4168 Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations

PART 114—CARNETS

1. The authority citation for part 114

is revised to read as follows:

Authority: 19 U.S.C. 66, 1202 (General

Note 20, Harmonized Tariff Schedule of the

United States), 1623, 1624.

2. In § 114.1, paragraphs (b) and (c)

are amended by adding the phrase ‘‘or

bilateral Agreement’’ immediately after

the words ‘‘Customs Convention’’ each

time they appear, and a new paragraph

(g) is added to read as follows:

§ 114.1 Definitions.

* * * * *

(g) TECRO/AIT Carnet. ‘‘TECRO/AIT

carnet’’ means the document issued

pursuant to the Bilateral Agreement

between the Taipei Economic and

Cultural Representative Office (TECRO)

and the American Institute in Taiwan

(AIT) to cover the temporary admission

of goods.

3. Section 114.2 is amended by

revising the section heading and the

introductory text and by adding a new

paragraph (d) to read as follows:

§ 114.2 Customs Conventions and

Agreements.

The regulations in this part relate to

carnets provided for in the following

Customs Conventions and Agreements:

* * * * *

(d) Agreement Between the Taipei

Economic and Cultural Representative

Office in the United States and the

American Institute in Taiwan on

TECRO/AIT Carnet for the Temporary

Admission of Goods (hereinafter

referred to as the Agreement).

§ 114.3 [Amended]

4. In § 114.3, the introductory text in

paragraph (a) and paragraph (a)(2) are

amended by adding the words ‘‘or

Agreement’’ immediately after the word

‘‘Convention’’ each time it appears.

§ 114.11 [Amended]

5. Section 114.11 is amended by

adding the words ‘‘or Agreement’’

immediately after the word

‘‘Convention’’ each time it appears.

6. Section 114.22 is amended by

redesignating paragraph (d) as

paragraph (e) and adding a new

paragraph (d) to read as follows:

§ 114.22 Coverage of carnets.

* * * * *

(d) TECRO/AIT carnet.—(1) Use. The

TECRO/AIT carnet is acceptable for the

following two categories of goods to be

temporarily imported, unless

importation is prohibited under the

laws and regulations of the United

States:

(i) Professional equipment; and

(ii) Commercial samples and

advertising material imported for the

purpose of being shown or

demonstrated with a view to soliciting

orders.

(2) Issue and use. (i) Issuing

associations shall indicate on the cover

of the TECRO/AIT carnet the customs

territory in which it is valid and the

name and address of the guaranteeing

association.

(ii) The period fixed for re-exportation

of goods imported under cover of a

TECRO/AIT carnet shall not in any case

exceed the period of validity of that

carnet.

* * * * *

7. Section 114.23 is amended by

adding a new paragraph (c) to read as

follows:

§ 114.23 Maximum period.

* * * * *

(c) TECRO/AIT carnet. A TECRO/AIT

carnet shall not be issued with a period

of validity exceeding one year from the

date of issue. This period of validity

cannot be extended and must be shown

on the front cover of the carnet.

§ 114.24 [Amended]

8. Section 114.24 is amended by

adding the phrase ‘‘or TECRO/AIT’’

immediately after the abbreviation

‘‘A.T.A.’’.

§ 114.25 [Amended]

9. Section 114.25 is amended by

adding the phrase ‘‘or TECRO/AIT’’

immediately after the abbreviation

‘‘A.T.A.’’.

§ 114.26 [Amended]

10. In § 114.26, paragraphs (a) and (b)

are amended by adding the phrase ‘‘or

TECRO/AIT’’ immediately after the

abbreviation ‘‘A.T.A.’’ each time it

appears.

§ 114.31 [Amended]

11. Section 114.31(b) is amended by

adding the phrase ‘‘or TECRO/AIT’’

immediately after the abbreviation

‘‘A.T.A.’’.

§ 114.32 [Amended]

12. Section 114.32 is amended by

adding the phrase ‘‘or TECRO/AIT’’

immediately after the abbreviation

‘‘A.T.A.’’ the first time it appears and by

adding the phrase ‘‘or TECRO/AIT

Agreement’’ immediately after the

phrase ‘‘A.T.A. Convention’’.

§ 114.33 [Amended]

13. Section 114.33 is amended by

adding the words ‘‘or Agreement’’

immediately after the word

‘‘Convention’’.

§ 114.34 [Amended]

14. Section 114.34 is amended by

adding, in the heading and text of

paragraph (b), the phrase ‘‘or TECRO/

AIT’’ immediately after the abbreviation

‘‘A.T.A.’’ each time it appears.

George J. Weise,

Commissioner of Customs.

Approved: August 22, 1997.

Dennis M. O’Connell,

Acting Deputy Assistant Secretary of the

Treasury.

[FR Doc. 98–1950 Filed 1–27–98; 8:45 am]

BILLING CODE 4820–02–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8762]

RIN 1545–AB43

Installment Obligations Received From

Liquidating Corporations

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations relating to the use of the

installment method to report the gain

recognized by a shareholder who

receives, in exchange for the

shareholder’s stock, certain installment

obligations that are distributed upon the

complete liquidation of a corporation.

Changes to the applicable tax law were

made by the Installment Sales Revision

Act of 1980 and the Tax Reform Act of

1986. These regulations affect taxpayers

who receive installment obligations in

exchange for their stock upon the

complete liquidation of a corporation.

DATES: This regulation is effective

January 28, 1998.

For dates of applicability, see § 1.453–

11(e) of these regulations.

