[Federal Register Volume 73, Number 181 (Wednesday, September 17, 2008)]
[Rules and Regulations]
[Pages 53934-53987]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-21006]



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Part II





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 602



Unified Rule for Loss on Subsidiary Stock; Final Rule

Federal Register / Vol. 73, No. 181 / Wednesday, September 17, 2008 / 
Rules and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9424]
RIN 1545-BB61


Unified Rule for Loss on Subsidiary Stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations under sections 358, 
362(e)(2), and 1502 of the Internal Revenue Code (Code). The 
regulations apply to corporations filing consolidated returns, and 
corporations that enter into certain tax-free reorganizations. The 
regulations provide rules for determining the tax consequences of a 
member's transfer (including by deconsolidation and worthlessness) of 
loss shares of subsidiary stock. In addition, the regulations provide 
that section 362(e)(2) generally does not apply to transactions between 
members of a consolidated group. Finally, the regulations conform or 
clarify various provisions of the consolidated return regulations, 
including those relating to adjustments to subsidiary stock basis.

DATES: Effective Date: These regulations are effective on September 17, 
2008.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.358-6(f)(3), 1.1502-13(l)(1), 1.1502-19(h), 1.1502-21(h)(1)(iii), 
1.1502-30(c), 1.1502-31(h)(1), 1.1502-32(h)(9), 1.1502-33(j)(1), 
1.1502-35(j), 1.1502-36(h), 1.1502-75(l), 1.1502-80(a)(4), 1.1502-
80(h), 1.1502-80(j), 1.1502-91(h)(2), and 1.1502-99(b)(4).

FOR FURTHER INFORMATION CONTACT: Marcie P. Barese at (202) 622-7790, 
Sean P. Duffley at (202) 622-7770, or Theresa Abell at (202) 622-7700 
(none of the numbers are toll-free).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-2096. The collection of information 
in these final regulations is in Sec.  1.1502-36(e)(5). The collection 
of information is necessary to allow a corporation to redetermine basis 
under the basis redetermination rule when it sells all the stock of a 
subsidiary, to modify the application of the attribute reduction rule, 
to apply the Unified Loss Rule retroactively to certain intercompany 
transfers, and to reattribute a section 382 limitation.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number.
    Books or records relating to the collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On January 23, 2007, the IRS and Treasury Department issued a 
notice of proposed rulemaking (REG-157711-02, 2007-8 IRB 537, 72 FR 
2964) (January 2007 proposal) that included proposed regulations under 
Sec.  1.1502-36 (Unified Loss Rule). The proposed Unified Loss Rule 
would implement aspects of the repeal of the General Utilities doctrine 
and address the duplication of loss by consolidated groups. The 
proposed Unified Loss Rule consisted of three principal rules that 
would apply when a member (M) transferred a loss share of stock of a 
subsidiary (S): A basis redetermination rule (that would reallocate 
investment adjustments to address both noneconomic and duplicated stock 
loss), a basis reduction rule (that would address noneconomic stock 
loss), and an attribute reduction rule (that would address duplicated 
loss).
    In addition, the January 2007 proposal included proposed 
regulations under Sec.  1.1502-13(e)(4) that would address the 
application of section 362(e)(2) to certain intercompany transactions. 
The January 2007 proposal also included proposed regulations that would 
make various technical and administrative revisions to other provisions 
of the consolidated return regulations and to regulations regarding 
stock basis following certain corporate restructuring transactions.
    No public hearing regarding the proposed regulations was requested 
or held. Written, electronic, and oral comments responding to the 
notice of proposed rulemaking were received. After consideration of all 
the comments, these final regulations generally adopt the rules of the 
proposed regulations other than proposed Sec.  1.1502-13(e)(4) and its 
related provisions. The significant comments and modifications are 
discussed in this preamble.

1. The Unified Loss Rule

A. General Comments
    In general, commentators and practitioners have consistently 
described the provisions of the proposed Unified Loss Rule as reaching 
a fair and reasonable systemic balance. They have generally concurred 
with the major policy decisions reflected in the proposed regulations, 
including the retention of the loss limitation model, the rejection of 
a tracing approach, the application of the rule to built-in income, and 
the systemic prevention of loss duplication. However, commentators and 
practitioners have also consistently raised concerns regarding both the 
complexity of the proposed rules and the anticipated difficulty in 
compiling the data required to implement the proposed rules, especially 
those relating to transfers of stock of subsidiaries that hold stock in 
other subsidiaries.
    The IRS and Treasury Department recognize that the proposed rules 
are complex. However, as recognized by commentators and practitioners, 
the complexity of the rules is a result of the balancing of benefits 
and burdens arising from the presumptions on which the rules are based. 
The IRS and Treasury Department are concerned, therefore, that 
simplifying the proposed rules would adversely impact the fundamental 
fairness the rules are intended to achieve. Nevertheless, careful 
consideration has been given to all simplifying suggestions, and they 
have been incorporated wherever possible.
    The suggestions regarding the general application and operation of 
the rule, and the conclusions reached as to each, are set forth in this 
section A of this preamble. Suggestions relating to individual 
paragraphs of the Unified Loss Rule and to other regulations in the 
January 2007 proposal, including proposed Sec.  1.1502-13(e)(4), and 
the conclusions reached as to each, are set forth in the following 
sections.
i. Order of Application of the Unified Loss Rule and Other Adjustments
    The January 2007 proposal provided that the Unified Loss Rule would 
apply to a transfer of a share of subsidiary stock if, after giving 
effect to all applicable rules of law (other than the Unified Loss 
Rule), the share is a loss share. The provisions of the proposed 
Unified Loss Rule would then apply sequentially to adjust subsidiary 
stock basis and attributes. Any adjustments

[[Page 53935]]

required under the Unified Loss Rule would be given effect immediately 
before the transfer.
    Commentators found the timing rules unclear, particularly as they 
related to the application of other provisions of the consolidated 
return regulations that also purport to apply immediately before a 
transaction. The IRS and Treasury Department have considered this 
comment and agree that there could be some uncertainty in this respect.
    To address this concern, Sec.  1.1502-36(a)(3)(i) of these final 
regulations provides that the Unified Loss Rule applies when a member 
transfers a share of subsidiary stock and, after taking into account 
the effects of all rules of law applicable as of the transfer, even 
those that would not be given effect until after the transfer, the 
share is a loss share. Such effects may be attributable to lower-tier 
dispositions and worthlessness, as well as to the application of the 
Unified Loss Rule. Although the determination of whether a transferred 
share is a loss share is made as of the transfer, the Unified Loss Rule 
as a whole applies, and any adjustments required under the Unified Loss 
Rule are given effect, immediately before the transfer.
    When the Unified Loss Rule applies to a transfer, its individual 
provisions are each applied in order. Thus, as described in Sec.  
1.1502-36(a)(3)(i) of these final regulations, the general rule is that 
paragraph (b) applies first with respect to a transferred loss share 
(or shares). Then, if there is still a transfer of a loss share after 
the application of paragraph (b), paragraph (c) applies to the loss 
share (or shares). Finally, if there is still a transfer of a loss 
share after the application of paragraph (c), paragraph (d) applies 
with respect to that loss share (or shares). Section 1.1502-
36(a)(3)(ii) provides detailed instruction regarding the order in which 
the individual provisions of the Unified Loss Rule apply if there are 
transfers at multiple tiers in the same transaction.
ii. Application of Unified Loss Rule to Nondeconsolidating Transfers
    Several commentators have suggested that the final regulations 
include an election to defer basis recovery in the case of a 
nondeconsolidating transfer. Under such an election, a group could 
avoid applying the Unified Loss Rule to such transfers by shifting the 
basis of a transferred share (to the extent such basis exceeds the 
share's value) to other shares held by members. As a result, the group 
would forego any current loss, but the Unified Loss Rule would continue 
to be applicable to any subsequent transfer of loss shares of stock of 
that subsidiary.
    The IRS and Treasury Department are concerned that such an election 
could cause significant administrative complexity. The IRS and Treasury 
Department are also concerned that such an election could cause 
substantial distortions that could adversely affect the treatment of 
subsequent deconsolidating transfers. For example, a basis shift 
resulting from such an election could significantly increase the 
disconformity amount of the retained shares, potentially causing a 
substantial and inappropriate reduction in the basis of the retained 
shares when they are ultimately transferred. Further, because this 
relief would only address transfers of minority interests, and the IRS 
and Treasury Department believe that such transfers reflect a small 
portion of subsidiary stock dispositions, the IRS and Treasury 
Department do not believe such a rule would give rise to any 
significant relief. Accordingly, this suggestion was not adopted.
    Other suggestions were made that would apply special rules to 
nondeconsolidating transfers. The final regulations generally do not 
adopt special rules for nondeconsolidating transfers. The principal 
reasons are the complexity a dual system would create and the small 
number of transactions expected to be affected by such rules. In 
addition, the IRS and Treasury Department believe that taxpayers will 
typically be able to restructure nondeconsolidating transfers to avoid 
the application of the Unified Loss Rule, for example, by issuing 
subsidiary stock.
iii. Application of Unified Loss Rule to Deferred Recognition Transfers
    The proposed regulations provided that all transfers of loss shares 
of subsidiary stock are immediately subject to the Unified Loss Rule 
when the stock is transferred, even if any loss recognized on the 
transfer would be deferred. The IRS and Treasury Department had 
concluded that the immediate application of the Unified Loss Rule was 
necessary to prevent the significant administrative burden of 
retroactively applying the Unified Loss Rule to members' bases in 
shares of subsidiary stock, and to the subsidiary's attributes, long 
after a stock sale.
    Commentators questioned the need to apply the Unified Loss Rule to 
a transfer in which any loss that would be recognized would be 
deferred, citing as a model Sec.  1.1502-20(a)(3) (deferring the 
application of Sec.  1.1502-20, the Loss Disallowance Rule). 
Commentators also observed that single-entity principles seemed to 
suggest that an intercompany transfer is not an appropriate time to 
apply the Unified Loss Rule, urging that it would be more appropriate 
to apply the Unified Loss Rule to such a transfer when the intercompany 
item is taken into account.
    The IRS and Treasury Department have considered these comments and 
are persuaded that single-entity principles would be furthered, and 
group income would be more clearly reflected, if the application of the 
Unified Loss Rule were coordinated with the intercompany transaction 
provisions in Sec.  1.1502-13. Accordingly, under these final 
regulations, if a member transfers a share of subsidiary stock to 
another member and any gain or loss on the transfer is deferred under 
Sec.  1.1502-13, the Unified Loss Rule applies to the transfer, or to 
any subsequent transfer of that share by a member, when the 
intercompany item is taken into account. At that time, the 
determination of whether the Unified Loss Rule applies and, if so, the 
consequences of its application are made by treating the buying and 
selling members as divisions of a single corporation. The final 
regulations also provide that appropriate adjustments will be made to 
intercompany item(s), any member's basis in the subsidiary's share, 
and/or the subsidiary's attributes in order to further the purposes of 
both the Unified Loss Rule and the intercompany transaction provisions 
in Sec.  1.1502-13.
    Notwithstanding this modification of the treatment of intercompany 
transfers, the IRS and Treasury Department continue to believe that the 
deferral of loss recognized on a sale of subsidiary stock should not, 
in general, defer the application of the Unified Loss Rule. One reason 
is that postponing the application of the Unified Loss Rule in 
transfers that are not intercompany transactions would likely make it 
much more difficult, and in some cases impossible, to obtain the 
information and make the determinations necessary to apply the rule. 
Another reason is that such an approach could require subsequent 
adjustments to attributes outside the consolidated group. Accordingly, 
these final regulations continue to apply the Unified Loss Rule to non-
intercompany transfers of loss shares at the time the stock is 
transferred, even if any loss recognized on the transfer is subject to 
deferral.
    These final regulations modify the definition of the term transfer 
to reflect both the general rule that the deferral of loss does not 
affect the determination of whether stock is transferred and the 
limited exception for intercompany transactions.

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iv. Application of Unified Loss Rule to Liquidations Under Section 332
    The proposed Unified Loss Rule provided that the term transfer 
generally includes transactions in which a member ceases to own 
subsidiary stock. However, the proposed regulations included an 
exception for section 381(a) transactions in which any member acquires 
assets of the subsidiary, provided that no gain or loss is recognized 
by member shareholders with respect to the subsidiary's stock. 
Commentators observed that this exclusion would apply to liquidations 
in which more than one member owns stock of the subsidiary and that, in 
such cases, upper-tier distortions could result because the basis 
redetermination rule would not apply.
    The IRS and Treasury Department agree with this observation and are 
concerned with the potential for distortion and abuse. Accordingly, 
under the final regulations, a disposition of subsidiary stock in a 
liquidation to which section 332 applies is not excepted from the 
definition of a transfer if more than one member owns stock in the 
liquidating subsidiary. However, the final regulations provide that, in 
the case of a multiple-member section 332 liquidation, neither 
paragraph (c) (the basis reduction rule) nor paragraph (d) (the 
attribute reduction rule) will apply to the transfer. Thus, if more 
than one member owns stock in a subsidiary and those members dispose of 
the subsidiary stock in a section 332 liquidation of the subsidiary, 
the transaction is subject to the other provisions of the Unified Loss 
Rule, in particular the basis redetermination rule in Sec.  1.1502-
36(b).
v. Basis in Lower-Tier Stock
    In formulating the proposed Unified Loss Rule, the IRS and Treasury 
Department believed that, by using information that taxpayers were 
otherwise required to create and maintain, the administrative burden on 
taxpayers would be minimal. However, commentators have uniformly 
expressed concern that taxpayers will find it costly and time-
consuming, if not impossible, to obtain the subsidiary stock basis 
information needed to apply many of the provisions of the Unified Loss 
Rule. Particular concern has been expressed regarding the lower-tier 
subsidiary rules in the proposed basis reduction rule (proposed Sec.  
1.1502-36(c)) and the proposed attribute reduction rule (proposed Sec.  
1.1502-36(d)). The reasons cited include the widespread practice of 
determining stock basis only when necessary to determine a person's tax 
liability, complicated intercompany accounting rules that make stock 
basis determinations prone to error, and the frequent inability to 
obtain accurate historical basis information when acquiring companies 
with lower-tier subsidiaries.
    To address this problem, several commentators have suggested 
modifying the proposed rules to apply solely based on the net inside 
attributes of lower-tier subsidiaries (the ``look-through'' approach). 
Those commentators have argued that information regarding inside 
attributes is much more regularly and reliably maintained and available 
than stock basis information.
    The IRS and Treasury Department recognize that adopting a look-
through approach would not only address the problem of inadequate stock 
basis data, it would also significantly simplify the application of the 
rules. However, the IRS and Treasury Department are concerned that a 
look-through approach could produce inappropriate results for groups 
transferring S stock if S holds stock of another subsidiary (S1) and 
S's basis in its S1 stock reflects unrecognized appreciation in S1's 
assets (built-in gain).

    Example. P, the common parent of a consolidated group, transfers 
$100 to S in exchange for S's sole outstanding share of stock. S 
purchases the sole outstanding share of S1 stock for $100 when S1 
holds one asset with a basis of $0 and a value of $100. S earns 
$100, increasing P's basis in S to $200. S1's asset declines in 
value to $0. P sells its S share to X, an unrelated person, for 
$100, recognizing a loss of $100. Under the basis reduction rule as 
proposed, P's basis in S stock is reduced by the lesser of S's 
disconformity amount and S's net positive adjustment. S's 
disconformity amount is $0, the excess of P's $200 basis in the S 
share over S's net inside attribute amount ($200, the sum of S's 
$100 cash and its $100 basis in the S1 share, which is not treated 
as reduced under the tentative reduction rule because there were no 
investment adjustments applied to the basis of the S1 share). 
Accordingly, although S had a $100 net positive adjustment, there is 
no reduction to P's basis in S stock and so P's $100 loss on the S 
stock is allowed. However, because the stock loss is duplicated in 
S's attributes, the attribute reduction rule will apply to eliminate 
S's inside loss.

    If a look-through approach were adopted, however, S's basis in its 
S1 share would be disregarded and S's disconformity amount would be 
$100 (the excess of P's $200 basis in its S share over S's $100 net 
inside attribute amount, computed as the sum of S's $100 cash and S1's 
$0 basis in its asset). As a result, P's basis in its S share would be 
reduced by $100, the lesser of S's $100 disconformity amount and S's 
$100 net positive adjustment. Although S would retain its $100 basis in 
its S1 share, P would recognize no loss on its sale of the S stock. 
Thus, the selling group would have suffered an economic loss but the 
loss would be neither recognized nor allowed. Such a result would be 
contrary to the general rule adopted in the proposed regulations, that 
stock basis is not presumed noneconomic to the extent there is no 
disconformity amount or no net positive adjustment amount.
    The IRS and Treasury Department recognize that, under the proposed 
regulations, a very different result follows where it is S1, not S, 
that earns the $100. In that case, the proposed regulation would treat 
S's basis in the S1 stock as tentatively reduced by $100 (the lesser of 
S1's $100 disconformity amount and S1's net positive adjustment). As a 
result, S would have a disconformity amount of $100 and P's basis in 
its S share would be reduced by $100 (the lesser of S's $100 
disconformity amount and S's $100 net positive adjustment). But the IRS 
and Treasury Department believe this result is appropriate because S1's 
disconformity amount evidences that S1 has at least $100 of built-in 
gain. Further, S1 has a net positive adjustment that evidences the 
recognition of that built-in gain. Thus, in this case, the facts 
indicate that S1's income is attributable to the recognition of built-
in gain and that, as a result, M's loss on the share of S stock should 
be treated as noneconomic.
    The IRS and Treasury Department recognize that this approach could 
lead to situations in which the location of an item is manipulated to 
produce inappropriate results, but believe there are adequate 
protections against such manipulation. See, for example, section 482 
and the various anti-abuse provisions of the consolidated return 
regulations, including these final regulations.
    For all these reasons, the IRS and Treasury Department continue to 
believe that including lower-tier stock basis in determinations made 
under the Unified Loss Rule more fully safeguards taxpayers' interests 
and generally produces more appropriate results.
    Several commentators argued that an elective look-through rule 
would address the concerns inherent in a mandatory look-through rule, 
as well as the concerns regarding the availability of stock basis 
information and the complexity of the proposed rules.
    The IRS and Treasury Department agree that an elective approach 
would mitigate the concerns presented by a mandatory look-through rule, 
but believe that an elective approach would

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not provide the desired simplification. The reason is that the decision 
will affect computations under both the basis reduction rule and the 
attribute reduction rule, and what may be taxpayer favorable for one 
rule may be taxpayer unfavorable for the other rule. Thus, the benefit 
(or burden) of ignoring lower-tier stock basis for the basis reduction 
rule will need to be weighed against any benefit (or burden) of 
ignoring lower-tier stock basis for the attribute reduction rule.
    The IRS and Treasury Department acknowledge that, in order to 
simplify compliance, some taxpayers might elect a look-through approach 
without making detailed alternative computations. However, the IRS and 
Treasury Department believe that, given the consequences of such an 
election, the vast majority of taxpayers will compute their tax 
treatment both with and without a look-through approach before deciding 
whether to make such an election. Thus, in the vast majority of cases, 
there would be little or no simplification from an elective look-
through approach, and one of the major goals of such a rule would not 
be achieved.
    Moreover, the IRS and Treasury Department believe that taxpayers 
making both computations will then universally choose the method that 
produces better results. While taxpayers are free to arrange their 
affairs so as to legitimately minimize their taxes, a system that will 
always operate to the disadvantage of one party or the other (in this 
case, the government) is not properly balanced.
    Accordingly, the IRS and Treasury Department believe that a 
mandatory look-through approach would produce inappropriate results in 
certain cases, and that an elective look-through approach would fail to 
achieve a significant amount of simplification and would significantly 
diminish the balance and fairness of the regulations. The final Unified 
Loss Rule therefore does not adopt any form of the look-through 
approach.
    Still, the IRS and Treasury Department recognize that determining 
lower-tier subsidiary stock basis may be difficult for the reasons 
previously noted. Further, although the need to determine lower-tier 
subsidiary stock basis is not particular to these regulations, the 
Unified Loss Rule arguably increases both the frequency and 
significance of these determinations. Accordingly, the IRS and Treasury 
Department are considering various proposals that would mitigate these 
difficulties on a system-wide basis.
    One alternative under consideration is a conforming basis election. 
Under this election, consolidated groups could determine members' bases 
in shares of subsidiary stock by treating the basis in each share owned 
by a member as being equal to the share's proportionate interest in the 
subsidiary's net inside attributes. If such an election were made, the 
determination would presumably be effective for all Federal income tax 
purposes. Further, because the determination of subsidiary stock basis 
is not a concern that is unique to the Unified Loss Rule, consideration 
is being given to allowing the election with respect to all 
subsidiaries, with no restrictions on consistency or the time for 
making elections. However, the IRS and Treasury Department are not 
certain that such a rule would materially simplify the determination of 
basis because taxpayers are likely to conclude that they must determine 
stock basis in judging whether to make the election. Further, the IRS 
and Treasury Department are concerned about the collateral consequences 
of such a rule.
    Accordingly, the IRS and Treasury Department are requesting 
comments regarding whether such an election would assist taxpayers and 
whether it would in fact provide any simplification. Additionally, 
comments are requested regarding what collateral consequences, if any, 
such an election should or would have, and whether such consequences 
are appropriate. The issues include, for example, whether such an 
election would be an appropriate means of eliminating excess loss 
accounts, whether it could potentially produce inappropriate cross-
chain basis shifts, or whether it could inappropriately facilitate the 
acceleration of losses.
    The IRS and Treasury Department also request comments regarding any 
other method for addressing this issue.
vi. Items Taken Into Account in Determining the Net Inside Attribute 
Amount
    As a result of various questions and comments received, the IRS and 
Treasury Department have reconsidered the inclusion of credits in the 
determination of the net inside attribute amount. Commentators have 
correctly observed that, at least with respect to credits held at the 
time of a taxable acquisition of subsidiary stock, credits are 
economically similar to other valuable attributes and it would be 
appropriate to take such credits into account in determining the 
disconformity amount. However, the proper treatment of other credits 
(that is, credits accruing after the subsidiary stock was acquired) in 
determining the disconformity amount, and of any credits (whenever 
accruing) in determining loss duplication, is less clear. Presumably, 
however, any such methodology would need to be tracing-based, and would 
therefore be expected to present the significant administrative 
concerns described in the preamble to the January 2007 proposal. 
Ultimately, no viable presumptive methodology was identified for 
determining the proper inclusion of credits, and so no change is made 
in the final Unified Loss Rule regarding the treatment of credits.
vii. Adjustments for Section 362(e)(2) Transactions
    As discussed in Section 3 of this preamble, the IRS and Treasury 
Department have concluded that section 362(e)(2) should generally not 
apply to intercompany transactions. However, section 362(e)(2) will 
apply to transactions occurring prior to September 17, 2008 if the 
taxpayer does not elect to apply the rule in the final regulations. In 
such cases, distortions will result and, thus, adjustments will need to 
be made. The IRS and Treasury Department are also concerned that there 
are other provisions that could create distortions. Accordingly, the 
final regulations retain the rule in proposed Sec.  1.1502-36(e)(2) 
that provided for adjustments to offset the effects of basis reductions 
required by section 362(e)(2) with respect to intercompany 
transactions, and the rule that provided for appropriate adjustments in 
cases raising similar issues. However, under the final regulations, 
taxpayers may make appropriate adjustments without a determination from 
the Commissioner.
viii. Effective/Applicability Date Issues
    As proposed, the Unified Loss Rule would have been applicable for 
all transfers on or after the date the regulations were published as 
final. Several practitioners observed that the proposed effective date 
caused problems for taxpayers attempting to negotiate transactions 
because they could not be certain what set of regulations would be in 
effect when their transactions were completed. Accordingly, 
commentators and practitioners requested that the regulations include a 
transition rule that would exclude transfers effected on or after the 
date the final regulations are published, if such transfers were made 
pursuant to a binding agreement in place before the publication date.
    The IRS and Treasury Department recognized the difficulty created 
by the proposed effective date and, in Notice 2008-9, 2008-3 IRB 277 
(regarding the Internal Revenue Bulletin generally, see

[[Page 53938]]

Sec.  601.601(d)(2)(ii)(b)), announced that the final regulations would 
include a transition rule for transfers between unrelated parties if 
made pursuant to an agreement that is binding before the date that 
final regulations are published and at all times thereafter. Further, 
Notice 2008-9 stated that the IRS and Treasury Department expect that 
the rule would incorporate the provisions of section 267(b) in 
determining whether persons are related for this purpose. Accordingly, 
as stated in Notice 2008-9, the final Unified Loss Rule applies to 
transfers on or after September 17, 2008, unless the transfer is made 
pursuant to a binding agreement between unrelated parties that was in 
effect before September 17, 2008 and at all times thereafter. The final 
regulations provide that the term related party has the same meaning as 
in section 267(b).
    One comment was also received suggesting that the final regulations 
include an election to apply their provisions retroactively. The IRS 
and Treasury Department considered this suggestion but are concerned 
that adopting such an approach would disrupt taxpayers' otherwise 
closed transactions and thereby exacerbate the problems caused by the 
uncertainty and instability in this area over these past years. 
Accordingly, the final Unified Loss Rule does not include an election 
to apply its provisions retroactively.
B. Section 1.1502-36(b): Basis Redetermination Rule
    Commentators generally recognize and concur with the need for a 
rule that reallocates investment adjustments to address the problems 
created when shares of stock are held with disparate bases. As 
illustrated in Sections B.3, B.4, and E of the preamble to the January 
2007 proposal, the allocation of investment adjustments under Sec.  
1.1502-32 can create a noneconomic stock loss on an individual share 
that would be eliminated under Sec.  1.1502-36(c). Similarly, the 
allocation of investment adjustments under Sec.  1.1502-32 can fail to 
eliminate a duplicated loss on an individual share. In both cases, 
however, the allocation creates no net loss if all the shares are taken 
into account. The basis redetermination rule in Sec.  1.1502-36(b) is 
designed to address these issues.
    Commentators have expressed concern, however, with both the 
availability of the investment adjustment data required to implement 
the rule and the complexity of the application of the rule.
    The IRS and Treasury Department recognize that the information may 
be difficult and costly to produce. However, unlike lower-tier 
subsidiary stock basis information, the information required to 
implement the basis redetermination rule (specifically, the investment 
adjustment history of the stock of the subsidiary that is being 
transferred) is generally information obtained from the group's own tax 
returns and other records. Groups are therefore, as a general matter, 
not dependent on other taxpayers for this information.
    Furthermore, the IRS and Treasury Department expect that this rule 
will apply to only a small number of transactions due to the exception 
for transactions in which members transfer all of their S stock to one 
or more nonmembers in a fully taxable transaction. Accordingly, it is 
anticipated that, in most transactions, taxpayers will not be required 
to redetermine basis. Moreover, in those situations in which it does 
apply, it accomplishes important objectives for both taxpayers and the 
government.
    Some commentators suggested allowing a member to be treated as 
having an averaged basis in its shares of S stock if S has only one 
class of stock outstanding and the member holds all of the S stock. The 
commentators argue that such an election could significantly reduce the 
number of taxpayers required to apply the basis redetermination rule. 
While that might be true, such basis averaging could result in 
additional complexities and distortions. For example, if a portion of 
the shares were previously transferred in an intercompany transaction 
and the bases in all of the subsidiary's shares were averaged, it might 
be difficult to determine the extent to which particular shares reflect 
the prior intercompany transaction. Further, averaging the basis in the 
subsidiary's shares could alter the application of section 267 and 
section 311.
    For all these reasons, the final Unified Loss Rule retains the 
basis redetermination rule without the suggested modifications.
    The final regulations do, however, modify the basis redetermination 
rule to omit the reallocation of positive investment adjustments 
applied to preferred shares under Sec.  1.1502-32. The reason is that 
Sec.  1.1502-32 allocates positive adjustments to preferred shares 
solely to account for the right to receive distributions. Thus, the 
positive Sec.  1.1502-32 adjustments allocated to preferred shares, 
like the adjustments for distributions (which were not reallocated 
under the proposed Unified Loss Rule), are based on economic changes in 
the shareholder's investment. As a result, they should have no 
correlation to unrecognized loss reflected in the bases of the shares 
and so should not be subject to this rule. The final regulations do, 
however, continue to permit the reallocation of both positive and 
negative adjustments from common to preferred shares in order to reduce 
or eliminate any loss on transferred preferred shares and any gain on 
either transferred or nontransferred preferred shares. The IRS and 
Treasury Department believe such reallocations are necessary and 
appropriate to address any reflection of unrecognized gain or loss in 
preferred shares attributable, for example, to contributions of assets 
in exchanged for preferred stock.
i. Exceptions to Basis Redetermination Rule
    The proposed basis redetermination rule contained two exceptions to 
its application, the ``no potential for redetermination'' exception and 
the ``disposition of entire interest'' exception.
    The proposed ``no potential for redetermination'' exception 
provided that basis redetermination is not required if redetermination 
would not change any member's basis in S stock. Some commentators found 
this exception confusing; others suggested that it offered no 
simplification because it would be necessary to apply the basis 
redetermination rule to determine whether the exception was available. 
Other commentators thought that it provided a useful safe harbor. The 
IRS and Treasury Department have concluded that the rule should be 
retained, but that it should be revised to state its scope and effect 
more clearly. Accordingly, under the final regulations, the basis 
redetermination rule does not apply if members' bases in shares of S 
common stock are equal (that is, there is no disparity) and members' 
bases in shares of S preferred stock reflect no gain or loss. The 
reason is that, under these circumstances, the only effect that a 
reallocation of investment adjustments could have would be an increase, 
not a decrease, in basis disparity.
    The proposed ``disposition of entire interest'' exception provided 
that basis redetermination is not required if, within the group's 
taxable year in which the transfer occurs, all of the shares of S stock 
held by members are transferred to a nonmember in a one or more fully 
taxable transactions. This rule differed from the basis reduction 
netting rule in proposed Sec.  1.1502-36(c)(7) and the net stock loss 
definition in proposed Sec.  1.1502-36(d)(3)(ii), which only netted 
among shares transferred in the same

