[Federal Register Volume 62, Number 11 (Thursday, January 16, 1997)]
[Rules and Regulations]
[Pages 2267-2275]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-656]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8711]
RIN 1545-AU82


Intangibles Under Sections 1060 and 338

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

-----------------------------------------------------------------------

SUMMARY: This document amends the temporary regulations under sections 
1060 and 338(b) of the Internal Revenue Code (Code) relating to 
purchase price allocations in taxable asset acquisitions and deemed 
asset purchases. The amendments revise the treatment of intangible 
assets in such acquisitions to take into account the enactment of 
section 197 by the Omnibus Budget Reconciliation Act of 1993. This 
document also makes conforming amendments to the final regulations 
under section 338. The regulations provide guidance regarding taxable 
asset acquisitions and deemed asset purchases resulting from elections 
under section 338. The text of the temporary regulations herein also 
serves as the text of the proposed regulations set forth in the notice 
of proposed rulemaking on this subject in the Proposed Rules section of 
this issue of the Federal Register.

EFFECTIVE DATE: These regulations are effective February 14, 1997.
    For dates of applicability, see Secs. 1.338(b)-2T(c)(4) and 1.1060-
1T(a)(2)(ii).

FOR FURTHER INFORMATION CONTACT: Brendan P. O'Hara, Office of Assistant 
Chief Counsel (Corporate), (202) 622-7530 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    These regulations amend the current temporary regulations under 
sections 1060 (Sec. 1.1060-1T) and 338(b) (Secs. 1.338(b)-2T and 
1.338(b)-3T) (the current regulations) with respect to the treatment of 
acquired intangible assets. They also amend related examples in the 
final regulations under section 338. Section 1060 provides for the 
allocation of purchase price among the assets of a trade or business 
under regulations. Section 338(b) provides for a similar allocation, 
also under regulations, for a deemed purchase of assets under section 
338. The current regulations employ a residual method of allocation. 
The legislative history of section 1060, adopted in 1986, noted with 
approval the use of the residual method under the section 338(b) 
regulations and required that the same method be used pursuant to 
regulations to be prescribed under section 1060. S. Rep. No. 99-313, 
99th Cong., 2d Sess. 253, 254 (1986); 1986-3 C.B. Vol. 3, 253-54.
    The current regulations place each acquired asset into one of four 
asset classes. The purchase price is allocated among the classes in 
priority order. No asset in any class except for the last class is 
allocated more than its fair market value. If the aggregate purchase 
price allocable to a particular class is less than the aggregate fair 
market value of the assets within the class, each asset is allocated an 
amount in proportion to its fair market value and nothing is allocated 
to any junior class.
    The four classes under the current regulations are as follows:

Class I--Cash and cash equivalents;
Class II--Certificates of deposit, U.S. government securities, readily 
marketable stock or securities, and foreign currency;
Class III--All assets not in Class I, II, or IV; and
Class IV--Intangible assets in the nature of goodwill and going concern 
value.

    Section 197 was enacted as part of the Omnibus Budget 
Reconciliation Act of 1993, Public Law 103-66, 107 Stat. 312 (1993) 
(the 1993 Act). Prior to the 1993 Act, acquired goodwill and going 
concern value were not amortizable, but other acquired intangible 
assets were amortizable if they could be separately identified and 
their useful lives determined with reasonable accuracy. Section 197 
responded to policy and administrative concerns regarding the treatment 
of acquired intangibles by providing similar treatment for goodwill, 
going concern value, and certain other intangible assets acquired in a 
taxable acquisition and held in connection with a trade or business. 
The 1993 Act allows taxpayers to amortize certain acquired intangible 
assets (amortizable section 197 intangibles) over 15 years, subject to 
certain exceptions.
    The report of the House Committee on Ways and Means accompanying 
the 1993 Act states that:

    It is expected that the present [regulations under sections 338 
and 1060] will be amended to reflect the fact that [section 197] 
allows an amortization deduction with respect to intangible assets 
in the nature of goodwill and going concern value. It is anticipated 
that the residual method specified in the regulations will be 
modified to treat all amortizable section 197 intangibles as Class 
IV assets and that this modification will apply to any acquisition 
of property to which [section 197] applies.

H.R. Rep. 111, 103d Cong., 1st Sess. 760, 776 (May 23, 1993), 1993-3 
C.B. 336, 352.

    The current regulations have not yet been amended in accordance 
with the legislative history of section 197. These new temporary 
regulations accomplish that change, with slight modifications, as 
discussed below.

Explanation of Provisions

    The temporary and final regulations are amended to conform to the 
legislative history of the 1993 Act by placing all amortizable section 
197 intangibles other than goodwill and going concern value in Class 
IV.
    However, the new regulations also include nonamortizable section 
197 intangibles in Class IV. Some section 197 intangibles are 
amortizable by the buyer though they were not amortizable by the 
seller. Other section 197 intangibles may not be amortizable because of 
the application of the anti-churning rules of section 197(f)(9). 
Although sections 338(b) and 1060 do not require conformity between the 
buyer and seller on purchase price allocations, they reflect strong 
policies encouraging conformity, including mandatory application of the 
rule of Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), cert. 
denied, 389 U.S. 858 (1967), in cases where the parties have agreed to 
an allocation, and a reporting system designed to reveal situations 
where the parties' allocations are inconsistent. These policies 
favoring conformity are best served by requiring both parties to 
include the same assets in each class. Moreover, this rule is also more 
consistent with section 1060(b) as amended by the 1993 Act. Section 
1060(b)(1) requires the parties to report, under regulations, ``the 
amount of consideration received for the assets which is allocable to 
section 197 intangibles.'' The term section 197 intangibles is more 
inclusive than amortizable section 197 intangibles. The goals of 
consistency, simplification, and administrability will be better 
achieved with respect to allocations to section

[[Page 2268]]

197 intangibles if all such assets are removed from Class III and 
isolated in a junior class (or classes). Accordingly, these regulations 
classify all section 197 intangibles (other than goodwill and going 
concern value) as Class IV assets.
    To reconcile the original intention of Congress in requiring the 
residual method of allocation for goodwill and going concern value with 
the legislative history of the 1993 Act, these regulations provide that 
goodwill and going concern value will be assigned to a true residual 
class, Class V. This method is consistent with the policies of section 
197 (which regards many intangible assets as the functional equivalent 
of goodwill and going concern value and thus treats them uniformly) as 
well as the original intention of the Tax Reform Act of 1986, Public 
Law 99-514, 100 Stat. 2085 (1986) (that goodwill and going concern 
value not be valued separately for purchase price allocation purposes). 
Allocating goodwill and going concern value to Class V avoids the need 
for determining the value of goodwill and going concern value through a 
non-residual method. Although this approach places some section 197 
intangibles in Class V instead of Class IV, it carries out the 
expectation set forth in the legislative history of the 1993 Act by 
making section 197 intangibles junior to all other assets in the 
allocation scheme. The practical significance of placing goodwill and 
going concern value in Class V is generally limited to circumstances in 
which fewer than all of the amortizable section 197 intangibles 
acquired in a single transaction are subsequently disposed of at a 
gain. Those situations, in any case, require some method of allocation 
among the intangibles.

