragraph (c) of this 

section for the reasons set forth in paragraph 

(i)(B) of this Example 7. Thus, after the 

application of paragraph (c) of this section, 

P’s sale of the S share is still a transfer of a 

loss share and, accordingly, subject to this 

paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. The attribute reduction 

amount is the same as computed in 

paragraph (i)(C)(1) of this Example 7 (because 

$50 of the basis in S1’s assets and the $50 

liability offset in the computation of S1’s net 

inside attribute amount of $150). 

(2) Allocation, apportionment, and 

application of S’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii)(A) of this section, S’s $600 attribute 

reduction amount is allocated 

proportionately (by basis) between S’s basis 

in Asset 1 ($400) and its deemed basis in the 

S1 share. For purposes of allocating the 

attribute reduction amount, deemed basis is 

only reduced for allocation purposes by cash, 

cash equivalents, and the value of publicly 

traded property (reduced by liabilities). Thus, 

there is no reduction to the basis of the S1 

share for purposes of allocating the attribute 

reduction amount. Accordingly, S’s $600 

attribute reduction amount is allocated $343 

($400/$700 × $600) to Asset 1 and $257 

($300/$700 × $600) to the S1 share. 

(3) Tier down of S’s attribute reduction 

amount, application of conforming 

limitation. Under paragraph (d)(5)(ii)(D) of 

this section, any portion of S’s attribute 

reduction amount allocated to the S1 stock is 

an attribute reduction amount of S1 

(regardless of the extent, if any, to which it 

is apportioned and applied to reduce the 

basis of any shares of S1 stock). Thus, the 

entire $257 of S’s attribute reduction amount 

allocated to the S1 share is an attribute 

reduction amount of S1. Under the general 

rules of this paragraph (d), the entire amount 

is allocated to, and would be applied to 

reduce, S1’s bases in Asset 2 and Asset 3, 

reducing the basis of both assets to $0. 

However, under paragraph (d)(5)(ii)(D)(2) of 

this section, the reduction is limited to the 

excess of S1’s net inside attribute amount 

($150) over S’s basis in the S1 share after 

reduction under this paragraph (d) ($43). 

Thus, of the $257 attribute reduction amount 

allocated to the S1 share, only $107 is 

applied proportionately to reduce S1’s bases 

in Asset 2 by $26.75 ($50/$200 × $107), to 

$23.25, and Asset 3 by $80.25 ($150/$200 × 

$107), to $69.75. The remaining $150 S1 

attribute reduction amount is disregarded has 

no further effect. 

(4) Basis restoration. Under paragraph 

(d)(5)(iii) of this section, after this paragraph 

(d) has been applied with respect to all 

transfers of subsidiary stock, any reduction 

made to the basis of a share of subsidiary 

stock under paragraph (d)(5)(ii)(B) of this 

section is reversed to the extent necessary to 

conform the basis of that share to the share’s 

allocable portion of the subsidiary’s net 

inside attribute amount. S1’s net inside 


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attribute amount after the application of this 

paragraph (d) is $43 ($23.25 basis in Asset 2 

plus $69.75 basis in Asset 3 minus $50 

liability) and thus the S1 share’s allocable 

portion of S1’s net inside attribute amount is 

$43. Accordingly, the basis of the share (as 

reduced by this paragraph (d)) is already 

conformed with its allocable portion of S1’s 

net inside attribute amount and no 

restoration will be required or permitted 

under paragraph (d)(5)(iii) of this section. 

Example 8. Election to reduce stock basis 

or reattribute attributes under paragraph 

(d)(6) of this section. (i) Deconsolidating sale. 

(A) Facts. P owns the sole outstanding share 

of M stock with a basis of $1,000. M owns 

all 100 outstanding shares of S stock with a 

basis of $2.10 per share ($210 total). M sells 

all its S shares to X for $1 per share (total 

$100) and makes no election under paragraph 

(d)(6) of this section. At the time of the sale, 

S has no liabilities and the following: 

Category Attribute Attribute 

amount 

Category A .................................................................................. NOL ............................................................................................ $10 

Category E .................................................................................. Basis of Asset 1 ......................................................................... 20 

Basis of Asset 2 ......................................................................... 180 

Total Category E .................................................................... 200 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is made under 

paragraph (b) of this section, either because 

redetermination would change no member’s 

basis in a share (S has only one class of stock 

outstanding and there is no disparity in the 

basis of the shares) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. No adjustment is 

required under paragraph (c) of this section 

because the net positive adjustment is $0. See 

paragraph (c)(3) of this section. Thus, after 

the application of paragraph (c) of this 

section, M’s transfer of the S shares is still 

a transfer of loss shares and, accordingly, 

subject to this paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of the net stock loss ($110, P’s 

aggregate basis in the transferred S shares 

($210) less the aggregate value of the 

transferred shares ($100)) and S’s aggregate 

inside loss. S’s aggregate inside loss is $110 

(S’s $210 net inside attribute amount (the $10 

NOL plus the $20 basis of Asset 1 plus the 

$180 basis of Asset 2) less the $100 value of 

all outstanding S shares). Thus, the attribute 

reduction amount is $110. 

(2) Application of attribute reduction 

amount. S’s $110 attribute reduction amount 

is applied as follows: 

Category Attribute Attribute 

amount 

Allocation of attribute reduction amount Adjusted attribute amount 

Category A ........................................................ NOL .............................................. $10 $10 $0 

Category E ........................................................ Basis of Asset 1 ........................... 20 (20/200 x $100) $10 10 

Basis of Asset 2 ........................... 180 (180/200 x $100) $90 90 

Total Category E ....................... 200 $100 100 

(D) Results. The P group realizes a $110 

loss on M’s sale of the S shares, which 

reduces P’s basis in the M share from $1,000 

to $890. The reduction of S’s attributes is not 

a noncapital, nondeductible expense of S and 

does not tier up to reduce the basis of the S 

shares or M share. Immediately after the 

transaction, the entities own the following: 

Entity Asset Basis 

P .................................................................................................. M share ...................................................................................... $890 

X .................................................................................................. 100 S shares .............................................................................. 100 

S .................................................................................................. Asset 1 ....................................................................................... 10 

Asset 2 ....................................................................................... 90 

(E) Election to reduce stock basis. The facts 

are the same as in paragraph (i)(A) of this 

Example 8 except that P elects under 

paragraph (d)(6) of this section to reduce M’s 

basis in the S shares by the full attribute 

reduction amount of $110, in lieu of S 

reducing its attributes. The election is 

effective for all transferred loss shares and is 

allocated to such shares in proportion to the 

loss in each share. Accordingly, the basis of 

each of the 100 transferred shares is reduced 

from $2.10 to $1.00. After giving effect to the 

election, the S shares are not loss shares and 

this section has no further application to the 

transfer. The reduction of M’s basis in the S 

shares pursuant to the election under 

paragraph (d)(6) of this section is a 

noncapital, nondeductible expense of M that 

will reduce P’s basis in the M share. See 

paragraph (d)(6)(iv) of this section. 