[[Page 53939]]

transaction. Commentators observed that this difference presents a 
potential for distortion and abuse if items are taken into account by S 
between transfers. While this problem exists to a certain extent if a 
transaction is comprised of steps that are not executed simultaneously, 
the problem may be significantly exacerbated by a rule that allowed 
netting among all transactions within a year. Moreover, because the 
netting rule in the basis reduction rule is intended, in part, to 
protect taxpayers when the basis redetermination rule is not applied, 
the IRS and Treasury Department believe that the application of these 
rules should be coextensive. Accordingly, the final regulations provide 
that this exception only applies if members dispose of their entire 
interest in S stock to one or more nonmembers, if all members' shares 
of S stock become worthless, or if all members' shares of S stock are 
either worthless or disposed of to one or more nonmembers, in one fully 
taxable transaction.
    Commentators also inquired whether the ``disposition of entire 
interest'' exception was mandatory, that is, whether the basis 
redetermination rule could be applied even if a group disposed of its 
entire interest in a transaction that qualifies for the exception. The 
IRS and Treasury Department recognize that taxpayers might choose to 
apply the basis redetermination rule in such cases in order to reduce 
gain or avoid the Unified Loss Rule with respect to upper-tier shares. 
The IRS and Treasury Department do not believe that doing so would be 
inappropriate, as the premise of the basis redetermination rule is that 
reallocations made under the rule are appropriate allocations. However, 
because the IRS and Treasury Department believe that taxpayers will 
most often not want to apply the basis redetermination rule, the final 
regulations generally provide that basis is not redetermined when the 
exception applies, but include an election to apply the basis 
redetermination rule in such cases.
ii. Manner in Which Investment Adjustments Are Reallocated
    Some commentators observed that the proposed rules were vague 
regarding the manner in which reallocations were to be made. The IRS 
and Treasury Department generally agree with this observation, but had 
concluded that the rule would work best if taxpayers were given 
considerable flexibility in determining how to make specific 
reallocations. In recognition of the fact that such an approach would 
allow differing interpretations, section F.2 of the preamble to the 
January 2007 proposal stated that the IRS would respect any reasonable 
method or formula employed in applying the basis redetermination rule.
    The IRS and Treasury Department continue to believe that the rule 
should be as flexible as possible. However, in response to these 
comments, the specific provisions of the final basis redetermination 
rule provide some additional guidance (discussed more fully in the next 
section). But the rule is still intended to be flexible in its 
application and, therefore, the final regulations explicitly provide 
that the reallocation of an investment adjustment may be made using any 
reasonable method or formula that is consistent with the basis 
redetermination rule and furthers the purposes of the Unified Loss 
Rule. Thus, like the proposed regulations, the final regulations 
contemplate that more than one result may be reasonable in any specific 
case.
iii. Decreasing Disparity in Basis of Members' Shares
    The general operating rules of the proposed basis redetermination 
rule provided that reallocations are made in a manner that reduces the 
extent to which there is disparity in members' bases in S stock. The 
IRS and Treasury Department have received various questions regarding 
the scope of this rule. Some practitioners read the rule to completely 
eliminate the loss on transferred shares even if overall disparity were 
increased. One practitioner suggested that the general rule, in 
referring only to the manner of redetermination, did not clearly 
restrict the amount of redetermination that would otherwise be required 
under the rules.
    To address these concerns, each of the specific allocation 
provisions in the final regulations includes a statement regarding the 
manner and extent to which allocations are to be made under the 
provision. In addition, the operating rules generally provide that the 
overall application of the rule must reduce disparity among members' 
bases in preferred shares of subsidiary stock (as provided in the 
applicable reallocation provisions) and among members' bases in common 
shares of subsidiary stock, to the greatest extent possible.
C. Section 1.1502-36(c): Basis Reduction Rule
    In general, commentators found the general structure of the basis 
reduction rule and its components (limiting basis reduction to the 
lesser of the share's disconformity amount and net positive adjustment) 
to be a reasonable approach to addressing the issue of noneconomic 
loss. The principal concern expressed was the anticipated difficulty 
with respect to gathering the information necessary to implement the 
lower-tier subsidiary rules. Nevertheless, commentators uniformly 
agreed that basis adjustments from lower-tier subsidiaries must be 
taken into account in order to identify and address noneconomic stock 
loss.
    The principal suggestion for addressing the lack of readily 
accessible and reliable information on lower-tier stock basis was to 
adopt a look-through approach, as discussed in section 1.A.v. of this 
preamble. For the reasons set forth in that section of this preamble, 
the final regulations do not adopt this approach. However, as noted, 
the IRS and Treasury Department continue to request and consider 
comments on mechanisms for alleviating the difficulty in determining 
lower-tier subsidiary stock basis.
    Commentators and practitioners did suggest a number of other 
modifications to the basis reduction rule. Those suggestions and the 
decisions reached are discussed in the following sections.
i. Treatment of Intercompany Debt
    Several commentators suggested revising the net positive adjustment 
amount to exclude items related to intercompany debt. The rationale for 
this suggestion was that, in general, the nature of such amounts makes 
them more like to capital transactions than the recognition of built-in 
gain or loss. Thus it is argued that these amounts should be treated 
like contributions and distributions, which are not included in the net 
positive adjustment amount.
    The IRS and Treasury Department recognize that, in certain 
circumstances, intercompany debt has some inherent similarity to 
capital contributions and distributions, at least with respect to the 
principal amounts of such obligations. However, the IRS and Treasury 
Department also recognize that there are circumstances in which 
unrecognized appreciation in intercompany debt can be reflected in 
stock basis. For example, if a subsidiary receives cash in exchange for 
newly issued stock when it holds an intercompany obligation, the basis 
of the newly issued shares will reflect a portion of any unrecognized 
appreciation in the obligation. Because the consequences of having that 
unrecognized appreciation reflected in stock basis are no different 
from the consequences of any other built-in gain, the regulations would 
have to provide a system to identify and monitor those

[[Page 53940]]

amounts. Such a system would need to rely on a tracing-based 
methodology, which the IRS and Treasury Department have rejected for 
the reasons articulated in the preamble to the January 2007 proposal. 
Accordingly, the IRS and Treasury Department have concluded that no 
special rules would be adopted for items related to intercompany debt.
ii. Disconformity Amount: Net Inside Attributes
    In the proposed regulations, the term net inside attributes was 
defined as the excess of the sum of S's loss carryovers, deferred 
deductions, and asset basis over S's liabilities. Although different 
rules applied to determine basis in lower-tier subsidiary stock, the 
terms otherwise had the same meaning for purposes of both the basis 
reduction and attribute reduction rules.
    The proposed regulations defined the term loss carryover to mean 
any net operating or capital loss carryover attributable to S that is 
or, under the principles of Sec.  1.1502-21 would be, carried to S's 
first taxable year, if any, following the year of the transfer. Thus, 
if a buyer were to waive a loss carryover under Sec.  1.1502-32(b)(4), 
the loss would not be carried to S's first taxable year after the 
transfer, and so it would be excluded from the computation of net 
inside attributes.
    Practitioners agree that this definition is appropriate for 
purposes of measuring loss duplication, as it prevents attributes that 
cannot be duplicated from being taken into account in computing S's 
attribute reduction amount. However, one commentator observed that this 
definition seemed inappropriate for purposes of measuring S's 
disconformity amount.
    The IRS and Treasury Department have considered this comment and 
agree that the definition is inappropriate for computing S's 
disconformity amount. As discussed in the January 2007 preamble, the 
disconformity amount was incorporated in the basis reduction rule in 
order to limit basis reduction to the net amount of a subsidiary's 
built-in gain. The IRS and Treasury Department believed that, by 
limiting basis reduction to the amount of net built-in gain, the basis 
reduction rule would not reduce stock basis by an amount that could not 
be attributed to the recognition of built-in gain.
    However, by adopting a definition of loss carryovers that required 
such losses to be carried to a separate return year, the rule allowed a 
waiver of a loss carryover under Sec.  1.1502-32(b)(4) to reduce the 
amount of a subsidiary's loss carryovers and, as a result, the 
subsidiary's net inside attributes. That, in turn, caused an increase 
in the subsidiary's disconformity amount. But, as the commentator 
observed, any disconformity created by the waiver of a loss carryover 
would be unrelated to the existence of built-in gain. Thus, this 
definition of loss carryovers undermined the protection otherwise 
afforded by the use of the disconformity amount as a limit on basis 
reduction.
    In addition, other commentators found the proposed rule unclear in 
its reference to losses that would be carried to a separate return 
year.
    To address these concerns, the final regulations provide that the 
term loss carryovers means those losses that are attributable to the 
subsidiary, including any losses that would be apportioned to the 
subsidiary under the principles of Sec.  1.1502-21(b)(2) if the 
subsidiary had a separate return year. However, because a waiver under 
Sec.  1.1502-32(b)(4) does affect the extent to which a loss can be 
duplicated, the final regulations provide that, solely for purposes of 
applying the attribute reduction rule, a subsidiary's loss carryovers 
(and therefore its net inside attributes) do not include the amount of 
any losses waived under Sec.  1.1502-32(b)(4).
D. Section 1.1502-36(d): The Attribute Reduction Rule
    As discussed in the preamble to the January 2007 proposal, the loss 
duplication component of the Unified Loss Rule addresses loss 
duplication systemically in order to clearly reflect the income of both 
the group and its members, including former members. The IRS and 
Treasury Department view this rule as a necessary and appropriate 
complement to Sec.  1.1502-32 because, together they work to eliminate 
the duplication of a group item once the group enjoys the benefit of 
the item, without regard to which of the duplicative items is 
recognized and allowed first. The IRS and Treasury Department also view 
this rule as a necessary and appropriate complement to the basis 
reduction rule because it eliminates S's unrecognized built-in loss to 
the extent it prevented the identification of S's recognized built-in 
gain (and thus prevented the reduction of noneconomic stock basis, and 
noneconomic stock loss). See sections C.3 and C.4.v of the preamble to 
the January 2007 proposal for a discussion of the interaction between 
unrecognized built-in loss and recognized built-in gain.
    Commentators generally agreed with the IRS and Treasury Department 
on the need for, and appropriateness of, the systemic approach to loss 
duplication. However, like the basis redetermination and basis 
reduction rules, the attribute reduction rule received considerable 
commentary regarding the issues of data availability and computational 
complexity. Commentators and practitioners made several suggestions for 
technical revisions to the proposed regulations. The IRS and Treasury 
Department have considered the suggestions received as well as other 
revisions to the proposed attribute reduction rule. The suggestions and 
conclusions are discussed in the following sections.
i. Lower-Tier Subsidiary Rules
    In general, commentators and practitioners recognize that the rules 
for measuring and eliminating loss duplication must take into account 
both the basis in lower-tier subsidiary stock and the attributes of 
lower-tier subsidiaries in order to be most effective. Nevertheless, as 
already noted, commentators expressed much concern regarding the 
administrability of the proposed lower-tier subsidiary rules. Their 
principal suggestion for addressing this concern was the adoption of a 
look-through approach that would address loss duplication only by 
taking lower-tier attributes into account.
    The IRS and Treasury Department considered a look-through approach 
when drafting the January 2007 proposal, but were concerned that such 
an approach would not adequately address loss duplication. The 
principal reason for this concern was that loss duplication can reside 
in the basis of lower-tier subsidiary stock and in the attributes of 
that lower-tier subsidiary and, moreover, that it can reside in those 
locations in differing amounts. Therefore, a rule that measures loss 
duplication solely by reference to lower-tier attributes, or solely by 
reference to lower-tier stock basis, would permit potentially 
significant amounts of loss duplication to avoid reduction. To avoid 
this problem, the IRS and Treasury Department concluded that the loss 
duplication regulations must measure loss duplication by reference to 
both.
    The IRS and Treasury Department recognized, however, that when 
duplication is not uniformly reflected in stock basis and attributes, 
this approach could cause an over-reduction in lower-tier attributes 
(when loss duplication resides primarily in lower-tier stock basis) or 
in lower-tier stock basis (when loss duplication resides primarily in 
lower-tier attributes). To prevent the former result, the conforming 
limitation on lower-tier attribute reduction limits the application of 
tiered-down attribute reduction (generally permitting a lower-

[[Page 53941]]

tier subsidiary's attributes to be reduced only to the extent necessary 
to conform them to members' bases in that subsidiary's stock, as 
reduced under this rule). To prevent the latter result, the basis 
restoration rule reverses reductions to lower-tier stock basis made by 
the Unified Loss Rule (generally to the extent necessary to conform 
members' bases in the subsidiary's stock to the subsidiary's net inside 
attributes, as reduced under this rule).
    Thus, these rules work together to protect the government's 
interests (by addressing the entire potential for loss duplication) and 
taxpayers' interests (by preventing the over-reduction of either lower-
tier stock basis or lower-tier attributes). Accordingly, the IRS and 
Treasury Department continue to believe these rules are essential to 
the balance and fundamental fairness of the Unified Loss Rule.
    Nevertheless, the IRS and Treasury Department recognize that the 
conforming limitation and basis restoration rules can add considerable 
complexity to the application of the Unified Loss Rule. To address this 
concern, commentators have suggested that one or the other of these 
rules could be omitted to simplify the proposed rule. The IRS and 
Treasury Department are concerned, however, that eliminating either of 
these rules would considerably undermine the overall fairness of the 
regulation. But the IRS and Treasury Department are persuaded that, if 
a taxpayer determines that the expected benefit of applying these rules 
is outweighed by the additional complexity, then that taxpayer should 
be permitted to choose not to apply these rules.
    Accordingly, these final regulations continue to measure the 
potential for loss duplication by taking both stock basis and 
attributes into account and continue to safeguard against over-
reduction of either inside attributes or stock basis by applying both 
the conforming limitation and the basis restoration rules. However, 
under the final regulations, taxpayers are permitted to elect not to 
apply the conforming limitation or the basis restoration rule if they 
decide the protection afforded by either or both of those rules does 
not outweigh the burden of applying them.
ii. Attribute Reduction Amount Below Five Percent of Value
    Although the fundamental structure of the attribute reduction rule 
has been retained, the IRS and Treasury Department have determined that 
it is appropriate to provide an exception to the application of the 
attribute reduction rule if the attribute reduction amount (that is, 
the duplicated loss) is small relative to the size of the transaction. 
This decision reflects a balancing of the need to eliminate duplicated 
loss and the administrative burden of applying the attribute reduction 
rule. Accordingly, under these final regulations, taxpayers must still 
compute their attribute reduction amount, but if the total attribute 
reduction amount is less than five percent of the aggregate value of 
the subsidiary shares that are transferred by members in the 
transaction, the attribute reduction rule does not apply to the 
transfer.
    However, the IRS and Treasury Department also recognize that, in 
certain circumstances, a taxpayer may prefer to have the attribute 
reduction rule apply. For example, a group may want to apply the rule 
in order to reattribute a subsidiary's attributes. Accordingly, the 
final regulations allow taxpayers to elect to apply the attribute 
reduction rule notwithstanding that their total attribute reduction 
amount is less than five percent of the aggregate value of the 
transferred shares. If this election is made, the attribute reduction 
rule will apply with respect to the entire attribute reduction amount 
determined in the transaction, and thus applies with respect to all 
members transferring shares, and all shares transferred, in the 
transaction.
iii. Ordering of Reduction of Recognized Losses
    Commentators generally agreed with the decision to reduce 
recognized losses (net operating loss (NOL) carryovers, capital loss 
carryovers, and deferred deductions, identified as Category A, Category 
B, and Category C attributes, respectively) before reducing asset 
basis, since the former items represent actual, identified losses. The 
proposed regulations provided that the attribute reduction amount would 
be first applied to reduce NOL carryovers (from oldest to newest), then 
capital loss carryovers (from oldest to newest), and then deferred 
deductions (proportionately). However, several commentators questioned 
the need for a mandatory order in which these attributes would be 
reduced. These commentators observed that, because loss duplication is 
a mathematical determination under the Unified Loss Rule, and because 
it is difficult (if not impossible) to know which attributes are 
economically duplicative of a stock loss, the reduction of any item in 
those categories should be equally appropriate and effective.
    The IRS and Treasury Department have reconsidered this issue and 
agree with the commentators. Accordingly, the final regulations provide 
that if the attribute reduction amount is less than the total 
attributes in Category A, Category B, and Category C, the taxpayer may 
specify the allocation of S's attribute reduction amount among the 
attributes in those categories.
    The final regulations do, however, prescribe a default allocation 
for the reduction of such attributes that is used to the extent the 
taxpayer does not specify an allocation. This default allocation 
differs from the order provided in the proposed rule in that capital 
loss carryovers (not NOLs) are reduced first. This modification was 
made in response to a commentator's suggestion, based on the 
observation that capital loss carryovers have a significantly shorter 
expiration period and are therefore more likely than NOLs to expire 
unused. Accordingly, except to the extent a taxpayer elects to specify 
an allocation, the final regulations first reduce capital loss 
carryovers (oldest to newest), then NOL carryovers (oldest to newest), 
and then deferred deductions (proportionately). This change in the 
order of reduction is intended to minimize the possibility that the 
attribute reduction rule will reduce attributes in an amount greater 
than the amount that would ultimately be available for duplicative use.
    The final regulations continue to provide that, regardless of the 
order in which attributes in these categories are reduced, they are 
reduced in full before any reduction is made to asset basis.
iv. Methodology for Reduction of Asset Basis
    Several commentators have suggested simplifying modifications to 
the manner in which asset basis is reduced under the attribute 
reduction rule. One is the elimination of the proposed Category D 
attributes (unrecognized losses on publicly traded property). This 
category was included in the proposed rule because the IRS and Treasury 
Department recognized that these amounts represent a readily 
identifiable loss that could be eliminated before the presumptive 
reduction of the bases of other assets. This approach prevented the 
attribute reduction rule from creating or increasing gain in publicly 
traded assets. However, commentators viewed this rule as increasing the 
complexity of an already complex analysis while providing only a 
marginal benefit.
    The IRS and Treasury Department are persuaded that this extra 
complexity might not be warranted in this context

[[Page 53942]]

and that the elimination of this rule would not materially affect the 
balance otherwise reached by the Unified Loss Rule. Accordingly, the 
final regulations include publicly traded property in the general asset 
basis category (now designated Category D).
    Another suggestion made by commentators was to apply the attribute 
reduction amount remaining after reducing Category A, Category B, and 
Category C attributes to reduce asset basis in the reverse order of the 
residual method of allocating consideration paid or received in a 
transaction under section 1060.
    The IRS and Treasury Department have concluded that this approach 
is readily administrable and reflects an appropriate balancing of 
presumptions regarding the location of duplicated loss. An important 
consideration is that such a rule reduces basis in purchased goodwill 
and going concern value before basis in other assets, and the IRS and 
Treasury Department are persuaded that duplicated loss is generally 
more likely to be reflected in the bases of such assets. Therefore, the 
elimination of the basis in those assets first seems particularly 
appropriate. Further, the IRS and Treasury Department believe that this 
approach would generally be more administrable than the proposed pro 
rata reduction of asset basis.
    Accordingly, these final regulations adopt this suggestion and 
generally provide that the attribute reduction amount is applied to 
reduce the basis of assets in the asset classes specified in Sec.  
1.338-6(b) other than Class I (cash and general deposit accounts, other 
than certificates of deposit held in depository institutions), but in 
the reverse order from the order specified in that section. Thus, under 
this reverse residual method, any attribute reduction amount applied to 
reduce asset basis is generally applied first to reduce any basis of 
assets in Class VII (proportionately, based on basis instead of value, 
until all such basis is eliminated). Any remaining attribute reduction 
amount is then applied in the same manner to reduce the basis of assets 
in each succeeding lower asset class, other than Class I.
    Notwithstanding the general adoption of this allocation methodology 
for Category D attributes, these final regulations provide that the 
portion of the attribute reduction amount that is not applied to 
attributes in Category A, Category B, and Category C, is first 
allocated between S's basis in any stock of lower-tier subsidiaries 
(treating all S's shares of any one lower-tier subsidiary as a deemed 
single share) and the subsidiary's other assets (treating the non-stock 
Category D assets as one asset). The allocation is made in proportion 
to S's deemed basis in each single share of lower-tier subsidiary stock 
and S's basis in the non-stock Category D asset (S's aggregate basis in 
all of its Category D assets other than subsidiary stock). Only the 
portion of the attribute reduction amount not allocated to lower-tier 
subsidiary stock is applied under the reverse residual method. This 
initial allocation between lower-tier subsidiary stock and other assets 
is necessary to ensure that, to the extent the attribute reduction 
amount reflects items attributable to a lower-tier subsidiary's stock 
basis or attributes, the attribute reduction amount is properly 
directed and applied to those items.
v. Suspension of Excess Attribute Reduction Amount
    Several commentators and practitioners questioned the need to 
suspend attribute reduction amounts in excess of reducible attributes 
and apply those suspended amounts to reduce or eliminate attributes 
otherwise arising when all or part of the liability is paid or 
otherwise satisfied, whether by S or another person. The IRS and 
Treasury Department proposed this rule because the mathematical 
operation of the formula for computing the attribute reduction amount 
results in such an excess only if there is a liability or similar item 
that has reduced economic value but that has not been taken into 
account for tax purposes (generally a contingent liability).
    The IRS and Treasury Department continue to believe that it is 
inappropriate to permit the duplication of economic losses that have 
not accrued for tax purposes and, therefore, that this rule is both 
necessary and appropriate. Accordingly, the rule is retained in the 
final regulations.
    The IRS and Treasury Department recognize that this rule could 
create an administrative burden that could last for many years and 
transfer to taxpayers beyond the initial buyer and seller. However, the 
IRS and Treasury Department believe that the elimination of the special 
rule for publicly traded property substantially lessens the 
administrative burden of this rule. The reason is that, under this 
revised approach in the final regulations, a subsidiary's attribute 
reduction amount can only exceed reducible assets to the extent of the 
subsidiary's Class I assets. In such cases, the IRS and Treasury 
Department do not believe the burden imposed to be unreasonable or, in 
most cases, substantial. Moreover, a taxpayer believing the rule to be 
overly burdensome in its situation can readily avoid any suspension of 
its attribute reduction amount by converting its Class I assets into 
assets of another class; in that case, the remaining attribute 
reduction amount will be applied to the bases of those assets and will 
not give rise to a suspended attribute reduction amount.
    The IRS and Treasury Department received a comment that, if the 
suspended attribute reduction rule is retained, it should be clarified 
to provide that present value principles are to be taken into account 
in valuing liabilities. The final regulations do not include an 
explicit statement on this point because the rule implicitly 
incorporates present value principles (by limiting the attribute 
reduction amount to the lesser of the net stock loss and the aggregate 
inside loss, which are both a function of value).
vi. Election to Reduce Stock Basis and/or Reattribute Attributes
    Several commentators suggested that the final regulations should 
expressly permit taxpayers to make a protective election to reattribute 
attributes (other than asset basis) and/or to reduce stock basis (and 
thereby reduce stock loss) in order to avoid attribute reduction. The 
IRS and Treasury Department intend these elections to be as flexible as 
possible. Accordingly, the final regulations explicitly provide that, 
if the election is made and it is ultimately determined that S has no 
attribute reduction amount, the election will have no effect, or if the 
election is made for an amount that exceeds S's finally determined 
attribute reduction amount, the election will have no effect to the 
extent of that excess.
    In addition, the final regulations permit taxpayers to reduce (or 
not reduce) stock basis, or to reattribute (or not reattribute) 
attributes, or some combination thereof, in any amount that does not 
exceed S's attribute reduction amount.
    Thus, under the final regulations, taxpayers have considerable 
flexibility in making this election, and may make a protective 
election.
    Further, in order to protect against inadvertent attribute 
reduction, these final regulations provide for a deemed stock basis 
reduction election equal to the net stock loss (taking into account any 
actual elections under Sec.  1.1502-36(d)(6)) in the case of a transfer 
in which the stock loss in the transferred shares would otherwise be 
permanently disallowed (for example under section 311(a)).
    Several commentators also questioned the need for a mandatory order 
for the reattribution of losses for the same

[[Page 53943]]

reasons they questioned the need for a mandatory order for the 
reduction of such attributes. For the reasons discussed in section 
1.D.iii. of this preamble, the IRS and Treasury Department agree that a 
mandatory order of reattribution is not necessary. Thus, under the 
final regulations, attributes are reattributed in the same amount, 
order, and category that they would otherwise be reduced under the 
attribute reduction rule. Accordingly, because the final regulations 
provide that taxpayers can specify the attributes in Category A, 
Category B, and Category C to be reduced, taxpayers may similarly 
specify the attributes in Category A, Category B, and Category C to be 
reattributed. Similar to the rule regarding the allocation of the 
attribute reduction amount, to the extent the taxpayer elects to 
reattribute attributes but does not specify the attributes to be 
reattributed, any attributes not specifically reattributed will be 
reattributed in the default amount, order, and category applicable for 
attribute reduction.
    Additionally, the final regulations revise the provisions regarding 
the election to reattribute attributes to provide for the reattribution 
of a section 382 limitation. The final regulations also include 
conforming amendments to the consolidated section 382 rules in 
Sec. Sec.  1.1502-90, 1.1502-91(h)(2), 1.1502-95(d), 1.1502-96(d), and 
1.1502-99(b)(4).
vii. The Conforming Limitation
    As previously discussed, the proposed regulations limited the 
application of the attribute reduction amount that tiered down to a 
lower-tier subsidiary in order to prevent an excessive reduction to 
that subsidiary's attributes. Under this limitation (the conforming 
limitation), the tier-down attribute reduction amount (when combined 
with any attribute reduction amount computed with respect to a transfer 
of the shares of the lower-tier subsidiary) could be applied to reduce 
a lower-tier subsidiary's attributes only to the extent necessary to 
conform those attributes to an amount equal to the sum of all members' 
bases in nontransferred shares, and the value of all members' 
transferred shares, of that subsidiary's stock.
    Commentators observed that the conforming limitation could allow 
duplication to survive the application of the attribute reduction rule 
when lower-tier stock basis reflects noneconomic basis. The 
commentators illustrated their observation with the following example:

    Example. M forms S with $100 of cash. S has no other assets or 
operations. S acquired S1 stock for $100 and no section 338 election 
is made with respect to such acquisition. S1 has one asset (A1) with 
a basis of $20 and a value of $100. S1 sells A1 for $100. M's basis 
in its S stock, and S's basis in its S1 stock, both increase by $80 
to $180. S1 invests the $100 of proceeds in another asset (A2). A2 
subsequently, declines in value to $40. M sells the S stock for $40.
    Under the proposed basis reduction rule, M's basis in the S 
stock is reduced by the lesser of S's $80 net positive adjustment 
and S's $80 disconformity amount (determined by treating S's $180 
basis in the S1 stock as tentatively reduced by $80, the lesser of 
S1's $80 net positive adjustment and S1's $80 disconformity amount). 
After the application of the proposed basis reduction rule, M would 
recognize a $60 loss on the sale of the S stock.
    Under the proposed attribute reduction rule, S's attribute 
reduction amount is $60 (the lesser of the $60 net stock loss, and 
S's $140 aggregate inside loss), and S would reduce its basis in the 
S1 stock by $60 to $120. Under the proposed attribute reduction 
rule, S's $60 attribute reduction amount allocated to the S1 stock 
becomes an attribute reduction amount of S1. However, under the 
proposed conforming limitation on tier-down attribute reduction, S1 
is not required to reduce its $100 basis in A2 because S1's $100 of 
attributes do not exceed S's post-reduction $120 basis in the S1 
stock. As a result, M's $60 loss continues to be duplicated in both 
S's basis in the S1 stock and S1's basis in A2.