FOR FURTHER INFORMATION CONTACT:

George F. Wright, (202) 662–4950 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Section 453(h), relating to the tax

treatment of installment obligations

received by a shareholder from a

liquidating corporation, was added to

the Internal Revenue Code of 1954 by

the Installment Sales Revision Act of

1980, Pub. L. 96–471, 94 Stat. 2247,

2250. Proposed regulations under

section 453(h) were published in the

Federal Register for January 13, 1984

(49 FR 1742). Subsequently, section
Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations 4169

453(h) was amended as part of the Tax

Reform Act of 1986, Pub. L. 99–514, 100

Stat. 2085, 2274, pursuant to which both

C and S corporations became subject to

tax upon making liquidating

distributions of installment obligations

to shareholders. The Technical and

Miscellaneous Revenue Act of 1988,

Pub. L. 100–647, 102 Stat. 3342, 3403,

added section 453B(h), which provides

that no gain or loss is recognized by S

corporations with respect to certain

liquidating distributions of installment

obligations. The regulations proposed

on January 13, 1984 (49 FR 1742), were

withdrawn by the notice of proposed

rulemaking published on January 22,

1997 (62 FR 3244), except for paragraph

(e) relating to liquidating distributions

received in more than one taxable year,

and paragraph (g) containing the

effective date provision. The notice of

proposed rulemaking published in the

Federal Register for January 22, 1997,

reserved paragraph (d) for liquidating

distributions received in more than one

taxable year. Written comments

responding to this notice were received.

No public hearing was held because no

hearing was requested. After

consideration of all comments received,

the proposed regulations are adopted as

revised by this Treasury decision.

Explanation of Provisions

A. Overview of Provisions

Prior to the Installment Sales Revision

Act of 1980, a shareholder recognized

gain or loss on receipt of an installment

obligation that was distributed by a

liquidating corporation in exchange for

the shareholder’s stock. Gain could not

be reported under the installment sale

provisions of section 453 as payments

were received on the obligation

distributed by the corporation in the

liquidation.

As enacted by the Installment Sales

Revision Act of 1980 and amended by

the Tax Reform Act of 1986, section

453(h) provides a different treatment for

certain installment obligations that are

distributed in a complete liquidation to

which section 331 applies. Under

section 453(h), a shareholder that does

not elect out of the installment method

treats the payments under the

obligation, rather than the obligation

itself, as consideration received in

exchange for the stock. The shareholder

then takes into account the income from

the payments under the obligation using

the installment method. In this manner,

the shareholder generally is treated as if

the shareholder sold the shareholder’s

stock to an unrelated purchaser on the

installment method.

This treatment under section 453(h)

applies generally to installment

obligations received by a shareholder (in

exchange for the shareholder’s stock) in

a complete liquidation to which section

331 applies if (a) the installment

obligations are qualifying installment

obligations, i.e., the installment

obligations are acquired in respect of a

sale or exchange of property by the

corporation during the 12-month period

beginning on the date a plan of

complete liquidation is adopted, and (b)

the liquidation is completed within that

12-month period. However, an

installment obligation acquired in a sale

or exchange of inventory, stock in trade,

or property held for sale in the ordinary

course of business qualifies for this

treatment only if the obligation arises

from a single bulk sale of substantially

all of such property attributable to a

trade or business of the corporation. If

an installment obligation arises from

both a sale or exchange of inventory,

etc., that does not comply with the

requirements of the preceding sentence

and a sale or exchange of other assets,

the portion of the installment obligation

that is attributable to the sale or

exchange of other assets is a qualifying

installment obligation.

B. Discussion of Comments

Interaction of Section 453(h) and

Limitations on the Installment Method

The regulations provide that, if the

stock of a liquidating corporation is

traded on an established securities

market, an installment obligation

received by a shareholder from that

corporation as a liquidating distribution

is not a qualifying installment obligation

and does not qualify for installment

reporting, regardless of whether the

requirements of section 453(h) are

otherwise satisfied. However, if an

installment obligation is received by a

shareholder from a liquidating

corporation whose stock is not publicly

traded, and the obligation arose from a

sale by the corporation of stock or

securities that are traded on an

established market, then the obligation

generally is a qualifying installment

obligation in the hands of the transferor.

An exception to the above rule applies

if the liquidating corporation is formed

or availed of for a principal purpose of

avoiding limitations on the availability

of installment sales treatment, such as

section 453(k), through the use of a

related party.

One commentator suggested that the

anti-abuse rule directed at cases in

which there is a principal purpose to

avoid section 453(k) is not necessary.

The commentator suggests that the

effect of a contribution of publiclytraded stock to a nonpublicly-traded

corporation, followed by the sale of the

publicly-traded stock for an installment

obligation and the liquidation of the

nonpublicly-traded corporation, is the

creation of two levels of tax because the

liquidating corporation must recognize

gain on the distribution of the

installment obligation. Accordingly, the

commentator does not believe that the

transaction offers any tax avoidance

opportunities that warrant a specific

anti-abuse rule.

The anti-abuse rule is directed at

circumvention of the prohibition in

section 453(k) against the use of the

installment method for a sale of

publicly-traded securities. It is designed

to prevent a shareholder from indirectly

entering into such a sale on the

installment method when the

shareholder could not have done so

through a direct sale. Accordingly, the

anti-abuse rule has been retained.

Liquidating Distributions Received in

More Than One Year

Under § 1.453–2(e) proposed on

January 13, 1984, if liquidating

distributions, including qualifying

installment obligations, are received in

more than one taxable year, a

shareholder must file an amended

return if the reallocation of basis

required under section 453(h)(2) affects

the computation of gain recognized in

an earlier year. If the shareholder has

transferred the installment obligation to

a person whose basis in the obligation

is determined by reference to the

shareholder’s basis, then the transferee

generally is required to reallocate basis

and, if necessary, file an amended

return. The proposed effective date

applied to distributions of qualifying

installment obligations made after

March 31, 1980.