Immediately after the transaction, the entities 

own the following: 

Entity Basis/attribute 

P .................................................................................................. M share ...................................................................................... $890 

X .................................................................................................. 100 S shares .............................................................................. 100 

S .................................................................................................. NOL ............................................................................................ 10 

Asset 1 ....................................................................................... 20 

Asset 2 ....................................................................................... 180 

(F) Election to reattribute losses. The facts 

are the same as in paragraph (i)(A) of this 

Example 8 except that P elects under 

paragraph (d)(6) of this section to reattribute 

S’s attributes. Although S’s attribute 

reduction amount is $110, P can only 


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reattribute attributes in Category A, Category 

B, and Category C. P can therefore elect to 

reattribute $10 of attributes (the NOL), and, 

as a result, will reduce S’s NOL to $0. The 

reattribution of the $10 NOL is a noncapital, 

nondeductible expense of S, and under 

§ 1.1502–32(c)(1)(ii)(B) this expense is 

allocated to the loss shares of S stock sold in 

proportion to the loss in the shares, or $.10 

per share. Further, this expense tiers up 

under the general rules of § 1.1502–32 and 

reduces P’s basis in the M stock by $10. After 

giving effect to the election, the P group 

would realize a $100 loss on M’s sale of the 

S shares. M could recognize the $100 stock 

loss (in which case S’s basis in Asset 1 and 

Asset 2 would be reduced to $10 and $90, 

respectively, as in paragraph (i)(C)(2) of this 

Example 8) or P could elect to reduce M’s 

basis in the S shares by all or any portion of 

the $100 stock loss (in which case S’s 

attribute reduction amount would be reduced 

by the amount of the reduction in the basis 

of the S stock, and S’s basis in Asset 1 and 

Asset 2 would be reduced proportionately). 

(ii) Nondeconsolidating sale. (A) Facts. The 

facts are the same as in paragraph (i)(A) of 

this Example 8, except that M only sells 20 

S shares (for a total of $20). 

(B) Application of paragraphs (b) and (c) 

of this section. No adjustment is required 

under paragraph (b) or paragraph (c) of this 

section for the reasons set forth in paragraph 

(i)(B) of this Example 8. Thus, after the 

application of paragraph (c) of this section, 

M’s sale of the S shares is still a transfer of 

loss shares and, accordingly, subject to this 

paragraph (d). 

(C) Attribute reduction under this 

paragraph (d). (1) Computation of attribute 

reduction amount. Under paragraph (d)(3) of 

this section, S’s attribute reduction amount is 

the lesser of the net stock loss ($22, P’s 

aggregate basis in the transferred S shares 

($42) less the aggregate value of the 

transferred shares ($20)) and S’s $110 

aggregate inside loss (as calculated in 

paragraph (i)(C)(1) of this Example 8). Thus, 

the attribute reduction amount is $22. 

(2) Application of attribute reduction 

amount. S’s $22 attribute reduction amount 

is applied as follows: 

Category Attribute Attribute 

amount 

Allocation of attribute reduction amount Adjusted attribute amount 

Category A ...................................................... NOL .............................................. $10 $10 $0 

Category E ...................................................... Basis of Asset 1 ........................... 20 (20/200 x $12) $1.20 18 .80 

Basis of Asset 2 ........................... 180 (180/200 x $12) $10.80 169 .20 

Total Category E ...................... 200 $12 188 

(D) Results. The P group realizes a $22 loss 

on M’s sale of the S shares, which reduces 

P’s basis in the M share from $1,000 to $978. 

The reduction of S’s attributes is not a 

noncapital, nondeductible expense of S and 

does not tier up to reduce the basis of the S 

shares or M share. Immediately after the 

transaction, the entities have the following: 

Entity Asset Basis 

P ................................................................................................. M share ..................................................................................... $978 

X ................................................................................................. 20 S shares ............................................................................... 20 

S ................................................................................................. Asset 1 ...................................................................................... 18 .80 

Asset 2 ...................................................................................... 169 .20 

(E) Election to reduce stock basis. The facts 

are the same as paragraph (ii)(A) of this 

Example 8, except that P elects under 

paragraph (d)(6) of this section to reduce M’s 

basis in the S shares by the full attribute 

reduction amount of $22, in lieu of S 

reducing its attributes. The election is 

effective for all transferred loss shares and is 

allocated to such shares in proportion to the 

loss in each share. Accordingly, the basis of 

each of the 20 transferred shares is reduced 

from $2.10 to $1.00. The P group realizes no 

loss on M’s sale of the S shares. The 

reduction of M’s basis in the S shares 

pursuant to the election under paragraph 

(d)(6) of this section is a noncapital, 

nondeductible expense of M that will reduce 

P’s basis in the M share. Immediately after 

the transaction, the entities have the 

following: 

Entity Basis/attribute 

P ................................................................................................. M share ..................................................................................... $978 

X ................................................................................................. 20 S shares ............................................................................... 20 

S ................................................................................................. NOL ........................................................................................... 10 

Asset 1 ...................................................................................... 20 

Asset 2 ...................................................................................... 180 

(F) Subsequent events. As the NOL is 

absorbed and/or Asset 1 or Asset 2 are 

depreciated or sold, the anti-duplication 

provision of § 1.1502–80(a) prevents the 

inclusion of the $10 NOL and $12 of realized 

loss on Asset 1 and Asset 2 in the investment 

adjustment to any shares. 

(G) Election to reattribute attributes. The 

facts are the same as paragraph (ii)(A) of this 

Example 8. Because S remains a member of 

the P group following M’s sale of S stock, P 

cannot elect under paragraph (d)(6) of this 

section to reattribute any portion of S’s 

attributes in lieu of attribute reduction. 

Example 9. Transfers at multiple tiers, gain 

and loss shares. (i) Facts. P owns the sole 

outstanding share of S stock with a basis of 

$700. S owns Asset 1 (basis of $170) and all 

ten outstanding shares of S1 common stock 

($170 basis in share 1, $10 basis in share 2, 

and $15 basis in each of share 3 through 

share 10). S1 owns the sole outstanding share 

of S2 ($0 basis), the sole outstanding share 

of S3 ($60 basis), and the sole outstanding 

share of S4 ($100 basis). S2’s sole asset is 

Asset 2 ($75 basis). S3’s sole asset is Asset 

3 ($75 basis). S4’s sole asset is Asset 4 ($80 

basis). In one transaction, P sells its S share 

to P1 (the common parent of a consolidated 

group) for $240, S sells S1 share 1 to X for 

$20, S transfers S1 share 2 to a partnership 

in a section 721 transaction, and S1 sells its 

S2 share to Y for $50. No election is made 

under paragraph (d)(6) to reduce stock basis 

or reattribute attributes. 

(ii) Transfer in lowest tier (only gain share). 

S1’s sale of the S2 share is a transfer of the 

S2 share and that is the lowest tier in which 

there is a transfer. There is no transfer of a 

loss share at that tier, and thus this section 

does not apply to that transfer. The gain 

recognized on the transfer of the S2 share is 

computed and is applied to adjust the basis 

of members’ shares of subsidiary stock under 

the principles of § 1.1502–32. Accordingly, 

$5 is allocated to each of S1 shares, 

increasing the basis of share 1 to $175, the 

basis of share 2 to $15, and the basis of each 

other share to $20. The $50 applied to S’s 


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bases in S1 shares then tiers up to increase 

P’s basis in the S share from $700 to $750. 