Effective Date

    These regulations are effective for applicable asset acquisitions, 
as defined in section 1060(c), completed on or after February 14, 1997, 
and for acquisition dates, as defined in section 338(h)(2), on or after 
February 14, 1997.
    As described above, the current regulations have been in conflict 
with the 1993 Act legislative history concerning the classification of 
amortizable section 197 intangibles other than goodwill and going 
concern value since August 10, 1993, generally (the date of enactment 
of section 197), and, in some cases, since 1991.
    The legislative history to the 1993 Act clearly contemplates that 
changes to the classification system would be made by amended 
regulations. In the absence of such amendments, the only system 
available under regulations was the four-class system established 
before the enactment of section 197. Further, the IRS revised Form 
8594, Asset Acquisition Statement under Section 1060, in January of 
1996 in a manner consistent with the legislative history, i.e., by 
placing all amortizable section 197 intangibles in Class IV. For 
acquisition dates before February 14, 1997, if section 197 applies to 
any asset acquired or deemed acquired, the taxpayer (and all related 
parties) may consistently (in all transactions in which AGUB, ADSP, 
MADSP, or consideration must be allocated under section 338 or 1060)--
    (i) apply these new rules in full as written;
    (ii) apply the current temporary regulations as written; or
    (iii) apply the current temporary regulations as written, but treat 
all amortizable section 197 intangibles as Class IV assets.

Special Analyses

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

Drafting Information

    The principal author of these regulations is Brendan P. O'Hara, 
Office of the Assistant Chief Counsel (Corporate), IRS. 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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. In Sec. 1.338-0, entries for Sec. 1.338(b)-2T(b)(2)(v) and 
Sec. 1.338(b)-2T(c)(4) are added to read as follows:


Sec. 1.338-0  Outline of topics.

* * * * *

Sec. 1.338(b)-2T  Allocation of adjusted grossed-up basis among 
target assets (temporary).

* * * * *
    (b) * * *
    (2) * * *
    (v) Class V assets.
    (c) * * *
    (4) Effective dates.
* * * * *
    Par. 3. Section 1.338-3 is amended by:
    1. Revising paragraph (b)(4).
    2. Revising paragraph (d)(8)(ii) Example 1, paragraph (e); Example 
2, paragraphs (a), (b), and (d); Example 3, paragraph (d); and Example 
4, paragraphs (d) and (f).
    The revisions read as follows:


Sec. 1.338-3  Deemed sale and aggregate deemed sale price.

* * * * *
    (b) * * *
    (4) Classes of assets. The classes of assets are defined in 
Sec. 1.338(b)-2T(b).
* * * * *
    (d) * * *
    (8) * * *
    (ii) * * *

    Example 1. * * *
    (e) The facts are the same as in paragraph (a) of this Example 
1, except that T also has goodwill (a Class V asset) with an 
appraised value of $10,000. The results are the same as in 
paragraphs (b) and (c) of this Example 1. Because the ADSP does not 
exceed the fair market value of the Class III asset, no amount is 
allocated to the Class V assets (assets in the nature of goodwill 
and going concern value).
    Example 2. * * *
    (a) P purchases all of the T stock for $140,000. On July 1 of 
Year 1, T has liabilities (not including the tax liability for 
deemed sale gain of its assets) of $50,000, cash (a Class I asset) 
of $10,000, readily marketable securities (a Class II asset) with a 
basis of $4,000 and a fair market value of $10,000, goodwill (a 
Class V asset) with a basis of $3,000, and the following Class III 
assets:

------------------------------------------------------------------------
                   Asset                      Basis       FMV      Ratio
------------------------------------------------------------------------
1. Land...................................     $5,000    $35,000     .14

[[Page 2269]]

                                                                        
2. Inventory..............................     10,000     50,000     .20
3. Equipment A (recomputed basis $80,000).      5,000     90,000     .36
4. Equipment B (recomputed basis $20,000).     10,000     75,000     .30
                                           -----------------------------
      Totals..............................    $30,000   $250,000    1.00
------------------------------------------------------------------------

    (b) The ADSP exceeds $20,000. Thus, $10,000 of the ADSP is 
allocated to the cash and $10,000 to the marketable securities. 
Except as provided in section 7701(g), the amount allocated to an 
asset (other than a Class V asset) cannot exceed its fair market 
value. See Sec. 1.338(b)-2T(c)(1) (relating to fair market value 
limitation).
* * * * *
    (d) Because, under the preliminary calculations of the ADSP, the 
amount to be allocated to the Class I, II, III, and IV assets does 
not exceed their aggregate fair market value, no ADSP amount is 
allocated to goodwill. Accordingly, the deemed sale of the goodwill 
results in a capital loss of $3,000. The portion of the ADSP 
allocable to the Class III assets is finally determined by taking 
into account this loss as follows:

ADSP<INF>III = (G - (I + II)) + L + T<INF>R  x  [(II - B<INF>II) + 
(ADSP<INF>III - B<INF>III) + (ADSP<INF>V - B<INF>V)]
1ADSP<INF>III = ($140,000 - ($10,000 + $10,000)) + $50,000 + .34  x  
[($10,000 - $4,000) + (ADSP<INF>III - $30,000) + ($0 - $3,000)]
ADSP<INF>III = $160,820 + .34ADSP<INF>III
.66ADSP<INF>III = $160,820
ADSP<INF>III = $243,666.67
* * * * *
    Example 3. * * *
    (d)(1) Based on the preliminary allocation, the ADSP is 
determined as follows: (In the formula, the amount allocated to the 
Class I assets is referred to as I, the amount allocated to the 
Class II assets as II, and the amount allocated to the Class III 
assets as III.)