    The IRS and Treasury Department agree that, under these facts, the 
attribute reduction rule does not eliminate all lower-tier duplication. 
However, this effect follows directly from policy decisions underlying 
the Unified Loss Rule, specifically, that it would be a loss limitation 
rule and that the basis reduction rule would apply only upon a 
disposition, deconsolidation, or worthlessness of a loss share. Under 
this approach, as long as a share is held by the same person and is 
subject to the consolidated return provisions, noneconomic lower-tier 
subsidiary stock basis is preserved. As a result, subsequent 
appreciation can permit the stock to be transferred without being 
subject to the Unified Loss Rule, and the noneconomic stock basis can 
reduce any gain that would otherwise be recognized. It is the 
preservation of that noneconomic stock basis that prevents the full 
elimination of duplicated loss in S1's attributes.
    The issue could be addressed in several ways. First, the decision 
to preserve basis until there is a loss transfer could be reversed. 
However, the rule would then either reduce lower-tier stock basis below 
value or rely on valuation to limit such basis reduction. The IRS and 
Treasury Department are concerned that adding a valuation component to 
this rule would present substantial administrative concerns. More 
importantly, however, the IRS and Treasury Department do not believe 
that such an approach adequately protects the balance struck in the 
regulation as proposed and so are not reconsidering that decision.
    Alternatively, the conforming limitation could be revised such that 
any conforming limit would be reduced by the amount of any tentative 
reduction to stock basis under the basis reduction rule. In the example 
set forth by the commentators, this would reduce S1's conforming 
limitation by $80 (S1's tentative reduction amount), from $120 to $40. 
As a result, S1's basis in A2 would be reduced to $40. While this would 
produce an appropriate result with respect to A2, it leaves S's basis 
in the S1 stock reflecting $80 of disconformity. Accordingly, absent 
additional adjustments, S's basis in the S1 stock could appear to 
reflect a noneconomic loss, and so the rule would remain imperfect.
    Moreover, the effect of such an approach would be to create a 
disconformity amount that is not related to built-in gain. 
Consequently, when the S1 stock is ultimately sold, economic loss could 
appear noneconomic and, therefore, could be eliminated under the basis 
reduction rule. Although the Unified Loss Rule affords some protection 
for this situation in the operating rules (see the discussion in 
section A.1.vii. of this preamble), the IRS and Treasury Department are 
concerned that the tracing necessary to make the adjustments to prevent 
the elimination of economic loss will present substantial 
administrative difficulty and, in many cases, may not be possible.
    Furthermore, in certain circumstances, the proposed conforming 
limitation on tier-down attribute reduction could prevent an 
unnecessary reduction in lower-tier inside attributes, for example, 
when the loss on S stock is attributable to the loss of built-in gain 
on an asset held by S (other than subsidiary stock).
    Based on all of these considerations, the IRS and Treasury 
Department have decided not to revise this rule in the final 
regulations, but will continue to consider the issue.
viii. Attribute Reduction in the Case of Certain Dispositions Due to 
Worthlessness and Where the Subsidiary Ceases to be a Member and Does 
Not Become a Nonmember
    Section 1.1502-35(f) generally provides that, if a member treats 
stock of S as worthless under section 165

[[Page 53944]]

(taking into account Sec.  1.1502-80(c)) and S continues as a member, 
or if M recognizes a loss on S stock and on the following day S is not 
a member and does not have a separate return year following the 
recognition of the loss, all losses treated as attributable to S under 
the principles of Sec.  1.1502-21(b)(2)(iv) are treated as expired as 
of the beginning of the day following the last day of the group's 
taxable year. This rule was intended to prevent any implication that 
S's share of the consolidated losses could be treated as remaining part 
of the consolidated net operating or capital loss carryover after S 
becomes worthless or is dissolved in a taxable transaction. The IRS and 
Treasury Department continue to believe that the regulations should 
explicitly clarify that such losses are removed from the consolidated 
losses.
    Commentators have observed that, in the specified circumstances, 
any credits and built-in losses attributable to S should also be 
eliminated to prevent their use after S either becomes worthless or is 
dissolved in a taxable transaction. The IRS and Treasury Department 
agree that, in such cases, S's credits and other attributes should no 
longer be available to the group.
    Accordingly, these final regulations provide a special attribute 
elimination rule that applies to transfers that result from one of two 
events. The first is M's transfer of a share of S stock caused solely 
by M treating the share as worthless under section 165 (taking into 
account the provisions of Sec.  1.1502-80(c)), if S remains a member of 
the group and M has a deduction or recognizes a loss with respect to 
the transfer of the share. The second is M's transfer of a share of S 
stock caused by S ceasing to be a member, if S has no separate return 
year and M recognizes a net deduction or loss on its S shares 
transferred in the transaction. When there is a transfer of S stock in 
either of these situations, S's net operating loss carryovers, capital 
loss carryovers, and deferred deductions (including S's share of such 
consolidated tax attributes) that are not otherwise reduced or 
reattributed under Sec.  1.1502-36(d), and S's credits (including S's 
share of consolidated credits), are eliminated. The IRS and Treasury 
Department do not believe that any special rule is required regarding 
any built-in loss in assets because excess asset basis should not 
survive the transactions to which this rule applies.
    In considering this rule, the IRS and Treasury Department 
recognized that the reason for eliminating S's attributes, including 
credits and deferred deductions, arises from the nature of the 
specified transactions, not from the amount of the member's basis in 
the stock transferred in the transaction. Further, as provided in Sec.  
1.1502-19(a)(2)(ii), an excess loss account is treated as basis that is 
a negative amount and a reference to P's basis in S's stock includes a 
reference to P's excess loss account. Accordingly, the IRS and Treasury 
Department have concluded that the elimination of S's attributes should 
occur whenever one of the specified transactions occurs, without regard 
to the amount of the basis of the transferred share. Under such an 
approach, the treatment of S's attributes following one of the 
specified transfers would be consistent irrespective of whether the 
aggregate basis in the members' shares is a positive number (which 
produces a net loss or deduction), a negative number (an excess loss 
account, which produces income or gain under Sec.  1.1502-19), or zero 
(which produces no income, gain, deduction or loss).
    Accordingly, these final regulations include a provision in Sec.  
1.1502-19 that applies to the same two transactions that will result in 
the complete elimination of S's attributes when members have net loss 
on S stock. Thus, it will apply when a share of S stock is worthless 
under section 165, the requirements of Sec.  1.1502-19(c)(1)(iii) are 
satisfied, members do not have a net deduction or loss on the S stock, 
and S continues as a member. It will also apply when S ceases to be a 
member, S has no separate return year, and members recognize an amount 
that is not a net loss on the subsidiary's stock in the transaction. 
When it applies, it will eliminate S's net operating loss carryovers, 
capital loss carryovers, and deferred deductions (including S's share 
of such consolidated tax attributes), and S's credits (including S's 
share of consolidated credits).
    Under both the Sec.  1.1502-36 and the Sec.  1.1502-19 elimination 
rules, attributes other than consolidated tax attributes (determined as 
of the event) are eliminated immediately before the event resulting in 
the application of the rule. Because consolidated tax attributes are 
first carried to the consolidated return year before being apportioned 
to a member's first separate return year, the IRS and Treasury 
Department do not believe that any special timing rule is required 
regarding the elimination of the portion of any consolidated tax 
attributes attributable to the member under either of these rules. 
Mechanically, the elimination of the member's portion of any 
consolidated tax attributes under either rule can only occur 
immediately after the close of the group's tax year that includes the 
event.
    To clarify that there is no duplicative adjustment, these final 
regulations provide that the elimination of these attributes under 
either rule is not a noncapital, nondeductible expense.

2. Other Sections Addressing Subsidiary Stock Loss: Sec. Sec.  
1.337(d)-1, 1.337(d)-2, 1.1502-20, and 1.1502-35

    In general, transfers of loss shares of subsidiary stock on or 
after September 17, 2008 will be subject to the Unified Loss Rule and 
not Sec.  1.337(d)-1, Sec.  1.337(d)-2, Sec.  1.1502-20, or Sec.  
1.1502-35. The IRS and Treasury Department do not expect that Sec.  
1.1502-20 will affect any transactions occurring on or after September 
17, 2008. However, because of the binding-commitment transition rule, 
the IRS and Treasury Department expect there will be some transactions 
occurring on or after September 17, 2008 that will be subject to 
Sec. Sec.  1.337(d)-1, 1.337(d)-2, and 1.1502-35. In addition, 
dispositions subject to Sec.  1.1502-35 will continue to be subject to 
the loss suspension and anti-loss reimportation rules in Sec.  1.1502-
35. Accordingly, the IRS and Treasury Department are removing Sec.  
1.1502-20 and retaining Sec. Sec.  1.337(d)-1, 1.337(d)-2, and 1.1502-
35, subject to certain modifications described below.
    Under these final regulations, Sec. Sec.  1.337(d)-1 and 1.337(d)-2 
are modified to state explicitly that they do not apply to transactions 
subject to the Unified Loss Rule. However, those sections remain 
otherwise applicable.
    Section 1.1502-35 is also modified to state explicitly that it does 
not apply to transfers subject to the Unified Loss Rule. Although the 
provisions of Sec.  1.1502-35 are largely unchanged in these final 
regulations, there are some significant modifications, and those 
modifications are described in the following paragraphs.
A. Ten-Year Termination of Application of Sec.  1.1502-35
    Under the final regulations, the loss suspension rule is revised to 
provide that it ceases to apply ten years after the stock disposition 
that gave rise to the suspended loss. The purpose of this modification 
is to conform the loss suspension rule and the anti-loss reimportation 
rule.
    In addition, the general provisions of Sec.  1.1502-35 are revised 
to apply only to losses allowed within ten years of the date that they 
are recognized. Thus, if a loss is deferred and taken into account more 
than ten years after the disposition, or if an exchanged basis asset is 
sold at a loss more than ten

[[Page 53945]]

years after the exchanged basis asset is acquired, the section will 
have no application to the loss. The purpose of this modification is to 
conform all application of Sec.  1.1502-35 to the ten-year rule 
applicable to loss suspension and anti-loss reimportation.
B. Location of Suspended Loss
    These final regulations modify Sec.  1.1502-35 to state explicitly 
that if M recognized a loss on S stock and the loss was suspended under 
Sec.  1.1502-35(c), and if M ceases to be a member when S remains a 
member, then, immediately before M ceases to be a member, P is treated 
as succeeding to the loss in a transaction to which section 381(a) 
applies. Thus, the suspended loss is explicitly preserved for use by 
the group that disposed of the loss stock, and the location of the loss 
is specified. However, Sec.  1.1502-35(c)(5)(i) provides that, ``[t]o 
the extent not reduced * * *, any loss suspended * * * shall be allowed 
* * * on a return filed by the group of which the subsidiary was a 
member on the date of the disposition of subsidiary stock that gave 
rise to the suspended loss * * * for the taxable year that includes the 
day before the first date on which the subsidiary * * * is not a member 
of such group or the date the group is allowed a worthless stock loss * 
* *.'' Further, Sec.  1.1502-35(c)(3) provides that ``any loss 
suspended * * * is treated as a noncapital, nondeductible expense of 
the member that disposes of subsidiary stock, incurred during the 
taxable year that includes the date of the disposition of stock [that 
gave rise to the suspended loss].'' Accordingly, the IRS and Treasury 
Department believe these final regulations merely clarify the rule in 
Sec.  1.1502-35.
C. Effect of Elimination of Reimported Item
    Under the anti-loss reimportation rule, a reimported item is 
generally eliminated immediately before it would be taken into account 
by the group. The regulations provided that the elimination of the item 
was a noncapital, nondeductible expense under Sec. Sec.  1.1502-
32(b)(2)(iii) and 1.1502-32(b)(3)(iii). A practitioner suggested that 
this result would inappropriately reduce upper-tier stock basis and, as 
a result, would either create noneconomic gain or eliminate economic 
loss. The IRS and Treasury Department considered modifying this 
provision but have concluded that the elimination of a reimported item 
is similar to the expiration of a separate return limitation year loss 
and should be similarly treated. Accordingly, this rule is not modified 
in the final regulations.

3. The Application of Section 362(e)(2) to Intercompany Transfers

    The proposed regulations included rules for suspending the 
application of section 362(e)(2) in the case of transactions between 
members of a consolidated group. The IRS and Treasury Department had 
proposed the rule because the interaction of section 362(e)(2) and the 
consolidated return provisions (which already address duplication 
issues) causes significant distortions, administrative burden, and the 
potential for inappropriate loss disallowance and gain creation. In 
general, the proposed rules were intended to postpone the application 
of section 362(e)(2) to an intercompany transaction until the 
consolidated return provisions could no longer address the loss 
duplication created in the intercompany transaction.
    To implement such a regime, however, complex tracing rules would be 
necessary to identify the extent to which duplication is eliminated and 
to continuously monitor the extent to which duplication could continue 
to be eliminated by the consolidated return provisions. Although the 
intent was to simplify the application of section 362(e)(2) in the 
consolidated return setting and to prevent the adjustments otherwise 
made under section 362(e)(2) from causing inappropriate results under 
the consolidated return provisions, commentators found these rules to 
be extremely complex and expect them to be extremely burdensome to 
administer. The IRS and Treasury Department concur with these views.
    Commentators offered two suggestions for addressing the concerns 
raised by the application of section 362(e)(2) to intercompany 
transactions.
    The first suggestion was to treat intercompany section 362(e)(2) 
transactions as taxable transactions to the extent of the net loss in 
the transferred assets. Thus, the losses would not be duplicated and, 
because the transfers would be intercompany transactions, Sec.  1.1502-
13 would police the recognition of the losses. The rationale supporting 
this approach was that using a familiar regime (specifically, the 
intercompany transaction provisions of Sec.  1.1502-13) would lessen 
the overall complexity of the provisions as well as the administrative 
burden placed on taxpayers and the government. Although this approach 
would be less burdensome than the approach in the proposed regulations, 
the IRS and Treasury Department are concerned that this approach would 
still impose an unnecessary administrative burden. Further, unlike 
either the general application of Sec.  1.1502-13 to a nonrecognition 
transaction or the general application of section 362(e)(2), this 
approach would effectively preserve the original location of the net 
loss in the transferred assets.
    The second suggestion was to modify the consolidated return 
provisions to make section 362(e)(2) generally inapplicable to 
intercompany transactions. Commentators stated that applying section 
362(e)(2) to intercompany transactions gives rise to administrative 
burden and complexity even if the taxable intercompany transaction 
model were adopted. Further, they argued that applying section 
362(e)(2) to intercompany transactions is unnecessary because the 
consolidated return regulations (including the Unified Loss Rule) are 
already structured to address duplication of loss (and gain) within the 
group (including its members and former members) in a manner and scope 
that has been determined appropriate in the consolidated return 
setting, given the competing single and separate entity policy issues. 
The application of section 362(e)(2) to intercompany transactions is 
thus not only generally unnecessary and burdensome, it is disruptive of 
the balance struck in the various consolidated return provisions, most 
notably the investment adjustment rules in Sec.  1.1502-32 and the 
Unified Loss Rule in Sec.  1.1502-36.
    For these reasons, the IRS and Treasury Department have concluded 
that section 362(e)(2) should generally not apply to intercompany 
transactions. Accordingly, these final regulations add a new paragraph 
(h) in Sec.  1.1502-80, which makes section 362(e)(2) generally 
inapplicable to intercompany transactions. The purpose of the provision 
is to allow the consolidated return provisions to address loss 
duplication. The IRS and Treasury Department are therefore withdrawing 
proposed Sec.  1.1502-13(e)(4), which proposed the suspension of the 
application of section 362(e)(2) to intercompany transactions.
    Notwithstanding the decision to make section 362(e)(2) generally 
inapplicable to intercompany transactions, the IRS and Treasury 
Department are concerned that the inapplicability of section 362(e)(2) 
could be used to reach inappropriate results. For example, assume M 
transfers a loss asset to S in exchange for new shares in a transaction 
to which section 351(a) applies, S has an asset with offsetting 
appreciation,

[[Page 53946]]

and later M sells only the new shares received in exchange for the loss 
asset. If S has no aggregate inside loss, the Unified Loss Rule will 
not require any attribute reduction. Accordingly, if S remains a 
member, the group could obtain more than a single benefit for its 
economic loss. The final regulations therefore include an anti-abuse 
rule that provides for appropriate adjustments to be made to clearly 
reflect the income of the group if a taxpayer acts with a view to 
prevent the consolidated return provisions from properly addressing 
loss duplication. The final regulations also include an example that 
illustrates both an abusive fact pattern (similar to the one described) 
and a nonabusive fact pattern (similar to the one described, except 
that all the stock is sold).

4. Proposed Revisions to the Investment Adjustment Provisions, Sec.  
1.1502-32

    In the January 2007 proposal, the IRS and Treasury Department 
proposed several modifications to the investment adjustment rules in 
Sec.  1.1502-32. The principal modifications that were proposed related 
to the treatment of items attributable to property transferred in an 
intercompany section 362(e)(2) transaction and to the treatment of 
items attributable to the application of Sec.  1.1502-36(d).
    As discussed in section 3 of this preamble, these final regulations 
make section 362(e)(2) generally inapplicable to intercompany 
transactions. Accordingly, the IRS and Treasury Department are 
withdrawing proposed Sec.  1.1502-32(c)(1)(ii)(A) (regarding the 
allocation of items otherwise attributable to intercompany section 
362(e)(2) transactions).
    Proposed regulations addressing the treatment of items attributable 
to the application of Sec.  1.1502-36(d) are finalized as Sec.  1.1502-
32(c)(1)(ii). The IRS and Treasury Department have clarified the 
language of the proposed rule, but have made no substantive change to 
that rule.
    In addition, the proposed regulations made various nonsubstantive 
modifications to the language of Sec.  1.1502-32 that were intended to 
simplify, clarify, and then conform various sections of the 
regulations. Those proposed changes are adopted without substantive 
change.

5. Miscellaneous Amendments to Other Regulations

    In addition to the various provisions directly related to the 
treatment of losses on subsidiary stock and to the treatment of 
intercompany section 362(e)(2) transactions, the January 2007 proposal 
included a number of proposed modifications to regulations unrelated to 
subsidiary stock loss issues. The proposed revisions are described in 
Section I of the preamble to the January 2007 proposal. These final 
regulations adopt those proposed regulations without substantive 
change.
    These final regulations also include several additional provisions 
that are either additional technical corrections to existing 
regulations or expansions of regulatory modifications proposed in the 
January 2007 proposal and adopted as final in this Treasury decision.
A. Technical Amendment to Sec.  1.1502-13(g)(3)(i)(B)(2)
    One commentator suggested an expansion of Sec.  1.1502-
13(g)(3)(i)(B)(2), which prevents the application of Sec.  1.1502-
13(c)(6)(i) to items of income or gain attributable to the reduction in 
basis of an intercompany obligation by reason of sections 108 and 1017 
and Sec.  1.1502-28 (and thereby prevents such items from being 
excluded from income). The commentator noted that the same rule should 
be applied to items of income or gain attributable to the reduction in 
basis of an intercompany obligation by reason of Sec.  1.1502-36(d), in 
order to prevent the circumvention of the effects of attribute 
reduction. The IRS and Treasury Department agree that such a revision 
would be a helpful clarification and that change is incorporated in 
these final regulations.
B. Amendments to Sec.  1.1502-33(e) ``Whole-Group'' Exception
    In the January 2007 proposal, modifications were proposed to the 
``whole-group'' exceptions in Sec.  1.1502-13(j)(5) (excepting whole-
group acquisitions from the general rule that deconsolidations require 
intercompany items to be taken into account) and Sec.  1.1502-19(c)(3) 
(excepting whole-group acquisitions from the general rule that 
deconsolidations require excess loss accounts to be taken into 
account).
    In response to the proposed changes to the whole-group exceptions 
in Sec. Sec.  1.1502-13 and 1.1502-19, commentators suggested that a 
similar revision would be appropriate for the whole-group exception in 
Sec.  1.1502-33(e)(2). That rule excepts whole-group acquisitions from 
the general rule in Sec.  1.1502-33(e)(1) that eliminates a member's 
earnings and profits upon deconsolidation. The IRS and Treasury 
Department agree that the same reasoning supports the modification of 
all three whole-group exceptions.
    Accordingly, these final regulations modify the whole-group 
exception in all three provisions, Sec. Sec.  1.1502-13(j)(5), 1.1502-
19(c)(3), and 1.1502-33(e)(2), to allow for their application without 
regard to whether the acquirer is a member of a consolidated group 
prior to the acquisition. Further, these final regulations provide that 
taxpayers may elect to apply each of these modified whole-group 
exceptions retroactively.
C. Anti-Duplicative Adjustments Provisions
    The January 2007 proposal included a set of modifications that was 
intended to simplify several existing provisions by removing all 
references to the continued applicability of the Code and all of the 
anti-duplicative adjustment rules, and including such rule in a single 
paragraph in Sec.  1.1502-80. The IRS and Treasury Department believed 
this change would simplify the regulations, as well as remove any 
potential for inadvertent omission or negative implication in other 
provisions where such concepts are or should be applicable.
    Commentators questioned whether the removal of the discussion of 
the anti-duplicative adjustment rule in various sections of the 
consolidated return regulations would eliminate guidance that is 
helpful to taxpayers and that establishes certain policy 
determinations. The IRS and Treasury Department have considered these 
comments and concluded that it is appropriate to retain the anti-
duplicative adjustment rule in the various sections of the consolidated 
return regulations, but to add a cross reference to the rule in Sec.  
1.1502-80(a). To provide additional guidance in Sec.  1.1502-80(a), the 
final regulations provide that, in determining the application of the 
anti-duplicative adjustment rule, the purposes of the provisions and 
single-entity principles are taken into account.
    In addition, the final regulations modify the general anti-
duplicative adjustment rule in Sec.  1.1502-80 to clarify that its 
principles apply to adjustments, inclusions, and all similar items.
D. Technical Correction to Text Example in Sec.  1.1502-75(d)(1)
    A practitioner informed the IRS and Treasury Department that the 
rationale in the text example in Sec.  1.1502-75(d)(1) needed 
modification. Section 1.1502-75(d)(1) provides that a group remains in 
existence for a tax year if the common parent remains as the common 
parent and at least one subsidiary that was affiliated with it at the 
end of the prior year remains affiliated with it at the beginning of 
the year. It then sets forth an example in which, at the end of 1965, P 
is the common parent of a group

[[Page 53947]]

that includes S and, at the beginning of 1966, P is still the common 
parent of a group that includes S. The example concludes that the group 
continues through 1966 even though P acquires another subsidiary and S 
leaves the group.
    The practitioner noted that the result is correct, but that the 
rationale is misleading and appears to be based on a prior formulation 
of the continuation of the group rule. Accordingly, these final 
regulations revise the analysis of this text example so that the 
rationale reflects the current continuation of the group rule.
E. Amendment to the Section 358 Stock Basis Rules for Certain 
Triangular Reorganizations
    In addition to adopting the proposed technical correction to the 
cross-reference paragraph in Sec.  1.358-6(e), these final regulations 
add triangular G reorganizations (other than by statutory merger) to 
the definition of triangular reorganizations in Sec.  1.358-6(b)(2).
F. Request for Comments on Gain Duplication
    Finally, in the preamble to the January 2007 proposal, the IRS and 
Treasury Department requested comments on the need for a provision that 
would address the gain duplication that occurs when S stock is sold at 
a gain and that gain is attributable to unrecognized net appreciation 
in S's assets. The IRS and Treasury Department have not previously 
addressed this form of gain duplication directly because taxpayers can 
structure their transactions to avoid duplicative recognition of the 
gain, for example, by selling assets directly or by electing to have 
their stock sales treated as assets sales under section 338. While it 
is believed that taxpayers generally have adequate means to mitigate 
this problem, comments were requested.
    In response, commentators expressed the view that the IRS and 
Treasury Department underestimate the frequency and extent of gain 
duplication and overestimate the efficacy of self-help mechanisms.
    Some commentators suggested that gain duplication could be 
addressed through a section 338-like election, pursuant to which gain 
recognized on subsidiary stock could be allocated to the basis of the 
subsidiary's assets, at least to the extent necessary to bring the 
basis of the assets into conformity with the basis of the stock in the 
buyer's hands. However, those commentators have explicitly stated that 
they are not urging this or any other particular model. Moreover, the 
IRS and Treasury Department have been advised that there is 
disagreement among commentators and practitioners as to whether the 
additional burden and complexity inherent in such additional rules 
would be warranted by the potential relief they could provide.
    Accordingly, the IRS and Treasury Department will continue to 
accept comments and consider this issue.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required.
    These regulations are necessary to provide taxpayers with immediate 
guidance regarding the tax consequences of a member's transfer of loss 
shares of subsidiary stock to prevent the creation and recognition of 
noneconomic stock loss and prevent the group from obtaining more than 
one tax loss from a single economic loss. Further, these regulations 
are necessary to provide taxpayers with immediate guidance regarding 
various other provisions of the consolidated return regulations. 
Therefore, good cause is found for dispensing with a delayed effective 
date pursuant to 5 U.S.C. 553(d)(3).
    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.
    It is hereby certified that these regulations will not have a 
significant economic impact on a substantial number of small entities. 
This certification is based on the fact that these regulations 
primarily affect affiliated groups of corporations that have elected to 
file consolidated returns, which tend to be larger businesses. 
Moreover, the number of taxpayers affected is minimal. Therefore, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) is not required.

Drafting Information

    The principal authors of these regulations are Marcie Barese, Sean 
Duffley, and Theresa Abell of the Office of Associate Chief Counsel 
(Corporate). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.1502-36 also issued under 26 U.S.C. 1502 * * *
    Section 1.1502-36 also issued under 26 U.S.C. 337(d). * * *

0
Par. 2. Section 1.337(d)-1 is amended by adding two sentences at the 
end of paragraph (a)(1) to read as follows:


Sec.  1.337(d)-1  Transitional loss limitation rule.

    (a) * * * (1) * * * However, for transactions involving loss shares 
of subsidiary stock occurring on or after September 17, 2008, see Sec.  
1.1502-36. Further, this section does not apply to a transaction that 
is subject to Sec.  1.1502-36.
* * * * *

0
Par. 3. Section 1.337(d)-2 is amended by adding two sentences at the 
end of paragraph (a)(1) to read as follows:


Sec.  1.337(d)-2  Loss limitation rules.

    (a) * * * (1) * * * However, for transactions involving loss shares 
of subsidiary stock occurring on or after September 17, 2008, see Sec.  
1.1502-36. Further, this section does not apply to a transaction that 
is subject to Sec.  1.1502-36.
* * * * *

0
Par. 4. Section 1.358-6 is amended by:
0
1. Adding paragraph (b)(2)(v).
0
2. Revising paragraph (e).
0
3. Revising the heading for paragraph (f) and adding paragraph (f)(3).
    The additions and revisions read as follows:


Sec.  1.358-6  Stock basis in certain triangular reorganizations.

* * * * *
    (b) * * *
    (2) * * *
    (v) Triangular G reorganization. A triangular G reorganization is 
an acquisition by S (other than by statutory merger) of substantially 
all of T's assets in a title 11 or similar case in exchange for P stock 
in a transaction that qualifies as a reorganization under section

[[Page 53948]]

368(a)(1)(G) by reason of the application of section 368(a)(2)(D).
* * * * *
    (e) Cross-reference regarding triangular reorganizations involving 
members of a consolidated group. For rules relating to stock basis 
adjustments made as a result of a triangular reorganization in which P 
and S, or P and T, as applicable, are, or become, members of a 
consolidated group, see Sec.  1.1502-30. However, if a transaction is a 
group structure change, stock basis adjustments are determined under 
Sec.  1.1502-31 and not under Sec.  1.1502-30, even if the transaction 
also qualifies as a triangular reorganization otherwise subject to 
Sec.  1.1502-30.
    (f) Effective/applicability dates. * * *
    (3) Triangular G reorganization and special rule for triangular 
reorganizations involving members of a consolidated group. Paragraphs 
(b)(2)(v) and (e) of this section shall apply to triangular 
reorganizations occurring on or after September 17, 2008. However, 
taxpayers may elect to apply paragraph (b)(2)(v) of this section to 
triangular reorganizations occurring before September 17, 2008 and on 
or after December 23, 1994.

0
Par. 5. Section 1.362-4 is added to read as follows:


Sec.  1.362-4  Limitations on built-in loss duplication.

    (a) Purpose and scope--(1) In general. [Reserved].
    (2) Intercompany transactions. For rules relating to the 
application of section 362(e)(2) to transfers between members of a 
consolidated group on or after October 22, 2004, see Sec.  1.1502-
80(h).
    (b) [Reserved].

0
Par. 6. Section 1.1502-13 is amended by:
    1. Revising the heading and adding a new first sentence in 
paragraph (a)(4).
    2. Revising paragraphs (f)(6)(ii), (g)(3)(ii)(B)(2), (j)(5)(i)(A).
    3. Revising the last sentence of paragraph (f)(6)(iv)(A).
    4. Removing the second sentence in paragraph (f)(6)(v).
    5. Revising the heading for paragraph (l) and adding two sentences 
at the end of paragraph (l)(1).
    The revisions and additions read as follows:


Sec.  1.1502-13  Intercompany transactions.