(iii) Transfers in next highest tier (loss 

share). S’s sale of the S1 share 1 and S’s 

transfer of the S1 share 2 to a partnership are 

both transfers of stock in the next higher tier. 

However, only the S1 share 1 is a loss share 

and so this section only applies with respect 

to the transfer of that share. 

(A) Basis redetermination under paragraph 

(b) of this section. Under paragraph 

(b)(2)(i)(A) of this section, members’ bases in 

S1 shares are redetermined by first removing 

the positive investment adjustments applied 

to the bases of transferred loss shares. 

Accordingly, the $5 positive investment 

adjustment applied to the basis of S1 share 

1 is removed, reducing the basis of S1 share 

1 from $175 to $170. Because there were no 

negative adjustments made to the bases of S1 

shares, there are no negative adjustments that 

can be reallocated to further reduce the basis 

of S1 share 1. Finally, under paragraph 

(b)(2)(ii)(B), the positive investment 

adjustment removed from S1 share 1 is 

reallocated and applied to increase the bases 

of other S1 shares in a manner that reduces 

disparity to the greatest extent possible. 

Accordingly, the entire $5 is reallocated and 

applied to increase the basis of S1 share 2, 

from $15 to $20. After basis is redetermined 

under paragraph (b) of this section, S1 share 

1 is still a loss share and therefore subject to 

basis reduction under paragraph (c) of this 

section. 

(B) Basis reduction under paragraph (c) of 

this section. No adjustment is required to the 

basis of S1 share 1 under paragraph (c) of this 

section because, although the disconformity 

amount is $149 (the excess of the $170 stock 

basis over the share’s $21 allocable portion 

of S1’s net inside attribute amount ($210, 

determined under paragraph (c)(5) of this 

section as S1’s basis in the stock of S2 

(adjusted for the gain recognized) ($50), S3 

($60), and S4 ($100))), the share’s net positive 

adjustment is $0 (because the $5 positive 

investment adjustment originally allocated to 

S1 share 1 was reallocated to S1 share 2 

under paragraph (b) of this section). See 

paragraph (c)(3) of this section. 

(C) Computation of loss, adjustments to 

stock basis. S recognizes a loss of $150 on the 

sale of the S1 share 1 ($170 adjusted basis 

minus $20 amount realized). P’s basis in its 

S share is therefore decreased by the $150 

loss recognized by S (on the sale of the S1 

share) and increased by the $50 gain that 

tiered up from S1 (as a result of S1’s sale of 

the S2 share). Following these adjustments, 

P’s basis in the S share is $600 and the sale 

of the S share is still a transfer of a loss share. 

(iv) Transfer in highest tier (loss share). 

The sale of the S share is a transfer in the 

next higher tier, which is the highest tier in 

this transaction. Because the sale is a transfer 

of a loss share, it is subject to this section. 

(A) Basis redetermination and basis 

reduction under paragraphs (b) and (c) of 

this section. No adjustment is required under 

paragraph (b) of this section, either because 

there is no potential for redetermination 

(members hold only one share of S stock) or 

because P transfers the group’s entire interest 

in S to a nonmember in a fully taxable 

transaction. See, respectively, paragraphs 

(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. In 

addition, no adjustment is required under 

paragraph (c) of this section because, 

although the disconformity amount is $230 

(the excess of the $600 stock basis over the 

$370 allocable portion of S’s net inside 

attribute amount ($370, determined under 

paragraph (c)(5) of this section as S’s basis in 

the stock of S1 (adjusted for the loss 

recognized) ($200) and Asset 1 ($170))), the 

share’s net positive adjustment is $0. See 

paragraph (c)(3) of this section. Accordingly, 

the sale of the S share is still a transfer of a 

loss share. Because there are no higher-tier 

loss shares transferred in the transaction, this 

paragraph (d) then applies with respect to the 

transfer of the S share. 

(B) Attribute reduction under this 

paragraph (d). (1) Computation of S’s 

attribute reduction amount. Under paragraph 

(d)(3) of this section, S’s attribute reduction 

amount is the lesser of P’s net stock loss and 

S’s aggregate inside loss. P’s net stock loss is 

$360 (the S share’s $600 adjusted basis minus 

$240 amount realized). S’s aggregate inside 

loss is the excess of S’s net inside attribute 

amount over the value of the S share. S’s net 

inside attribute amount is the sum of its 

bases in its assets, treating its S1 shares as 

a single share (the S1 stock) and treating S’s 

deemed basis in the S1 stock as its basis in 

that stock. Under paragraph (d)(5)(i)(C) of 

this section, when subsidiaries are owned in 

multiple tiers, deemed basis is first 

determined for shares at the lowest tier, and 

then for stock in each next higher tier. S1’s 

deemed basis in the S2 stock is $75 (the 

greater of $50 (S1’s basis in the S2 share ($0) 

increased by the $50 gain recognized) and 

$75 (S2’s basis in Asset 2)). S1’s deemed 

basis in the S3 stock is $75 (computed as the 

greater of $60 (S1’s basis in the S3 share) and 

$75 (S3’s basis in Asset 3)). S1’s deemed 

basis in the S4 stock is $100 (computed as 

the greater of $100 (S1’s basis in the S4 share) 

and $80 (S4’s basis in Asset 4)). Accordingly, 

S1’s net inside attribute amount is $250 ($75 

deemed basis in the S2 stock plus $75 

deemed basis in the S3 stock plus $100 

deemed basis in the S4 stock). S’s deemed 

basis in the S1 stock is the greater of the sum 

of S’s actual basis in each share of S1 stock 

(adjusted for any gain or loss recognized) and 

S1’s net inside attribute amount. S’s actual 

basis in the S1 stock, adjusted for the loss 

recognized, is $200 (the sum of S’s $170 basis 

in the S1 share 1 and S’s $20 basis in each 

other S1 share, reduced by the $150 loss 

recognized). Thus, S’s deemed basis in the S1 

stock is $250, the greater of $200 (aggregate 

basis in S1 shares, adjusted for loss 

recognized) and $250 (S1’s net inside 

attribute amount). As a result, S’s net inside 

attribute amount is $420, the sum of $250 

(S’s deemed basis in S1 stock) and $170 (S’s 

basis in Asset 1). Accordingly, the aggregate 

inside loss is $180, the excess of S’s net 

inside attribute amount ($420) over the value 

of all of the S stock ($240). S’s attribute 

reduction amount is therefore $180, the 

lesser of the net stock loss ($360) and the 

aggregate inside loss ($180). 