In the preamble to the 1997 proposed

regulations, the IRS and Treasury

Department suggested that an

alternative to the amended return

requirement would be to require the

shareholder to recognize in the current

year the additional amount of gain that

would have been recognized in the

earlier year had the total amount of the

liquidating distributions been known in

the earlier year. Comments were

requested regarding these and any other

methods of accomplishing the basis

reallocation. Proposed § 1.453–11(d)

relating to liquidating distributions

received in more than one taxable year

was reserved.

One commentator questioned whether

amended returns were necessary and

noted that the alternative method
4170 Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations

discussed in the preamble is simpler

and less burdensome for taxpayers. The

commentator then suggested an ordering

rule as another method of achieving the

intended purpose. Under the proposed

ordering rule, basis first would be

allocated to assets other than

installment obligations distributed in

the liquidation with the remainder

allocated to the installment obligations.

The commentator acknowledged that it

might not be appropriate to implement

this approach by regulation without

amending the statute.

The proposed ordering rule does not

satisfy the basis reallocation

requirement of section 453(h)(2) and

would require complex provisions to

implement it. Accordingly, the

suggested approach is not adopted in

the final regulations.

The purpose underlying section

453(h)(2) is to ensure that gain is

recognized in the appropriate year when

liquidating distributions are received in

more than one taxable year. The IRS and

Treasury Department believe that this

purpose can be substantially fulfilled

without imposing the burden of filing

amended returns. Accordingly, the final

regulations incorporate a current-year

recognition rule. Under the current-year

recognition rule, a shareholder is

required to recognize in the current year

the additional amount of gain that

would have been recognized in the

earlier year had the total amount of the

liquidating distributions been known in

the earlier year. In allocating basis to

calculate the gain to be reported in the

first year in which a liquidating

distribution is received, a shareholder is

required to reasonably estimate the

anticipated aggregate distributions. For

this purpose, the shareholder must take

into account distributions and other

events occurring up to the time at which

the return for the first taxable year is

filed. Section 1.453–2(e) of the 1984

proposal is adopted as revised by this

Treasury decision. The effective date

provision in § 1.453–2(g) of the proposal

is not adopted.

Recognition of Gain or Loss to the

Distributing Corporation Under Section

453B

Under section 453B, the disposition of

an installment obligation generally

results in the recognition of gain or loss

to the transferor. Thus, in accordance

with sections 453B and 336, a C

corporation generally recognizes gain or

loss upon the distribution of an

installment obligation to a shareholder

in exchange for the shareholder’s stock,

including complete liquidations covered

by section 453(h). Section 453B(d)

provides an exception to this general

rule if the installment obligation is

distributed in a liquidation to which

section 337(a) applies (regarding certain

complete liquidations of 80 percent or

more owned subsidiaries). However,

that exception does not apply to

liquidations under section 331.

In the case of a liquidating

distribution by an S corporation,

however, section 453B(h) provides that

if an S corporation distributes an

installment obligation in exchange for a

shareholder’s stock, and payments

under the obligation are treated as

consideration for the stock pursuant to

section 453(h)(1), then the distribution

generally is not treated as a disposition

of the obligation by the S corporation.

Thus, except for purposes of sections

1374 and 1375 (relating to certain builtin gains and passive investment

income), the S corporation does not

recognize gain or loss on the

distribution of the installment

obligation to a shareholder in a

complete liquidation covered by section

453(h). One commentator believed that

it is inequitable to allow a shareholder

to recognize gain on the installment

basis while the liquidating C

corporation has immediate recognition

upon distribution of an obligation. As

an alternative, the commentator

suggested that the corporation’s tax

liability arising from the distribution of

an obligation carry over to the

shareholders and be taken into account

by them as payments are received on the

obligation. The suggested approach

would be inconsistent with the statutory

provisions of sections 336 and 453B

and, accordingly, is not adopted in the

final regulations.

Another commentator requested that

the regulations provide relief from a

bunching of income that occurs for

shareholders receiving liquidating

distributions from S corporations. The

bunching can occur, for example, by

virtue of the interrelationship of the S

corporation and installment sale

provisions if, in the year in which assets

are sold, an S corporation receives a

payment on an installment obligation

arising from the sale before the

corporation liquidates. The

commentator suggested that the

regulations allow a shareholder first to

apply the basis in the stock against the

initial payment received, with any

remaining basis allocated to any

additional payments to be received.

Since the bunching of income results

from the successive application of

section 453(c) at the corporate and

shareholder levels and no statutory

exception for shareholders of S

corporations is provided, this issue

cannot be appropriately addressed in

these final regulations.

Incorporation of Guidance on Section

338(h)(10) Elections

Three commentators suggested that

the regulations be expanded to address

the use of the installment method to the

sale of stock of a corporation with

respect to which an election under

section 338(h)(10) has been made. This

issue does not arise under section

453(h) and is beyond the scope of these

regulations.

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 Internal Revenue

Code, the notice of proposed rulemaking

preceding these regulations was

submitted to the Chief Counsel for

Advocacy of the Small Business

Administration for comment on its

impact on small business.

Drafting Information

The principal author of these

regulations is George F. Wright of the

Office of Assistant Chief Counsel

(Income Tax and Accounting). 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 is amended by adding an entry

in numerical order to read as follows:

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

§ 1.453–11 also issued under 26

U.S.C. 453(j)(1) and (k). * * *

Par. 2. Section 1.453–11 is added to

read as follows:

§ 1.453–11 Installment obligations

received from a liquidating corporation.