    (a) * * *
    (4) Application of other rules of law. See Sec.  1.1502-80(a) 
regarding the general applicability of other rules of law and a 
limitation on duplicative adjustments. * * *
* * * * *
    (f) * * *
    (6) * * *
    (ii) Gain stock. For dispositions of P stock occurring before May 
16, 2000, see Sec.  1.1502-13(f)(6)(ii) as contained in 26 CFR part 1 
in effect on April 1, 2000. For dispositions of P stock occurring on or 
after May 16, 2000, see Sec.  1.1032-3.
* * * * *
    (iv) * * *
    (A) * * * If P grants M an option to acquire P stock in a 
transaction meeting the requirements of Sec.  1.1032-3, M is treated as 
having purchased the option from P for fair market value with cash 
contributed to M by P.
* * * * *
    (g) * * *
    (3) * * *
    (ii) * * *
    (B) * * *
    (2) Paragraph (c)(6)(i) of this section (treatment of intercompany 
items if corresponding items are excluded or nondeductible) will not 
apply to exclude any amount of income or gain attributable to a 
reduction of the basis of an intercompany obligation pursuant to 
sections 108 and 1017 and Sec.  1.1502-28 or to Sec.  1.1502-36(d); and
* * * * *
    (j) * * *
    (5) * * *
    (i) * * *
    (A) The acquisition of either the assets of the common parent of 
the terminating group in a reorganization described in section 
381(a)(2), or the stock of the common parent of the terminating group; 
or
* * * * *
    (l) Effective/applicability dates. * * *
    (1) * * * Paragraphs (a)(4), (f)(6)(ii), (f)(6)(iv)(A), 
(g)(3)(ii)(B)(2), and (j)(5)(i)(A) of this section apply with respect 
to transactions occurring on or after September 17, 2008. However, 
taxpayers may elect to apply paragraph (j)(5)(i)(A) of this section to 
transactions that occurred prior to September 17, 2008.
* * * * *

0
Par. 7. Section 1.1502-19 is amended by:
0
1. Removing the language ``P'' throughout the entire section and adding 
``M'' in its place.
0
2. Adding a new sentence at the end of paragraph (a)(1).
0
3. Revising paragraphs (a)(3), (c)(1)(iii)(A), and (c)(3)(i)(A).
0
4. Adding new paragraph (b)(1)(iv).
0
5. Revising the heading for paragraph (h) and adding three sentences at 
the end of paragraph (h)(1).
    The revisions and additions read as follows:


Sec.  1.1502-19  Excess loss accounts.

    (a) In general--(1) Purpose. * * * This section also provides rules 
for eliminating losses and other attributes attributable to S in 
certain cases in which S stock becomes worthless or S ceases to be a 
member and does not have a separate return year.
* * * * *
    (3) Application of other rules of law, duplicative recapture. See 
Sec.  1.1502-80(a) regarding the general applicability of other rules 
of law and a limitation on duplicative adjustments and recapture.
    (b) * * *
    (1) * * *
    (iv) Reduction of attributes in the case of certain dispositions by 
worthlessness or where S ceases to be a member and does not become a 
nonmember. If this paragraph (b)(1)(iv) applies, any net operating or 
capital loss carryover that is attributable to S, including any losses 
that would be apportioned to S under the principles of Sec.  1.1502-
21(b)(2) if S had a separate return year, any deferred deductions 
attributable to S, including S's portion of such consolidated tax 
attributes (for example, consolidated excess charitable contributions 
that would be apportioned to S under the principles of Sec.  1.1502-
79(e) if S had a separate return year), and any credit carryover 
attributable to S, including any consolidated credits that would be 
apportioned to S under the principles of Sec.  1.1502-79 if S had a 
separate return year, are eliminated. Attributes other than 
consolidated tax attributes (determined as of the disposition) are 
eliminated under this paragraph (b)(1)(iv) immediately before the 
disposition resulting in the application of this paragraph (b)(1)(iv). 
The elimination of attributes under this paragraph (b)(1)(iv) is not a 
noncapital, nondeductible expense described in Sec.  1.1502-
32(b)(2)(iii). This paragraph (b)(1)(iv) applies if--
    (A) A share of S stock becomes worthless under section 165, the 
requirements of paragraph (c)(1)(iii) of this section are satisfied, M 
does not recognize a net deduction or loss on the S stock, and S is a 
member of the group on the day following the last day of the group's 
taxable year during which the share becomes worthless; or
    (B) M recognizes any amount that is not a net deduction or loss on 
the stock of S in a transaction in which S ceases to be a member and 
does not become a nonmember.
* * * * *
    (c) * * *
    (1) * * *
    (iii) * * *
    (A) All of S's assets (other than its corporate charter and those 
assets, if

[[Page 53949]]

any, necessary to satisfy state law minimum capital requirements to 
maintain corporate existence) are treated as disposed of, abandoned, or 
destroyed for Federal income tax purposes (for example, under section 
165(a) or Sec.  1.1502-80(c), or, if S's asset is stock of a lower-tier 
member, the stock is treated as disposed of under this paragraph (c)). 
An asset of S is not considered to be disposed of or abandoned to the 
extent the disposition is in complete liquidation of S under section 
332 or is in exchange for consideration (other than relief from 
indebtedness);
* * * * *
    (3) * * *
    (i) * * *
    (A) The acquisition of either the assets of the common parent of 
the terminating group in a reorganization described in section 
381(a)(2), or the stock of the common parent of the terminating group; 
or
* * * * *
    (h) Effective/applicability dates--(1) * * * Paragraphs (a)(3), 
(c)(1)(iii)(A), and (c)(3)(i)(A) of this section apply with respect to 
determinations and transactions occurring on or after September 17, 
2008. However, taxpayers may elect to apply paragraph (c)(3)(i)(A) of 
this section to transactions that occurred prior to September 17, 2008. 
The last sentence of paragraph (a)(1) and paragraph (b)(1)(iv) of this 
section applies with respect to dispositions on or after December 16, 
2008.
* * * * *


Sec.  1.1502-20  [Removed]

0
Par. 8. Section 1.1502-20 is removed.


Sec.  1.1502-20T  [Removed]

0
Par. 9. Section 1.1502-20T is removed.

0
Par. 10. Section 1.1502-21 is amended by:
0
1. Removing the last sentence of paragraph (b)(1).
0
2. Removing paragraph (b)(3)(v).
0
3. Revising paragraphs (b)(2)(ii)(A), (b)(2)(iv)(B)(2)(iv), and (h)(6).
0
4. Adding a new paragraph (b)(2)(iv)(B)(2)(v).
0
5. Revising the heading for paragraph (h) and adding new paragraph 
(h)(1)(iii).
0
6. Revising the first sentence of paragraph (h)(8).
    The revisions and addition reads as follows:


Sec.  1.1502-21  Net operating losses.

* * * * *
    (b) * * *
    (2) * * *
    (ii) Special rules--(A) Year of departure from group. If a 
corporation ceases to be a member during a consolidated return year, 
net operating loss carryovers attributable to the corporation are first 
carried to the consolidated return year, then are subject to reduction 
under section 108 and Sec.  1.1502-28 (regarding discharge of 
indebtedness income that is excluded from gross income under section 
108(a)), and then are subject to reduction under Sec.  1.1502-36 
(regarding transfers of loss shares of subsidiary stock). Only the 
amount that is neither absorbed by the group in that year nor reduced 
under section 108 and Sec.  1.1502-28 or under Sec.  1.1502-36 may be 
carried to the corporation's first separate return year. For rules 
concerning a member departing a subgroup, see paragraph (c)(2)(vii) of 
this section.
* * * * *
    (iv) * * *
    (B) * * *
    (2) * * *
    (iv) Reduction of attributes for stock loss. If during a taxable 
year a member does not cease to be a member of the group and any 
portion of the CNOL attributable to any member is reduced under Sec.  
1.1502-36, the percentage of the CNOL attributable to each member as of 
immediately after the reduction of attributes under Sec.  1.1502-36 
shall be recomputed pursuant to paragraph (b)(2)(iv)(B)(2)(v) of this 
section.
    (v) Recomputed percentage. The recomputed percentage of the CNOL 
attributable to each member shall equal the unabsorbed CNOL 
attributable to the member at the time of the recomputation divided by 
the sum of the unabsorbed CNOL attributable to all of the members at 
the time of the recomputation. For purposes of the preceding sentence, 
a CNOL that is reduced under section 108 and Sec.  1.1502-28, or under 
Sec.  1.1502-36, or that is otherwise permanently disallowed or 
eliminated, shall be treated as absorbed.
* * * * *
    (h) Effective/applicability dates--(1) * * *
    (iii) Paragraphs (b)(2)(ii)(A) and (b)(2)(iv)(B)(2) of this section 
apply to taxable years for which the due date of the original return 
(without regard to extensions) is on or after September 17, 2008.
* * * * *
    (6) Certain prior periods. Paragraphs (b)(1), (b)(2)(iv)(A), 
(b)(2)(iv)(B)(1), and (c)(2)(vii) of this section apply to taxable 
years for which the due date of the original return (without regard to 
extensions) is after March 21, 2005. Paragraphs (b)(2)(ii)(A) and 
(b)(2)(iv)(B)(2) (as contained in 26 CFR part 1 revised as of April 1, 
2008) apply to taxable years for which the due date of the original 
return (without regard to extensions) is on or after March 21, 2005, 
and before September 17, 2008. Paragraph (b)(2)(ii)(A) of this section 
and Sec.  1.1502-21T(b)(1), (b)(2)(iv), and (c)(2)(vii), as contained 
in 26 CFR part 1 revised as of April 1, 2004, apply to taxable years 
for which the due date of the original return (without regard to 
extensions) is after August 29, 2003, and on or before March 21, 2005. 
For taxable years for which the due date of the original return 
(without regard to extensions) is on or before August 29, 2003, see 
paragraphs (b)(1), (b)(2)(ii)(A), (b)(2)(iv), and (c)(2)(vii) of this 
section and Sec.  1.1502-21T(b)(1) as contained in 26 CFR part 1 
revised as of April 1, 2003.
* * * * *
    (8) Losses treated as expired under Sec.  1.1502-35(f)(1). For 
rules regarding losses treated as expired under Sec.  1.1502-35(f) on 
or after March 10, 2006, see Sec.  1.1502-21(b)(3)(v) as contained in 
26 CFR part 1 in effect on April 1, 2006. * * *

0
Par. 11. Section 1.1502-30 is amended by:
0
1. Revising paragraph (b)(4).
0
2. Revising the heading for paragraph (c) and adding a second sentence.
    The revision and addition reads as follows:


Sec.  1.1502-30  Stock basis after certain triangular reorganizations.

* * * * *
    (b) * * *
    (4) Application of other rules of law. If a transaction otherwise 
subject to this section is also a group structure change subject to 
Sec.  1.1502-31, the provisions of Sec.  1.1502-31 and not this section 
apply to determine stock basis. See Sec.  1.1502-80(a) regarding the 
general applicability of other rules of law and a limitation on 
duplicative adjustments. See Sec.  1.1502-80(d) for the non-application 
of section 357(c) to P.
* * * * *
    (c) Effective/applicability date. * * * However, paragraph (b)(4) 
of this section applies to reorganizations occurring on or after 
September 17, 2008.

0
Par. 12. Section 1.1502-31 is amended by:
0
1. Revising paragraph (a)(2).
0
2. Revising the heading for paragraph (h) and revising paragraph 
(h)(1).
0
3. Removing paragraphs (i) and (j).
    The revisions read as follows:

[[Page 53950]]

Sec.  1.1502-31  Stock basis after a group structure change.

    (a) * * *
    (2) Application of other rules of law. If a transaction subject to 
this section is also a triangular reorganization otherwise subject to 
Sec.  1.1502-30, the provisions of this section and not those of Sec.  
1.1502-30 apply to determine stock basis. See Sec.  1.1502-80(a) 
regarding the general applicability of other rules of law and a 
limitation on duplicative adjustments.
* * * * *
    (h) Effective/applicability dates--(1) General rule. This section 
applies to group structure changes that occur after April 26, 2004. 
However, a group may apply this section to group structure changes that 
occurred on or before April 26, 2004, and in consolidated return years 
beginning on or after January 1, 1995. In addition, paragraph (a)(2) of 
this section applies to group structure changes that occurred on or 
after September 17, 2008. Paragraph (e)(2) of this section applies to 
any original consolidated Federal income tax return due (without 
extensions) after June 14, 2007. For original consolidated Federal 
income tax returns due (without extensions) after May 30, 2006, and on 
or before June 14, 2007, see Sec.  1.1502-31T as contained in 26 CFR 
part 1 in effect on April 1, 2007. For original consolidated Federal 
income tax returns due (without extensions) on or before May 30, 2006, 
see Sec.  1.1502-31 as contained in 26 CFR part 1 in effect on April 1, 
2006.
* * * * *

0
Par. 13. Section 1.1502-32 is amended by:
0
1. Removing the language ``P'' throughout the entire section and adding 
``M'' in its place.
0
2. Revising the heading, adding a new first sentence, and removing the 
last two sentences in paragraph (a)(2).
0
3. Revising paragraphs (b)(3)(ii)(C)(2), (c)(1), and (c)(2)(i).
0
4. Revising the first sentence of paragraphs (c)(2)(ii)(A) and (c)(3), 
and the first three sentences of paragraph (c)(4)(i), introductory 
text.
0
5. Removing paragraphs (b)(3)(iii)(C) and (b)(3)(iii)(D).
0
6. Revising the heading for paragraph (h) and adding paragraph (h)(9).
    The revisions and addition read as follows:


Sec.  1.1502-32  Investment adjustments.

    (a) * * *
    (2) Application of other rules of law, duplicative adjustments. See 
Sec.  1.1502-80(a) regarding the general applicability of other rules 
of law and a limitation on duplicative adjustments. * * *
* * * * *
    (b) * * *
    (3) * * *
    (ii) * * *
    (C) * * *
    (2) Expired loss carryovers. If the amount of the discharge exceeds 
the amount of the attribute reduction under sections 108 and 1017, and 
Sec.  1.1502-28, the excess nevertheless is treated as applied to 
reduce tax attributes to the extent a loss carryover attributable to S 
expired without tax benefit, the expiration was taken into account as a 
noncapital, nondeductible expense under paragraph (b)(3)(iii) of this 
section, and the loss carryover would have been reduced had it not 
expired.
* * * * *
    (c) Allocation of adjustments among shares of stock--(1) In 
general--(i) Distributions. The adjustment that is described in 
paragraph (b)(2)(iv) of this section (negative adjustments for 
distributions) is allocated to the shares of S stock to which the 
distribution relates.
    (ii) Special rules applicable in the case of certain loss transfers 
of subsidiary stock--(A) Losses reattributed pursuant to an election 
under Sec.  1.1502-36(d)(6)--(1) General rule. If a member transfers 
loss shares of S stock and the common parent elects under Sec.  1.1502-
36(d)(6) to reattribute all or a portion of S's attributes, S's 
resulting noncapital, nondeductible expense is allocated to all loss 
shares of S stock transferred by members in the transaction. The 
expense is allocated among those S shares in proportion to the loss in 
the shares. The tier-up of that expense is included in the remaining 
adjustment (see paragraph (c)(1)(iii) of this section).
    (2) Reattribution of attributes of a subsidiary that is lower-tier 
to S. If a member transfers loss shares of S stock and the common 
parent elects under Sec.  1.1502-36(d)(6) to reattribute attributes of 
a subsidiary (S2) that is lower-tier to S, S2's resulting noncapital, 
nondeductible expense is allocated among S2 shares held by members as 
of the transaction, other than those transferred in the transaction and 
with respect to which gain or loss was recognized (recognition 
transfer), in a manner that permits the full amount of the expense to 
tier up and be applied to the bases of the loss shares of S stock 
transferred by members in the transaction. The expense is allocated 
among those S2 shares with positive basis in a manner that, first, 
reduces the bases of S2's preferred shares to equalize and then 
eliminate loss and, second, reduces the bases of S2's common shares in 
a manner that reduces disparity among the bases of those common shares 
to the greatest extent possible. The noncapital, nondeductible expense 
applied to the S2 shares tiers up and is applied to the stock of any 
subsidiaries that are lower-tier to S (middle-tier subsidiaries) in a 
manner that will permit the full amount of this expense to be applied 
to reduce the bases of the loss shares of S stock transferred by 
members in the transaction. Similar to the allocation among the S2 
shares, the tier-up of this expense is allocated among the middle-tier 
subsidiary shares held by members as of the transaction, other than 
those transferred in a recognition transfer, in a manner that permits 
the full amount of the expense to tier up and be applied to the bases 
of the loss shares of S stock transferred by members in the 
transaction. The tier-up of this expense is allocated among those 
middle-tier subsidiary shares with positive basis in a manner that, 
first, reduces the bases of the middle-tier subsidiary's preferred 
shares to equalize and then eliminate loss and, second, reduces the 
bases of the middle-tier subsidiary's common shares in a manner that 
reduces disparity among the bases of those common shares to the 
greatest extent possible. The tier-up of this expense is allocated to 
the loss shares of S stock transferred by members in the transaction in 
the same manner as provided in paragraph (c)(1)(ii)(A)(1) of this 
section, and thereafter the tier-up of that expense is included in the 
remaining adjustment (see paragraph (c)(1)(iii) of this section).
    (3) Example. The following example illustrates the rules of this 
paragraph (c)(1)(ii)(A).

    Example. Assume P owns M1, P and M1 own M2, M2 owns S, M1 and S 
own S1, and M1 and S1 own S2. If S sells a portion of the S1 shares 
at a gain and M2 sells all of the S stock at a net loss (after 
adjusting the basis for the gain recognized by S on the sale of the 
S1 shares), and P elects under Sec.  1.1502-36(d)(6) to reattribute 
attributes of S2, the resulting noncapital, nondeductible expense is 
allocated entirely to the S2 shares held by S1 with positive basis 
in a manner that reduces the disparity in those bases to the 
greatest extent possible. The tier-up of this amount is allocated 
entirely to the S1 shares held by S (excluding the S1 shares sold) 
with positive basis in a manner that reduces the disparity in those 
bases to the greatest extent possible. The tier-up of this amount is 
allocated to the loss shares of S stock sold by M2 in proportion to 
the loss in those shares. The tier-up of this amount is then 
included in the remaining adjustment and tiers up from M2 to M1 and 
P, and from M1 to P under the general rules of this section.


[[Page 53951]]


    (B) Tier-up of reallocated investment adjustments subject to prior 
use limitation. If the reallocation of an investment adjustment under 
Sec.  1.1502-36(b)(2) is subject to the prior use limitation in Sec.  
1.1502-36(b)(2)(iii)(B)(2), no amount of the tier-up of such 
reallocated investment adjustment shall be allocated to any share whose 
prior use resulted in the application of the limitation. Thereafter, 
the tier-up of this amount is included in the remaining adjustment (see 
paragraph (c)(1)(iii) of this section).
    (iii) Remaining adjustment. The remaining adjustment is the 
adjustment that consists of the items described in paragraphs (b)(2)(i) 
through (b)(2)(iii) of this section (adjustments for taxable income or 
loss, tax-exempt income, and noncapital, nondeductible expenses), 
including adjustments to lower-tier stock basis that tier up under 
paragraph (a)(3)(iii) of this section, but only to the extent not 
specially allocated under paragraph (c)(1)(ii) of this section. The 
remaining adjustment is allocated among the shares of S stock as 
provided in paragraphs (c)(2) through (c)(4) of this section. If the 
remaining adjustment is positive, it is allocated first to any 
preferred stock as provided in paragraph (c)(3) of this section, and 
then to the common stock as provided in paragraph (c)(2) of this 
section. If the remaining adjustment is negative, it is allocated only 
to common stock as provided in paragraph (c)(2) of this section.
    (iv) Nonmember shares. No adjustment under this section that is 
allocated to a share for the period it is owned by a nonmember affects 
the basis of the share.
    (v) Cross-references. See paragraph (c)(4) of this section for the 
reallocation of adjustments, and paragraph (d) of this section for 
definitions. See Sec.  1.1502-19(d) for special allocations of basis 
determined or adjusted under the Internal Revenue Code (Code) with 
respect to excess loss accounts.
    (2) Common stock--(i) Allocation within a class. The remaining 
adjustment described in paragraph (c)(1)(iii) of this section that is 
allocable to a class of common stock is generally allocated equally to 
each share within the class. However, if a member has an excess loss 
account in a share of a class of common stock at the time a positive 
remaining adjustment is to be allocated, the portion of the positive 
remaining adjustment allocable to the member with respect to the class 
is allocated first to equalize and then eliminate that member's excess 
loss accounts. It is then allocated equally among the members' shares 
in that class. Similarly, the portion of any negative remaining 
adjustment allocable to the member with respect to the class is 
allocated equally to the member's shares with positive bases, 
eliminating all positive basis in shares of the class before creating 
or increasing any excess loss accounts. After positive basis is 
eliminated, any remaining portion of the negative remaining adjustment 
is allocated to equalize the member's excess loss accounts in the 
shares of that class to the greatest extent possible. Distributions and 
any adjustments or determinations under the Internal Revenue Code (for 
example, under section 358, including any modifications under Sec.  
1.1502-19(d)) are taken into account before the allocation is made 
under this paragraph (c)(2)(i).
    (ii) * * *
    (A) * * * If S has more than one class of common stock, the extent 
to which the remaining adjustment described in paragraph (c)(1)(iii) of 
this section is allocated to each class is determined, based on 
consistently applied assumptions, by taking into account the terms of 
each class and all other facts and circumstances relating to the 
overall economic arrangement. * * *
* * * * *
    (3) * * * If the remaining adjustment described in paragraph 
(c)(1)(iii) of this section is positive, it is allocated to preferred 
stock to the extent required (when aggregated with prior allocations to 
the preferred stock during the period that S is a member of the 
consolidated group) to reflect distributions described in section 301 
(and all other distributions treated as dividends) to which the 
preferred stock becomes entitled, and arrearages arising, during the 
period that S is a member of the consolidated group. * * *
* * * * *
    (4) * * * (i) * * * A member's basis in each share of S preferred 
and common stock must be redetermined whenever necessary to determine 
the tax liability of any person. See paragraph (b)(1) of this section. 
The redetermination is made by reallocating S's adjustments described 
in paragraphs (c)(1)(ii)(B) (specially allocated adjustments for tier-
up of reallocated investment adjustments subject to prior use 
limitation) and (c)(1)(iii) (remaining adjustments) of this section for 
each consolidated return year (or other applicable period) of the group 
by taking into account all of the facts and circumstances affecting 
allocations under this paragraph (c) as of the redetermination date 
with respect to all of the S shares. * * *
* * * * *
    (h) Effective/applicability date. * * *
    (9) Allocations of investment adjustments, including adjustments 
attributable to certain loss transfers; certain conforming amendments. 
Paragraphs (a)(2), (b)(3)(ii)(C)(2), (c)(1), (c)(2)(i), (c)(2)(ii)(A), 
(c)(3), and (c)(4)(i) of this section are applicable for determinations 
of the basis of stock of a subsidiary on or after September 17, 2008.
* * * * *


Sec.  1.1502-32T  [Removed]

0
Par. 14. Section 1.1502-32T is removed.

0
Par. 15. Section 1.1502-33 is amended by:
0
1. Revising the heading and adding a new first sentence to paragraph 
(a)(2).
0
2. Revising paragraph (e)(2)(i)(A).
0
3. Revising the heading for paragraph (j) and adding two sentences to 
the end of paragraph (j)(1).
    The additions and revision read as follows:


Sec.  1.1502-33  Earnings and profits.

    (a) * * *
    (2) Application of other rules of law, duplicative adjustments. See 
Sec.  1.1502-80(a) regarding the general applicability of other rules 
of law and a limitation on duplicative adjustments. * * *
* * * * *
    (e) * * *
    (2) * * *
    (i) * * *
    (A) The acquisition of either the assets of the common parent of 
the terminating group in a reorganization described in section 
381(a)(2), or the stock of the common parent of the terminating group; 
or
* * * * *
    (j) Effective/applicability date--(1) * * * Paragraphs (a)(2) and 
(e)(2)(i)(A) of this section apply with respect to determinations of 
the earnings and profits of a member in consolidated return years 
beginning on or after September 17, 2008. However, taxpayers may elect 
to apply paragraph (e)(2)(i)(A) of this section with respect to 
determinations of the earnings and profits of a member in consolidated 
return years beginning prior to September 17, 2008.
* * * * *

0
Par. 16. Section 1.1502-35 is amended by:
0
1. Revising paragraphs (a), (c)(3), (c)(4)(i), (c)(5)(i), (g)(3), 
(g)(6), (h), and (j).
0
2. Revising the heading of paragraph (c)(8).
0
3. Removing paragraph (k).

[[Page 53952]]

Sec.  1.1502-35  Transfers of subsidiary stock and deconsolidations of 
subsidiaries.

    (a) In general--(1) Purpose. The purpose of this section is to 
prevent a group from obtaining more than one tax benefit from a single 
economic loss. The provisions of this section shall be construed in a 
manner that is consistent with that purpose and in a manner that 
reasonably carries out that purpose.
    (2) Dates of applicability. This section applies if--
    (i) On or after March 7, 2002, a member recognizes a loss on the 
disposition of a share of stock of a subsidiary (or, on or after April 
10, 2007, a share of stock of a former subsidiary) or a carryover basis 
asset (subject to paragraph (c)(6) of this section),
    (ii) The member's loss on the share of subsidiary stock or the 
carryover basis asset is allowed on or before the date that is ten 
years after the disposition of the share or carryover basis asset, and
    (iii) If the disposition is of a share of subsidiary stock, it is 
not a transfer to which Sec.  1.1502-36 applies.
* * * * *
    (c) * * *
    (3) Treatment of suspended loss--(i) General rule. For purposes of 
the rules of Sec.  1.1502-32, any loss suspended pursuant to paragraph 
(c)(1) or (c)(2) of this section is treated as a noncapital, 
nondeductible expense of the member that disposes of subsidiary stock, 
incurred during the taxable year that includes the date of the 
disposition of stock to which paragraph (c)(1) or (c)(2) of this 
section applies. See Sec.  1.1502-32(b)(3)(iii)(C). Consequently, the 
basis of a higher-tier member's stock of the member that disposes of 
subsidiary stock is reduced by the suspended loss in the year it is 
suspended.
    (ii) Location of suspended loss following deconsolidation of 
selling member. If a member recognizes a loss that is suspended under 
this paragraph (c) but that member ceases to be a member of the group 
before the loss is allowable, the common parent is treated as 
succeeding to the loss in a transaction to which section 381(a) 
applies.
    (4) Reduction of suspended loss--(i) General rule. The amount of 
any loss suspended pursuant to paragraph (c)(1) or (c)(2) of Sec.  
1.1502-35 shall be reduced, but not below zero, by the subsidiary's 
(and any successor's) items of deduction and loss, and the subsidiary's 
(and any successor's) allocable share of items of deduction and loss of 
all lower-tier subsidiaries, that are allocable to the period beginning 
on the date of the disposition that gave rise to the suspended loss and 
ending on the day before the first date on which the subsidiary (and 
any successor) is not a member of the group of which it was a member 
immediately prior to the disposition (or any successor group), and that 
are taken into account in determining consolidated taxable income (or 
loss) of such group for any taxable year that includes any date on or 
after the date of the disposition and before the first date on which 
the subsidiary (and any successor) is not a member of such group; 
provided, however, that such reduction shall not exceed the excess of 
the amount of such items over the amount of such items that are taken 
into account in determining the basis adjustments made under Sec.  
1.1502-32 to stock of the subsidiary (or any successor) owned by 
members of the group. The preceding sentence shall not apply to items 
of deduction and loss to the extent that the group can establish that 
all or a portion of such items was not reflected in the computation of 
the duplicated loss with respect to the subsidiary on the date of the 
disposition of stock that gave rise to the suspended loss.
* * * * *
    (5) Allowable loss--(i) General rule. To the extent not reduced 
under paragraph (c)(4) of this section, any loss suspended pursuant to 
paragraph (c)(1) or (c)(2) of this section shall be allowed, to the 
extent otherwise allowable under applicable provisions of the Internal 
Revenue Code and regulations, on a return filed by the group of which 
the subsidiary was a member on the date of the disposition of 
subsidiary stock that gave rise to the suspended loss (or any successor 
group) for the taxable year that includes the earlier of--
    (A) The day before the first date on which the subsidiary (and any 
successor) is not a member of such group or the date the group is 
allowed a worthless stock loss under section 165 (taking into account 
the provisions of Sec.  1.1502-80(c)) with respect to all of the 
subsidiary stock owned by members and;
    (B) The date that is ten years after the date of the disposition of 
subsidiary stock that gave rise to the suspended loss.
* * * * *
    (8) No elimination of economic loss. * * *
* * * * *
    (g) * * *
    (3) Anti-loss reimportation rule--(i) Conditions for application. 
This paragraph (g)(3) applies when--
    (A) A member of a group (selling group) recognized and was allowed 
a loss with respect to a share of stock of S, a subsidiary or former 
subsidiary of the selling group;
    (B) That stock loss was duplicated (in whole or in part) in S's 
attributes (duplicating items) at the earlier of the time that the loss 
was recognized or that S ceased to be a member; and
    (C) Within ten years of the date that S ceased to be a member, 
there is a reimportation event. For this purpose, a reimportation event 
is any event after which a duplicating item is a reimported item. A 
reimported item is any duplicating item that is reflected in the 
attributes of any member of the selling group, including S, or, if not 
reflected in the attributes, would be properly taken into account by 
any member of the selling group (for example as the result of a 
carryback).
    (ii) Effect of application. Immediately before the time that a 
reimported item (or any portion of a reimported item) would be properly 
taken into account (but for the application of this paragraph (g)(3)), 
such item (or such portion of the item) is reduced to zero and no 
deduction or loss is allowed, directly or indirectly, with respect to 
that item.
    (iii) Operating rules. For purposes of this paragraph (g)(3)--
    (A) The terms member, subsidiary, and group include their 
predecessors and successors to the extent necessary to effectuate the 
purposes of this section; and
    (B) The reduction of a reimported item (other than duplicating 
items that are carried back to a consolidated return year of the 
selling group) is a noncapital, nondeductible expense within the 
meaning of Sec.  1.1502-32(b)(3)(iii).
* * * * *
    (6) General anti-avoidance rule. If a taxpayer acts with a view to 
avoid the purposes of this section, appropriate adjustments will be 
made to carry out the purposes of this section.
    (h) Application of other rules of law. See Sec.  1.1502-80(a) 
regarding the general applicability of other rules of law.
* * * * *
    (j) Effective/applicability dates. This section applies with 
respect to stock transfers, deconsolidations of subsidiaries, 
determinations of worthlessness, and stock dispositions on or after 
September 17, 2008. For prior law, see Sec. Sec.  1.1502-35 and 1.1502-
35T as contained in 26 CFR part 1 in effect on April 1, 2008.