(2) Allocation, apportionment, and 

application of S’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii) of this section, S’s $180 attribute 

reduction amount is allocated 

proportionately (by basis) between Asset 1 

and its S1 stock. Under paragraph 

(d)(5)(ii)(A) of this section, for purposes of 

allocating S’s $180 attribute reduction 

amount, S’s deemed basis in the S1 stock is 

reduced by the value of any transferred S1 

shares (and other items that are not relevant 

here). Additionally, for this purpose, S’s 

deemed basis in S1 stock is reduced by S’s 

nontransferred S1 shares’ allocable portion of 

the value of S1’s transferred shares of each 

lower-tier subsidiary’s stock (and other items 

that are not relevant here). Accordingly, for 

purposes of allocating S’s attribute reduction 

amount, S’s deemed basis in the S1 stock 

must be reduced by $80 (the $40 value of the 

two transferred S1 shares, and S’s eight 

nontransferred S1 shares’ $40 allocable 

portion of the $50 value of the transferred S2 

share), to $170. Thus, $90 of the attribute 

reduction amount ($170/$340 × $180) is 

allocated to Asset 1 and $90 of the attribute 

reduction amount ($170/$340 × $180) is 

allocated to the S1 stock. Under paragraph 

(d)(5)(ii)(B)(1) of this section, none of the $90 

allocated to the S1 stock is apportioned to 

share 1 because loss is recognized on the 

transfer of share 1. Under paragraph 

(d)(5)(ii)(B)(2) of this section, the $90 

allocated amount is apportioned among other 

nine shares of S1 stock in a manner that 

reduces disparity to the greatest extent 

possible. Accordingly, of the total $90 

allocated amount, $10 is apportioned to each 

of the remaining shares of S1 stock. Under 

paragraph (d)(5)(ii)(B)(3) of this section, 

however, an apportioned amount cannot be 

applied to reduce the basis of a transferred 

share below its value. Because the basis of 

share 2 is already equal to its value, none of 

the $10 apportioned to share 2 is applied to 

reduce its basis. The amounts apportioned to 

the remaining S1 shares, however, are 

applied to reduce the bases of those shares 

without limitation, reducing the basis of each 

from $20 to $10. As a result, immediately 

after the allocation and application of S’s 

attribute reduction amount, S’s basis in Asset 

1 is $80 ($170 minus $90), its basis in share 

1 is $170, its basis in share 2 is $20, and its 

basis in each other share of S1 stock is $10. 

Under paragraph (d)(5)(ii)(D) of this section, 

the entire $90 of S’s attribute reduction 

amount that was allocated to the S1 stock is 

an attribute reduction amount of S1, 

regardless of the fact that none of the 

allocated amount was apportioned to share 1 

and none of the amount apportioned to share 

2 was applied to reduce the basis of share 2. 

(v) Attribute reduction under this 

paragraph (d) in next lower tier. (A) 

Computation of S1’s attribute reduction 

amount. S’s sale of share 1 is a transfer of a 

loss share and is in the next lower tier. Thus, 

this paragraph (d) next applies with respect 

to S’s transfer of share 1. S1’s attribute 

reduction amount will include both the $90 

attribute reduction amount that tiered down 

from S and any attribute reduction amount 

resulting from the application of this 

paragraph (d) with respect to S’s transfer of 

the S1 share 1 (S1’s direct attribute reduction 

amount). Under paragraph (d)(3) of this 

section, S1’s direct attribute reduction 

amount is the lesser of the net stock loss on 


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transferred S1 shares and S1’s aggregate 

inside loss. The net stock loss on transferred 

S1 shares is $150, computed as the excess of 

S’s $190 adjusted bases in transferred shares 

of S1 stock ($170 in share 1 plus $20 in share 

2) over the value of those shares ($40). S1’s 

aggregate inside loss is $50, the excess of S1’s 

$250 net inside attribute amount (as 

calculated in paragraph (iv)(B)(1) of this 

Example 10) over the $200 value of all 

outstanding S1 shares (extrapolated from the 

amount realized on the sale of share 1). 

Therefore, S1’s direct attribute reduction 

amount is $50, the lesser of the $150 net 

stock loss and S1’s $50 aggregate inside loss. 

S1’s total attribute reduction amount is thus 

$140, the sum of the $90 attribute reduction 

amount that tiered down from S and the $50 

direct attribute reduction amount computed 

with respect to the transfer of share 1. 

(B) Allocation, apportionment, and 

application of S1’s attribute reduction 

amount. Under paragraphs (d)(4) and 

(d)(5)(ii) of this section, S1’s $140 attribute 

reduction amount is allocated 

proportionately (by basis) among the S2 

stock, the S3 stock, and the S4 stock. As 

described in paragraph (iv)(B)(2) of this 

Example 10, under paragraph (d)(5)(ii)(A) of 

this section, for purposes of allocating S1’s 

$140 attribute reduction amount, S1’s 

deemed basis in the S2 stock is reduced by 

the value of the transferred S2 share. 

Accordingly, for purposes of allocating S1’s 

attribute reduction amount, S1’s deemed 

basis in the S2 stock must be reduced by $50 

(the value of the transferred S2 share), to $25. 

Thus, $17.50 of S1’s attribute reduction 

amount ($25/$200 × $140) is allocated to the 

S2 stock, $52.50 of S1’s attribute reduction 

amount ($75/$200 × $140) is allocated to the 

S3 stock, and $70 of S1’s attribute reduction 

amount ($100/$200 × $140) is allocated to the 

S4 stock. Under paragraph (d)(5)(ii)(B)(1) of 

this section, none of the amount allocated to 

S2 stock is apportioned to the S2 share 

because gain was recognized on the transfer 

of the S2 share. However, the $52.50 

allocated to the S3 stock is apportioned and 

applied to reduce the basis in the S3 share, 

from $60 to $7.50, and the $70 allocated to 

the S4 stock is apportioned and applied to 

reduce the basis of the S4 share, from $100 

to $30. (Note: Although the conforming 

limitation in paragraph (d)(5)(ii)(D)(2) of this 

section limits the application of tier down 

attribute reduction such that the total amount 

of attribute reduction applied to reduce S1’s 

attributes does not exceed $130 (the excess 

of S1’s $250 net inside attribute amount over 

$120, the value of the transferred S1 shares 

($40) plus the basis of the nontransferred S1 

shares after reduction ($80)), this limitation 

does not apply because only $122.50 ($52.50 

plus $70) of attribute reduction is applied to 

reduce S1’s attributes.) Under paragraph 

(d)(5)(ii)(D) of this section, the attribute 

reduction amount allocated to the S2 stock, 

the S3 stock, and the S4 stock becomes an 

attribute reduction amount of S2, S3, and S4, 

respectively (even though the amount 

allocated to S2 stock was not apportioned or 

applied to reduce the basis of the S2 share). 

(vi) Attribute reduction under this 

paragraph (d) in lowest tier. Although the 

sale of the S2 share is a transfer of subsidiary 

stock at the next lower tier, the S2 share is 

not a loss share. Thus, this paragraph (d) 

does not apply with respect to that transfer. 

However, S2, S3, and S4 have attribute 

reduction amounts that tiered down from S1 

and that are applied to reduce attributes 

under the provisions of this paragraph (d). 

(A) Tier down of S1’s attribute reduction 

amount to S2. Under the general rules of this 

paragraph (d), S2’s $17.50 attribute reduction 

amount is allocated and applied to reduce 

S2’s basis in Asset 2 from $75 to $57.50. 

(B) Tier down of S1’s attribute reduction 

amount to S3. Under the general rules of this 

paragraph (d), S3’s $52.50 of attribute 

reduction amount is allocated and applied to 

reduce S3’s basis in Asset 3 from $75 to 

$22.50. 