ADSP = G + L + T<INF>R  x  [(II - B<INF>II) + (III - B<INF>III) + 
(ADSP - (I + II + III + B<INF>V))]
ADSP = $150,000 + $50,000 + .34  x  [($10,000 - $4,000) + ($250,000 
- $30,000) + (ADSP - ($10,000 + $10,000 + $250,000 + $3,000))]
ADSP = $200,000 + .34ADSP - $15,980 .66ADSP = $184,020
ADSP = $278,818.18

    (2) Because the ADSP as determined exceeds the aggregate fair 
market value of the Class I, II, III, and IV assets, the $250,000 
amount preliminarily allocated to the Class III assets is 
appropriate. Thus, the amount of the ADSP allocated to Class III 
assets equals their aggregate fair market value ($250,000), and the 
allocated ADSP amount for each Class III asset is its fair market 
value. Further, because there are no Class IV assets, the allocable 
ADSP amount for the Class V asset (goodwill) is $8,818.18 (the 
excess of the ADSP over the aggregate ADSP amounts for the Class I, 
II, and III assets).
    Example 4. * * *
    (d) Because the portion of the preliminary ADSP allocable to 
Class III assets ($243,666.67) does not exceed their fair market 
value ($250,000), no amount is allocated to Class V assets for T. 
Further, this amount ($243,666.67) is allocated among T's Class III 
assets in proportion to their fair market values. See paragraph (e) 
of Example 2. Tentatively, $48,733.34 of this amount is allocated to 
the T1 stock.
* * * * *
    (f) The facts are the same as in paragraph (a) of this Example 
4, except that the T1 inventory has a $12,500 basis and a $62,500 
value, the T1 stock has a $62,500 value, and T owns 80% of the T1 
stock. In preliminarily calculating ADSPIII, the T1 stock can be 
disregarded but, because T owns only 80% of the T1 stock, only 80% 
of T1 asset basis and value should be taken into account in 
calculating T's ADSP. By taking into account 80% of these amounts, 
the remaining calculations and results are the same as in paragraphs 
(b), (c), (d), and (e) of this Example 4, except that the grossed-up 
basis in T's recently purchased T1 stock is $44,455.00 ($35,564.00/
0.8).

    Par. 4. Section 1.338(b)-2T is amended by:
    1. Revising paragraphs (b)(2), (c)(1), and (c)(3)(iii).
    2. Adding paragraph (c)(4).
    3. Revising paragraph (d) Example 1, paragraphs (vi) and (x) 
through (xiii).
    4. Revising paragraph (d) Example 2, paragraphs (vi) through 
(viii).
    The revisions and addition read as follows:


Sec. 1.338(b)-2T  Allocation of adjusted grossed-up basis among target 
assets (temporary).

* * * * *
    (b) * * *
    (2) Other assets--(i) In general. Subject to the limitations and 
other special rules of paragraph (c) of this section, adjusted grossed-
up basis (as reduced by Class I assets) is allocated among Class II 
assets of target held at the beginning of the day after the acquisition 
date in proportion to their fair market values at such time, then among 
Class III assets so held in such proportion, then among Class IV assets 
so held in such proportion, and finally to Class V assets.
    (ii) Class II assets. Class II assets are certificates of deposit, 
U.S. Government securities, readily marketable stock or securities 
(within the meaning of Sec. 1.351-1(c)(3)), foreign currency, and other 
items designated in the Internal Revenue Bulletin by the Internal 
Revenue Service.
    (iii) Class III assets. Class III assets are all assets of target 
other than Class I, II, IV, and V assets.
    (iv) Class IV assets. Class IV assets are all section 197 
intangibles, as defined in section 197, except those in the nature of 
goodwill and going concern value.
    (v) Class V assets. Class V assets are section 197 intangibles in 
the nature of goodwill and going concern value.
    (c) * * *
    (1) Basis not to exceed fair market value. The amount of adjusted 
grossed-up basis allocated to an asset (other than Class V assets) 
shall not exceed the fair market value of that asset at the beginning 
of the day after the acquisition date. For modification of this fair 
market value limitation with respect to certain contingent income 
assets, see Sec. 1.338(b)-3T(g).
* * * * *
    (3) * * *
    (iii) Allocation of adjusted grossed-up basis. Subject to the 
limitations in paragraphs (c)(1) and (2) of this section, adjusted 
grossed-up basis (after reduction by the amount of Class I assets) is 
allocated among Class II, III, IV, and V assets of target held at the 
beginning of the day after the acquisition date in proportion to their 
fair market values at such time. For this purpose, the fair market 
value of Class V assets is deemed to be the excess, if any, of the 
hypothetical purchase price over the sum of the amount of the Class I 
assets and the fair market values of the Class II, III, and IV assets.
    (4) Effective dates. This section applies for acquisition dates on 
or after February 14, 1997. For acquisition dates before February 14, 
1997, if section 197 does not apply to any asset deemed acquired, the 
provisions of the regulations in effect before February 14, 1997, apply 
(see Sec. 1.338(b)-2T as contained in 26 CFR part 1 revised April 1, 
1996). For acquisition dates before February 14, 1997, if section 197 
applies to any asset deemed acquired, the taxpayer (and all related 
parties) may consistently (in all transactions in which AGUB, ADSP, 
MADSP, or consideration must be allocated under section 338 or 1060)--
    (i) Apply the provisions of this section;
    (ii) Apply the provisions of this section as in effect before 
February 14, 1997 (see Sec. 1.338(b)-2T as contained in 26 CFR part 1 
revised April 1, 1996); or

[[Page 2270]]

    (iii) Apply the provisions of this section as in effect before 
February 14, 1997 (see Sec. 1.338(b)-2T as contained in 26 CFR part 1 
revised April 1, 1996), but treat all amortizable section 197 
intangibles as Class IV assets.
    (d) * * *

    Example 1. * * *
    (vi) T has no Class IV assets. The amount allocated to T's Class 
V assets (assets in the nature of goodwill and going concern value) 
is $150, i.e., $2,500-$2,350.
* * * * *
    (x) Assume that at the beginning of the day after the 
acquisition date, T1's cash and the fair market values of its Class 
III and IV assets are as follows:

------------------------------------------------------------------------
                                                                   Fair 
         Asset class                         Asset                market
                                                                  value 
------------------------------------------------------------------------
I............................  Cash............................    $50 *
III..........................  Equipment.......................      200
IV...........................  Patent..........................      350
                                                                --------
                               Total...........................     $600
------------------------------------------------------------------------
* Amount                                                                