Sec.  1.1502-35T  [Removed]

0
Par. 17. Section 1.1502-35T is removed.

0
Par. 18. Section 1.1502-36 is added to read as follows:

[[Page 53953]]

Sec.  1.1502-36  Unified loss rule.

    (a) In general--(1) Scope. This section provides rules for 
adjusting members' bases in stock of a subsidiary (S) and for reducing 
S's attributes when a member (M) transfers a loss share of S stock. See 
paragraph (f) of this section for definitions of the terms used in this 
section, including transfer and value.
    (2) Purpose. The rules in this section have two principal purposes. 
The first is to prevent the consolidated return provisions from 
reducing a group's consolidated taxable income through the creation and 
recognition of noneconomic loss on S stock. The second is to prevent 
members (including former members) of the group from collectively 
obtaining more than one tax benefit from a single economic loss. 
Additional purposes are set forth in other paragraphs of this section. 
The rules of this section must be interpreted and applied in a manner 
that is consistent with and reasonably carries out the purposes of this 
section.
    (3) Overview--(i) General application of section. This section 
applies when M transfers a share of S stock and, after taking into 
account the effects of all applicable rules of law (even if the 
adjustments required by such provisions are not deemed effective until 
after the transfer, such as certain adjustments required under sections 
108 and 1017 and Sec.  1.1502-28), the share is a loss share. When this 
section applies, paragraph (b) of this section applies first and may 
redetermine members' bases in their shares of S stock. If the 
transferred share is a loss share after any basis redetermination under 
paragraph (b) of this section, paragraph (c) of this section applies 
and may reduce M's basis in the transferred loss share. If the 
transferred share is a loss share after any basis reduction required by 
paragraph (c) of this section, paragraph (d) of this section applies 
and may reduce attributes of S and subsidiaries that are lower-tier to 
S. Although the determination of whether there is a transfer of a loss 
share is made as of the transfer, this section applies, and any 
adjustments it requires are given effect, immediately before the 
transfer. Paragraphs (e), (f), and (g) of this section provide general 
operating rules (including rules for transfers of S stock between 
members), definitions, and an anti-abuse rule, respectively.
    (ii) Stock of multiple subsidiaries transferred in the 
transaction--(A) Initial application of section to transferred shares 
in lowest tier. If shares of stock of more than one subsidiary are 
transferred in a transaction, the application of this section begins at 
the lowest tier. If no transferred shares of stock of the lowest-tier 
subsidiary (S2) are loss shares, any gain recognized with respect to 
the S2 shares immediately tiers up and adjusts members' bases in 
subsidiary stock under Sec.  1.1502-32. However, if any of the 
transferred S2 shares are loss shares, paragraph (b) of this section 
applies with respect to those shares. If, after the application of 
paragraph (b) of this section, any transferred S2 shares are still loss 
shares, paragraph (c) of this section applies with respect to those 
shares. If, after the application of paragraph (c) of this section, any 
transferred S2 shares are still loss shares and P makes an election 
under paragraph (d)(6) of this section with respect to those S2 shares, 
then paragraph (d) of this section applies with respect to those 
shares, but only to the extent necessary to give effect to the 
election. After taking into account the effects of any adjustments 
required by this initial application of this section, recognized gain 
or loss is computed on all transferred S2 shares. Any adjustments under 
paragraph (b) or (c) of this section, the effect of any election under 
paragraph (d)(6) of this section, any gain or loss recognized on the 
transferred S2 shares (whether allowed or disallowed), and any other 
related or resulting adjustments then tier-up and apply to adjust 
members' bases in subsidiary stock under Sec.  1.1502-32.
    (B) Initial application of section to transferred shares in higher 
tiers. After taking into account the effects of any adjustments 
described in paragraph (a)(3)(ii)(A) of this section, transferred 
shares in the next higher tier, and then in each next higher tier 
successively, other than the transferred loss shares at the highest 
tier, are treated in the manner described in paragraph (a)(3)(ii)(A) of 
this section.
    (C) Application of section to transferred shares in highest tier. 
After paragraphs (b) and (c) of this section, and, to the extent 
necessary to give effect to any election under paragraph (d)(6) of this 
section, paragraph (d) of this section, have been applied to or with 
respect to all lower-tier transferred loss shares, and after all lower-
tier adjustments have been taken into account (whether resulting from 
the application of paragraph (b) or (c) of this section, an election 
under paragraph (d)(6) of this section, the recognition of gain or loss 
on a transfer, or otherwise), paragraphs (b), then (c), and then (d) of 
this section apply with respect to the highest-tier shares that are 
transferred loss shares.
    (D) Final application of section to transferred shares in lower 
tiers. After paragraph (d) of this section has been applied with 
respect to transferred loss shares in the highest tier, it is applied 
with respect to transferred shares in each next lower tier, 
successively, to the extent such shares are loss shares after the 
application of paragraph (d) of this section.
    (4) Other rules of law and coordination with deferral and 
disallowance provisions. In general, this section applies and has 
effect immediately upon the transfer of a loss share even if the loss 
is deferred, disallowed, or otherwise not taken into account under any 
other applicable rules of law. However, see paragraph (e)(3) of this 
section for special rules applicable to shares of S stock transferred 
in an intercompany transaction. See section Sec.  1.1502-80(a) for the 
general applicability of other rules of law and a limitation on 
duplicative adjustments.
    (5) Nomenclature, factual assumptions adopted in this section. 
Unless otherwise stated, for purposes of this section, the following 
nomenclature and assumptions are adopted. P is the common parent of a 
consolidated group of which S, M, and M1 are members. X is not a member 
of the P group. If a corporation has preferred stock outstanding, it is 
stock described in section 1504(a)(4). The examples set forth the only 
facts, elections, and activities relevant to the example. All 
transactions are between unrelated persons and are independent of each 
other. Tax liabilities and their effect, and the application of any 
other loss disallowance or deferral provisions of the Internal Revenue 
Code (Code) or regulations, including but not limited to section 267, 
are disregarded. All persons report on a calendar year basis and use 
the accrual method of accounting. All parties comply with filing and 
other requirements of this section and all other provisions of the Code 
and regulations.
    (b) Basis redetermination to reduce disparity--(1) In general--(i) 
Purpose and scope. The rules of this paragraph (b) reduce the extent to 
which there is disparity in members' bases in shares of S stock. These 
rules supplement the operation of the investment adjustment system; 
their purpose is to prevent the realization of noneconomic loss and 
facilitate the elimination of duplicated loss when members hold S 
shares with disparate bases. The rules of this paragraph (b) only 
reallocate investment adjustments previously applied to members' bases 
in shares of S stock, thus they do not alter the aggregate amount of 
basis in shares of S stock held by members or the aggregate amount of

[[Page 53954]]

investment adjustments applied to shares of S stock.
    (ii) Special rules for applicability of redetermination rule. 
Notwithstanding the general rule in paragraph (b)(2) of this section, 
members' bases in shares of S stock are not redetermined under this 
paragraph (b) if--
    (A) There is no disparity among members' bases in shares of S 
common stock and no member owns a share of S preferred stock with 
respect to which there is unrecognized gain or loss; or
    (B) All the shares of S stock held by members are transferred to 
one or more nonmembers, become worthless under section 165 (taking into 
account the provisions of Sec.  1.1502-80(c)), or a combination 
thereof, in one fully taxable transaction. However, in such a case, P 
may elect to redetermine such bases under this paragraph (b). Such an 
election is made in the manner provided in paragraph (e)(5) of this 
section. If stock of more than one subsidiary is transferred in the 
transaction, the election may be made with respect to one or more of 
such subsidiaries.
    (iii) Investment adjustment. For purposes of this paragraph (b), 
the term investment adjustment includes adjustments specially allocated 
under Sec.  1.1502-32(c)(1)(ii)(B) and remaining adjustments described 
in Sec.  1.1502-32(c)(1)(iii). In applying any provision of this 
section, the term includes all such adjustments reflected in the basis 
of the share as of the application of the provision, whether originally 
allocated under Sec.  1.1502-32 or otherwise. The term therefore 
includes adjustments previously reallocated to the share, and it does 
not include adjustments previously reallocated from the share, whether 
pursuant to this section or any other provision of law. It also 
includes the proportionate amount of adjustments reflected in the 
exchanged basis of a share, such as the basis determined under section 
358 in connection with a reorganization or a transaction qualifying 
under section 355.
    (2) Basis redetermination rule. If M transfers a loss share of S 
stock, all members' bases in all their shares of S stock are subject to 
redetermination under this paragraph (b). The determination of whether 
a share is a loss share is made as of the transfer, taking into account 
the effects of all applicable rules of law. The redeterminations are 
made immediately before applying paragraph (c) of this section and in 
accordance with the following:
    (i) Decreasing the bases of transferred loss shares--(A) Removing 
positive investment adjustments from transferred loss shares of common 
stock. M's basis in each of its transferred loss shares of S common 
stock is first reduced, but not below value, by removing positive 
investment adjustments previously applied to the basis of the share. 
The positive investment adjustments removed from transferred loss 
shares of S common stock are reallocated under paragraph (b)(2)(ii) of 
this section after negative investment adjustments are reallocated 
under paragraph (b)(2)(i)(B) of this section.
    (B) Reallocating negative investment adjustments from shares of S 
common stock. If a transferred share is still a loss share after 
applying paragraph (b)(2)(i)(A) of this section, M's basis in the share 
is reduced, but not below value, by reallocating negative investment 
adjustments to the transferred loss share (whether common or preferred 
stock) from members' shares of S common stock that are not transferred 
loss shares. The adjustments reallocated under this paragraph 
(b)(2)(i)(B) are reallocated and applied first to M's bases in 
transferred loss shares of S preferred stock and then to M's bases in 
transferred loss shares of S common stock. Reallocations under this 
paragraph (b)(2)(i)(B) are made in a manner that, to the greatest 
extent possible, reduces the disparity among members' bases in all 
transferred loss shares of S preferred stock, and reduces the disparity 
among members' bases in all shares of S common stock.
    (ii) Increasing the bases of gain preferred and all common shares--
(A) Preferred stock. After the application of paragraph (b)(2)(i) of 
this section, the positive investment adjustments removed from 
transferred loss shares of S common stock under paragraph (b)(2)(i)(A) 
of this section are reallocated and applied to increase, but not above 
value, members' bases in shares of S preferred stock (without regard to 
whether such shares are transferred in the transaction). Reallocations 
under this paragraph (b)(2)(ii)(A) are made in a manner that, to the 
greatest extent possible, reduces the disparity among members' bases in 
all shares of S preferred stock.
    (B) Common stock. Any positive investment adjustments removed from 
transferred loss shares of S common stock under paragraph (b)(2)(i)(A) 
of this section and not reallocated and applied to S preferred shares 
are reallocated and applied to increase members' bases in shares of S 
common stock. Reallocations are made to shares of S common stock 
without regard to whether a particular share is a loss share or a 
transferred share, and without regard to the share's value. 
Reallocations under this paragraph (b)(2)(ii)(B) are made in a manner 
that, to the greatest extent possible, reduces the disparity among 
members' bases in all shares of S common stock.
    (iii) Operating rules--(A) Method. In general, reallocations should 
be made first with respect to the earliest available adjustments. 
However, the overall application of this paragraph (b) to a transaction 
must be made in a manner that, to the greatest extent possible, reduces 
basis disparity (as provided in paragraphs (b)(2)(i)(B) and (b)(2)(ii) 
of this section). The specific reallocation of an investment adjustment 
under this paragraph (b) may be made using any reasonable method or 
formula that is consistent with the provisions of this paragraph (b)(2) 
and furthers the purposes of this section.
    (B) Limits on reallocation--(1) Restriction to members' outstanding 
shares. Investment adjustments can only be reallocated to shares that 
were held by members at the time the adjustment was originally applied.
    (2) Limitation by prior use--(i) In general. In order to prevent 
the reallocation of investment adjustments from either increasing or 
decreasing members' aggregate bases in subsidiary stock, no investment 
adjustment (positive or negative) may be reallocated under this 
paragraph (b)(2) to the extent that it was (or would have been) used 
prior to the time that it would otherwise be reallocated under this 
paragraph (b)(2). For this purpose, an investment adjustment was used 
(or would have been used) to the extent that it was reflected in (or 
would have been reflected in) the basis of a share of subsidiary stock 
and the basis of that share has already been taken into account, 
directly or indirectly, in determining income, gain, deduction, or loss 
(including by affecting the application of this section to a prior 
transfer of subsidiary stock) or in determining the basis of any 
property that is not subject to Sec.  1.1502-32. However, if the prior 
use was in an intercompany transaction, an investment adjustment may be 
reallocated to the extent that Sec.  1.1502-13 has prevented the gain 
or loss on the transaction from being taken into account. (In that 
case, appropriate adjustments must be made to the intercompany item 
from the prior intercompany transaction that has not yet been taken 
into account.) Further, if an investment adjustment was reflected in 
(or would have been reflected in) the basis of a share that has been 
taken into account, the limitation on reallocation under this paragraph 
(b)(2)(iii)(B)(2)

[[Page 53955]]

does not apply to the extent the basis of that share would not change 
as a result of the reallocation (for example, because the reallocation 
is between shares that are both lower-tier to the share with the 
previously used basis). See Sec.  1.1502-32(c)(1)(ii)(B) regarding 
special allocations applicable to the tier-up of the reallocated 
investment adjustment if the reallocation is limited under this 
paragraph (b)(2)(iii)(B)(2) due to prior use at a higher tier.
    (ii) Example. The application of this paragraph (b)(2)(iii)(B)(2) 
is illustrated by the following example:

    Example. (i) Facts. P owns all 20 shares of M stock, and 10 
shares of S stock. M owns the remaining 10 shares of S stock. In 
year 1, S recognizes $200 of income that results in a $10 positive 
investment adjustment being allocated to each share of S stock. The 
group does not recognize any other items. The $100 positive 
adjustment to M's basis in the S stock tiers up, and results in a $5 
positive adjustment to each share of M stock. In year 2, P sells one 
share of M stock and recognizes a gain. In year 3, M sells one loss 
share of S stock, and this paragraph (b) applies and requires a 
reallocation of the year 1 positive investment adjustment applied to 
the basis of the transferred S share.
    (ii) Application of limitation by prior use. M's basis in the 
transferred loss share of S stock reflects a $10 positive investment 
adjustment attributable to S's year 1 income. Under the general rule 
of this paragraph (b), that $10 would be subject to reallocation to 
reduce basis disparity. However, that $10 adjustment had originally 
tiered up to adjust P's basis in its M shares and, as a result, $.50 
of that adjustment was reflected in P's basis in each share of M 
stock. When P sold the share of M stock, the basis of that share 
(which included the tiered-up $.50) was used in determining the gain 
on the sale. Thus, $.50 of the $10 investment adjustment originally 
allocated to the transferred S share that tiered-up to the sold M 
share was previously used and, as such, cannot be reallocated in a 
manner that would (if it were the original allocation) affect the 
basis of the sold M share. Accordingly, no more than $9.50 of the 
adjustment to M's transferred S share could be reallocated to P's 
shares of S stock. If so, under the special allocation rule in Sec.  
1.1502-32(c)(1)(ii)(B), the tier-up of this $9.50 would only be 
allocated among P's remaining 19 shares of M stock. Alternatively, 
all $10 of the investment adjustment could be reallocated to M's 
other S shares (because the tier-up to P's M shares would have been 
the same regardless which of M's shares of S stock were adjusted).
    (iii) Application of limitation where adjustment would have been 
used. The facts are the same as in paragraph (i) of this Example 
except that M does not sell any shares of S stock and, in year 3, P 
sells a loss share of S stock. As in paragraph (i) of this Example, 
when P sold the share of M stock, the basis of that share was used 
in determining the gain on the share. When P sells the loss share of 
S stock, the $10 positive investment adjustment from S's year 1 
income cannot be reallocated in a manner that would (if it were the 
original adjustment) affect the basis of the sold M share. If this 
$10 positive investment adjustment had originally been allocated to 
the S shares held by M, $.50 of the $10 investment adjustment would 
have tiered up to the M share that P sold, would have been reflected 
in P's basis in that M share, and would have been used in 
determining P's gain or loss on the sale. Accordingly, up to $9.50 
of the $10 investment adjustment applied to the basis of P's 
transferred S share could be reallocated to M's shares of S stock. 
If so, under the special allocation rule in Sec.  1.1502-
32(c)(1)(ii)(B), the tier-up of this $9.50 would only be allocated 
among P's remaining 19 shares of M stock. Alternatively, all $10 of 
the investment adjustment could be reallocated to P's other S 
shares.

    (3) Examples. The general application of this paragraph (b) is 
illustrated by the following examples:

    Example 1. Transfer of stock received in section 351 exchange. 
(i) Redetermination to prevent noneconomic loss. (A) Facts. For many 
years, M has owned two assets, Asset 1 and Asset 2. On January 1, 
year 1, M receives the only four outstanding shares of S common 
stock (Block 1 shares) in exchange for Asset 1, which has a basis 
and value of $80. Section 351 applies to the exchange and, 
therefore, under section 358, M's aggregate basis in the Block 1 
shares is $80 ($20 per share). On July 1, year 2, M receives another 
share of S common stock (Block 2 share) in exchange for Asset 2, 
which has a basis of $0 and value of $20. Section 351 applies to 
this exchange and, under section 358, M's basis in the Block 2 share 
is $0. On October 1, year 3, S sells Asset 2 for $20, recognizing a 
$20 gain. On December 31, year 3, M sells one of its Block 1 shares 
to X for $20. After taking into account the effects of all 
applicable rules of law, M's basis in each Block 1 share is $24 (M's 
original $20 basis increased under Sec.  1.1502-32 by $4, the 
share's allocable portion of the $20 gain recognized on the sale of 
Asset 2). In addition, M's basis in its Block 2 share is $4 (M's 
original $0 basis increased under Sec.  1.1502-32 by $4 (the share's 
allocable portion of the $20 gain recognized on the sale of Asset 
2)). M's sale of the Block 1 share is a transfer of a loss share and 
therefore subject to this section.
    (B) Basis redetermination under this paragraph (b). Under this 
paragraph (b), M's bases in all its shares of S stock are subject to 
redetermination. First, paragraph (b)(2)(i)(A) of this section 
applies to reduce M's basis in the transferred loss share, but not 
below value, by removing positive investment adjustments applied to 
the basis of the share. Accordingly, M's basis in the transferred 
Block 1 share is reduced by $4 (the amount of the positive 
investment adjustment applied to the share), from $24 to $20. Even 
if there were negative investment adjustments applied to adjust the 
bases of nontransferred common shares, no further reduction to the 
basis of the share would be required under this paragraph (b) 
because the basis of the transferred share is then equal to the 
share's value. Under paragraph (b)(2)(ii)(B) of this section, the 
positive investment adjustment removed from the transferred loss 
share is reallocated and applied to increase M's bases in its S 
common shares in a manner that reduces disparity in M's bases in all 
the S common shares, to the greatest extent possible. Accordingly, 
the $4 positive investment adjustment removed from the Block 1 share 
is reallocated and applied to the basis of the Block 2 share, 
increasing it from $4 to $8.
    (C) Application of paragraphs (c) and (d) of this section. 
Because M's sale of the Block 1 share is not a transfer of a loss 
share after the application of this paragraph (b), neither paragraph 
(c) of this section nor paragraph (d) of this section applies to the 
transfer.
    (ii) Redetermination to eliminate duplicated loss. (A) Facts. 
The facts are the same as in paragraph (i)(A) of this Example 1, 
except that, at the time of the second contribution, the value of 
Asset 1 had declined to $20 and so, instead of contributing Asset 2, 
M contributed Asset 3 to S in exchange for the Block 2 share. At the 
time of that exchange, Asset 3 had a basis and value of $5. On 
October 1, year 3, S sells Asset 1 for $20, recognizing a $60 loss 
that is absorbed by the group. On December 31, year 3, M sells one 
of its Block 1 shares to X for $5. After taking into account the 
effects of all applicable rules of law, M's basis in each Block 1 
share is $8 (M's original $20 basis decreased under Sec.  1.1502-32 
by $12 (the share's allocable portion of the $60 loss recognized on 
the sale of Asset 1)). M's basis in its Block 2 share is an excess 
loss account of $7 (M's original basis of $5 reduced under Sec.  
1.1502-32 by $12, the share's allocable portion of the loss 
recognized on the sale of Asset 1). M's sale of the Block 1 share is 
a transfer of a loss share and therefore subject to this section.
    (B) Basis redetermination under this paragraph (b). Under this 
paragraph (b), M's bases in all its shares of S stock are subject to 
redetermination. There are no positive investment adjustments and so 
there is no adjustment under paragraph (b)(2)(i)(A) of this section. 
However, under paragraph (b)(2)(i)(B) of this section, M's basis in 
the transferred Block 1 share is reduced, but not below value, by 
reallocating negative investment adjustments from common shares that 
are not transferred loss shares. In total, there were $48 of 
negative investment adjustments applied to common shares that are 
not transferred loss shares. Accordingly, M's basis in the Block 1 
share is reduced by $3, from $8 to its value of $5. Under paragraph 
(b)(2)(i)(B) of this section, the negative investment adjustments 
applied to the transferred share are reallocated from (and therefore 
cause an increase in the basis of) S common shares that are not 
transferred loss shares in a manner that reduces disparity among 
members' bases in all S common shares to the greatest extent 
possible. Accordingly, the $3 negative investment adjustment 
reallocated and applied to the transferred Block 1 share is 
reallocated entirely from the Block 2 share, increasing the basis in 
the Block 2 share from an excess loss account of $7 to an excess 
loss account of $4.
    (C) Application of paragraphs (c) and (d) of this section. 
Because M's sale of the Block

[[Page 53956]]

1 share is not a transfer of a loss share after the application of 
this paragraph (b), neither paragraph (c) of this section nor 
paragraph (d) of this section applies to the transfer.
    (iii) Nonapplicability of redetermination rule to sale of entire 
interest. The facts are the same as in paragraph (ii)(A) of this 
Example 1, except that, on December 31, year 3, M sells all its 
shares of S stock to X for $25. M's sale of the S stock to X is a 
transfer of all of the shares of S stock held by members to one or 
more nonmembers in one fully taxable transaction and, therefore, 
basis is not redetermined under this paragraph (b). Accordingly, the 
sale of the Block 1 shares remains a transfer of loss shares and, as 
such, subject to paragraphs (c) and (d) of this section. However, 
paragraphs (c)(7) and (d)(3)(i)(A) of this section apply netting 
principles to prevent adjustments under either paragraph (c) or 
paragraph (d) of this section, respectively. Alternatively, the 
group could elect to apply this paragraph (b). In that case, the $12 
negative adjustment applied to the Block 2 shares would be 
reallocated to the Block 1 shares with the result that there would 
be no loss (or gain) on any of the transferred shares following the 
application of this paragraph (b). In that case, there would be no 
further application of this section to the transfer.
    (iv) Transfer of entire interest, partially taxable. The facts 
are the same as in paragraph (iii) of this Example 1, except that, 
instead of selling the Block 2 share to X, M contributes the share 
to a nonmember in a section 351 exchange that is part of the same 
transaction. Although all the S shares held by members are 
transferred in the transaction, not all the shares are transferred 
to one or more nonmembers in one fully taxable transaction. 
Therefore, paragraph (b)(1)(ii)(B) of this section does not apply 
and M must redetermine its bases in its shares of S stock under this 
paragraph (b). In total, there were $12 of negative investment 
adjustments applied to common shares that are not transferred loss 
shares (the Block 2 share, a gain share). Accordingly, M's basis in 
each of the Block 1 shares is reduced by $3, from $8 to its value of 
$5. Under paragraph (b)(2)(i)(B) of this section, the negative 
investment adjustments applied to the transferred shares are 
reallocated from (and therefore cause an increase in the basis of) S 
shares that are not transferred loss shares in a manner that reduces 
disparity among members' bases in all S common shares to the 
greatest extent possible. Accordingly, the $12 negative investment 
adjustment reallocated and applied to the transferred Block 1 shares 
is reallocated entirely from the Block 2 share, increasing the basis 
in the Block 2 share from an excess loss account of $7 to a basis of 
$5. Because M's transfer is not a transfer of loss shares after the 
application of this paragraph (b), neither paragraph (c) of this 
section nor paragraph (d) of this section applies to the transfer.

    Example 2. Redetermination increases basis of transferred loss 
share. (i) Facts. On January 1, year 1, M owns all 10 outstanding 
shares of S common stock. Five of the shares have a basis of $20 per 
share (Block 1 shares) and five of the shares have a basis of $10 
per share (Block 2 shares). S's only asset, Asset 1, has a basis of 
$50. S has no other attributes. On October 1, year 1, S sells Asset 
1 for $100, recognizing a $50 gain. On December 31, year 2, M sells 
one Block 1 share and one Block 2 share to X for $10 per share. 
After taking into account the effects of all applicable rules of 
law, M's basis in each Block 1 share is $25 (M's original $20 basis 
increased under Sec.  1.1502-32 by $5, the share's allocable portion 
of the $50 gain recognized on the sale of Asset 1), and M's basis in 
each Block 2 share is $15 (M's original $10 basis increased under 
Sec.  1.1502-32 by $5, the share's allocable portion of the $50 gain 
recognized on the sale of Asset 1). M's sale of the Block 1 and 
Block 2 shares is a transfer of loss shares and therefore subject to 
this section.
    (ii) Basis redetermination under this paragraph (b). Under this 
paragraph (b), M's bases in all its shares of S stock are subject to 
redetermination. First, paragraph (b)(2)(i)(A) of this section 
applies to reduce M's basis in the transferred Block 1 and Block 2 
shares, but not below value, by removing the positive investment 
adjustments applied to the bases of the transferred loss shares. 
Accordingly, the basis of the transferred Block 1 share is reduced 
by $5, from $25 to $20. The basis of the transferred Block 2 share 
is also reduced by $5, from $15 to $10. (Although the transferred 
Block 1 share is still a loss share, there is no reduction to its 
basis under paragraph (b)(2)(i)(B) of this section because there 
were no negative investment adjustments applied to the bases of the 
S common shares that are not transferred loss shares.) Next, 
paragraph (b)(2)(ii)(B) of this section applies to reallocate and 
apply the $10 of positive investment adjustments removed from the 
transferred loss shares to increase M's bases in its S common shares 
in a manner that reduces the disparity in its bases in all S common 
shares to the greatest extent possible. Accordingly, of the $10 of 
positive investment adjustments to be reallocated, $6 is reallocated 
and applied to the basis of the transferred Block 2 share 
(increasing it from $10 to $16) and $4 is reallocated and applied 
equally to the basis of each of the four retained Block 2 shares 
(increasing the basis of each from $15 to $16). After giving effect 
to the reallocations under this paragraph (b), M's basis in each 
retained Block 1 share is $25, M's basis in the transferred Block 1 
share is $20, and M's basis in each Block 2 share is $16.
    (iii) Application of paragraph (c) of this section. After the 
application of this paragraph (b), M's sale of the Block 1 and Block 
2 shares is still a transfer of loss shares and, accordingly, 
subject to paragraph (c) of this section. No adjustment is required 
to the basis of the transferred Block 1 share under paragraph (c) of 
this section because, after its basis is redetermined under this 
paragraph (b), the net positive adjustment to the basis of the share 
is $0. See paragraph (c)(3) of this section. However, under 
paragraph (c) of this section M's basis in the transferred Block 2 
share is reduced by $6 (the lesser of its net positive adjustment, 
$6, and its disconformity amount, $6), from $16 to $10, its value. 
See paragraph (c)(2) of this section.
    (iv) Application of paragraph (d) of this section. After the 
application of paragraph (c) of this section, M's sale of the Block 
1 share is still a transfer of a loss share and, accordingly, 
subject to paragraph (d) of this section. No adjustment is required 
under paragraph (d) of this section because there is no aggregate 
inside loss. See paragraph (d)(3)(iii) of this section. Because M's 
sale of the Block 2 share is no longer a transfer of a loss share 
after the application of paragraph (c) of this section, paragraph 
(d) of this section does not apply to the transfer of the Block 2 
share.