(a) In general—(1) Overview. Except

as provided in section 453(h)(1)(C)
Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations 4171

(relating to installment sales of

depreciable property to certain closely

related persons), a qualifying

shareholder (as defined in paragraph (b)

of this section) who receives a

qualifying installment obligation (as

defined in paragraph (c) of this section)

in a liquidation that satisfies section

453(h)(1)(A) treats the receipt of

payments in respect of the obligation,

rather than the receipt of the obligation

itself, as a receipt of payment for the

shareholder’s stock. The shareholder

reports the payments received on the

installment method unless the

shareholder elects otherwise in

accordance with § 15a.453–1(d) of this

chapter.

(2) Coordination with other

provisions—(i) Deemed sale of stock for

installment obligation. Except as

specifically provided in section

453(h)(1)(C), a qualifying shareholder

treats a qualifying installment

obligation, for all purposes of the

Internal Revenue Code, as if the

obligation is received by the shareholder

from the person issuing the obligation in

exchange for the shareholder’s stock in

the liquidating corporation. For

example, if the stock of a corporation

that is liquidating is traded on an

established securities market, an

installment obligation distributed to a

shareholder of the corporation in

exchange for the shareholder’s stock

does not qualify for installment

reporting pursuant to section 453(k)(2).

(ii) Special rules to account for the

qualifying installment obligation—(A)

Issue price. A qualifying installment

obligation is treated by a qualifying

shareholder as newly issued on the date

of the distribution. The issue price of

the qualifying installment obligation on

that date is equal to the sum of the

adjusted issue price of the obligation on

the date of the distribution (as

determined under § 1.1275–1(b)) and

the amount of any qualified stated

interest (as defined in § 1.1273–1(c))

that has accrued prior to the distribution

but that is not payable until after the

distribution. For purposes of the

preceding sentence, if the qualifying

installment obligation is subject to

§ 1.446–2 (e.g., a debt instrument that

has unstated interest under section 483),

the adjusted issue price of the obligation

is determined under § 1.446–2(c) and

(d).

(B) Variable rate debt instrument. If

the qualifying installment obligation is

a variable rate debt instrument (as

defined in § 1.1275–5), the shareholder

uses the equivalent fixed rate debt

instrument (within the meaning of

§ 1.1275–5(e)(3)(ii)) constructed for the

qualifying installment obligation as of

the date the obligation was issued to the

liquidating corporation to determine the

accruals of original issue discount, if

any, and interest on the obligation.

(3) Liquidating distributions treated as

selling price. All amounts distributed or

treated as distributed to a qualifying

shareholder incident to the liquidation,

including cash, the issue price of

qualifying installment obligations as

determined under paragraph (a)(2)(ii)(A)

of this section, and the fair market value

of other property (including obligations

that are not qualifying installment

obligations) are considered as having

been received by the shareholder as the

selling price (as defined in § 15a.453–

1(b)(2)(ii) of this chapter) for the

shareholder’s stock in the liquidating

corporation. For the proper method of

reporting liquidating distributions

received in more than one taxable year

of a shareholder, see paragraph (d) of

this section. An election not to report on

the installment method an installment

obligation received in the liquidation

applies to all distributions received in

the liquidation.

(4) Assumption of corporate liability

by shareholders. For purposes of this

section, if in the course of a liquidation

a shareholder assumes secured or

unsecured liabilities of the liquidating

corporation, or receives property from

the corporation subject to such

liabilities (including any tax liabilities

incurred by the corporation on the

distribution), the amount of the

liabilities is added to the shareholder’s

basis in the stock of the liquidating

corporation. These additions to basis do

not affect the shareholder’s holding

period for the stock. These liabilities do

not reduce the amounts received in

computing the selling price.

(5) Examples. The provisions of this

paragraph (a) are illustrated by the

following examples. Except as otherwise

provided, assume in each example that

A, an individual who is a calendar-year

taxpayer, owns all of the stock of T

corporation. A’s adjusted tax basis in

that stock is $100,000. On February 1,

1998, T, an accrual method taxpayer,

adopts a plan of complete liquidation

that satisfies section 453(h)(1)(A) and

immediately sells all of its assets to

unrelated B corporation in a single

transaction. The examples are as

follows:

Example 1. (i) The stated purchase price

for T’s assets is $3,500,000. In consideration

for the sale, B makes a down payment of

$500,000 and issues a 10-year installment

obligation with a stated principal amount of

$3,000,000. The obligation provides for

interest payments of $150,000 on January 31

of each year, with the total principal amount

due at maturity.

(ii) Assume that for purposes of section

1274, the test rate on February 1, 1998, is 8

percent, compounded semi-annually. Also

assume that a semi-annual accrual period is

used. Under § 1.1274–2, the issue price of the

obligation on February 1, 1998, is $2,368,450.

Accordingly, the obligation has $631,550 of

original issue discount ($3,000,000–

$2,368,450). Between February 1 and July 31,

$19,738 of original issue discount and

$75,000 of qualified stated interest accrue

with respect to the obligation and are taken

into account by T.

(iii) On July 31, 1998, T distributes the

installment obligation to A in exchange for

A’s stock. No other property is ever

distributed to A. On January 31, 1999, A

receives the first annual payment of $150,000

from B.

(iv) When the obligation is distributed to

A on July 31, 1998, it is treated as if the

obligation is received by A in an installment

sale of shares directly to B on that date.

Under § 1.1275–1(b), the adjusted issue price

of the obligation on that date is $2,388,188

(original issue price of $2,368,450 plus

accrued original issue discount of $19,738).

Accordingly, the issue price of the obligation

under paragraph (a)(2)(ii)(A) of this section is

$2,463,188, the sum of the adjusted issue

price of the obligation on that date

($2,388,188) and the amount of accrued but

unpaid qualified stated interest ($75,000).