    (xi) The amount of AGUB allocable to T1's Class III and IV 
assets is first reduced by the $50 of cash.
    (xii) Since the remaining amount of AGUB ($570) is an amount 
which exceeds the fair market value of T1's only Class III asset, 
the equipment, the amount allocated to the equipment is its fair 
market value ($200). After that, the remaining amount of AGUB ($370) 
exceeds the fair market value of T1's only Class IV asset, the 
patent. Thus, the amount allocated to the patent is its fair market 
value ($350).
    (xiii) The amount allocated to T1's Class V assets (assets in 
the nature of goodwill and going concern value) is $20, i.e., 
$570-$550.
    Example 2.* * *
    (vi) The amount of AGUB ($2,700) available to allocate to T's 
assets is reduced by the amount of cash to $2,500, i.e., 
$2,700-$200. This $2,500 balance is then allocated among the Class 
II, III, IV, and V assets in proportion to, and not in excess of, 
their fair market values (as determined under Sec. 1.338(b)-
2T(c)(3)(iii)).
    (vii) Under paragraph (c)(3) of this section, the fair market 
value of the Class V assets is deemed to be $150, i.e., the $3,000 
hypothetical purchase price minus $2,850 (the sum of T's cash, $200, 
and the fair market value of its Class II, III, and IV assets, 
$2,650). The allocation is as follows:

Portfolio of marketable securities.............................   * $268
Inventory......................................................      268
Accounts receivable............................................      536
Building.......................................................      714
Land...........................................................      178
Investment in T1...............................................      402
Goodwill and going concern value...............................      134
                                                                --------
    Total......................................................  $2,500 
                                                                        
* All numbers rounded for convenience.                                  

    (viii) If the AGUB of T is increased (or decreased) as a result 
of a subsequent adjustment, the hypothetical purchase price and the 
deemed fair market value of the Class V assets shall be redetermined 
and the increase (or decrease) in AGUB shall be allocated among T's 
acquisition date assets pursuant to Sec. 1.338(b)-3T(f). The 
increase (or decrease) in AGUB is allocated pursuant to 
Sec. 1.338(b)-3T(f) even if the hypothetical purchase price, as 
redetermined, no longer exceeds AGUB, as redetermined.

    Par. 5. Section 1.338(b)-3T is amended by:
    1. Revising paragraphs (e)(1), (f)(1), and (f)(2).
    2. In paragraph (j), redesignating Example (1) through Example (8) 
as Example 1 through Example 8.
    3. Revising the following newly designated examples in paragraph 
(j): Example 1; Example 2; Example 3, paragraph (i) and paragraphs (v) 
through (vii); and Example 6 through Example 8.
    The revisions read as follows:


Sec. 1.338(b)-3T  Subsequent adjustments to adjusted grossed-up basis 
(temporary).

* * * * *
    (e) * * *
    (1) In general. If adjusted grossed-up basis was allocated in 
accordance with the rules of Sec. 1.338(b)-2T(b)(2), a decrease in 
adjusted gross-up basis (as determined under paragraph (c)(3) of this 
section) is allocated in the following order: first, as a reduction in 
the bases of target's Class V acquisition date assets, second, as a 
reduction of the bases of target's Class IV acquisition date assets in 
proportion to their fair market values at the beginning of the day 
after the acquisition date, third, as a reduction of the bases of 
target's Class III acquisition date assets in proportion to their fair 
market values at the beginning of the day after the acquisition date, 
and finally, as a reduction of the bases of target's Class II 
acquisition date assets in proportion to their fair market values at 
the beginning of the day after the acquisition date. The decrease in 
adjusted grossed-up basis allocated to an asset shall not exceed the 
adjusted grossed-up basis of target previously allocated to that asset. 
If adjusted grossed-up basis was allocated among target's assets 
pursuant to Sec. 1.338(b)-2T(c)(3), a decrease in adjusted grossed-up 
basis (as determined under paragraph (c)(3) of this section) is 
accounted for in accordance with the rules of paragraph (f) of this 
section.
* * * * *
    (f) * * *
    (1) Scope. This paragraph (f) applies if adjusted grossed-up basis 
was allocated among new target's Class II, III, IV, and V assets in 
accordance with Sec. 1.338(b)-2T(c)(3) and an adjustment event occurs 
after the close of the new target's first taxable year.
    (2) Allocation of increases (decreases) in adjusted grossed-up 
basis. If an adjustment event after the close of new target's first 
taxable year increases (or decreases) adjusted grossed-up basis, the 
following items shall be redetermined, taking into account such 
adjustment event: the hypothetical purchase price, the deemed fair 
market value of Class V assets, and the adjusted grossed-up basis 
allocable to each acquisition date asset under Sec. 1.338(b)-2T(c)(3) 
(the redetermined (c)(3) amount). (The redetermination of the deemed 
fair market value of Class V assets under this paragraph (f)(2) is made 
by taking into account the target's Class I assets and the fair market 
values of its Class II, III, and IV assets at the beginning of the day 
after the acquisition date.) If the redetermined (c)(3) amount for an 
acquisition date asset exceeds the amount of adjusted grossed-up basis 
previously allocated to such asset (taking into account prior 
adjustments under this paragraph (f)), an amount of adjusted grossed-up 
basis equal to such excess shall be allocated to such asset. If the 
amount of the adjusted grossed-up basis previously allocated to an 
acquisition date asset (taking into account prior adjustments under 
this paragraph (f)) exceeds the redetermined (c)(3) amount for that 
asset, an amount equal to such excess shall be allocated as a reduction 
in the basis of such asset. The rules of paragraph (d)(2) of this 
section (or paragraph (e)(2) of this section) apply for the treatment 
of amounts allocable under this paragraph (f) to an acquisition date 
asset that has been disposed of, depreciated, amortized, or depleted.
* * * * *
    (j) * * *
    Example 1. (i)(A) T's assets other than goodwill and going 
concern value, and their fair market values at the beginning of the 
day after the acquisition date, are as follows:

------------------------------------------------------------------------
                                                                   Fair 
         Asset class                         Asset                market
                                                                  value 
------------------------------------------------------------------------
III..........................  Building........................     $100
III..........................  Stock of X (not a target).......      200
                                                                --------
                               Total...........................     $300
------------------------------------------------------------------------

    (B) T has no liabilities other than a contingent obligation and 
T does not use the elective formula under section 338(h)(11).
    (ii)(A) On September 1, 1997, P purchases all of the outstanding 
stock of T for $270 and makes an express election for T. The 
grossed-up basis of the T stock and T's adjusted grossed-up basis 
(AGUB) are both $270. The AGUB is ratably allocated among T's Class 
III