(C) Tier down of S1’s attribute reduction 

amount to S4, application of conforming 

limitation. Under the general rules of this 

paragraph (d), S4’s $70 attribute reduction 

amount is allocated to, and would be applied 

to reduce, S4’s basis in Asset 4. However, 

under paragraph (d)(5)(ii)(D)(2) of this 

section, the reduction is limited to the excess 

of S4’s net inside attribute amount ($80) over 

the basis of the S4 share ($30, after reduction 

under this paragraph (d)). As a result, only 

$50 (the excess of $80 over $30) of S4’s $70 

attribute reduction amount is applied to S4’s 

basis in Asset 4, reducing it from $80 to $30. 

The remaining $20 of S4’s attribute reduction 

amount is disregarded and has no further 

effect. 

(vii) Application of basis restoration rule. 

After all adjustments required under this 

paragraph (d) have been given effect, 

reductions made to the basis of subsidiary 

stock under this paragraph (d) are subject to 

reversal under the basis restoration rule in 

paragraph (d)(5)(iii) of this section. Under 

this rule, adjustments are reversed (and basis 

is restored) only to the extent necessary to 

conform the basis of each share with its 

allocable portion of the subsidiary’s net 

inside attribute amount. The restoration 

adjustments are first made at the lowest tier 

and then at each next higher tier 

successively. 

(A) Basis restoration at lowest tier. No 

restoration is permitted with respect to the 

S2 share because the basis of the S2 share 

was not reduced under paragraph (d)(5)(ii)(B) 

of this section. S3’s net inside attribute 

amount ($22.50, after reduction under this 

paragraph (d)) exceeds S1’s basis in the S3 

share ($7.50, after reduction under this 

paragraph (d)) by $15. To conform S1’s basis 

in the S3 share to S3’s net inside attribute 

amount, the $52.50 reduction to the basis of 

the S3 share under paragraph (d)(5)(ii)(B) of 

this section is reversed by $15 (restoring 

basis to $22.50). The restoration of S1’s basis 

in the S3 share does not tier up to affect the 

basis in stock of any other subsidiary. S1’s 

basis in the S4 share ($30, after reduction 

under this paragraph (d)) is already 

conformed with S4’s net inside attribute 

amount ($30, after reduction under this 

paragraph (d)) and no restoration will be 

required or permitted under paragraph 

(d)(5)(iii) of this section. 

(B) Basis restoration at next higher tier. 

Each share of S1 stock has an allocable 

portion of S1’s net inside attribute amount 

equal to $10.25 (1⁄10 × $102.50, the sum of 

S1’s adjusted bases in its S2 stock ($50, $0 

plus $50 gain recognized), S3 stock ($22.50 

after restoration), and S4 stock ($30)). Neither 

S’s basis in S1 share 1 nor S’s basis in S1 

share 2 was reduced under this paragraph 

(d). Accordingly the basis of neither share is 

subject to restoration under paragraph 

(d)(5)(iii) of this section. However, S’s basis 

in each of its other shares of S1 stock was 

reduced by $10, from $20 to $10. 

Accordingly, the reduction to the basis of 

each of those shares is reversed to the extent 

of $.25, to restore the basis of each such share 

to $10.25 (its allocable portion of S1’s net 

inside attribute amount). 

(vii) Results. After the application of this 

section, P recognizes a loss of $360 on the 

sale of the S share, S recognizes a loss of 

$150 on the sale of S1 share 1, and S1 

recognizes a $50 gain on the sale of the S2 

share. Immediately after the transaction, the 

entities each directly own the following: 

Entity Asset Basis Value 

P1 .......................................................................... S share ................................................................ $240 ............................... $240 

P ............................................................................ Proceeds of the sale of S share ......................... 240 ................................. 240 

S ............................................................................ Proceeds of sale of Share 1 of S1 stock ............ 20 ................................... 20 

Partnership interest received for Share 2 ........... $20 ................................. 20 

Shares 3 through 10 of S1 stock ........................ 82 ($10.25 per share) .... ........................

S1 .......................................................................... Proceeds of sale of S2 share .............................. 50 ................................... 50 

The S3 share ....................................................... 22.50 .............................. ........................

The S4 share ....................................................... 30 ................................... ........................

S2 .......................................................................... Asset 2 ................................................................. 57.50 .............................. ........................

S3 .......................................................................... Asset 3 ................................................................. 22.50 .............................. ........................

S4 .......................................................................... Asset 4 ................................................................. 30 ................................... ........................

X ............................................................................ Share 1 of S1 stock ............................................. 20 ................................... 20 

Y ............................................................................ The S2 share ....................................................... 50 ................................... 50 

Partnership ............................................................ Share 2 of S1 stock ............................................. 20 ................................... 20 


jlentini on PROD1PC65 with PROPOSAL2
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(e) Operating rules—(1) Predecessors, 

successors. This section applies to 

predecessor or successor persons, 

groups, and assets to the extent 

necessary to effectuate the purposes of 

the section. 

(2) Adjustments for prior transactions 

that altered stock basis or other 

attributes. In certain situations, M’s 

basis in S stock or S’s attributes are 

adjusted in a manner that alters the 

relationship between stock basis and 

inside attributes. Such adjustments 

affect the extent to which this 

relationship identifies unrecognized 

asset gain reflected in stock basis and 

the extent to which loss is duplicated. 

The provisions of this paragraph (e)(2) 

modify the computations in paragraphs 

(c) and (d) of this section to adjust for 

the effects of such adjustments. 

(i) Reductions to S’s basis in assets or 

other attributes pursuant to section 

362(e)(2)(A). If S’s attributes have been 

reduced under section 362(e)(2) (taking 

into account the provisions of § 1.1502–

13(e)(4)), then the disconformity amount 

of the S shares received (or deemed 

received) in the transaction to which 

section 362(e)(2) applied is reduced by 

the amount that the basis in such shares 

would have been reduced under section 

362(e)(2)(C) (taking into account the 

provisions of § 1.1502–13(e)(4)) had 

such an election been made. In addition, 

for purposes of determining the attribute 

reduction amount under paragraph (d) 

of this section resulting from the 

transfer of any S shares received (or 

deemed received) in a transaction to 

which section 362(e)(2) applied, and for 

purposes of applying paragraph 

(d)(5)(ii)(D)(2) of this section 

(conforming limitation) to S, the basis in 

such shares is treated as reduced by the 

amount the basis in such shares would 

have been reduced under section 

362(e)(2)(C) (taking into account the 

provisions of § 1.1502–13(e)(4)) had 

such an election been made. 

(ii) Reductions to the basis of any 

share of S stock pursuant to an election 

under section 362(e)(2)(C). If the basis of 

any share of S stock has been reduced 

as the result of an election under section 

362(e)(2)(C) (taking into account the 

provisions of § 1.1502–13(e)(4)), then, 

for purposes of computing either any S 

share’s disconformity amount or S’s 

aggregate inside loss, and for purposes 

of applying paragraph (d)(5)(iii) of this 

section (stock basis restoration) to S, S’s 

net inside attribute amount is reduced 

by the amount that S’s attributes would 

have been reduced under section 

362(e)(2)(A) (taking into account the 

provisions of § 1.1502–13(e)(4)) in the 

absence of an election under section 

362(e)(2)(C) (taking into account the 

provisions of § 1.1502–13(e)(4)). 