(v) The selling price and contract price of

A’s stock in T is $2,463,188, and the gross

profit is $2,363,188 ($2,463,188 selling price

less A’s adjusted tax basis of $100,000). A’s

gross profit ratio is thus 96 percent (gross

profit of $2,363,188 divided by total contract

price of $2,463,188).

(vi) Under §§ 1.446–2(e)(1) and 1.1275–

2(a), $98,527 of the $150,000 payment is

treated as a payment of the interest and

original issue discount that accrued on the

obligation from July 31, 1998, to January 31,

1999 ($75,000 of qualified stated interest and

$23,527 of original issue discount). The

balance of the payment ($51,473) is treated

as a payment of principal. A’s gain

recognized in 1999 is $49,414 (96 percent of

$51,473).

Example 2. (i) T owns Blackacre,

unimproved real property, with an adjusted

tax basis of $700,000. Blackacre is subject to

a mortgage (underlying mortgage) of

$1,100,000. A is not personally liable on the

underlying mortgage and the T shares held

by A are not encumbered by the underlying

mortgage. The other assets of T consist of

$400,000 of cash and $600,000 of accounts

receivable attributable to sales of inventory in

the ordinary course of business. The

unsecured liabilities of T total $900,000.

(ii) On February 1, 1998, T adopts a plan

of complete liquidation complying with

section 453(h)(1)(A), and promptly sells

Blackacre to B for a 4-year mortgage note

(bearing adequate stated interest and

otherwise meeting all of the requirements of

section 453) in the face amount of $4 million.

Under the agreement between T and B, T (or

its successor) is to continue to make

principal and interest payments on the

underlying mortgage. Immediately thereafter,

T completes its liquidation by distributing to

A its remaining cash of $400,000 (after
4172 Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations

payment of T’s tax liabilities), accounts

receivable of $600,000, and the $4 million B

note. A assumes T’s $900,000 of unsecured

liabilities and receives the distributed

property subject to the obligation to make

payments on the $1,100,000 underlying

mortgage. A receives no payments from B on

the B note during 1998.

(iii) Unless A elects otherwise, the

transaction is reported by A on the

installment method. The selling price is $5

million (cash of $400,000, accounts

receivable of $600,000, and the B note of $4

million). The total contract price also is $5

million. A’s adjusted tax basis in the T

shares, initially $100,000, is increased by the

$900,000 of unsecured T liabilities assumed

by A and by the obligation (subject to which

A takes the distributed property) to make

payments on the $1,100,000 underlying

mortgage on Blackacre, for an aggregate

adjusted tax basis of $2,100,000.

Accordingly, the gross profit is $2,900,000

(selling price of $5 million less aggregate

adjusted tax basis of $2,100,000). The gross

profit ratio is 58 percent (gross profit of

$2,900,000 divided by the total contract price

of $5 million). The 1998 payments to A are

$1 million ($400,000 cash plus $600,000

receivables) and A recognizes gain in 1998 of

$580,000 (58 percent of $1 million).

(iv) In 1999, A receives payment from B on

the B note of $1 million (exclusive of

interest). A’s gain recognized in 1999 is

$580,000 (58 percent of $1 million).

(b) Qualifying shareholder. For

purposes of this section, qualifying

shareholder means a shareholder to

which, with respect to the liquidating

distribution, section 331 applies. For

example, a creditor that receives a

distribution from a liquidating

corporation, in exchange for the

creditor’s claim, is not a qualifying

shareholder as a result of that

distribution regardless of whether the

liquidation satisfies section

453(h)(1)(A).

(c) Qualifying installment obligation—

(1) In general. For purposes of this

section, qualifying installment

obligation means an installment

obligation (other than an evidence of

indebtedness described in § 15a.453–

1(e) of this chapter, relating to

obligations that are payable on demand

or are readily tradable) acquired in a

sale or exchange of corporate assets by

a liquidating corporation during the 12-

month period beginning on the date the

plan of liquidation is adopted. See

paragraph (c)(4) of this section for an

exception for installment obligations

acquired in respect of certain sales of

inventory. Also see paragraph (c)(5) of

this section for an exception for

installment obligations attributable to

sales of certain property that do not

generally qualify for installment method

treatment.

(2) Corporate assets. Except as

provided in section 453(h)(1)(C), in

paragraph (c)(4) of this section (relating

to certain sales of inventory), and in

paragraph (c)(5) of this section (relating

to certain tax avoidance transactions),

the nature of the assets sold by, and the

tax consequences to, the selling

corporation do not affect whether an

installment obligation is a qualifying

installment obligation. Thus, for

example, the fact that the fair market

value of an asset is less than the

adjusted basis of that asset in the hands

of the corporation; or that the sale of an

asset will subject the corporation to

depreciation recapture (e.g., under

section 1245 or section 1250); or that the

assets of a trade or business sold by the

corporation for an installment obligation

include depreciable property, certain

marketable securities, accounts

receivable, installment obligations, or

cash; or that the distribution of assets to

the shareholder is or is not taxable to

the corporation under sections 336 and

453B, does not affect whether

installment obligations received in

exchange for those assets are treated as

qualifying installment obligations by the

shareholder. However, an obligation

received by the corporation in exchange

for cash, in a transaction unrelated to a

sale or exchange of noncash assets by

the corporation, is not treated as a

qualifying installment obligation.

(3) Installment obligations distributed

in liquidations described in section

453(h)(1)(E)—(i) In general. In the case

of a liquidation to which section

453(h)(1)(E) (relating to certain

liquidating subsidiary corporations)

applies, a qualifying installment

obligation acquired in respect of a sale

or exchange by the liquidating

subsidiary corporation will be treated as

a qualifying installment obligation if

distributed by a controlling corporate

shareholder (within the meaning of

section 368(c)) to a qualifying

shareholder. The preceding sentence is

applied successively to each controlling

corporate shareholder, if any, above the

first controlling corporate shareholder.