[[Page 2271]]

assets in proportion to their fair market values as follows:

------------------------------------------------------------------------
                             Asset                                Basis 
------------------------------------------------------------------------
Building ($270 x 100/300)......................................     $ 90
Stock ($270 x 200/300).........................................      180
                                                                --------
      Total....................................................     $270
------------------------------------------------------------------------

    (B) No amount is allocated to the Class V assets. New T is a 
calendar year taxpayer. Assume that the X stock is a capital asset 
in the hands of new T.
    (iii) On January 1, 1998, new T sells the X stock and uses the 
proceeds to purchase inventory.
    (iv) On June 30, 1999, the contingent liability of old T becomes 
fixed and determinable. The amount of the liability is $60.
    (v) T's AGUB increases by $60 from $270 to $330. This $60 
increase in AGUB is first allocated among T's acquisition date 
assets in accordance with the provisions of Sec. 1.338(b)-2T. Since 
the redetermined AGUB for T ($330) exceeds the sum of the fair 
market values at the beginning of the day after the acquisition date 
of the Class III acquisition date assets ($300), AGUB allocated to 
those assets is limited to those fair market values under 
Sec. 1.338(b)-2T(c)(1). As there are no Class IV assets, the 
remaining AGUB of $30 is allocated to goodwill and going concern 
value (Class V assets). The amount of increase in AGUB allocated to 
each acquisition date asset is determined as follows:

------------------------------------------------------------------------
                                    Original   Redetermined  Increase in
              Asset                   AGUB         AGUB          AGUB   
------------------------------------------------------------------------
Building........................         $ 90          $100          $10
X Stock.........................          180           200           20
Goodwill and going concern value            0            30           30
                                 ---------------------------------------
      Total.....................         $270          $330          $60
------------------------------------------------------------------------

    (vi) Since the X stock was disposed of before the contingent 
liability became fixed and determinable, no amount of the increase 
in AGUB attributable to such stock may be allocated to any T asset. 
Rather, such amount, $20, is allowed as a capital loss to T for the 
taxable year 1999 under the principles of Arrowsmith v. 
Commissioner, 344 U.S. 6 (1952). In addition, the $10 increase in 
AGUB allocated to the building and the $30 increase in AGUB 
allocated to the goodwill and going concern value are treated as 
basis redeterminations in 1999. See paragraph (d)(2) of this 
section.
    Example 2. (i) On January 1, 1998, P purchases all of the 
outstanding stock of T and makes an express election for T. T does 
not use the elective formula under section 338(h)(11). Assume that 
the AGUB of T is $500 and is allocated among T's acquisition date 
assets as follows:

------------------------------------------------------------------------
         Asset class                         Asset                Basis 
------------------------------------------------------------------------
III..........................  Machinery.......................     $150
III..........................  Land............................      250
V............................  Goodwill and going concern value      100
                                                                --------
                               Total...........................     $500
------------------------------------------------------------------------

    (ii) On September 30, 1998, P filed a claim against the selling 
shareholders of T in a court of appropriate jurisdiction alleging 
fraud in the sale of the T stock.
    (iii) On January 1, 2007, the former shareholders refund part of 
the purchase price to P in a settlement of the lawsuit. This refund 
results in a decrease of T's AGUB of $140.
    (iv) Under paragraph (e)(1) of this section, the decrease in 
AGUB is allocated among T's acquisition date assets. First, because 
$100 was originally allocated to the Class V assets, $100 of the 
decrease is allocated to those assets. As there were no Class IV 
assets acquired, the remaining decrease in AGUB ($40) is allocated 
to the Class III assets in proportion to their fair market values at 
the beginning of the day after the acquisition date. Thus, $15 is 
allocated to the machinery ($40 x 150/$400) and $25 to the land ($40 
x 250/$400).
    (v) Assume that, as a result of deductions under section 168, 
the adjusted basis of the machinery immediately before the decrease 
in AGUB is zero. The machinery is treated as if it were disposed of 
before the decrease is taken into account. In 2007, T recognizes 
income of $15, the character of which is determined under the 
principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and the 
tax benefit rule. No adjustment to the basis of T's assets is made 
for any tax paid on this amount. Assume also that, as a result of 
amortization deductions, the adjusted basis of the goodwill and 
going concern value immediately before the decrease in AGUB is $40. 
A similar adjustment to income is made in 2007 with respect to the 
$60 of previously amortized goodwill and going concern value.
    (vi) In summary, the basis of T's acquisition date assets, as of 
January 1, 2007, is as follows:

------------------------------------------------------------------------
                             Asset                                Basis 
------------------------------------------------------------------------
Machinery......................................................       $0
Land...........................................................      225
Goodwill and going concern value...............................        0
------------------------------------------------------------------------

    Example 3. (i) Assume that the facts are the same as Example 2 
of Sec. 1.338(b)-2T(d) except that the recently purchased stock is 
acquired for $1,600 plus additional payments that are contingent 
upon T's future earnings. Thus, T's AGUB, determined as of the 
beginning of the day after the acquisition date (after reduction by 
T's cash of $200), is $2,500 and is allocable among T's Class II, 
III, IV, and V acquisition date assets pursuant to Sec. 1.338(b)-
2T(c)(3)(iii) as follows:

------------------------------------------------------------------------
                             Asset                                Basis 
------------------------------------------------------------------------
Portfolio of marketable securities.............................    *$268
Inventory......................................................      268
Accounts receivable............................................      536
Building.......................................................      714
Land...........................................................      178
Investment in T1...............................................      402
Goodwill and going concern value...............................      134
                                                                --------
      Total....................................................  $2,500 
------------------------------------------------------------------------
*All numbers rounded for convenience.                                   

* * * * *
    (v) Under Sec. 1.338(b)-2T(c)(3) the redetermined fair market 
value of Class V assets is deemed to be $400, i.e., the hypothetical 
purchase price, as redetermined, of $3,250 minus $2,850 (the sum of 
T's cash, $200, and the fair market values of its Class II, III, and 
IV assets, $2,650).
    (vi) The amount of AGUB available to allocate to T's Class II, 
III, IV, and V acquisition date assets is $2,700 (i.e., redetermined 
AGUB reduced by cash). AGUB allocable to each of T's acquisition 
date assets (i.e., the redetermined (c)(3) amount) is redetermined 
using the deemed fair market value of the Class V assets from 
paragraph (v) of this Example as follows:

Portfolio of marketable securities.............................    *$266
Inventory......................................................      266
Accounts receivable............................................      531
Building.......................................................      708
Land...........................................................      177
Investment in T1...............................................      398
Goodwill and going concern value...............................      354
      Total....................................................  $2,700 
                                                                        
* All numbers rounded for convenience.                                  