(iii) Other adjustments. The 

Commissioner shall make such 

adjustments as appropriate if the 

relationship between a member’s basis 

in a share of S stock and the share’s 

allocable portion of S’s attributes has 

been altered, other than by the operation 

of § 1.1502–32 or this section, provided 

that such change is not otherwise 

addressed in this section. Taxpayers 

may request a written determination 

from the Commissioner determining 

that other adjustments to M’s basis in S 

stock or S’s attributes are to be adjusted 

in a manner consistent with the 

principles of this paragraph (e)(2) for 

purposes of making the computations 

under paragraphs (c) and (d) of this 

section. 

(iv) Example. The application of this 

paragraph (e)(2) is illustrated by the 

following example: 

Example. Adjustments for intercompany 

section 362(e)(2) transaction. (i) Adjustments 

for reduction of S’s basis in assets. (A) Facts. 

In an intercompany section 362(e)(2) 

transaction (within the meaning of § 1.1502–

13(e)(4)(i)), P contributes Asset 1 to newly 

formed S in exchange for the sole 

outstanding share of S stock. At the time of 

the contribution, P’s basis in Asset 1 was 

$100 and its value was $20. Accordingly, S’s 

basis of A1 would have been reduced by $80 

under section 362(e)(2) and that $80 is a 

section 362(e)(2) amount within the meaning 

of § 1.1502–13(e)(4)(ii)(A). P sells the S share 

for $20 in year 3. As of the time of the sale, 

no portion of the section 362(e)(2) amount 

has been taken into account and thus the 

entire $80 is a remaining section 362(e)(2) 

amount reflected in S’s basis in Asset 1 and 

P’s basis in the share of S stock. P’s sale of 

the S share is a section 362(e)(2) application 

event within the meaning of § 1.1502–

13(e)(4)(iii) and therefore, immediately before 

the sale, S’s basis in Asset 1 is reduced by 

$80 pursuant to section 362(e)(2) and 

§ 1.1502–13(e)(4)(iv). Under § 1.1502–

13(e)(4)(iv)(C), this reduction is not a 

noncapital, nondeductible expense described 

in § 1.1502–32(b)(2)(iii), and does not affect 

P’s basis in the S share. The sale is also a 

transfer of a loss share and therefore subject 

to the provisions of this section. 

(B) Application of paragraph (b) of this 

section. No adjustment is required under 

paragraph (b) of this section, either because 

there is no potential for redetermination 

(members hold only one share of S stock) or 

because P transfers the group’s entire interest 

in S to a nonmember in a fully taxable 

transaction. See, respectively, paragraphs 

(b)(1)(ii)(A) and (b)(1)(ii)(B) of this section. 

After the application of paragraph (b) of this 

section, P’s sale of the S share is still a 

transfer of a loss share and therefore subject 

to this paragraph (c). 

(C) Basis reduction under paragraph (c) of 

this section. In determining the reduction of 

basis under paragraph (c) of this section, the 

share’s disconformity amount is reduced by 

$80, the amount that the basis in the S share 

would have been reduced under § 1.1502–

13(e)(4)(v) had such an election been made. 

The disconformity amount (and the net 

positive adjustment) are $0 and so no basis 

adjustment will be made under paragraph (c) 

of this section. The transferred share is still 

a loss share and so is therefore subject to 

paragraph (d) of this section. 

(D) Attribute reduction under paragraph 

(d) of this section. In determining the 

attribute reduction amount under paragraph 

(d)(3) of this section, P’s basis in the 

transferred share is treated as reduced by 

$80, the amount that the basis in the S share 

would have been reduced under § 1.1502–

13(e)(4)(v) had such an election been made. 

As a result, P recognizes an $80 loss on the 

sale of the S stock, but, for purposes of 

applying paragraph (d) of this section, the net 

stock loss and, therefore, the attribute 

reduction amount are $0. 

(ii) Adjustments for election to reduce 

stock basis under section 362(e)(2)(C). The 

facts are the same as in paragraph (i) of this 

Example, except that P and S elect to reduce 

P’s basis in the S share by $80 under 

§ 1.1502–13(e)(4)(v). As a result, the basis of 

Asset 1 remains $100 and, immediately 

before the sale of the S stock, P’s basis in the 

S share is reduced to $20. Because the share 

is then not a loss share, this section does not 

apply to the transfer. If, instead, the share 

were sold for less than $20, it would be a loss 

share and the transfer would be subject to 

this section. In that case, for purposes of 

computing the S share’s disconformity 

amount, S’s aggregate inside loss, and 

applying paragraph (d)(5)(iii) of this section, 

S’s net inside attributes would be treated as 

reduced by $80,the amount that S’s attributes 

would have been reduced under § 1.1502–

13(e)(4)(iv) had the election under § 1.1502–

13(e)(4)(v) not been made. 

(3) Plural, singular. All terms used in 

this section include both the plural and 

singular as the context may require. 

(f) Definitions. In addition to the 

definitions in other paragraphs of this 

section and in § 1.1502–1, the following 

definitions apply for purposes of this 

section. 

(1) Allocable portion has the same 

meaning as in § 1.1502–32(b)(4)(iii)(B). 

Thus, for example, within a class of 

stock, each share has the same allocable 

portion of the net inside attribute 

amount and, if there is more than one 

class of stock, the net inside attribute 

amount is allocated to each class by 

taking into account the terms of each 

class and all other facts and 

circumstances relating to the overall 

economic arrangement. 

(2) Deferred deduction means any 

deduction for expenses or loss that 

would be taken into account under 

general tax accounting principles as of 

the time of the transfer of the share, but 

that is nevertheless not taken into 

account immediately after the transfer 

by reason of the application of a deferral 

provision. Such provisions include, for 


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example, sections 267(f) and 469, and 

§ 1.1502–13. Deferred deduction also 

includes equivalent amounts, such as 

negative adjustments under section 475 

(mark to market accounting method for 

dealers in securities) and 481 

(adjustments required by changes in 

method of accounting). 

(3) Distribution has the same meaning 

as in § 1.1502–32(b)(3)(v). 

(4) Higher tier, lower tier. A subsidiary 

(S1) (and its shares of stock) is higher 

tier with respect to another subsidiary 

(S2) (and its shares of stock) if 

investment adjustments made to the 

basis of shares of S2 stock under 

§ 1.1502–32 affect the investment 

adjustments made to the basis of the 

stock of S1. A subsidiary (S1) (and its 

shares of stock) is lower tier with respect 

to another subsidiary (S) (and its shares 

of stock) if investment adjustments 

made to the basis of shares of S1 stock 

affect the investment adjustments made 

to the basis of shares of S stock. The 

term lowest-tier subsidiary generally 

refers to a subsidiary that owns no stock 

of another subsidiary. The term highesttier subsidiary generally refers to a 

subsidiary the stock of which is not 

lower tier to any shares transferred in 

the transaction. 

(5) Liability means a liability that has 

been incurred within the meaning of 

section 461(h), except to the extent 

otherwise provided in paragraph 

(d)(4)(ii)(A)(1) of this section. 

(6) Loss carryover means any net 

operating or capital loss carryover 

attributable to S that is or, under the 

principles of § 1.1502–21, would be 

carried to S’s first taxable year, if any, 

following the year of the transfer. 

(7) Loss share, gain share. A loss 

share is a share of stock with a basis that 

exceeds its value. A gain share is a share 

of stock with a value that exceeds its 

basis. 