(ii) Examples. The provisions of this

paragraph (c)(3) are illustrated by the

following examples:

Example 1. (i) A, an individual, owns all

of the stock of T corporation, a C corporation.

T has an operating division and three whollyowned subsidiaries, X, Y, and Z. On February

1, 1998, T, Y, and Z all adopt plans of

complete liquidation.

(ii) On March 1, 1998, the following sales

are made to unrelated purchasers: T sells the

assets of its operating division to B for cash

and an installment obligation. T sells the

stock of X to C for an installment obligation.

Y sells all of its assets to D for an installment

obligation. Z sells all of its assets to E for

cash. The B, C, and D installment obligations

bear adequate stated interest and meet the

requirements of section 453.

(iii) In June 1998, Y and Z completely

liquidate, distributing their respective assets

(the D installment obligation and cash) to T.

In July 1998, T completely liquidates,

distributing to A cash and the installment

obligations respectively issued by B, C, and

D. The liquidation of T is a liquidation to

which section 453(h) applies and the

liquidations of Y and Z into T are

liquidations to which section 332 applies.

(iv) Because T is in control of Y (within the

meaning of section 368(c)), the D obligation

acquired by Y is treated as acquired by T

pursuant to section 453(h)(1)(E). A is a

qualifying shareholder and the installment

obligations issued by B, C, and D are

qualifying installment obligations. Unless A

elects otherwise, A reports the transaction on

the installment method as if the cash and

installment obligations had been received in

an installment sale of the stock of T

corporation. Under section 453B(d), no gain

or loss is recognized by Y on the distribution

of the D installment obligation to T. Under

sections 453B(a) and 336, T recognizes gain

or loss on the distribution of the B, C, and

D installment obligations to A in exchange

for A’s stock.

Example 2. (i) A, a cash-method individual

taxpayer, owns all of the stock of P

corporation, a C corporation. P owns 30

percent of the stock of Q corporation. The

balance of the Q stock is owned by unrelated

individuals. On February 1, 1998, P adopts

a plan of complete liquidation and sells all

of its property, other than its Q stock, to B,

an unrelated purchaser for cash and an

installment obligation bearing adequate

stated interest. On March 1, 1998, Q adopts

a plan of complete liquidation and sells all

of its property to an unrelated purchaser, C,

for cash and installment obligations. Q

immediately distributes the cash and

installment obligations to its shareholders in

completion of its liquidation. Promptly

thereafter, P liquidates, distributing to A

cash, the B installment obligation, and a C

installment obligation that P received in the

liquidation of Q.

(ii) In the hands of A, the B installment

obligation is a qualifying installment

obligation. In the hands of P, the C

installment obligation was a qualifying

installment obligation. However, in the

hands of A, the C installment obligation is

not treated as a qualifying installment

obligation because P owned only 30 percent

of the stock of Q. Because P did not own the

requisite 80 percent stock interest in Q, P was

not a controlling corporate shareholder of Q

(within the meaning of section 368(c))

immediately before the liquidation.

Therefore, section 453(h)(1)(E) does not

apply. Thus, in the hands of A, the C

obligation is considered to be a third-party

note (not a purchaser’s evidence of

indebtedness) and is treated as a payment to

A in the year of distribution. Accordingly, for

1998, A reports as payment the cash and the

fair market value of the C obligation

distributed to A in the liquidation of P.

(iii) Because P held 30 percent of the stock

of Q, section 453B(d) is inapplicable to P.

Under sections 453B(a) and 336, accordingly,
Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations 4173

Q recognizes gain or loss on the distribution

of the C obligation. P also recognizes gain or

loss on the distribution of the B and C

installment obligations to A in exchange for

A’s stock. See sections 453B and 336.

(4) Installment obligations

attributable to certain sales of

inventory—(i) In general. An installment

obligation acquired by a corporation in

a liquidation that satisfies section

453(h)(1)(A) in respect of a broken lot of

inventory is not a qualifying installment

obligation. If an installment obligation is

acquired in respect of a broken lot of

inventory and other assets, only the

portion of the installment obligation

acquired in respect of the broken lot of

inventory is not a qualifying installment

obligation. The portion of the

installment obligation attributable to

other assets is a qualifying installment

obligation. For purposes of this section,

the term broken lot of inventory means

inventory property that is sold or

exchanged other than in bulk to one

person in one transaction involving

substantially all of the inventory

property attributable to a trade or

business of the corporation. See

paragraph (c)(4)(ii) of this section for

rules for determining what portion of an

installment obligation is not a qualifying

installment obligation and paragraph

(c)(4)(iii) of this section for rules

determining the application of

payments on an installment obligation

only a portion of which is a qualifying

installment obligation.

(ii) Rules for determining

nonqualifying portion of an installment

obligation. If a broken lot of inventory

is sold to a purchaser together with

other corporate assets for consideration

consisting of an installment obligation

and either cash, other property, the

assumption of (or taking property

subject to) corporate liabilities by the

purchaser, or some combination thereof,

the installment obligation is treated as

having been acquired in respect of a

broken lot of inventory only to the

extent that the fair market value of the

broken lot of inventory exceeds the sum

of unsecured liabilities assumed by the

purchaser, secured liabilities which

encumber the broken lot of inventory

and are assumed by the purchaser or to

which the broken lot of inventory is

subject, and the sum of the cash and fair

market value of other property received.

This rule applies solely for the purpose

of determining the portion of the

installment obligation (if any) that is

attributable to the broken lot of

inventory.