    (vii) As illustrated by this example, the application of 
paragraph (f) of this section results in a basis increase for some 
assets and a basis decrease for other assets. The amount of increase 
(or decrease) in AGUB allocated to each acquisition date asset is 
determined as follows:

[[Page 2272]]



------------------------------------------------------------------------
                                                               Increase 
                                    Original   Redetermined      (or    
              Asset                   AGUB        (c)(3)      decrease) 
                                                  amount       in AGUB  
------------------------------------------------------------------------
Portfolio of marketable.........                                        
securities......................         $268          $266         $(2)
Inventory.......................          268           266          (2)
Accounts receivable.............          536           531          (5)
Building........................          714           708          (6)
Land............................          178           177          (1)
Investment in T1................          402           398          (4)
Goodwill and going concern value          134           354          220
                                 ---------------------------------------
      Total.....................       $2,500        $2,700         $200
------------------------------------------------------------------------

* * * * *
    Example 6. (i)(A) T has three assets (other than goodwill and 
going concern value) whose fair market values as of the beginning of 
the day after the acquisition date are as follows:

------------------------------------------------------------------------
                                                                   Fair 
         Asset class                         Asset                market
                                                                  value 
------------------------------------------------------------------------
III..........................  Building........................     $100
III..........................  Equipment.......................       50
IV...........................  Secret process..................       50
                               Total...........................     $200
------------------------------------------------------------------------

    (B) The secret process is a section 197 intangible. T has no 
liabilities. Assume that no election under section 338 (h)(10) or 
(h)(11) is in effect.
    (ii) On January 1, 1998, P purchases all of the outstanding T 
stock for $225 plus 50 percent of the net profits generated by the 
secret process for each of the next three years, determinable and 
payable on January 1 of each following year. P and T are calendar 
year taxpayers.
    (iii) As of the beginning of January 2, 1998, T's AGUB is $225, 
allocated as follows:

------------------------------------------------------------------------
         Asset class                         Asset                Basis 
------------------------------------------------------------------------
III..........................  Building........................     $100
III..........................  Equipment.......................       50
IV...........................  Secret process..................       50
V............................  Goodwill and going concern value       25
                                                                --------
                               Total...........................     $225
------------------------------------------------------------------------

    (iv) On January 1, 1999, $5 is paid by P for the T stock by 
reason of the net profits from the secret process. The payments are 
not attributable in any respect to any of T's other acquisition date 
assets. As a result, T's AGUB on January 1, 1999 is increased by $5.
    (v) Assume that on January 1, 1999, the fair market value of the 
secret process is redetermined to be $52. (For purposes of this 
redetermination, only those circumstances that resulted in the 
increase to AGUB are taken into account.)
    (vi) On January 1, 1999, only $2 of the $5 increase in AGUB is 
allocated to the secret process because the increase in AGUB so 
allocated cannot increase the basis of the secret process above its 
redetermined fair market value ($52). The balance of the increase is 
allocated to goodwill and going concern value because the fair 
market value limitation of Sec. 1.338(b)-2T(c)(1) precludes 
allocating additional AGUB to the Class III and IV assets.
    (vii) The price for which old target is deemed to have sold the 
secret process is increased to reflect the $2 increase allocated to 
its basis to new target. See Sec. 1.338-3(d) and paragraph (h)(1) of 
this section.
    (viii) If the fair market value of the secret process as of 
January 1, 1999, is unchanged from the fair market value as of the 
beginning of the day after the acquisition date, then the $5 
increase in AGUB is allocated to T's goodwill and going concern 
value.
    Example 7. (i) The facts are the same as in Example 6 except 
that--
    (A) The secret process is valued at $75 as of the beginning of 
the day after the acquisition date; and
    (B) P pays $250 for the T stock and the former T shareholders 
agree to refund a portion of the purchase price to P for each of the 
three years that the net income from the secret process is less than 
$15 per year, determinable and payable on January 1 of the next 
year.
    (ii) Assume that the secret process in the hands of new T is an 
amortizable section 197 intangible and, therefore, on January 1, 
1999, new T's adjusted basis in the secret process is $70 (i.e., 
$75-$5 of allowable amortization).
    (iii) Assume the net income from the process is less than $15 
for 1998, and on January 1, 1999, P receives a refund that reduces 
the stock purchase price by $3.
    (iv) Assume that as of January 1, 1999, the fair market value of 
the secret process is redetermined to be $65. (For purposes of this 
redetermination, only those circumstances that resulted in the 
decrease to AGUB are taken into account.)
    (v) As of January 1, 1999, the AGUB of T is decreased by $3. 
This decrease is allocated to the secret process, the basis of which 
becomes $67 (i.e., $70-$3) and is amortizable over the remaining 14 
years.
    (vi) The price for which old target is deemed to have sold the 
secret process is decreased to reflect the $3 decrease allocated to 
its basis to new target. See Sec. 1.338-3(d) and paragraph (h)(1) of 
this section.
    Example 8. The facts are the same as in Example 6 except that 
the intangible Class IV asset is a patent instead of a secret 
process. The redetermination of the fair market value of the patent 
on January 1, 1999, is made without regard to the decrease in the 
remaining life of the patent because that is not a circumstance that 
resulted in the increase in AGUB.

    Par. 6. Section 1.1060-1T is amended by:
    1. Designating the text of paragraph (a)(2) following the heading 
as paragraph (a)(2)(i), adding a heading to newly designated paragraph 
(a)(2)(i), and adding paragraph (a)(2)(ii).
    2. In paragraph (a)(3), revising the outline of topics entries for 
(a)(2), (b)(2) and (h)(3).
    3. Revising the seventh sentence of paragraph (b)(4).
    4. Revising paragraphs (d)(2), (e)(1), and (f)(3)(i).
    5. Revising the following examples in paragraph (g): Example 1; 
Example 2; Example 3, paragraphs (i), (viii), and (xi); and Example 4.
    6. Revising paragraph (h)(3).
    The additions and revisions read as follows:


Sec. 1.1060-1T  Special allocation rules for certain asset acquisitions 
(temporary).