    Example 3. Tiered subsidiaries. (i) Transfer of all shares of 
common stock. (A) Facts. P owns the sole outstanding share of S 
stock with a basis of $100, and the sole outstanding share of M 
stock with a basis of $300. M has $200 and owns an asset with a 
basis of $0. S owns one asset, Asset 1, with a basis of $100. At a 
time when Asset 1 has a value of $200, S issues a second share of 
common stock to M in exchange for $200. Later S sells Asset 1 for 
$200, recognizing a $100 gain. After taking into account the effects 
of all applicable rules of law, P's basis in its S stock is $150 
(P's original $100 basis increased under Sec.  1.1502-32 by $50, the 
share's allocable portion of the $100 gain recognized on the sale of 
Asset 1), M's basis in its S stock is $250 (M's original $200 basis 
increased under Sec.  1.1502-32 by $50, the share's allocable 
portion of the $100 gain recognized on the sale of Asset 1), and P's 
basis in its M stock is $350 (P's original $300 basis increased 
under Sec.  1.1502-32 by $50, the tier-up of M's increase in its 
basis in its S stock). P then sells its M share and its S share to X 
for $300 and $200, respectively. M and S are not members of the same 
consolidated group immediately after the sale. Therefore, the M 
share and both of the S shares are transferred in the transaction. 
Regarding P's sale of its share of S stock and its share of M stock, 
see paragraph (f)(10)(i)(A) of this section (ceasing to own a share 
in a taxable transaction) and paragraph (f)(10)(i)(C) of this 
section (nonmember acquires share); regarding M's share of S stock, 
see paragraph (f)(10)(i)(B) of this section (ceasing to be members 
of the same group). The application of this section begins with 
respect to the stock of S, the subsidiary at the lowest tier in 
which there is a transfer of subsidiary stock. See paragraph 
(a)(3)(ii) of this section. Although both P and M transfer their S 
shares, only M's S share is a loss share. Thus, only M's transfer is 
a transfer of a loss share of S stock and only M's transfer is 
subject to this section.
    (B) Application of section to transferred S shares. Although 
only M's transfer is subject to this section, all members' bases in 
their shares of S stock are subject to redetermination under this 
paragraph (b). First, paragraph (b)(2)(i)(A) of this section applies 
to reduce M's basis in its transferred S share, but not below value, 
by removing the positive investment adjustment applied to that 
share. Accordingly, the basis of M's S share is reduced by $50, from 
$250 to $200 (under Sec.  1.1502-32, that redetermination adjustment 
tiers up to reduce P's basis in its M stock by $50, from $350 to 
$300). Because there are no negative adjustments to reallocate under 
paragraph (b)(2)(i)(B) of this section, paragraph (b)(2)(ii)(B) of 
this section

[[Page 53957]]

then applies to reallocate and apply the $50 positive investment 
adjustment removed from the transferred loss S share to increase P's 
basis in its S share in a manner that reduces disparity among 
members' bases in all S common shares to the greatest extent 
possible. Accordingly, all $50 of the positive investment adjustment 
is reallocated and applied to P's basis in its S share (increasing 
the basis from $150 to $200). Because M's transfer of its S share is 
not a transfer of a loss share after the application of this 
paragraph (b), neither paragraph (c) of this section nor paragraph 
(d) of this section applies to that transfer.
    (C) Application of section to transfers at next higher tier. 
After the adjustments to M's share of S stock are given effect, P's 
transfer of its share of M stock is not a transfer of a loss share 
and so this section does not apply to that transfer.
    (D) Result of application of section. After the application of 
this section, P recognizes no gain or loss on its sale of either the 
S share or the M share. In addition, the unrecognized (noneconomic) 
loss in M's basis in its S share is eliminated. The results would be 
the same if, in addition to the facts in paragraph (i)(A) of this 
Example 3, M transferred its S share to a X in a fully taxable 
transaction and, as permitted under paragraph (b)(1)(ii)(B) of this 
section, P elected to redetermine basis under this paragraph (b).
    (ii) Transfer of less than all lower-tier shares of stock. (A) 
Facts. The facts are the same as in paragraph (i)(A) of this Example 
1, except that M and S are members of the same consolidated group 
immediately after the sale. Therefore, in this case, M's S share is 
not transferred and so this section has no application with respect 
to M's S share. P's transfer of its S share is not a transfer of a 
loss share and so is also not subject to this section. However, P's 
sale of its share of M stock is a transfer of a loss share and is 
subject to this section.
    (B) Basis redetermination under this paragraph (b). Although P's 
transfer of its share of M stock is subject to this section, this 
paragraph (b) does not apply to the transfer because there is only 
one share of M stock outstanding (and so there can be no disparity 
among members' bases in common shares and there are no outstanding 
preferred shares with respect to which there can be unrecognized 
gain or loss). Accordingly, after the application of this paragraph 
(b), P's sale of its M share is still a transfer of a loss share and 
therefore subject to paragraph (c) of this section.
    (C) Application of paragraphs (c) and (d) of this section. Under 
paragraph (c) of this section, P must reduce its basis in its M 
share by $50, the lesser of its net positive adjustment ($50, see 
paragraph (c)(3) of this section) and its disconformity amount 
($150, see paragraphs (c)(4), (c)(5), and (c)(6) of this section). 
As a result, the share is no longer a loss share and the transfer is 
not subject to paragraph (d) of this section.
    (D) Result of application of section. After the application of 
this section, P recognizes a $50 gain on its sale of the S share and 
no loss on its sale of the M share. Although there is unrecognized 
loss preserved in M's basis in its S share, if M later transfers the 
share when it is a loss share, that transfer will be subject to this 
section.

    Example 4. Application to outstanding common and preferred 
shares. (i) Facts. P owns all the stock of M and all eight 
outstanding shares of S common stock. S also has two shares of 
nonvoting preferred stock outstanding; the preferred shares each 
have a $100 annual, cumulative preference as to dividends. M owns 
one of the preferred shares (PS1) and P owns the other (PS2). On 
January 1, year 1, the bases and values of the outstanding S shares 
are:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                    Preferred                                     Common
                                                               -----------------------------------------------------------------------------------------
                                                                  PS1      PS2      CS1      CS2      CS3      CS4      CS5      CS6      CS7      CS8
                                                                  (M)      (P)      (P)      (P)      (P)      (P)      (P)      (P)      (P)      (P)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Basis.........................................................     1250      990     1025      710      550      400      375      250      215      100
Value.........................................................     1000     1000      375      375      375      375      375      375      375      375
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (A) As of January 1, year 1, there are no arrearages on the 
preferred stock. In year 1, S has a $1100 capital loss and $100 of 
ordinary income. The group absorbs the loss and the negative 
remaining adjustment of $1000 is allocable entirely to the common 
stock, equally to each common share ($125 per share). See Sec.  
1.1502-32(c)(1)(iii) and (c)(2).
    (B) In year 2, S has $700 of ordinary income and a $100 ordinary 
loss. Also, on October 1, year 2, S declares and makes a $200 
dividend distribution with respect to the preferred stock ($100 per 
share). Under Sec.  1.1502-32(c)(1)(i), a negative adjustment of 
$100 is first allocated to each of the preferred shares to reflect 
the declaration of the dividend. The $600 positive remaining 
adjustment determined under Sec.  1.1502-32(c)(1)(iii) (reflecting 
S's net income reduced by the distribution) is then allocated to 
each of the preferred shares to the extent of its entitlement to 
dividends accruing in year 1 and year 2 ($200 per share). See Sec.  
1.1502-32(c)(1)(iii) and (c)(3). The $200 of the positive remaining 
adjustment not allocated to the preferred shares is then allocated 
to the common stock, equally to each common share ($25 per share). 
See Sec.  1.1502-32(c)(1)(iii) and (c)(2). After taking into account 
the effects of all applicable rules of law, the adjusted bases and 
the values of the shares as of January 1, year 3, are:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                           Preferred                                          Common
                                                     ---------------------------------------------------------------------------------------------------
                                                      PS1  (M)  PS2  (P)  CS1  (P)   CS2 (P)   CS3 (P)   CS4 (P)   CS5 (P)   CS6 (P)   CS7 (P)   CS8 (P)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Basis...............................................      1250       990      1025       710       550       400       375       250       215       100
Year 1Sec.   1.1502-32 adjustments..................       N/A       N/A      -125      -125      -125      -125      -125      -125      -125      -125
Year 2Sec.   1.1502-32 adjustments..................      -100      -100       +25       +25       +25       +25       +25       +25       +25       +25
                                                          +200      +200  ........  ........  ........  ........  ........  ........  ........  ........
                                                     -------------------------------
                                                          +100      +100  ........  ........  ........  ........  ........  ........  ........  ........
                                                     ===============================
Adjusted basis......................................      1350      1090       925       610       450       300       275       150       115         0
Value...............................................      1100      1100       275       275       275       275       275       275       275       275
Unrecognized gain/(loss)............................     (250)        10     (650)     (335)     (175)      (25)         0       125       160       275
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (C) On January 1, year 3, M sells PS1 for $1100 and P sells CS2 
for $275. The sales of PS1 and CS2 are transfers of loss shares and 
therefore subject to this section.
    (ii) Basis redetermination under this paragraph (b). Under this 
paragraph (b), all members' bases in shares of S stock are subject 
to redetermination in accordance with the following:
    (A) Removing positive investment adjustments from transferred 
loss common shares. First, paragraph (b)(2)(i)(A) of this section 
applies to reduce P's basis in CS2, but not below value, by removing 
the positive investment adjustment applied to the basis of the 
share. Accordingly, P's basis in CS2 is reduced by $25, from $610 to 
$585.

[[Page 53958]]

    (B) Reallocating negative investment adjustments from common 
shares that are not transferred loss shares. Because the transferred 
shares remain loss shares after the removal of positive investment 
adjustments, their bases are further reduced under paragraph 
(b)(2)(i)(B) of this section, but not below value, by reallocating 
negative investment adjustments applied to common shares that are 
not transferred loss shares. Reallocations are made first to 
preferred shares and then to the common shares, in a manner that 
reduces disparity among members' bases in transferred loss preferred 
shares, and reduces disparity among members' bases in all common 
shares, to the greatest extent possible. The loss on PS1 is $250, 
the remaining loss on CS2 is $310, and the total amount of negative 
investment adjustments applied to shares that are not transferred 
loss shares is $875 (the sum of the negative adjustments applied to 
all common shares other than CS2). Thus, $250 of negative investment 
adjustments are reallocated and applied to the basis of PS1, 
reducing it to the share's value, $1100. The negative investment 
adjustments are reallocated from the common shares that are not 
transferred loss shares in a manner that reduces disparity among 
members' bases in all common shares to the greatest extent possible. 
The negative investment adjustments may be reallocated to PS1 from 
the common shares that are not transferred loss shares as follows: 
$125 from each of CS7 and CS8. Such reallocations increase the basis 
of CS7 by $125, from $115 to $240, and increase the basis of CS8 by 
$125, from $0 to $125. Negative investment adjustments are then 
reallocated to CS2 from the common shares that are not transferred 
loss shares in a manner that reduces disparity among members' bases 
in all common shares to the greatest extent possible. The negative 
investment adjustments may be reallocated to CS2 from the other 
common shares as follows: $80 from CS4, $105 from CS5, and $125 from 
CS6. Such reallocations reduce the basis of CS2 by $310, from $585 
to $275, increase the basis of CS4 by $80, from $300 to $380, 
increase the basis of CS5 by $105, from $275 to $380, and increase 
the basis of CS6 by $125, from $150 to $275. However, there may be 
other reasonable reallocations.
    (C) Increasing basis by reallocated positive investment 
adjustments. Under paragraph (b)(2)(ii)(A) of this section, the $25 
positive investment adjustment removed from CS2 (the transferred 
loss common share) is then reallocated and applied to increase the 
basis of preferred shares, but not above value. Accordingly, $10 of 
that amount is reallocated to PS2, increasing its basis from $1090 
to $1100, its value. Under paragraph (b)(2)(ii)(B) of this section, 
the remaining $15 is reallocated and applied to the common shares in 
a manner that reduces disparity among members' bases in all common 
shares to the greatest extent possible. The $15 positive investment 
adjustment that is reallocated to common shares may be reallocated 
entirely to CS8, increasing its basis from $125 to $140. However, 
there may be other reasonable reallocations.
    (D) Summary of the reallocation of adjustments. The adjustments 
made under this paragraph (b) are:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                           Preferred                                          Common
                                                     ---------------------------------------------------------------------------------------------------
                                                      PS1  (M)  PS2  (P)  CS1  (P)   CS2 (P)   CS3 (P)   CS4 (P)   CS5 (P)   CS6 (P)   CS7 (P)   CS8 (P)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Adjusted basis before redetermination...............      1350      1090       925       610       450       300       275       150       115         0
Removing positive adjustments from transferred loss   ........  ........  ........       -25
 shares.............................................
Reallocating negative adjustments...................      -250  ........  ........      -310  ........       +80      +105      +125      +125      +125
Applying positive adjustments removed from            ........       +10  ........  ........  ........  ........  ........  ........  ........       +15
 transferred loss shares............................
Basis after redetermination.........................      1100      1100       925       275       450       380       380       275       240       140
Value...............................................      1100      1100       275       275       275       275       275       275       275       275
Gain/(loss).........................................         0         0     (650)         0     (175)     (105)     (105)         0        35       135
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (iii) Application of paragraphs (c) and (d) of this section. 
Because M's sale of PS1 and P's sale of CS2 are not transfers of 
loss shares after the application of this paragraph (b), paragraphs 
(c) and (d) of this section do not apply.
    (iv) Higher-tier effects. The $250 reduction in the basis of PS1 
under this paragraph (b) is a noncapital, nondeductible expense 
under Sec.  1.1502-32(b)(3)(iii)(B) that will be included in the 
year 3 investment adjustment to be applied to P's basis in its M 
stock.

    (c) Stock basis reduction to prevent noneconomic loss--(1) In 
general. The rules of this paragraph (c) reduce M's basis in a 
transferred share of S stock to prevent noneconomic stock loss and thus 
promote the clear reflection of the group's income. These rules limit 
the reduction to M's basis in the S share to the amount of net 
unrealized appreciation reflected in the share's basis as of the 
transfer (the disconformity amount). These rules also limit the 
reduction to M's basis in the S share to the portion of the share's 
basis that is attributable to investment adjustments made pursuant to 
the consolidated return regulations.
    (2) Basis reduction rule. This paragraph (c) applies if M transfers 
a share of S stock and, after taking into account the effects of all 
applicable rules of law, including any adjustments under paragraph (b) 
of this section, the share is a loss share. Under this paragraph (c), 
M's basis in the share is reduced, but not below value, by the lesser 
of--
    (i) The share's net positive adjustment (as defined in paragraph 
(c)(3) of this section); and
    (ii) The share's disconformity amount (as defined in paragraph 
(c)(4) of this section).
    (3) Net positive adjustment. A share's net positive adjustment is 
the greater of--
    (i) Zero; and
    (ii) The sum of all investment adjustments reflected in the basis 
of the share. The term investment adjustment has the same meaning as in 
paragraph (b)(1)(iii) of this section, except that it includes all 
adjustments specially allocated under Sec.  1.1502-32(c)(1)(ii).
    (4) Disconformity amount. A share's disconformity amount is the 
excess, if any, of--
    (i) M's basis in the share; over
    (ii) The share's allocable portion of S's net inside attribute 
amount (as defined in paragraph (c)(5) of this section).
    (5) Net inside attribute amount. S's net inside attribute amount is 
determined as of the transfer, taking into account all applicable rules 
of law (even if the adjustments required by such rules are not deemed 
effective until after the transfer, such as certain adjustments 
required under sections 108 and 1017 and Sec.  1.1502-28). S's net 
inside attribute amount is the sum of S's net operating and capital 
loss carryovers, deferred deductions, money, and basis in assets other 
than money, reduced by the amount of S's liabilities. For this purpose, 
S's basis in any share of lower-tier subsidiary stock is generally S's 
basis in that share, adjusted to reflect any gain or loss recognized in 
the

[[Page 53959]]

transaction with respect to the share and any other related or 
resulting adjustments to the basis of the share. However, see paragraph 
(c)(6) of this section for special rules regarding the computation of 
S's net inside attribute amount for purposes of this paragraph (c) if S 
holds stock of a subsidiary that is not transferred in the transaction. 
See paragraph (f) of this section for definitions of ``allocable 
portion,'' ``deferred deduction,'' ``liability,'' ``loss carryover,'' 
and other relevant terms.
    (6) Determination of S's net inside attribute amount if S owns 
stock of a lower-tier subsidiary--(i) Overview. If a loss share of S 
stock is transferred when S holds a share of stock of another 
subsidiary (S1) and the S1 share is not transferred in the same 
transaction, S's net inside attribute amount is determined by treating 
S's basis in its S1 share as tentatively reduced under this paragraph 
(c)(6). The purpose of this rule is to reduce the extent to which S1's 
investment adjustments increase noneconomic loss on S stock (as a 
result of S1's recognition of items that are indirectly reflected in a 
member's basis in a share of S stock).
    (ii) General rule for nontransferred shares of lower-tier 
subsidiary stock. For purposes of determining the disconformity amount 
of a share of S stock, S's basis in a nontransferred share of S1 stock 
is treated as reduced by the share's tentative reduction amount. The 
tentative reduction amount is the lesser of the S1 share's net positive 
adjustment and the S1 share's disconformity amount.
    (iii) Multiple tiers of nontransferred shares. If S directly or 
indirectly owns nontransferred shares of stock of subsidiaries in 
multiple tiers, then, subject to the limitations in paragraph 
(c)(6)(iv) of this section (regarding nontransferred shares that are 
lower-tier to transferred shares), the rules of this paragraph (c)(6) 
first apply to determine the tentatively reduced basis of stock of the 
subsidiary at the lowest tier. These rules then apply to determine the 
tentatively reduced basis of nontransferred shares of stock of 
subsidiaries successively at each next higher tier that is lower-tier 
to S. The tentative reductions at each tier are treated as noncapital, 
nondeductible expenses that tier up under the principles of Sec.  
1.1502-32, and, as such, result in a tentative reduction of basis and 
any net positive adjustment of subsidiary shares that are lower-tier to 
S.
    (iv) Nonapplicability of tentative basis reduction rule to 
transferred shares. The tentative basis reduction rule in this 
paragraph (c)(6) does not apply to any share of stock of a lower-tier 
subsidiary (S1) that is transferred in the same transaction in which 
the S share is transferred. Further, for purposes of determining the S 
share's disconformity amount, the tentative basis reduction rule in 
this paragraph (c)(6) only applies with respect to stock of a lower-
tier subsidiary if such stock is lower-tier to a nontransferred S1 
share. The purpose of this rule is to prevent tentative adjustments to 
the bases of lower-tier shares if this paragraph (c) has already 
applied with respect to the shares, without regard to whether such 
application resulted in the reduction of the basis of any share.
    (v) Example. The rules of this paragraph (c)(6) are illustrated by 
the following example:

    Example. (i) Facts. M owns the sole outstanding share of S 
stock, S owns the sole outstanding share of S1 stock, S1 owns all 
five outstanding shares of S2 stock (the bases of which are equal), 
and S2 owns the sole outstanding share of S3 stock. The basis of 
each of the shares reflects its allocable portion of a $5 positive 
investment adjustment attributable to income recognized by S3. The 
basis of the S share exceeds its value by $10 and the basis of the 
S1 share exceeds its value by $5. The basis of each S2 share is $1 
less than its value. In one transaction, M sells its S share to X, 
S1 issues new shares in an amount that prevents S and S1 from being 
members of the same group, and S1 sells one of its S2 shares to an 
unrelated individual. S1, S2, and S3 elect to file a consolidated 
return following the transaction.
    (ii) General applicability of section. As a result of the 
transaction, there is a transfer of the S share and the S2 share 
that was sold (because both shares were sold to nonmembers) and of 
the S1 share (because S and S1 cease to be members of the same group 
as a result of the stock issuance). The transfer of the S2 share is 
not a transfer of a loss share, and so this section does not apply 
to that transfer. The transfers of the S and S1 shares are transfers 
of loss shares, and so this section applies to those transfers. The 
S3 share and the four retained S2 shares are not transferred in the 
transaction. Under paragraph (a)(3)(ii)(A) of this section, this 
section applies first to the transfer of the S1 share because it is 
the lowest-tier transferred loss share.
    (iii) Application of paragraph (b) of this section and this 
paragraph (c) to transfer of S1 stock. First, the $1 gain recognized 
on the transfer of the S2 share tiers up to adjust the basis of each 
upper-tier share. The transferred S1 share is still a loss share (by 
$4) and is therefore subject to this section. Although the transfer 
is subject to paragraph (b) of this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S1 stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the S1 share is still a loss share and, as such, subject to 
this paragraph (c). In determining the amount of any basis reduction 
under this paragraph (c), the disconformity amount of the S1 share 
is computed by comparing S's basis in its S1 share to S1's net 
inside attribute amount (because there is only one S1 share 
outstanding, the entire amount is allocable to that share). In 
determining S1's net inside attribute amount, the tentative 
reduction rule in this paragraph (c)(6) applies to nontransferred 
lower-tier shares (provided they are lower-tier to nontransferred 
shares). Thus, the rule applies to S1's four retained shares of S2 
stock and to S2's share of S3 stock. The tentative reduction begins 
at the lowest level (S2's share of S3 stock) and any tentative 
reduction amount tiers up as a noncapital, nondeductible expense 
under the principles of Sec.  1.1502-32, tentatively reducing the 
bases of any upper tier nontransferred shares that are lower-tier to 
the transferred loss share (the S1 share). Accordingly, each of S1's 
nontransferred share of S2 stock is tentatively reduced by its 
portion of the tentative reduction to S2's share of S3 stock. S1 
then applies the tentative reduction rule to its four nontransferred 
S2 shares. S1's net inside attribute amount is the sum of its basis 
in each of its nontransferred S2 shares, as tentatively reduced 
under this paragraph (c)(6) and S1's actual basis in the transferred 
S2 share, increased to reflect the gain recognized on the sale of 
that share. After the application of this paragraph (c) to the 
transfer of the S1 share, paragraph (b) of this section applies to 
M's transfer of the S share.
    (iv) Application of section to transfer of S stock. Because the 
S share is still a loss share after applying paragraph (b) of this 
section and this paragraph (c) to the transfer of the S1 stock, this 
section applies to M's transfer of the S share. Although paragraph 
(b) of this section applies to the transfer, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
this paragraph (c). In determining the disconformity amount of the S 
share, S's net inside attribute amount is determined using S's 
actual basis in the transferred S1 stock (after any reduction under 
this paragraph (c)), because the tentative reduction rule in this 
paragraph (c)(6) does not apply to shares that are transferred in 
the transaction. All other shares are lower-tier to the transferred 
S1 share and are therefore also not subject to tentative reduction 
for purposes of determining the disconformity amount of the S share. 
After the application of this paragraph (c) to the transfer of the S 
share, paragraph (d) of this section applies with respect to M's 
transfer of the S share. After the application of paragraph (d) of 
this

[[Page 53960]]

section with respect to the transfer of the S share, if the S1 share 
is still a loss share, paragraph (d) of this section applies with 
respect to S's transfer of the S1 share.

    (7) Netting of gains and losses taken into account--(i) General 
rule. Solely for purposes of computing the basis reduction required 
under this paragraph (c), the basis of each transferred loss share of S 
stock is treated as reduced proportionately (as to loss) by the amount 
of income or gain taken into account by members with respect to 
transferred shares of S stock, provided that--
    (A) The shares are transferred in one transaction; and
    (B) The gain is taken into account as of the transaction.
    (ii) Example. The netting rule of this paragraph (c)(7) is 
illustrated by the following example:

    Example. Disposition of gain and loss shares. (i) Facts. M owns 
the only three outstanding shares of S stock. Share A has a basis of 
$54, Share B has a basis of $100, and Share C has a basis of $80. In 
the same transaction, M sells all three S shares to X for $60 each. 
M realizes a gain of $6 on Share A, a loss of $40 on Share B, and a 
loss of $20 on Share C. M's sales of Share B and Share C are 
transfers of loss shares and therefore subject to this section. M's 
sale is a transfer of all of the shares of S stock held by members 
to one or more nonmembers in one fully taxable transaction and, 
therefore, basis is not redetermined under paragraph (b) of this 
section. See paragraph (b)(1)(ii)(B) of this section. The transfer 
is then subject to this paragraph (c). However, for this purpose, M 
treats its bases in Share B and Share C as reduced by the $6 gain 
taken into account on Share A. The gain is allocated to Share B and 
Share C proportionately based on the amount of loss in each share. 
Thus, $4 of gain ($40/$60 x $6) is treated as allocated to Share B 
and $2 of gain ($20/$60 x $6) is treated as allocated to Share C. 
Accordingly, M computes the basis reduction required under this 
paragraph (c) by treating its basis in Share B as $96 ($100 less $4) 
and its basis in Share C as $78 ($80 less $2). If, after the 
application of this paragraph (c), the sales of Share B and Share C 
are still transfers of loss shares, then the transfers are subject 
to paragraph (d) of this section. (Although the bases of Share B and 
Share C are not actually reduced by any portion of the gain, 
paragraph (d)(3)(i)(A) of this section applies netting principles to 
limit adjustments under paragraph (d) of this section.)
    (ii) Disposition of stock with deferred gain. The facts are the 
same as in paragraph (i) of this Example, except that M sells the 
gain share to another member. Under Sec.  1.1502-13, M's gain 
recognized on Share A is not taken into account in the taxable year 
of the transfer and therefore cannot be treated as reducing M's loss 
recognized on Share B and Share C for purposes of this paragraph 
(c). The applicability of this section to the transfer of Share A is 
determined as of the time that the intercompany item (the gain on 
M's sale to the other member) is taken into account; see paragraph 
(e)(3) of this section. However, if Share B (instead of Share A) 
were sold to a member, the entire gain on Share A would be treated 
as reducing the loss on Share C for purposes of applying this 
paragraph (c); see paragraph (e)(3) of this section.

    (8) Examples. The application of this paragraph (c) is illustrated 
by the following examples.