(iii) Application of payments. If, by

reason of the application of paragraph

(c)(4)(ii) of this section, a portion of an

installment obligation is not a qualifying

installment obligation, then for

purposes of determining the amount of

gain to be reported by the shareholder

under section 453, payments on the

obligation (other than payments of

qualified stated interest) shall be

applied first to the portion of the

obligation that is not a qualifying

installment obligation.

(iv) Example. The following example

illustrates the provisions of this

paragraph (c)(4). In this example,

assume that all obligations bear

adequate stated interest within the

meaning of section 1274(c)(2) and that

the fair market value of each

nonqualifying installment obligation

equals its face amount. The example is

as follows:

Example. (i) P corporation has three

operating divisions, X, Y, and Z, each

engaged in a separate trade or business, and

a minor amount of investment assets. On July

1, 1998, P adopts a plan of complete

liquidation that meets the criteria of section

453(h)(1)(A). The following sales are

promptly made to purchasers unrelated to P:

P sells all of the assets of the X division

(including all of the inventory property) to B

for $30,000 cash and installment obligations

totalling $200,000. P sells substantially all of

the inventory property of the Y division to

C for a $100,000 installment obligation, and

sells all of the other assets of the Y division

(excluding cash but including installment

receivables previously acquired in the

ordinary course of the business of the Y

division) to D for a $170,000 installment

obligation. P sells 1⁄3 of the inventory

property of the Z division to E for $100,000

cash, 1⁄3 of the inventory property of the Z

division to F for a $100,000 installment

obligation, and all of the other assets of the

Z division (including the remaining 1⁄3 of the

inventory property worth $100,000) to G for

$60,000 cash, a $240,000 installment

obligation, and the assumption by G of the

liabilities of the Z division. The liabilities

assumed by G, which are unsecured

liabilities and liabilities encumbering the

inventory property acquired by G, aggregate

$30,000. Thus, the total purchase price G

pays is $330,000.

(ii) P immediately completes its

liquidation, distributing the cash and

installment obligations, which otherwise

meet the requirements of section 453, to A,

an individual cash-method taxpayer who is

its sole shareholder. In 1999, G makes a

payment to A of $100,000 (exclusive of

interest) on the $240,000 installment

obligation.

(iii) In the hands of A, the installment

obligations issued by B, C, and D are

qualifying installment obligations because

they were timely acquired by P in a sale or

exchange of its assets. In addition, the

installment obligation issued by C is a

qualifying installment obligation because it

arose from a sale to one person in one

transaction of substantially all of the

inventory property of the trade or business

engaged in by the Y division.

(iv) The installment obligation issued by F

is not a qualifying installment obligation

because it is in respect of a broken lot of

inventory. A portion of the installment

obligation issued by G is a qualifying

installment obligation and a portion is not a

qualifying installment obligation, determined

as follows: G purchased part of the inventory

property (with a fair market value of

$100,000) and all of the other assets of the

Z division by paying cash ($60,000), issuing

an installment obligation ($240,000), and

assuming liabilities of the Z division

($30,000). The assumed liabilities ($30,000)

and cash ($60,000) are attributed first to the

inventory property. Therefore, only $10,000

of the $240,000 installment obligation is

attributed to inventory property.

Accordingly, in the hands of A, the G

installment obligation is a qualifying

installment obligation to the extent of

$230,000, but is not a qualifying installment

obligation to the extent of the $10,000

attributable to the inventory property.

(v) In the 1998 liquidation of P, A receives

a liquidating distribution as follows:

Item

Qualifying

installment obligations

Cash and

other

property

Cash .......................... ................ $190,000

B note ........................ $200,000 ................

C note ....................... $100,000 ................

D note ....................... $170,000 ................

F note ........................ ................ $100,000

G note 1 ..................... $230,000 $ 10,000

Total ................... $700,000 $300,000

1Face amount $240,000.

(vi) Assume that A’s adjusted tax basis in

the stock of P is $100,000. Under the

installment method, A’s selling price and the

contract price are both $1 million, the gross

profit is $900,000 (selling price of $1 million

less adjusted tax basis of $100,000), and the

gross profit ratio is 90 percent (gross profit

of $900,000 divided by the contract price of

$1 million). Accordingly, in 1998, A reports

gain of $270,000 (90 percent of $300,000

payment in cash and other property). A’s

adjusted tax basis in each of the qualifying

installment obligations is an amount equal to

10 percent of the obligation’s respective face

amount. A’s adjusted tax basis in the F note,

a nonqualifying installment obligation, is

$100,000, i.e., the fair market value of the

note when received by A. A’s adjusted tax

basis in the G note, a mixed obligation, is

$33,000 (10 percent of the $230,000

qualifying installment obligation portion of

the note, plus the $10,000 nonqualifying

portion of the note).

(vii) With respect to the $100,000 payment

received from G in 1999, $10,000 is treated

as the recovery of the adjusted tax basis of

the nonqualifying portion of the G

installment obligation and $9,000 (10 percent

of $90,000) is treated as the recovery of the

adjusted tax basis of the portion of the note

that is a qualifying installment obligation.

The remaining $81,000 (90 percent of

$90,000) is reported as gain from the sale of

A’s stock. See paragraph (c)(4)(iii) of this

section.
4174 Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations

(5) Installment obligations

attributable to sales of certain

property—(i) In general. An installment

obligation acquired by a liquidating

corporation, to the extent attributable to

the sale of property described in

paragraph (c)(5)(ii) of this section, is not

a qualifying obligation if the corporation

is formed or availed of for a principal

purpose of avoiding section 453(b)(2)

(relating to dealer dispositions and

certain other dispositions of personal

property), section 453(i) (relating to

sales of property subject to recapture),

or section 453(k) (relating to

dispositions under a revolving credit

plan and sales of stock or securities

traded on an established securities

market) through the use of a party

bearing a relationship, either directly or

indirectly, described in section 267(b) to

any shareholder of the corporation.