    (a) * * *
    (2)  Effective   date--(i)  In  general. * * *
    (ii) Allocation of consideration. Paragraphs (d) and (h)(3) of this 
section and conforming amendments to other provisions of this section 
apply to applicable asset acquisitions completed on or after February 
14, 1997. For applicable asset acquisitions completed before February 
14, 1997, if section 197 does not apply to any of the acquired assets, 
the provisions of the regulations in effect before February 14, 1997 
apply (see Sec. 1.1060-1T as contained in 26 CFR part 1 revised April 
1, 1996). For applicable asset acquisitions completed before February 
14, 1997, if section 197 applies to any of the acquired assets, the 
taxpayer (and related parties) may consistently (in all transactions in 
which AGUB (as defined in Sec. 1.338(b)-1), ADSP (as defined in 
Sec. 1.338-3), MADSP (as defined in Sec. 1.338(h)(10)-1), or 
consideration must be allocated under section 338 or 1060)--
    (A) Apply the provisions of this section;

[[Page 2273]]

    (B) Apply the provisions of this section as in effect before 
February 14, 1997 (see Sec. 1.1060-1T as contained in 26 CFR part 1 
revised April 1, 1996); or
    (C) Apply the provisions of this section as in effect before 
February 14, 1997 (see Sec. 1.1060-1T as contained in 26 CFR part 1 
revised April 1, 1996), but treat all amortizable section 197 
intangibles as Class IV assets.
    (3) * * *

    (a) * * *
    (2) Effective date.
    (i) In general.
    (ii) Allocation of consideration.
* * * * *
    (d) * * *
    (2) Assets other than Class I assets.
    (i) In general.
    (ii) Class II assets.
    (iii) Class III assets.
    (iv) Class IV assets.
    (v) Class V assets.
* * * * *
    (h) * * *
    (3) Interim procedures for Form 8594.

    (b) * * *
    (4) * * * The money and other property that are treated as 
transferred in exchange for the like-kind property (and which are 
excluded from the assets to which section 1060 applies) are considered 
to come from the following assets in the following order: first from 
Class I assets, then from Class II assets, then from Class III assets, 
then from Class IV assets, and then from Class V assets. * * *
* * * * *
    (d) * * *
    (2) Assets other than Class I assets--(i) In general. Subject to 
the limitations and other special rules of paragraph (e) of this 
section, consideration (as reduced by the amount of Class I assets) is 
allocated among Class II assets transferred by the seller in proportion 
to the fair market values of such Class II assets on the purchase date, 
then among Class III assets transferred by the seller in proportion to 
the fair market values of such Class III assets on that date, then 
among Class IV assets transferred by the seller in proportion to the 
fair market values of such Class IV assets on that date, and finally to 
Class V assets.
    (ii) Class II assets. Class II assets are certificates of deposit, 
U.S. government securities, readily marketable stock or securities 
(within the meaning of Sec. 1.351-1(c)(3)), foreign currency, and other 
items designated in the Internal Revenue Bulletin by the Internal 
Revenue Service.
    (iii) Class III assets. Class III assets are all assets other than 
Class I, II, IV, and V assets.
    (iv) Class IV assets. Class IV assets are all section 197 
intangibles, as defined in section 197, except those in the nature of 
goodwill and going concern value.
    (v) Class V assets. Class V assets are section 197 intangibles in 
the nature of goodwill and going concern value.
    (e) * * *
    (1) Allocation not to exceed fair market value. The amount of 
consideration allocated to an asset (other than Class V assets) shall 
not exceed the fair market value of that asset on the purchase date.
* * * * *
    (f) * * *
    (3) * * *
    (i) In general. A decrease in consideration is allocated in the 
following order: first, as a reduction in the amount previously 
allocated to Class V assets, second, as a reduction in the amount 
previously allocated to Class IV assets in proportion to their fair 
market values, third, as a reduction in the amount previously allocated 
to Class III assets in proportion to their fair market values, and 
finally, as a reduction in the amount previously allocated to Class II 
assets in proportion to their fair market values. Decreases in 
consideration allocated to an asset shall not exceed the amount of 
consideration previously allocated to that asset. Except as provided in 
paragraph (f)(4)(ii) of this section (relating to patents and similar 
property), the fair market value is the fair market value on the 
purchase date.
* * * * *
    (g) * * *

    Example 1. (i) On January 1, 1998, S, a sole proprietor, sells 
to P, a corporation, a group of assets which constitute a trade or 
business under paragraph (b)(2) of this section. P pays S $2,000 in 
cash and assumes $1,000 in liabilities. Thus, the total 
consideration is $3,000.
    (ii) Assume that P acquires no Class I assets and that on the 
purchase date, the fair market values of the Class II, Class III, 
and Class IV assets S sold to P are as follows:

------------------------------------------------------------------------
                                                                   Fair 
         Asset class                         Asset                market
                                                                  value 
------------------------------------------------------------------------
II...........................  Portfolio of marketable             $ 400
                                securities.                             
                                                                --------
                                 Total Class II................    $ 400
III..........................  Furniture and fixtures..........    $ 800
                               Building........................      800
                               Land............................      200
                               Equipment.......................      400
                               Accounts receivable.............      100
                                                                --------
                               Total Class III.................   $2,300
IV...........................  Covenant not to compete.........     $100
                                                                --------
                               Total Class IV..................     $100
------------------------------------------------------------------------

    (iii) Under paragraphs (d)(1) and (2) of this section, the 
amount of consideration allocable to the Class II, III, IV, and V 
assets is the total consideration reduced by the amount of any Class 
I assets. Since P acquired no Class I assets, the total 
consideration of $3,000 is next allocated first to Class II, then to 
Class III, and then to Class IV assets. Since the fair market value 
of the Class II assets is $400, $400 of consideration is allocated 
to the Class II assets. Since the remaining amount of consideration 
is $2,600 ($3,000 - $400), an amount which exceeds the sum of the 
fair market values of the Class III assets ($2,300), the amount 
allocated to each Class III asset is its fair market value. Since, 
after the allocation to Class III assets, the remaining amount of 
consideration is $300 ($3,000 - ($400 + $2,300)), an amount which 
exceeds the fair market value of the Class IV asset ($100), the 
amount allocated to the Class IV asset is its fair market value. 
Thus, the total amount allocated to the Class II assets is $400, the 
total amount allocated to the Class III assets is $2,300, and the 
total amount allocated to the Class IV asset is $100.
    (iv) The amount allocated to the Class V assets (assets in the 
nature of goodwill and going concern value) is $200 (i.e., $3,000 - 
($400 + $2,300 + $100)).
    Example 2. (i) Assume the same facts as in Example 1.Assume 
further that P and S each use the calendar year as the taxable year 
and that, on September 30, 1998, P files a claim against S alleging 
fraud in the sale of all of the assets.
    (ii) On January 1, 2007, S refunds $400 of the purchase price to 
P in a settlement of the lawsuit.
    (iii) Under paragraph (f)(3)(i) of this section, both S and P 
take into account the $400 decrease in consideration and allocate it 
among the assets. First, since $200 of consideration previously was 
allocated to the assets in the nature of goodwill and going concern 
value (Class V assets), $200 of the decrease in consideration is 
allocated to those assets. Then, since $100 of consideration 
previously was allocated to the only Class IV asset, the covenant 
not to compete, the next $100 of the remaining decrease in 
consideration ($200) is allocated to that asset. The remaining 
decrease in consideration ($100) is then allocated to the Class III 
assets in proportion to their fair market values on the purchase 
date as follows:

[[Page 2274]]



------------------------------------------------------------------------
                                                          Decrease in   
                                  Fair    Allocation     consideration  
             Asset               market    fraction     ($100  x  Col.  
                                 value                       (2))       
------------------------------------------------------------------------
Furniture and fixtures........     $800    800/2,300              $34.78
Building......................      800    800/2,300               34.78
Land..........................      200    200/2,300                8.70
Equipment.....................      400    400/2,300               17.39
Accounts receivable...........      100    100/2,300                4.35
                               -----------------------------------------
      Total...................   $2,300                          $100.00
------------------------------------------------------------------------

    (iv) In summary, the redetermined consideration that S received for 
the group of assets is $2,600 after taking into account the decrease in 
consideration. After allocating the decrease, P's and S's redetermined 
consideration is as follows:

----------------------------------------------------------------------------------------------------------------
                                                                   Original       Decrease in      Redetermined 
                            Asset                               consideration    consideration    consideration 
----------------------------------------------------------------------------------------------------------------
Portfolio of marketable securities...........................          $400.00            $0.00          $400.00
Furniture and fixtures.......................................           800.00            34.78           765.22
Building.....................................................           800.00            34.78           765.22
Land.........................................................           200.00             8.70           191.30
Equipment....................................................           400.00            17.39           382.61
Accounts receivable..........................................           100.00             4.35            95.65
Covenant not to compete......................................           100.00           100.00             0.00
Goodwill and going concern value.............................           200.00           200.00             0.00
                                                              --------------------------------------------------
      Total..................................................        $3,000.00          $400.00        $2,600.00
----------------------------------------------------------------------------------------------------------------

    (v) Assume that, as a result of deductions under section 168, P's 
adjusted basis in the equipment immediately before the decrease in 
consideration is zero. P, therefore, treats the equipment as if it were 
disposed of before the decrease is taken into account. In 2007, P 
recognizes income of $17.39, the character of which is determined under 
the principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and 
the tax benefit rule. No adjustment to the basis of P's assets is made 
for any tax paid on this amount. Assume also that, as a result of 
amortization deductions, the adjusted basis of the covenant not to 
compete and the goodwill and going concern value immediately before the 
decrease in consideration is $120. A similar adjustment to income is 
made in 2007 with respect to the $180 of previously amortized covenant 
not to compete and goodwill and going concern value.
    Example 3. (i) On January 1, 1998, A transfers assets X, Y, and Z 
worth $1,000 to B in exchange for assets D, E, and F, worth $100, plus 
$1,000 cash.
* * * * *
    (viii) A, as transferor of assets X, Y, and Z, received $100 that 
must be allocated under section 1060 and paragraph (d) of this section. 
Since A transferred no Class I, II, III, or IV assets to which section 
1060 applies, the $100 is allocated to Class V assets (assets in the 
nature of goodwill and going concern value).
* * * * *
    (xi) B, as transferee of assets X, Y, and Z, gave A $100 that 
must be allocated under section 1060 and paragraph (d) of this 
section. Since B received from A no Class I, II, III, or IV assets 
to which section 1060 applies, the $100 consideration is allocated 
by B to Class V assets (assets in the nature of goodwill and going 
concern value).
    Example 4. (i) On January 1, 1998, S, a sole proprietor, sells 
to P, a corporation, a group of assets which constitutes a trade or 
business under paragraph (b)(2) of this section. S, who plans to 
retire immediately, also executes a covenant not to compete in P's 
favor. P pays S $3,000 in cash and assumes $1,000 in liabilities. 
Thus, the total consideration is $4,000.
    (ii) On the purchase date, P and S also execute a separate 
agreement that states that the fair market values of the Class II, 
Class III, and Class IV assets S sold to P are as follows:

------------------------------------------------------------------------
                                                                   Fair 
         Asset class                         Asset                market
                                                                  value 
------------------------------------------------------------------------
II...........................  Portfolio of marketable              $500
                                securities.                             
                                                                --------
                                 Total Class II................     $500
III..........................  Furniture and fixtures..........     $800
                                 Building......................      800
                                 Land..........................      200
                                 Equipment.....................      400
                                 Accounts receivable...........      200
                                                                --------
                               Total Class III.................   $2,400
IV...........................  Covenant not to compete.........     $900
                                                                --------
                               Total Class IV..................     $900
------------------------------------------------------------------------

    (iii) P and S each allocate the consideration in the transaction 
among the assets transferred under paragraph (d) of this section in 
accordance with the agreed upon fair market values of the assets, so 
that $500 is allocated to Class II assets, $2,400 is allocated to 
Class III assets, $900 is allocated to Class IV assets, and $200 
($4,000 total consideration less $3,800 allocated to asset classes 
II, III, and IV is allocated to the Class V assets (assets in the 
nature of goodwill and going concern value).
    (iv) In connection with the examination of P's return, the 
District Director, in determining the fair market values of the 
assets transferred, may disregard the parties' agreement. Assume 
that the District Director correctly determines that the fair market 
value of the covenant not to compete was $100. Since the allocation 
of consideration among Class II, III, and IV assets results in 
allocation up to the fair market value limitation, the $800 of 
unallocated consideration resulting from the District Director's 
redetermination of the value of the covenant not to compete is 
allocated to Class V assets (assets in the nature of goodwill and 
going concern value).

    (h) * * *
    (3) Interim procedures for Form 8594. Until such time, if any, as 
Form 8594 is revised to require otherwise, the sum of the amounts 
allocated to Classes IV and

[[Page 2275]]

V should be reported on Form 8594 as Class IV assets.

    Approved: December 20, 1996.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-656 Filed 1-9-97; 2:53 pm]
BILLING CODE 4830-01-U