    Example 1. Appreciation reflected in stock basis at acquisition. 
(i) Appreciation recognized as gain. (A) Facts. On January 1, year 
1, M purchases the sole outstanding share of S stock for $100. At 
that time, S owns two assets, Asset 1 with a basis of $0 and a value 
of $40, and Asset 2 with a basis and value of $60. In year 1, S 
sells Asset 1 for $40, recognizing a $40 gain. On December 31, year 
1, M sells its S share for $100. After taking into account the 
effects of all applicable rules of law, M's basis in the S share is 
$140 (M's original $100 basis increased under Sec.  1.1502-32 by 
$40, the share's allocable portion of the gain recognized on the 
sale of Asset 1). M's sale of the S share is a transfer of a loss 
share and therefore subject to this section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in the S share, $140, is reduced, but not 
below value, $100, by the lesser of the share's net positive 
adjustment and disconformity amount. The share's net positive 
adjustment is the greater of zero and the sum of all investment 
adjustments (as defined in paragraph (b)(1)(iii) of this section) 
applied to the basis of the share. The only investment adjustment 
applied to the basis of the share is the $40 adjustment attributable 
to the gain recognized on the sale of Asset 1. Thus, the share's net 
positive adjustment is $40. The share's disconformity amount is the 
excess, if any, of its basis, $140, over its allocable portion of 
S's net inside attribute amount. S's net inside attribute amount is 
the sum of S's money ($40 from the sale of Asset 1) and S's basis in 
Asset 2, $60, or $100. The share is the only outstanding S share and 
so its allocable portion of the $100 net inside attribute amount is 
the entire $100. Thus, the share's disconformity amount is $40, the 
excess of $140 over $100. The lesser of the net positive adjustment, 
$40, and the share's disconformity amount, $40, is $40. Accordingly, 
immediately before the application of paragraph (d) of this section, 
M's basis in the share is reduced by $40, from $140 to $100.
    (D) Application of paragraph (d) of this section. Because M's 
sale of the S share is not a transfer of a loss share after the 
application of this paragraph (c), paragraph (d) of this section 
does not apply to the transfer.
    (ii) Appreciation recognized as income earned in the consumption 
of built-in gain. The facts are the same as in paragraph (i)(A) of 
this Example 1, except that, instead of selling Asset 1, the value 
of Asset 1 is consumed in the production of $40 of income in year 1 
(reducing the value of Asset 1 to $0). Because the net positive 
adjustment includes items of income as well as items of gain, the 
results are the same as those described in paragraph (i) of this 
Example 1.
    (iii) Post-acquisition appreciation eliminates stock loss. The 
facts are the same as in paragraph (i)(A) of this Example 1 except 
that, in addition, the value of Asset 2 increases to $100 before the 
stock is sold. As a result, M sells the S share for $140. Because 
M's sale of the S share is not a transfer of a loss share, this 
section does not apply to the transfer, notwithstanding that P's 
basis in the S share was increased by the gain recognized on Asset 
1.
    (iv) Distributions. (A) Facts. The facts are the same as in 
paragraph (i)(A) of this Example 1 except that, in addition, S 
declares and makes a $10 dividend distribution before the end of 
year 1. As a result, the value of the share decreases and M sells 
the share for $90. After taking into account the effects of all 
applicable rules of law, M's basis in the S share is $130 (M's 
original $100 basis increased under Sec.  1.1502-32 by $30, the $10 
distribution on the share reduced by the share's allocable portion 
of the $40 gain recognized on the sale of Asset 1). M's sale of the 
S share is a transfer of a loss share and therefore subject to this 
section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section for the reasons 
set forth in paragraph (i)(B) of this Example 1. Therefore, after 
the application of paragraph (b) of this section, the share is still 
a loss share and, as such, subject to this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in the S share, $130, is reduced, but not 
below value, $90, by the lesser of the share's net positive 
adjustment and disconformity amount. The share's net positive 
adjustment is $40 (the sum of all investment adjustments (as defined 
in paragraph (b)(1)(iii) of this section) applied to the basis of 
the share). The share's disconformity amount is the excess of its 
basis, $130, over its allocable portion of S's net inside attribute 
amount. S's net inside attribute amount is $90, the sum of S's money 
($30, the $40 sale proceeds less the $10 distribution) and S's basis 
in Asset 2, $60. The share is the only outstanding S share and so 
its allocable portion of the $90 net inside attribute amount is the 
entire $90. The lesser of the share's net positive adjustment, $40, 
and its disconformity amount, $40, is $40. Accordingly, immediately 
before the application of paragraph (d) of this section, the basis 
in the share is reduced by $40, from $130 to $90.
    (D) Application of paragraph (d) of this section. Because M's 
sale of the S share is not

[[Page 53961]]

a transfer of a loss share after the application of this paragraph 
(c), paragraph (d) of this section does not apply to the transfer.

    Example 2. Loss of appreciation reflected in basis. (i) Facts. 
On January 1, year 1, M purchases the sole outstanding share of S 
stock for $100. At that time, S owns two assets, Asset 1 with a 
basis of $0 and a value of $40, and Asset 2 with a basis and value 
of $60. The value of Asset 1 declines to $0 and M sells its S share 
for $60. After taking into account the effects of all applicable 
rules of law, M's basis in the S share is $100. M's sale of the S 
share is a transfer of a loss share and therefore subject to this 
section.
    (ii) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
this paragraph (c).
    (iii) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's $100 basis in the S share is reduced, but not 
below its $60 value by the lesser of the share's net positive 
adjustment and disconformity amount. There were no investment 
adjustments applied to M's basis in the share and so the share's net 
positive adjustment is $0. Thus, although the share's disconformity 
amount is $40 (the excess of M's $100 basis in the share over the 
share's $60 allocable portion of S's net inside attribute amount), 
no basis reduction is required under this paragraph (c).
    (iv) Application of paragraph (d) of this section. After the 
application of this paragraph (c), M's sale of the S share is still 
a transfer of a loss share, and, accordingly, subject to paragraph 
(d) of this section. No adjustment is required under paragraph (d) 
of this section because there is no aggregate inside loss. See 
paragraph (d)(3)(iii) of this section.

    Example 3. Items accruing after S becomes a member. (i) 
Recognition of loss accruing after S becomes a member. (A) Facts. On 
January 1, year 1, M purchases the sole outstanding share of S stock 
for $100. At that time, S owns two assets, Asset 1, with a basis of 
$0 and a value of $40, and Asset 2, with a basis and value of $60. 
In year 1, S sells Asset 1 for $40, recognizing a $40 gain. Also in 
year 1, the value of Asset 2 declines and S sells Asset 2 for $20, 
recognizing a $40 loss that is absorbed by the group. On December 
31, year 1, M sells its S share for $60. After taking into account 
the effects of all applicable rules of law, M's basis in the S share 
is $100 (M's original $100 basis, unadjusted under Sec.  1.1502-32 
because the $40 gain recognized on the sale of Asset 1 and the $40 
loss on the sale of Asset 2 net, resulting in an adjustment of $0). 
M's sale of the S share is a transfer of a loss share and therefore 
subject to this section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in the S share is reduced, but not below 
the share's $60 value, by the lesser of the share's net positive 
adjustment and disconformity amount. The share's net positive 
adjustment is $0. Thus, although the share has a disconformity 
amount of $40 (the excess of M's basis in the share, $100, over the 
share's allocable portion of S's net inside attribute amount, $60), 
no basis reduction is required under this paragraph (c).
    (D) Application of paragraph (d) of this section. After the 
application of this paragraph (c), M's sale of the S share is still 
a transfer of a loss share, and, accordingly, subject to paragraph 
(d) of this section. No adjustment is required under paragraph (d) 
of this section because there is no aggregate inside loss. See 
paragraph (d)(3)(iii) of this section.
    (ii) Recognition of gain accruing after S becomes a member. (A) 
Facts. The facts are the same as in paragraph (i)(A) of this Example 
3, except that M does not sell the S share and S does not sell 
either asset in year 1. In addition, in year 2, the value of Asset 1 
declines to $0, the value of Asset 2 returns to $60, and S creates 
Asset 3 (with a basis of $0). In year 3, S sells Asset 3 for $40, 
recognizing a $40 gain. On December 31, year 3, M sells its S share 
for $100. After taking into account the effects of all applicable 
rules of law, M's basis in the S share is $140 (M's original $100 
basis increased under Sec.  1.1502-32 by $40 (the share's allocable 
portion of the gain recognized on the sale of Asset 3 in year 3)). 
M's sale of the S share is a transfer of a loss share and therefore 
subject to this section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section for the reasons 
set forth in paragraph (i)(B) of this Example 3. Therefore, after 
the application of paragraph (b) of this section, the share is still 
a loss share and, as such, subject to this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in the S share, $140, is reduced, but not 
below value, $100, by the lesser of the share's net positive 
adjustment and disconformity amount. The share's net positive 
adjustment is $40 (the year 3 investment adjustment). The share's 
disconformity amount is the excess of its basis, $140, over its 
allocable portion of S's net inside attribute amount. S's net inside 
attribute amount is $100, the sum of S's money ($40 from the sale of 
Asset 3) and its basis in its assets ($60 (the sum of Asset 1's 
basis of $0 and Asset 2's basis of $60)). S's $100 net inside 
attribute amount is allocable entirely to the sole outstanding S 
share. Thus, the share's disconformity amount is the excess of $140 
over $100, or $40. The lesser of the share's net positive 
adjustment, $40, and its disconformity amount, $40, is $40. 
Accordingly, the basis in the share is reduced by $40, from $140 to 
$100.
    (D) Application of paragraph (d) of this section. Because M's 
sale of the S share is not a transfer of a loss share after the 
application of this paragraph (c), paragraph (d) of this section 
does not apply to the transfer.
    (iii) Recognition of income earned after S becomes a member. The 
facts are the same as in paragraph (ii)(A) of this Example 3, except 
that instead of creating Asset 3, S earns $40 of income from 
services provided in year 3. Because the net positive adjustment 
includes items of income as well as items of gain, the results are 
the same as those described in paragraph (ii) of this Example 3.

    Example 4. Computing the disconformity amount. (i) Unrecognized 
loss reflected in stock basis. (A) Facts. M owns the sole 
outstanding share of S stock with a basis of $100. S owns two 
assets, Asset 1 with a basis of $20 and a value of $60, and Asset 2 
with a basis of $60 and a value of $40. In year 1, S sells Asset 1 
for $60, recognizing a $40 gain. On December 31, year 1, M sells the 
S share for $100. After taking into account the effects of all 
applicable rules of law, M's basis in the S share is $140 (M's 
original $100 basis increased under Sec.  1.1502-32 by $40, the 
share's allocable portion of the gain recognized on the sale of 
Asset 1). M's sale of the S share is a transfer of a loss share and 
therefore subject to this section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in the S share, $140, is reduced, but not 
below the share's $100 value, by the lesser of the share's net 
positive adjustment and disconformity amount. The share's net 
positive adjustment is $40 (the year 1 investment adjustment). The 
share's disconformity amount is the excess of its basis, $140, over 
its allocable portion of S's net inside attribute amount. S's net 
inside attribute amount is $120, the sum of S's money ($60 from the 
sale of Asset 1) and S's basis in Asset 2, $60. S's net inside 
attribute amount is allocable entirely to the sole outstanding S 
share. Thus, the share's disconformity amount is $20, the excess of 
$140 over $120. The lesser of the share's net positive adjustment, 
$40, and its disconformity amount, $20, is $20. Accordingly, the 
basis in the share is reduced by $20, from $140 to $120.

[[Page 53962]]

    (D) Application of paragraph (d) of this section. After the 
application of this paragraph (c), M's sale of the S share is still 
a transfer of a loss share, and, accordingly, S's attributes (to the 
extent of the $20 duplicated loss) are subject to reduction under 
paragraph (d) of this section.
    (ii) Loss carryover. The facts are the same as in paragraph 
(i)(A) of this Example 4, except that Asset 2 has a basis of $0 
(rather than $60) and S has a $60 loss carryover (as defined in 
paragraph (f)(6) of this section). The analysis is the same as 
paragraph (i) of this Example 4. Furthermore, the analysis of the 
application of this paragraph (c) would be the same if the $60 loss 
carryover were subject to a section 382 limitation from a prior 
ownership change, or if, instead, the $60 loss carryover were 
subject to the limitation in Sec.  1.1502-21(c) on losses carried 
from separate return limitation years.
    (iii) Liabilities. The facts are the same as in paragraph (i)(A) 
of this Example 4, except that S borrows $100 before M sells the S 
share. S's net inside attribute amount remains $120, computed as the 
sum of S's money ($160, $60 from the sale of Asset 1 plus the $100 
borrowed) and S's basis in Asset 2, $60, less its liabilities, $100. 
Thus, the S share's disconformity amount remains the excess of $140 
over $120, or $20. The results are the same as in paragraph (i) of 
this Example 4.

    Example 5. Computing the allocable portion of the net inside 
attribute amount. (i) Facts. On January 1, year 1, M owns all five 
outstanding shares of S stock with a basis of $20 per share. S owns 
Asset with a basis of $0. In year 1, S sells Asset for $100, 
recognizing a $100 gain. On December 31, year 1, M sells one of the 
S shares, Share 1, for $20. After taking into account the effects of 
all applicable rules of law, M's basis in Share 1 is $40 (M's 
original $20 basis increased under Sec.  1.1502-32 by $20 (the 
share's allocable portion of the gain recognized on the sale of 
Asset)). M's sale of Share 1 is a transfer of a loss share and 
therefore subject to this section.
    (ii) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, basis is not redetermined under 
paragraph (b) of this section because there is no disparity among 
M's bases in shares of S common stock and there are no shares of S 
preferred stock outstanding (so there can be no unrecognized gain or 
loss with respect to preferred shares). See paragraph (b)(1)(ii)(A) 
of this section. After the application of paragraph (b) of this 
section, M's sale of Share 1 is still a transfer of a loss share and 
therefore subject to this paragraph (c).
    (iii) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's $40 basis in Share 1 is reduced, but not below 
its $20 value by the lesser of the share's net positive adjustment 
and disconformity amount. Share 1's net positive adjustment is $20 
(the year 1 investment adjustment). Share 1's disconformity amount 
is the excess of its $40 basis over its allocable portion of S's net 
inside attribute amount. S's net inside attribute amount is equal to 
the amount of S's money ($100 from the sale of the asset). Share 1's 
allocable portion of S's $100 net inside attribute amount is $20 (1/
5 x $100). Thus, Share 1's disconformity amount is the excess of $40 
over $20, or $20. The lesser of the share's $20 net positive 
adjustment and its $20 disconformity amount is $20. Accordingly, the 
basis in the share is reduced by $20, from $40 to $20.
    (iv) Application of paragraph (d) of this section. Because M's 
sale of Share 1 is not a transfer of a loss share after the 
application of this paragraph (c), paragraph (d) of this section 
does not apply to the transfer.

    Example 6. Liabilities. (i) In general. (A) Facts. On January 1, 
year 1, M purchases the sole outstanding share of S stock for $100. 
At that time, S owns Asset, with a basis of $0 and value of $100, 
and $100 cash. S also has a $100 liability. In year 1, S declares 
and makes a $60 dividend distribution to M and recognizes $20 of 
income. The value of Asset declines to $60 and, on December 31, year 
1, M sells the S share for $20. After taking into account the 
effects of all applicable rules of law, M's basis in the S share is 
$60 (M's original $100 basis decreased under Sec.  1.1502-32 by $40 
(the net of the $60 distribution and the $20 income recognized)). 
M's sale of the S share is a transfer of a loss share and therefore 
subject to this section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in the S share, $60, is reduced, but not 
below value, $20, by the lesser of the share's net positive 
adjustment and disconformity amount. The share's net positive 
adjustment is $20 (the year 1 investment adjustment, as defined in 
paragraph (b)(1)(iii) of this section). The share's disconformity 
amount is the excess of its basis, $60, over its allocable portion 
of S's net inside attribute amount. S's net inside attribute amount 
is negative $40, computed as the sum of S's money ($60 ($100 less 
the $60 distribution plus the $20 income recognized)) and S's basis 
in Asset, $0, less S's liability, $100. S's net inside attribute 
amount is allocable entirely to the sole outstanding S share. Thus, 
the share's disconformity amount is the excess of $60 over negative 
$40, or $100. The lesser of the share's net positive adjustment, 
$20, and its disconformity amount, $100, is $20. Accordingly, the 
basis in the share is reduced by $20, from $60 to $40.
    (D) Application of paragraph (d) of this section. After the 
application of this paragraph (c), the S share is still a loss share 
and, accordingly, S's attributes are subject to reduction under 
paragraph (d) of this section. No adjustment is required under 
paragraph (d) of this section, however, because there is no 
aggregate inside loss. See paragraph (d)(3)(iii) of this section.
    (ii) Excluded cancellation of indebtedness income--insufficient 
attributes available for reduction under sections 108 and 1017, and 
Sec.  1.1502-28. (A) Facts. The facts are the same as in paragraph 
(i)(A) of this Example 6, except that M does not sell the S share. 
Instead, in year 4, Asset is destroyed in a fire and S spends its 
$60 on deductible expenses that are not absorbed by the group. S's 
loss becomes part of the consolidated net operating loss (CNOL). In 
year 5, S becomes insolvent and S's debt is discharged. Because of 
S's insolvency, S's discharge of indebtedness income is excluded 
under section 108 and, as a result, S's attributes are subject to 
reduction under sections 108 and 1017, and Sec.  1.1502-28. S's only 
attribute is the portion of the CNOL attributable to S, $60, and it 
is reduced to $0. There are no other consolidated attributes. In 
year 5, the S stock (which is treated as a capital asset) becomes 
worthless under section 165, taking into account Sec.  1.1502-80(c). 
After taking into account the effects of all applicable rules of 
law, M's basis in the S share is $60 (M's original $100 basis 
decreased under Sec.  1.1502-32 by the year 1 investment adjustment 
of $40 (the net of the $60 distribution and the $20 income 
recognized). The investment adjustment for year 5 is $0 (the net of 
the $60 tax exempt income from the excluded COD applied to reduce 
attributes and the $60 noncapital, nondeductible expense from the 
reduction of S's portion of the CNOL)). Under paragraph 
(f)(10)(i)(D) of this section, a share is transferred on the last 
day of the taxable year during which it becomes worthless under 
section 165 if the share is treated as a capital asset, or the date 
the share becomes worthless if the share is not treated as a capital 
asset, taking into account Sec.  1.1502-80(c). Accordingly, M 
transfers the loss share of S stock on December 31, year 5, and the 
transfer is therefore subject to this section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section for the reasons 
set forth in paragraph (i)(B) of this Example 6. Therefore, after 
the application of paragraph (b) of this section, the share is still 
a loss share and, as such, subject to this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in its S share, $60, is reduced, but not 
below value, $0, by the lesser of the share's net positive 
adjustment and disconformity amount. The share's net positive 
adjustment is $20 (the year 1 investment adjustment, as defined in 
paragraph (b)(1)(iii) of this section). The share's disconformity 
amount is the excess of its basis, $60, over its allocable portion 
of S's net inside attribute amount. S's net inside attribute amount 
is $0. (The effects of the attribute reduction required under 
sections 108 and 1017 and Sec.  1.1502-28 are taken into account in 
applying this section; therefore, for purposes of this section, S's 
portion of the CNOL is treated as eliminated under section 108 and 
Sec.  1.1502-28.) S's net inside attribute amount is allocable 
entirely to the sole outstanding S share. Thus, the share's 
disconformity amount is the excess of $60 over $0, or $60. The 
lesser of the share's net positive adjustment, $20, and its 
disconformity amount, $60, is $20.

[[Page 53963]]

Accordingly, the basis in the share is reduced by $20, from $60 to 
$40, immediately before the transfer.
    (D) Application of paragraph (d) of this section. After the 
application of this paragraph (c), the S share is still a loss 
share, and, accordingly, S's attributes are subject to reduction 
under paragraph (d) of this section. No adjustment is required under 
paragraph (d) of this section, however, because there is no 
aggregate inside loss. See paragraph (d)(3)(iii) of this section.
    (iii) Excluded cancellation of indebtedness income--full 
attribute reduction under sections 108 and 1017, and Sec.  1.1502-28 
(using attributes attributable to another member). (A) Facts. The 
facts are the same as in paragraph (ii)(A) of this Example 6 except 
that M loses the $60 distributed in year 1 and the group does not 
absorb the loss. Thus, as of December 31, year 5, the CNOL is $120, 
attributable $60 to S and $60 to P. As a result, under Sec.  1.1502-
28(a)(4), after the portion of the CNOL attributable to S is reduced 
to $0, the remaining $40 of excluded COD applies to the portion of 
the CNOL attributable to P, reducing it from $60 to $20. After 
taking into account the effects all applicable rules of law, M's 
basis in the S share at the end of year 5 is $100 (M's original $100 
basis decreased under Sec.  1.1502-32 by $40 at the end of year 1 
and then increased under Sec.  1.1502-32 by $40 at the end of year 5 
(the net of the $100 tax exempt income from the excluded COD applied 
to reduce attributes and the $60 noncapital, nondeductible expense 
from the reduction of S's portion of the CNOL)). Under paragraph 
(f)(10)(i)(D) of this section, a share is transferred on the last 
day of the taxable year during which it becomes worthless under 
section 165 if the share is treated as a capital asset, or the date 
the share becomes worthless if the share is not treated as a capital 
asset, taking into account Sec.  1.1502-80(c). Accordingly, M 
transfers the loss share of S stock on December 31, year 5, and the 
transfer is therefore subject to this section.
    (B) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section for the reasons 
set forth in paragraph (i)(B) of this Example 6. Therefore, after 
the application of paragraph (b) of this section, the share is still 
a loss share and, as such, subject to this paragraph (c).
    (C) Basis reduction under this paragraph (c). Under this 
paragraph (c), M's basis in the S share, $100, is reduced, but not 
below value, $0, by the lesser of the share's net positive 
adjustment and disconformity amount. The share's net positive 
adjustment is $60 (the sum of the year 1 investment adjustment, as 
defined in paragraph (b)(1)(iii) of this section, $20, and the year 
5 investment adjustment, $40). The share's disconformity amount is 
the excess of its basis, $100, over its allocable portion of S's net 
inside attribute amount. S's net inside attribute amount is $0 
(taking into account the effects of the attribute reduction required 
under sections 108 and 1017 and Sec.  1.1502-28). S's net inside 
attribute amount is allocable entirely to the sole outstanding S 
share. The share's disconformity amount is therefore $100. The 
lesser of the share's net positive adjustment, $60, and its 
disconformity amount, $100, is $60. Accordingly, M's basis in the 
share is reduced by $60, from $100 to $40, immediately before the 
transfer.
    (D) Application of paragraph (d) of this section. After the 
application of this paragraph (c), the S share is still a loss 
share, and, accordingly, S's attributes are subject to reduction 
under paragraph (d) of this section. No adjustment is required under 
paragraph (d) of this section, however, because there is no 
aggregate inside loss. See paragraph (d)(3)(iii) of this section.

    Example 7. Lower-tier subsidiary (no transfer of lower-tier 
stock). (i) Facts. M owns the sole outstanding share of S stock with 
a basis of $160. S owns two assets, Asset 1 with a basis and value 
of $100, and the sole outstanding share of S1 stock with a basis of 
$60. S1 owns one asset, Asset 2, with a basis of $20 and value of 
$60. In year 1, S1 sells Asset 2 to X for $60, recognizing a $40 
gain. On December 31, year 1, M sells its S share to Y, a member of 
another consolidated group, for $160. After taking into account the 
effects of all applicable rules of law, M's basis in the S share is 
$200 (M's original $160 basis increased under Sec.  1.1502-32 by $40 
(to reflect the tier-up of the adjustment to S's basis in the S1 
stock for the gain recognized on S1's sale of Asset 2)). M's sale of 
the S share is a transfer of a loss share and therefore subject to 
this section. (S does not transfer the S1 share because S and S1 are 
members of the same group following the transfer. See paragraph 
(f)(10) of this section.)
    (ii) Application of paragraph (b) of this section. Although the 
transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
this paragraph (c).
    (iii) Basis reduction under this paragraph (c). (A) In general. 
Under this paragraph (c), M's basis in the S share, $200, is 
reduced, but not below value, $160, by the lesser of the share's net 
positive adjustment and disconformity amount. The S share's net 
positive adjustment is $40. The share's disconformity amount is the 
excess of its basis, $200, over the share's allocable portion of S's 
net inside attribute amount. S's net inside attribute amount is the 
sum of S's basis in Asset 1, $100, and S's basis in the S1 share.
    (B) S's basis in the S1 share. Although S's actual basis in the 
S1 share is $100 (S's original $60 basis increased under Sec.  
1.1502-32 by $40 (the share's allocable portion of the gain 
recognized on the sale of Asset 2)), for purposes of computing the S 
share's disconformity amount, S's net inside attribute amount is 
determined by treating S's basis in the S1 share as tentatively 
reduced by the lesser of the S1 share's net positive adjustment and 
the S1 share's disconformity amount. The S1 share's net positive 
adjustment is $40 (the year 1 investment adjustment). The S1 share's 
disconformity amount is the excess of its basis, $100, over the 
share's allocable portion of S1's net inside attribute amount. S1's 
net inside attribute amount is equal to the amount of S1's money 
($60 from the sale of Asset 2), and is allocable entirely to the 
sole outstanding S1 share. Thus, the S1 share's disconformity amount 
is the excess of $100 over $60, or $40. The lesser of the S1 share's 
net positive adjustment, $40, and its disconformity amount, $40, is 
$40. Accordingly, for purposes of computing the disconformity amount 
of the S share, S's net inside attribute amount is determined by 
treating S's basis in its S1 share as tentatively reduced by $40, 
from $100 to $60.
    (C) The disconformity amount of M's S share. S's net inside 
attribute amount is treated as the sum of its basis in Asset 1, 
$100, and its tentatively reduced basis in the S1 share, $60, or 
$160. S's net inside attribute amount is allocable entirely to the 
sole outstanding S share. Thus, the S share's disconformity amount 
is the excess of $200 over $160, or $40.
    (D) Amount of reduction. M's basis in its S share is reduced by 
the lesser of the S share's net positive adjustment, $40, and 
disconformity amount, $40, or $40. Accordingly, M's basis in the S 
share is reduced by $40, from $200 to $160.
    (E) Effect on S's basis in its S1 share. The tentative reduction 
under this paragraph (c) has no effect on S's actual basis in the S1 
share. Thus, after the application of this paragraph (c), S owns the 
S1 share with a basis of $100 (S's original $60 basis increased 
under Sec.  1.1502-32 by $40 (the share's allocable portion of the 
gain recognized on the sale of Asset 2)).
    (iv) Application of paragraph (d) of this section. Because M's 
sale of the S share is not a transfer of a loss share after the 
application of this paragraph (c), paragraph (d) of this section 
does not apply to the transfer.