(8) Preferred stock, common stock. 

Preferred stock and common stock have 

the same meanings as in § 1.1502–

32(d)(2) and (3), respectively. 

(9) Publicly traded property. Property 

is publicly traded property if it is traded 

on an established market within the 

meaning of § 1.1273–2(f). 

(10) Transaction includes all the steps 

taken pursuant to the same plan or 

arrangement. 

(11) Transfer—(i) Definition. Except 

as provided in paragraph (f)(11)(ii) of 

this section, for purposes of this section, 

M transfers a share of S stock on the 

earliest of—

(A) The date that M ceases to own the 

share as a result of a transaction in 

which, but for the application of this 

section, M would recognize gain or loss 

with respect to the share; 

(B) The date that M and S cease to be 

members of the same group; 

(C) The date that a nonmember 

acquires the share from M; and 

(D) The last day of the taxable year 

during which the share becomes 

worthless under section 165(g), taking 

into account the provisions of § 1.1502–

80(c). 

(ii) Excluded transactions. 

Notwithstanding paragraph (f)(11)(i) of 

this section, M does not transfer a share 

of S stock if—

(A) M ceases to own the share as a 

result of a section 381(a) transaction in 

which any member acquires assets from 

S or in which S acquires assets from M, 

provided that, in either case, M 

recognizes no gain or loss with respect 

to the share; or 

(B) M ceases to own the share as a 

result of a distribution of the share to a 

nonmember in a transaction to which 

section 355 applies, provided M does 

not recognize any gain or loss with 

respect to the share as a result of the 

distribution of the share. 

(12) Value means the amount 

realized, if any, or otherwise the fair 

market value. 

(g) Anti-abuse rule—(1) General rule. 

If a taxpayer acts with a view to avoid 

the purposes of this section or to apply 

the rules of this section to avoid the 

purposes of any other rule of law, 

appropriate adjustments will be made to 

carry out the purposes of this section or 

such other rule of law. 

(2) Examples. The following examples 

illustrate the principles of the anti-abuse 

rule in this paragraph (g). No 

implication is intended regarding the 

potential applicability of any other antiabuse rules: 

Example 1. Stuffing gain asset to eliminate 

loss. (i) Facts. On January 1, year 1, P owns 

Asset 1 with a basis of $0 and a value of 

$100. On that same date, P purchases the sole 

outstanding share of S stock for $100. At that 

time, S owns Asset 2 with a basis of $0 and 

a value of $100. In year 1, S sells Asset 2 for 

$100. In year 2, with a view to avoiding the 

basis reduction rule in paragraph (c) of this 

section upon the sale of the S share, P 

contributes Asset 1 to S in a transaction to 

which section 351 applies and receives an 

additional share of S stock with a basis of $0 

under section 358. On December 31, year 2, 

P sells its two S shares for $200. After 

applying and giving effect to all generally 

applicable rules of law (other than this 

section), P’s basis in the original share of S 

stock is $200 (P’s original $100 basis, 

increased by $100 under § 1.1502–32 to 

reflect the $100 gain recognized on the sale 

of Asset 2), and P’s basis in the other share 

of S stock is $0. 

(ii) Analysis. Absent the application of this 

paragraph (g), P would not recognize any net 

gain or loss on the sale of the two S shares. 

Under paragraph (c)(7) of this section, for 

purposes of computing the basis reduction 

required by paragraph (c) of this section, P’s 

basis in the original share of S stock would 

be treated as reduced by the gain recognized 

on the other share of S stock. Further, P 

would not recognize any net stock loss 

within the meaning of paragraph (d)(3)(ii) of 

this section. Accordingly, this section would 

not apply to the transfer of the S shares. 

However, because P contributed Asset 1 to S 

with a view to avoiding the basis reduction 

rule in paragraph (c) of this section, the 

contribution of Asset 1 is disregarded for 

purpose of applying this section. 

Accordingly, this section applies to the sale 

of the S share without regard to the 

contribution of Asset 1, and the basis of the 

original S share is reduced by $100 under 

paragraph (c) of this section. P recognizes no 

gain or loss on the sale of the original S 

share, and $100 of gain on the sale of the 

other S share. 

Example 2. Loss Trafficking. (i) Facts. On 

January 1, year 1, P purchases the sole 

outstanding share of S stock for $100. At that 

time, S owns one asset, Asset 1, with a basis 

of $0 and a value of $100. In year 1, S sells 

Asset 1 for $100 and, with a view to 

eliminating the disconformity amount, S 

purchases the sole outstanding share of X 

stock, a corporation with a $100 NOL and an 

asset with a basis and value of $1, from an 

unrelated party for $1. In year 2, X is 

liquidated into S in a transaction to which 

section 332 applies. On December 31, year 2, 

P sells its S share for $100. After applying 

and giving effect to all generally applicable 

rules of law (other than this section), P’s 

basis in the S share is $200 (P’s original $100 

basis, increased under § 1.1502–32 to reflect 

the $100 gain recognized on the sale of Asset 

1). P’s sale of the S share is a transfer of a 

loss share and therefore subject to the 

provisions of this section. 

(ii) Analysis. No adjustment is required 

under paragraph (b) of this section, either 

because there is no potential for 

redetermination (members hold only one 

share of S stock) or because P transfers the 

group’s entire interest in S to a nonmember 

in a fully taxable transaction. See, 

respectively, paragraphs (b)(1)(ii)(A) and 

(b)(1)(ii)(B) of this section. Under paragraph 

(c) of this section, P’s basis in the S share 

($200) is reduced, but not below the share’s 

value ($100), by the lesser of the share’s net 

positive adjustment and disconformity 

amount. The share’s net positive adjustment 

is the greater of zero and the sum of all 

investment adjustments applied to the basis 

of the share, computed without taking 

distributions into account. There are no 

distributions. The only investment 

adjustment to the S share is the $100 positive 

adjustment attributable to the gain 

recognized on the sale of Asset 1. The share’s 

net positive adjustment is therefore $100. 

The share’s disconformity amount is the 

excess, if any, of its basis ($200) over its 

allocable portion of S’s net inside attribute 

amount. Because S purchased the X stock 

and liquidated X with a view to avoiding the 

purposes of this section (to utilize X’s 

attributes to minimize the disconformity 

amount of the S loss share), the attributes 

acquired from X are disregarded for purposes 


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Federal Register / Vol. 72, No. 14 / Tuesday, January 23, 2007 / Proposed Rules 3019 

of applying this section. Accordingly, S’s net 

inside attribute amount is limited to S’s 

money ($100 from the sale of Asset 1, less $1 

for the purchase of the X stock), or $99. The 

loss share’s allocable portion of the $99 net 

inside attribute amount is $99. The loss 

share’s disconformity amount is therefore the 

excess of $200 over $99, or $101. The lesser 

of the share’s net positive adjustment ($100) 

and disconformity amount ($101) is $100. As 

a result, the basis in the loss share is reduced 

by $100, and P recognizes no gain or loss on 

the sale of the S share. 