(ii) Covered property. Property is

described in this paragraph (c)(5)(ii) if,

within 12 months before or after the

adoption of the plan of liquidation, the

property was owned by any shareholder

and—

(A) The shareholder regularly sold or

otherwise disposed of personal property

of the same type on the installment plan

or the property is real property that the

shareholder held for sale to customers

in the ordinary course of a trade or

business (provided the property is not

described in section 453(l)(2) (relating to

certain exceptions to the definition of

dealer dispositions));

(B) The sale of the property by the

shareholder would result in recapture

income (within the meaning of section

453(i)(2)), but only if the amount of the

recapture income is equal to or greater

than 50 percent of the property’s fair

market value on the date of the sale by

the corporation;

(C) The property is stock or securities

that are traded on an established

securities market; or

(D) The sale of the property by the

shareholder would have been under a

revolving credit plan.

(iii) Safe harbor. Paragraph (c)(5)(i) of

this section will not apply to the

liquidation of a corporation if, on the

date the plan of complete liquidation is

adopted and thereafter, less than 15

percent of the fair market value of the

corporation’s assets is attributable to

property described in paragraph

(c)(5)(ii) of this section.

(iv) Example. The provisions of this

paragraph (c)(5) are illustrated by the

following example:

Example. Ten percent of the fair market

value of the assets of T is attributable to stock

and securities traded on an established

securities market. T owns no other assets

described in paragraph (c)(5)(ii) of this

section. T, after adopting a plan of complete

liquidation, sells all of its stock and

securities holdings to C corporation in

exchange for an installment obligation

bearing adequate stated interest, sells all of

its other assets to B corporation for cash, and

distributes the cash and installment

obligation to its sole shareholder, A, in a

complete liquidation that satisfies section

453(h)(1)(A). Because the C installment

obligation arose from a sale of publicly

traded stock and securities, T cannot report

the gain on the sale under the installment

method pursuant to section 453(k)(2). In the

hands of A, however, the C installment

obligation is treated as having arisen out of

a sale of the stock of T corporation. In

addition, the general rule of paragraph

(c)(5)(i) of this section does not apply, even

if a principal purpose of the liquidation was

the avoidance of section 453(k)(2), because

the fair market value of the publicly traded

stock and securities is less than 15 percent

of the total fair market value of T’s assets.

Accordingly, section 453(k)(2) does not apply

to A, and A may use the installment method

to report the gain recognized on the

payments it receives in respect of the

obligation.

(d) Liquidating distributions received

in more than one taxable year. If a

qualifying shareholder receives

liquidating distributions to which this

section applies in more than one taxable

year, the shareholder must reasonably

estimate the gain attributable to

distributions received in each taxable

year. In allocating basis to calculate the

gain for a taxable year, the shareholder

must reasonably estimate the

anticipated aggregate distributions. For

this purpose, the shareholder must take

into account distributions and other

relevant events or information that the

shareholder knows or reasonably could

know up to the date on which the

federal income tax return for that year

is filed. If the gain for a taxable year is

properly taken into account on the basis

of a reasonable estimate and the exact

amount is subsequently determined the

difference, if any, must be taken into

account for the taxable year in which

the subsequent determination is made.

However, the shareholder may file an

amended return for the earlier year in

lieu of taking the difference into account

for the subsequent taxable year.

(e) Effective date. This section is

applicable to distributions of qualifying

installment obligations made on or after

January 28, 1998.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

Approved: December 18, 1997.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 98–1820 Filed 1–27–98; 8:45 am]

BILLING CODE 4830–01–U

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8760]

RIN 1545–AU72 and 1545–AU73

Continuity of Interest and Continuity of

Business Enterprise

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations providing guidance

regarding satisfaction of the continuity

of interest and continuity of business

enterprise requirements for corporate

reorganizations. The final regulations

affect corporations and their

shareholders.

DATES: These regulations are effective

January 28, 1998.

Applicability: These regulations apply

to transactions occurring after January

28, 1998, except that they do not apply

to any transaction occurring pursuant to

a written agreement which is (subject to

customary conditions) binding on

January 28, 1998, and at all times

thereafter.

FOR FURTHER INFORMATION CONTACT:

Regarding § 1.368–1(e) (continuity of

interest) §§ 1.338–2 and 1.368–1 (a) and

(b): Phoebe Bennett, (202) 622–7750 (not

a toll-free number); regarding § 1.368–

1(d) (continuity of business enterprise)

and, §§ 1.368–1 (a) and (b), 1.368–2(k):

Marlene Peake Oppenheim, (202) 622–

7750 (not a toll free number).

SUPPLEMENTARY INFORMATION:

Background

On December 23, 1996, the IRS

published a notice of proposed

rulemaking (REG–252231–96) in the

Federal Register (61 FR 67512) relating

to the continuity of interest (COI)

requirement (proposed COI regulations).

On January 3, 1997, the IRS published

a notice of proposed rulemaking (REG–

252233–96) in the Federal Register (62

FR 36101) (proposed COBE regulations)

relating to (1) the continuity of business

enterprise (COBE) requirement; and (2)

transfers of acquired assets or stock

following certain otherwise qualifying

reorganizations (remote continuity of

interest). Many written comments were

received in response to these notices of

proposed rulemaking. A public hearing

on both proposed regulations was held

on May 7, 1997. After consideration of

all comments, the regulations proposed

by REG–252231–96 and REG–252233–

96 are adopted as revised by this