Example 3. Use of a partnership to prevent 

current attribute reduction. (i) Facts. P owns 

100 shares of S stock with a basis of $10 

each. S owns Asset 1 with a basis of $1000 

and a value of $100. In year 1, with a view 

to preventing a current reduction in the basis 

of Asset 1, S and M form a partnership. S 

contributes Asset 1 and M contributes Asset 

2. On December 31, year 1, P sells 20 S shares 

for $1 each. After applying paragraph (c) of 

this section, P’s basis in each transferred S 

share is still $10, and P recognizes a $180 

loss (a $9 loss on each transferred S share). 

(ii) Analysis. No adjustment is required 

under paragraph (b) of this section because 

S has only one class of stock outstanding and 

there is no disparity in the basis of the 

shares. See paragraph (b)(1)(ii)(A) of this 

section. No adjustment is required under 

paragraph (c) of this section because the net 

positive adjustment is $0. See paragraph 

(c)(3) of this section. Absent the application 

of this paragraph (g), under paragraph (d) of 

this section S’s attribute reduction amount of 

$180 would be applied to reduce S’s basis in 

the partnership interest. Because S acted 

with a view to avoiding a current reduction 

in the basis of Asset 1 under paragraph (d) 

of this section, this section is applied by 

treating S as if it held Asset 1 at the time of 

the stock sale. 

Example 4. Creation of an intercompany 

receivable to mitigate attribute reduction. (i) 

Facts. P owns 100 shares of S stock each with 

equal basis that exceeds value. S owns Asset 

1 with a basis that exceeds value and cash. 

In year 1, with a view to mitigating a 

reduction in the basis of Asset 1, S lends the 

cash to M. On December 31, year 1, P sells 

20 S shares and recognizes a loss. 

(ii) Analysis. No adjustment is required 

under paragraph (b) of this section because 

S has only one class of stock outstanding and 

there is no disparity in the basis of the 

shares. See paragraph (b)(1)(ii)(A) of this 

section. No adjustment is required under 

paragraph (c) of this section because the net 

positive adjustment is $0. See paragraph 

(c)(3) of this section. Absent the application 

of this paragraph (g), under paragraph (d) of 

this section S’s attribute reduction amount 

would be applied to proportionately reduce 

the basis in S’s assets. Accordingly, S’s basis 

in both its intercompany receivable and 

Asset 1 would be reduced. Because S acted 

with a view to mitigating the reduction in the 

basis of Asset 1 under paragraph (d) of this 

section, this section is applied without regard 

to the intercompany receivable. Accordingly, 

S’s basis in Asset 1 is reduced by the full 

attribute reduction amount. 

(h) Effective date. This section applies 

to all transfers on or after the date these 

regulations are published as final 

regulations in the Federal Register. For 

rules applicable on and after March 10, 

2006, and before the date these 

regulations are published as final 

regulations in the Federal Register, see 

§§ 1.1502–35 and 1.337(d)–2 as 

contained in 26 CFR part 1 in effect on 

January 1, 2007. For rules applicable on 

and after March 3, 2005 and before 

March 10, 2006, see §§ 1.337(d)–2T, 

1.1502–20 and 1.1502–35T as contained 

in 26 CFR part 1 in effect on April 1, 

2005. For rules applicable before March 

3, 2005, see §§ 1.337(d)–2T, 1.1502–20, 

and 1.1502–35T as contained in 26 CFR 

part 1 in effect on April 1, 2004. 

Par. 16. Section 1.1502–80 is 

amended by: 

1. Revising paragraphs (a) and (c). 

2. Adding new paragraph (g). 

The revisions and addition reads as 

follows: 

§ 1.1502–80 Applicability of other 

provisions of law. 

(a) In general. The Internal Revenue 

Code, or other law, shall be applicable 

to the group to the extent the regulations 

do not exclude its application. To the 

extent not excluded, other rules operate 

in addition to, and may be modified by, 

these regulations. Thus, for example, in 

a transaction to which section 381(a) 

applies, the acquiring corporation will 

succeed to the tax attributes described 

in section 381(c). Furthermore, sections 

269 and 482 apply for any consolidated 

year. However, in a recognition 

transaction otherwise subject to section 

1001, for example, the rules of section 

1001 continue to apply, but may be 

modified by the intercompany 

transaction regulations under § 1.1502–

13. Nothing in these regulations shall be 

interpreted or applied to require an 

adjustment to a member’s basis in 

subsidiary stock or other attributes to 

the extent the adjustment would have 

the effect of duplicating another 

adjustment required under the Code or 

other rule of law, including other 

provisions of these regulations. 

* * * * * 

(c) Deferral of section 165—(1) 

General rule. Subsidiary stock is not 

treated as worthless under section 165 

until immediately before the earlier of 

the time—

(i) The stock is worthless within the 

meaning of § 1.1502–19(c)(1)(iii); and 

(ii) The subsidiary for any reason 

ceases to be a member of the group. 

(2) Cross reference. See § 1.1502–36 

for additional rules relating to stock 

loss. 

* * * * * 

(g) Effective dates. Paragraphs (a) and 

(c) of this section are applicable on or 

after the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 17. Section 1.1502–91 is 

amended by revising paragraph (h)(2) to 

read as follows: 

§ 1.1502–91 Application of section 382 

with respect to a consolidated group. 

* * * * * 

(h) * * * 

(2) Disposition of stock or an 

intercompany obligation of a member. 

Gain or loss recognized by a member on 

the disposition of stock (including stock 

described in section 1504(a)(4) and 

§ 1.382–2T(f)(18)(ii) and (iii)) of another 

member is treated as a recognized gain 

or loss for purposes of section 382(h)(2) 

(unless disallowed) even though gain or 

loss on such stock was not included in 

the determination of a net unrealized 

built-in gain or loss under paragraph 

(g)(1) of this section. Gain or loss 

recognized by a member with respect to 

an intercompany obligation is treated as 

recognized gain or loss only to the 

extent (if any) the transaction gives rise 

to aggregate income or loss within the 

consolidated group. The first sentence 

of this paragraph (h)(2) is applicable on 

or after the date these regulations are 

published as final regulations in the 

Federal Register. 

* * * * * 

Par. 18. For each section listed in the 

table, remove the language in the 

‘‘Remove’’ column and add in its place 

the language in the ‘‘Add’’ column as set 

forth below: 


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3020 Federal Register / Vol. 72, No. 14 / Tuesday, January 23, 2007 / Proposed Rules 

Section Remove Add 

§ 1.267(f)–1(k) .................................................... § 1.337(d)–2; § 1.1502–35 ................................ § 1.1502–36. 

§ 1.597–4(g)(2)(v) ............................................... §§ 1.337(d)–2 and § 1.1502–35(f) .................... § 1.1502–36. 

§ 1.1502–11(b)(3)(ii)(c) ....................................... §§ 1.337(d)–2 and § 1.1502–35 ....................... § 1.1502–36. 

§ 1.1502–12(r) .................................................... §§ 1.337(d)–2 and § 1.1502–35 ....................... § 1.1502–36. 

§ 1.1502–15(b)(2)(iii) .......................................... §§ 1.337(d)–2, 1.1502–35, or ........................... § 1.1502–36. 

§ 1.1502–32(b)(3)(iii)(B) ..................................... § 1.1502–35(b) or (f)(2).

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 07–187 Filed 1–16–07; 10:51 am] 

BILLING CODE 4830–01–P 


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