    (d) Attribute reduction to prevent duplication of loss--(1) In 
general. The rules of this paragraph (d) reduce attributes of S and its 
lower-tier subsidiaries to the extent they duplicate a net loss on 
shares of S stock transferred by members in one transaction. This rule 
furthers single-entity principles by preventing S (or its lower-tier 
subsidiaries) from using deductions and losses to the extent that the 
group or its members (including former members) have either used, or 
preserved for later use, a corresponding loss in S shares.
    (2) Attribute reduction rule--(i) General rule. If a transferred 
share is a loss share after taking into account the effects of all 
applicable rules of law, including any adjustments under paragraph (b), 
(c), or (d)(5)(iii) of this section, S's attributes are reduced by S's 
attribute reduction amount immediately before the transfer. S's 
attribute reduction amount is determined under paragraph (d)(3) of this 
section and

[[Page 53964]]

applied in accordance with the provisions of paragraphs (d)(4), (d)(5), 
and (d)(6) of this section. In addition, paragraph (d)(7) of this 
section provides for additional attribute reduction in the case of 
certain transfers due to worthlessness and certain transfers not 
followed by a separate return year.
    (ii) Attribute reduction amount less than five percent of value. 
This paragraph (d) generally does not apply to a transaction if the 
aggregate attribute reduction amount in the transaction is less than 
five percent of the aggregate value of the shares transferred by 
members in the transaction. However, in such a case, P may elect to 
apply this paragraph (d) to the transaction. If such an election is 
made, this paragraph (d) will apply with respect to the entire 
aggregate attribute reduction amount determined in the transaction. 
Such an election is made in the manner provided in paragraph (e)(5) of 
this section.
    (3) Attribute reduction amount--(i) In general. S's attribute 
reduction amount is the lesser of--
    (A) The net stock loss (as defined in paragraph (d)(3)(ii) of this 
section); and
    (B) S's aggregate inside loss (as defined paragraph (d)(3)(iii) of 
this section).
    (ii) Net stock loss. The net stock loss is the excess, if any, of--
    (A) The aggregate basis of all shares of S stock transferred by 
members in the transaction; over
    (B) The aggregate value of those shares.
    (iii) Aggregate inside loss--(A) In general. S's aggregate inside 
loss is the excess, if any, of--
    (1) S's net inside attribute amount; over
    (2) The value of all outstanding shares of S stock.
    (B) Net inside attribute amount. S's net inside attribute amount 
generally has the same meaning as in paragraph (c)(5) of this section. 
However, if S holds stock of a lower-tier subsidiary, the provisions of 
paragraph (d)(5) of this section (and not the provisions of paragraph 
(c)(6) of this section) modify the computation of S's net inside 
attribute amount for purposes of this paragraph (d).
    (iv) Lower-tier subsidiaries. See paragraph (d)(5) of this section 
for special rules relating to the application of this paragraph (d) if 
S owns shares of stock of a subsidiary.
    (4) Application of attribute reduction amount--(i) Attributes 
available for reduction. S's attributes available for reduction under 
this paragraph (d) are--
    (A) Category A. Capital loss carryovers;
    (B) Category B. Net operating loss carryovers;
    (C) Category C. Deferred deductions; and
    (D) Category D. Basis of assets other than assets identified as 
Class I assets in Sec.  1.338-6(b)(1).
    (ii) Rules of application--(A) Category A, Category B, and Category 
C attributes. S's attribute reduction amount is first allocated and 
applied to reduce the attributes in Category A, Category B, and 
Category C.
    (1) Attribute reduction amount less than total attributes in 
Category A, Category B, and Category C. If S's attribute reduction 
amount is less than S's total attributes in Category A, Category B, and 
Category C, all of S's attribute reduction amount will be applied to 
reduce such attributes. However, P may specify the allocation of S's 
attribute reduction amount among such attributes. An election to 
specify the allocation of S's attribute reduction amount is made in the 
manner provided in paragraph (e)(5) of this section. To the extent that 
P does not specify an allocation of S's attribute reduction amount, S's 
attribute reduction amount will be applied to reduce any Category A 
attributes not reduced as a result of the specific allocation of S's 
attribute reduction amount, from oldest to newest, until they are 
eliminated. Then, any remaining attribute reduction amount will be 
applied to reduce any Category B attributes not reduced as a result of 
the specific allocation of S's attribute reduction amount, from oldest 
to newest, until they are eliminated. Finally, any remaining attribute 
reduction amount will be applied to reduce any Category C attributes 
not reduced as a result of the specific allocation of S's attribute 
reduction amount, proportionately.
    (2) Attribute reduction amount not less than the total attributes 
in Category A, Category B, and Category C. If S's attribute reduction 
amount equals or exceeds S's total attributes in Category A, Category 
B, and Category C, all such attributes are eliminated and any remaining 
attribute reduction amount is allocated and applied as provided in 
paragraphs (d)(4)(ii)(B) and (d)(4)(ii)(C) of this section.
    (B) Category D attributes. Any attribute reduction amount not 
applied to reduce S's Category A, Category B, and Category C attributes 
is allocated and applied as provided in this paragraph (d)(4)(ii)(B) 
and, to the extent applicable, paragraph (d)(5) of this section.
    (1) Allocation if S holds stock of another subsidiary. If S holds 
shares of stock of another subsidiary, the attribute reduction amount 
not applied to reduce S's Category A, Category B, and Category C 
attributes is first allocated between S's shares of lower-tier 
subsidiary stock and S's other Category D assets in the manner provided 
in paragraph (d)(5)(ii) of this section. S's attribute reduction amount 
allocated to shares of lower-tier subsidiary stock is applied to reduce 
S's bases in those shares, becomes an attribute reduction amount of the 
lower-tier subsidiary, and, subject to certain limitations, reduces the 
lower-tier subsidiary's attributes. See paragraphs (d)(5)(iii) through 
(d)(5)(vi) of this section.
    (2) Allocation and application of attribute reduction amount not 
applied to lower-tier subsidiary stock. Any portion of S's attribute 
reduction amount not applied to reduce S's Category A, Category B, and 
Category C attributes and not allocated to lower-tier subsidiary stock 
is allocated to S's Category D assets other than lower-tier subsidiary 
stock in the manner provided in this paragraph (d)(4)(ii)(B)(2). Such 
amount is first allocated to S's bases (if any) in its assets 
identified as Class VII assets in Sec.  1.338-6(b)(2)(vii). If the 
attribute reduction amount allocated to Class VII assets is less than 
S's aggregate basis in those assets, it is applied proportionately (by 
basis) to reduce the bases of such assets. If the attribute reduction 
amount allocated to Class VII assets equals or exceeds S's aggregate 
basis in those assets, it is applied to reduce the bases of such assets 
to zero. Any remaining attribute reduction amount is then allocated and 
applied in the same manner to reduce S's bases (if any) in assets 
identified as Class VI assets in Sec.  1.338-6(b)(2)(vi), and then to 
reduce S's bases (if any) in its assets identified in Sec.  1.338-
6(b)(2) as Class V, Class IV, Class III, and Class II, successively.
    (C) Attribute reduction amount exceeding attributes available for 
reduction. If the amount to be allocated and applied to attributes in 
Category D other than lower-tier subsidiary stock exceeds the amount of 
attributes in that category, then--
    (1) To the extent of any liabilities of S that are not taken into 
account for tax purposes before the transfer, such excess amount is 
suspended. The suspended amount is applied proportionately to reduce 
any amounts attributable to S that would be deductible or capitalizable 
as a result of such liabilities being taken into account by S or any 
other person. Solely for purposes of this paragraph (d)(4)(ii)(C)(1) 
and paragraph (d)(5)(ii)(B) of this section, the term liability means 
any liability or

[[Page 53965]]

obligation the satisfaction of which would be required to be 
capitalized as an assumed liability by a person that purchased all of 
S's assets and assumed all of S's liabilities in a single transaction.
    (2) To the extent such excess amount is greater than any amount 
suspended under paragraph (d)(4)(ii)(C)(1) of this section, it is 
disregarded and has no further effect.
    (iii) Time and effect of attribute reduction. In general, the 
reduction of attributes is effective immediately before the transfer of 
a loss share of S stock. If the reduction to a member's basis in a 
share of lower-tier subsidiary stock exceeds the basis of that share, 
to the extent the excess is not restored under paragraph (d)(5)(vi) of 
this section it is an excess loss account in that share (and such 
excess loss account is not taken into account under Sec.  1.1502-19 or 
otherwise as a result of the transaction). The reductions to attributes 
required under this paragraph (d)(4), including by reason of paragraph 
(d)(5)(v) of this section (tier down of attribute reduction amounts to 
lower-tier subsidiaries), are not noncapital, nondeductible expenses 
described in Sec.  1.1502-32(b)(2)(iii).
    (5) Special rules applicable if S holds stock of another 
subsidiary. If S holds shares of stock of any other subsidiary (S1) as 
of a transfer of loss shares of S stock, the rules of this paragraph 
(d)(5) apply with respect to each such subsidiary.
    (i) Treatment of lower-tier subsidiary stock for computation of S's 
attribute reduction amount. For purposes of determining S's net inside 
attribute amount and attribute reduction amount under paragraph (d)(3) 
of this section--
    (A) Single share. All of S's shares of S1 stock held as of the 
transfer of S stock (whether or not transferred in, or held by S 
immediately after, the transaction) are treated as a single share of 
stock (generally referred to as the S1 stock); and
    (B) Deemed basis. S's basis in its S1 stock is treated as its 
deemed basis in the stock, which is equal to the greater of--
    (1) The sum of S's basis in each share of S1 stock (adjusted to 
reflect any gain or loss recognized on the transfer of any S1 shares in 
the transaction, whether allowed or disallowed); and
    (2) The portion of S1's net inside attribute amount allocable to 
S's shares of S1 stock.
    (C) Multiple tiers. For purposes of computing deemed basis under 
paragraph (d)(5)(i)(B) of this section, a subsidiary's basis in stock 
of a lower-tier subsidiary is the deemed basis in that lower-tier 
subsidiary stock. Thus, if stock is held in multiple tiers, the 
computation of deemed basis begins at the lowest tier, so that the 
computation of deemed basis at each tier takes into account the deemed 
basis of all lower-tier shares.
    (ii) Allocation of S's attribute reduction amount between lower-
tier subsidiary stock and other Category D assets. The portion of S's 
attribute reduction amount that is not applied to reduce S's Category 
A, Category B, and Category C attributes must be allocated between each 
of S's deemed single shares of S1 stock and all of S's other Category D 
assets. For this purpose, S's Category D assets other than lower-tier 
subsidiary stock are treated as one asset with a basis equal to the 
aggregate bases of all Category D assets other than lower-tier 
subsidiary stock (non-stock Category D asset). S's attribute reduction 
amount is allocated proportionately (by basis) between (among) the non-
stock Category D asset and S's deemed single share(s) of S1 stock. (See 
paragraphs (d)(4)(ii)(B)(2) and (d)(4)(ii)(C) of this section regarding 
the portion of S's attribute reduction amount allocated to the Category 
D assets other than lower-tier subsidiary stock.) For this purpose, S's 
basis in each deemed single share of S1 stock is its deemed basis 
(determined under paragraphs (d)(5)(i)(B) and (d)(5)(i)(C) of this 
section), reduced by--
    (A) The value of S's transferred shares of S1 stock; and
    (B) The nontransferred S1 shares' allocable portion of the excess 
of S1's non-loss assets over S1's liabilities (including liabilities 
described in paragraph (d)(4)(ii)(C)(1) of this section). For this 
purpose, S1's non-loss assets are--
    (1) S1's assets identified as Class I assets in Sec.  1.338-
6(b)(1),
    (2) The value of S1's transferred shares of lower-tier subsidiary 
stock, and
    (3) The nontransferred lower-tier subsidiary shares' allocable 
portions of lower-tier non-loss assets (net of liabilities, including 
liabilities described in paragraph (d)(4)(ii)(C)(1) of this section) of 
all lower-tier subsidiaries.
    (iii) Application of attribute reduction amount to S's S1 stock. 
The portion of S's attribute reduction amount allocated under paragraph 
(d)(5)(ii) of this section to each deemed single share of S1 stock 
(allocated attribute reduction amount) is apportioned among, and 
applied to reduce S's bases in, individual S1 shares in accordance with 
the following--
    (A) No portion of the allocated attribute reduction amount is 
apportioned to an individual share of transferred S1 stock if gain or 
loss is recognized on its transfer (recognition transfer);
    (B) The allocated attribute reduction amount is apportioned among 
all of S's other shares of S1 stock in a manner that, first reduces the 
loss in and disparity among S's bases in loss shares of S1 preferred 
stock to the greatest extent possible, and then reduces the disparity 
among S's bases in the shares of S1 common stock (other than those 
transferred in a recognition transfer) to the greatest extent possible;
    (C) The allocated attribute reduction amount apportioned to an 
individual S1 share is applied to reduce the basis of that share to, 
but not below, value if the share is either a preferred share or a 
common share that is transferred other than in a recognition transfer; 
and
    (D) The allocated attribute reduction amount apportioned to an 
individual S1 share is applied to reduce the basis of that share 
without regard to value if the share is a common share that is not 
transferred in the transaction.
    (iv) Unapplied allocated attribute reduction amount. Any portion of 
the allocated attribute reduction amount that is not applied to reduce 
S's basis in a share of S1 stock has no effect on any other attributes 
of S, it is not a noncapital, nondeductible expense of S, and it does 
not cause S to recognize income or gain. However, such amounts continue 
to be part of the allocated attribute reduction amount for purposes of 
the tier down rule in paragraph (d)(5)(v) of this section.
    (v) Tier down of attribute reduction amount--(A) General rule. The 
allocated attribute reduction amount of each deemed single share of S1 
stock is an attribute reduction amount of S1 (tier-down attribute 
reduction amount). Accordingly, the tier-down attribute reduction 
amount, in combination with any attribute reduction amount computed 
with respect to the transferred S1 shares (if any) (direct S1 attribute 
reduction amount), applies to reduce S1's attributes under the 
provisions of this paragraph (d). The tier-down attribute reduction 
amount is an attribute reduction amount of S1 that must be allocated to 
S1's assets, and may become an allocated attribute reduction amount of 
lower-tier subsidiary stock (and thus a tier-down attribute reduction 
amount of a lower-tier subsidiary), even if its application to S1's 
attributes is limited under paragraph (d)(5)(v)(B) of this section.
    (B) Conforming limitation on reduction of lower-tier subsidiary's 
attributes. Notwithstanding the general rule in paragraph (d)(5)(v)(A) 
of this section, and unless P elects otherwise in the manner provided 
in paragraph (e)(5)

[[Page 53966]]

of this section, the application of S1's tier-down attribute reduction 
amount to S1's attributes is limited to an amount equal to the excess 
of the portion of S1's net inside attribute amount that is allocable to 
all S1 shares held by members as of the transaction (whether or not 
transferred in the transaction) over the sum of--
    (1) Any direct S1 attribute reduction amount;
    (2) The aggregate value of all S1 shares transferred by members in 
the transaction with respect to which gain or loss was recognized 
(recognition transfer);
    (3) The sum of all members' bases (after any reduction under this 
section, including this paragraph (d)) in any shares of S1 stock 
transferred by members in the transaction (other than in a recognition 
transfer), reduced by any direct S1 attribute reduction amount computed 
with respect to the transfer of such S1 shares; and
    (4) The sum of all members' bases (after any reduction under this 
section, including this paragraph (d)) in any nontransferred shares of 
S1 stock held as of the transaction.
    (vi) Stock basis restoration--(A) In general. After paragraph 
(d)(5)(v) of this section has applied with respect to all shares of 
subsidiary stock transferred in the transaction, lower-tier subsidiary 
stock basis is restored under this paragraph (d)(5)(vi). Under this 
paragraph (d)(5)(vi), the reductions to members' bases in shares of 
lower-tier subsidiary stock under paragraph (d)(5)(iii) of this section 
are reversed to the extent necessary to restore such bases to an amount 
that conforms the basis of each such share to its allocable portion of 
the subsidiary's net inside attribute amount, taking into account any 
reductions under this paragraph (d). Restoration adjustments are first 
made at the lowest tier and then at each next higher tier successively. 
Restoration adjustments do not tier up to affect the bases of higher-
tier shares. Rather, restoration is computed and applied separately at 
each tier. For purposes of this rule, when computing a subsidiary's net 
inside attribute amount--
    (1) The subsidiary's basis in stock of a lower-tier subsidiary is 
the actual basis of the stock after application of this paragraph (d); 
and
    (2) Any attribute reduction amount allocated to the subsidiary's 
Category D assets other than lower-tier subsidiary stock that is 
suspended under paragraph (d)(4)(ii)(C)(1) of this section is treated 
as reducing the subsidiary's net inside attribute amount.
    (B) Election not to restore basis. Notwithstanding paragraph 
(d)(5)(vi)(A) of this section, P may elect not to restore basis in 
stock of a lower-tier subsidiary that was reduced under paragraph 
(d)(5)(iii) of this section. An election not to restore lower-tier 
subsidiary stock basis is made in the manner provided in paragraph 
(e)(5) of this section.
    (6) Elections to reduce the potential for loss duplication--(i) In 
general. Notwithstanding the general operation of this paragraph (d), P 
may elect to reduce the potential for loss duplication, and thereby 
reduce or avoid attribute reduction. To the extent of S's attribute 
reduction amount tentatively computed without regard to any election 
under this paragraph (d)(6), P may elect--
    (A) To reduce all or any portion (including any portion in excess 
of a specified amount) of members' bases in transferred loss shares of 
S stock;
    (B) To reattribute all or any portion (including any portion in 
excess of a specified amount) of S's Category A, Category B, and 
Category C attributes (including such attributes of lower-tier 
subsidiaries), to the extent they would otherwise be subject to 
reduction under this paragraph (d); or
    (C) Any combination thereof.
    (ii) Manner and effect of election. An election to reduce loss 
duplication under this paragraph (d)(6) is made in the manner provided 
in paragraph (e)(5) of this section. Although such elections are 
irrevocable, they have no effect--
    (A) If there is no attribute reduction amount; or
    (B) To the extent S's attribute reduction amount is less than the 
amount specified in the election.
    (iii) Order of application--(A) Stock of one subsidiary transferred 
in the transaction. If shares of stock of only one subsidiary are 
transferred in the transaction, any stock basis reduction and 
reattribution of attributes (including from lower-tier subsidiaries) is 
deemed to occur immediately before the application of this paragraph 
(d). If a transferred share is still a loss share after giving effect 
to this election, the other provisions of this paragraph (d) then apply 
with respect to that share.
    (B) Stock of multiple subsidiaries transferred in the transaction. 
If shares of stock of more than one subsidiary are transferred in the 
transaction and elections under this paragraph (d)(6) are made with 
respect to transfers of stock of subsidiaries in multiple tiers, effect 
is given to the elections from the lowest tier to the highest tier in 
the manner provided in this paragraph (d)(6)(iii)(B). The amount of the 
election for the transfer at the lowest tier is determined by applying 
this paragraph (d) with respect to the transferred loss shares of this 
lowest-tier subsidiary immediately after applying paragraphs (b) and 
(c) of this section to the stock of such subsidiary. The effect of any 
stock basis reduction or reattribution of losses immediately tiers up 
under Sec.  1.1502-32 to adjust members' bases in higher-tier shares. 
Elections and adjustments are then made with respect to transfers at 
each next higher tier successively.
    (iv) Special rules for reattribution elections--(A) In general. 
Because the reattribution election is intended to provide the group a 
means to retain certain S attributes, and not to change the location of 
attributes where S continues to be a member of the same group as P, the 
election to reattribute attributes may only be made if S becomes a 
nonmember (within the meaning of Sec.  1.1502-19(c)(2)) as a result of 
the transaction and S does not become a member of any group that 
includes P. The election to reattribute S's attributes can only be made 
for attributes in Category A, Category B, and Category C. The 
attributes that would otherwise be reduced under paragraph (d)(4) of 
this section may be reattributed to P. Accordingly, P may specify the 
attributes in Category A, Category B, and Category C to be 
reattributed. Such an election is made in the manner provided in 
paragraph (e)(5) of this section. To the extent that P elects to 
reattribute attributes but does not specify the attributes to be 
reattributed, any attributes not specifically reattributed will be 
reattributed in the default amount, order, and category described in 
paragraph (d)(4)(ii)(A)(1) of this section. P succeeds to reattributed 
attributes as if such attributes were succeeded to in a transaction to 
which section 381(a) applies. Any owner shift of the subsidiary 
(including any deemed owner shift resulting from section 382(g)(4)(D) 
or section 382(l)(3)) in connection with the transaction is not taken 
into account under section 382 with respect to the reattributed 
attributes. (See Sec.  1.1502-96(d) for rules relating to section 382 
and the reattribution of losses under this paragraph (d)(6).) The 
reattribution of S's attributes is a noncapital, nondeductible expense 
described in Sec.  1.1502-32(b)(2)(iii). See Sec.  1.1502-
32(c)(1)(ii)(A) regarding special allocations applicable to such 
noncapital, nondeductible expense. If P elects to reattribute S 
attributes (including attributes of a lower-tier subsidiary) and reduce 
S stock basis, the reattribution is given effect before the stock basis 
reduction.

[[Page 53967]]

    (B) Insolvency limitation. If S, or any higher-tier subsidiary, is 
insolvent within the meaning of section 108(d)(3) at the time of the 
transfer, S's losses may be reattributed only to the extent they exceed 
the sum of the separate insolvencies of any subsidiaries (taking into 
account only S and its higher-tier subsidiaries) that are insolvent. 
For purposes of determining insolvency, liabilities owed to higher-tier 
members are not taken into account, and stock of a subsidiary that is 
limited and preferred as to dividends and that is not owned by higher-
tier members is treated as a liability to the extent of the amount of 
preferred distributions to which the stock would be entitled if the 
subsidiary were liquidated on the date of the transfer.
    (C) Limitation on reattribution from lower-tier subsidiaries. P's 
ability to reattribute attributes of lower-tier subsidiaries is limited 
under this paragraph (d)(6)(iv)(C) in order to prevent circular 
computations of the attribute reduction amount. Accordingly, attributes 
that would otherwise be reduced as a result of tier-down attribute 
reduction under paragraph (d)(5)(v) of this section may only be 
reattributed to the extent that the reduction in the basis of any 
lower-tier subsidiary stock resulting from the noncapital, 
nondeductible expense (as allocated under Sec.  1.1502-
32(c)(1)(ii)(A)(2)) will not create an excess loss account in any such 
stock.
    (v) Special rules for stock basis reduction elections--(A) In 
general. An election to reduce basis in S stock is made with respect to 
all members' bases in loss shares of S stock that are transferred in 
the transaction. The reduction is allocated among all such shares in 
proportion to the amount of loss on each share. This reduction in S 
stock basis is a noncapital, nondeductible expense described in Sec.  
1.1502-32(b)(2)(iii) of the transferring member.
    (B) Adjustment to the attribute reduction amount. The attribute 
reduction amount (determined under paragraph (d)(3)(i) of this section) 
is treated as reduced by the amount of any elective reduction in the 
basis of the S stock under this paragraph (d)(6). Accordingly, the 
election to reduce stock basis under this paragraph (d)(6) is treated 
as reducing or eliminating the duplication even if the shares of S 
stock are loss shares after giving effect to the election.
    (C) Deemed stock basis reduction election in the case of certain 
disallowed stock losses. If there is a net stock loss in transferred 
shares after taking into account any actual elections under this 
paragraph (d)(6), and the stock loss would otherwise be permanently 
disallowed (for example, under section 311(a)), P will be deemed to 
have made a stock basis reduction election equal to such net stock 
loss.
    (7) Additional attribute reduction in the case of certain transfers 
due to worthlessness and certain transfers not followed by a separate 
return year--(i) In general. Notwithstanding any other provision of 
this paragraph (d), if a transfer is subject to this paragraph (d)(7) 
any of S's Category A, Category B, and Category C attributes not 
otherwise reduced or reattributed under this paragraph (d), and any 
credit carryover attributable to S, including any consolidated credits 
that would be apportioned to S under the principles of Sec.  1.1502-79 
if S had a separate return year, are eliminated. Attributes other than 
consolidated tax attributes are eliminated under this paragraph 
(d)(7)(i) immediately before the transfer subject to this paragraph 
(d)(7)(i). The elimination of attributes under this paragraph (d)(7)(i) 
is not a noncapital, nondeductible expense described in Sec.  1.1502-
32(b)(2)(iii).
    (ii) Transfers subject to this paragraph (d)(7). A transfer is 
subject to this paragraph (d)(7) if--
    (A) M transfers a share of S stock solely by reason of a transfer 
defined in paragraph (f)(10)(i)(D) of this section (worthlessness where 
the provisions of Sec.  1.1502-80(c) are satisfied), M recognizes a net 
deduction or loss on the share, and S is a member of the group on the 
day following the last day of the group's taxable year during which the 
share becomes worthless under section 165 (taking into account the 
provisions of Sec.  1.1502-80(c)), or
    (B) M recognizes a net deduction or loss on the stock of S in a 
transaction in which S ceases to be a member and does not become a 
nonmember within the meaning of Sec.  1.1502-19(c)(2).
    (iii) Example. The application of this paragraph (d) to transfers 
due to worthlessness and to loss transfers not followed by separate 
return years is illustrated by the following example.

    Example. (i) Worthlessness where S continues as a member. M owns 
the sole share of S stock. The share is worthless under section 165. 
In addition, S has disposed of all its assets within the meaning of 
Sec.  1.1502-19(c)(1)(iii)(A) and therefore satisfies the provisions 
of Sec.  1.1502-80(c). M claims a worthless securities deduction 
with respect to the share. The worthlessness is a transfer of the S 
share, a loss share, and therefore subject to this section. After 
the application of paragraphs (b) and (c) of this section, M's basis 
in the share (and therefore M's net stock loss) is $75. The portion 
of the consolidated net operating loss attributable to S is $100. 
Under the general rules of this paragraph (d), S's attribute 
reduction amount is $75 (the lesser of M's $75 net stock loss and 
S's $100 aggregate inside loss ($100 net inside attribute amount 
over $0 value of S share)). S's attributes are reduced by $75, from 
$100 to $25. In addition, if S remains a member of the P group, this 
paragraph (d)(7) applies to eliminate the remaining $25 of the 
consolidated net operating loss attributable to S because the S 
share is worthless, and M recognizes a deduction (taking into 
account Sec.  1.1502-80(c)) with respect to the share. Accordingly, 
after the application of this section, M recognizes a $75 worthless 
securities deduction, S has $0 net inside attributes, and the 
consolidated net operating loss is reduced by a total of $100.
    (ii) Dissolution of insolvent subsidiary. The facts are the same 
as in paragraph (i) of this Example, except that S is insolvent, 
does not dispose of all its assets within the meaning of Sec.  
1.1502-19(c)(1)(iii)(A), M causes S to be legally dissolved, and the 
S share held by M is cancelled without consideration. Under 
paragraph (d)(7)(ii)(B) of this section, the dissolution of S is 
subject to this paragraph (d)(7) and the result is the same as in 
paragraph (i) of this Example. The result would also be the same if 
instead of being legally dissolved, S was converted into an entity 
that is disregarded as separate from M.
    (iii) Stock cancelled in connection with a section 381(a) 
transaction with another member. M owns the sole share of S common 
stock with a basis of $75. M1 owns the sole share of S preferred 
stock. The value of S's assets (net of liabilities) is less than the 
liquidation preference on the S preferred stock. In a reorganization 
described in section 368(a)(1)(D), S transfers all of its assets to 
M2 in exchange for M2 common stock and M2's assumption of S's 
liabilities, S distributes all of the M2 common stock received in 
the exchange to M1 in exchange for M1's S preferred stock, the S 
common stock held by M is cancelled without consideration, and S 
ceases to exist. Notwithstanding that M is not entitled to treat its 
common share of S stock as worthless until Sec.  1.1502-80(c) is 
satisfied, M's share is transferred within the meaning of paragraph 
(f)(10)(i)(A) of this section because M ceases to own the share in a 
transaction in which, but for this section (and notwithstanding the 
deferral of any amount recognized on the transfer, other than by 
reason of Sec.  1.1502-13), M would recognize a loss or deduction 
with respect to the share. Accordingly, there is a transfer of the S 
common share and this section applies to the transfer. There are no 
adjustments under paragraphs (b) or (c) of this section because no 
investment adjustments have been applied to the bases of the shares. 
The transfer of the S common stock is subject to the general rules 
of this paragraph (d), but is not subject to the additional 
attribute reduction under this paragraph (d)(7) because the transfer 
was not solely by reason of worthlessness where Sec.  1.1502-80(c) 
is satisfied, and S did not cease to be a member because M2 is a 
successor to S.
    (iv) Stock cancelled in connection with a section 381(a) 
transaction with a nonmember. The facts are the same as in

[[Page 53968]]

paragraph (iii) of this Example, except that the S preferred share 
is held by X, instead of M2 acquiring S's assets, S merges into Y in 
a reorganization described in section 368(a)(1)(A), M1 receives all 
of the Y stock issued in the merger in exchange for M1's S preferred 
stock, and Y does not become a member as a result of the 
transaction. M treats the cancelled S common stock as worthless, and 
Sec.  1.1502-80(c) is satisfied because S ceases to be a member. In 
this case, there is a transfer of M's S common share because it 
becomes worthless (taking into account Sec.  1.1502-80(c)); because 
M ceases to own the share in a transaction in which, but for this 
section (and notwithstanding the deferral of any amount recognized 
on the transfer, other than by reason of Sec.  1.1502-13), M would 
recognize a loss or deduction with respect to the share; and because 
M and S cease to be members of the same group. The transfer of the S 
common stock is subject to the general rules of this paragraph (d), 
but is not subject to the additional attribute reduction under this 
paragraph (d)(7) because the transfer was not solely by reason of 
worthlessness where Sec.  1.1502-80(c) is satisfied and, although S 
did cease to be a member, S became a nonmember within the meaning of 
Sec.  1.1502-19(c)(2) because Y is a successor to S.

    (8) Examples. The application of this paragraph (d) is illustrated 
by the following examples:

    Example 1. Computation of attribute reduction amount. (i) 
Transfer of all S shares. (A) Facts. M owns all 100 of the 
outstanding shares of S stock with a basis of $2 per share. S owns 
land with a basis of $100, has a $120 loss carryover, and has no 
liabilities. Each share has a value of $1. M sells 30 of the S 
shares to X for $30. As a result of the sale, M and S cease to be 
members of the same group. Accordingly, all 100 of the S shares are 
transferred. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and 
(f)(10)(i)(C) (with respect to the 30 S shares sold to X) of this 
section. M's transfer of the S shares is a transfer of loss shares 
and therefore subject to this section.
    (B) Application of paragraphs (b) and (c) of this section. 
Although the transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
no disparity among M's bases in shares of S common stock and there 
are no shares of S preferred stock outstanding (so there can be no 
unrecognized gain or loss on preferred stock). See paragraph 
(b)(1)(ii)(A) of this section. Therefore, after the application of 
paragraph (b) of this section, the share is still a loss share and, 
as such, subject to paragraph (c) of this section. No adjustment is 
required under paragraph (c) of this section because the net 
positive adjustment is $0. See paragraph (c)(3) of this section. 
Thus, after the application of paragraph (c) of this section, M's 
transfer of the S shares is still a transfer of loss shares and, 
accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). Under this 
paragraph (d), S's attributes are reduced by S's attribute reduction 
amount. Paragraph (d)(3) of this section provides that S's attribute 
reduction amount is the lesser of the net stock loss and S's 
aggregate inside loss. The net stock loss is the excess of the $200 
aggregate bases of the transferred shares over the $100 aggregate 
value of the transferred shares, or $100. S's aggregate inside loss 
is the excess of its $220 net inside attribute amount (the sum of 
the $100 basis in the land and the $120 loss carryover) over the 
$100 value of all outstanding S shares, or $120. The attribute 
reduction amount is therefore the lesser of the $100 net stock loss 
and the $120 aggregate inside loss, or $100. Under paragraph (d)(4) 
of this section, S's $100 attribute reduction amount is allocated 
and applied to reduce S's $120 loss carryover to $20. Under 
paragraph (d)(4)(iii) of this section, the reduction of the loss 
carryover is not a noncapital, nondeductible expense and has no 
effect on M's basis in the S stock.
    (ii) Transfer of less than all S shares. (A) Facts. The facts 
are the same as in paragraph (i)(A) of this Example 1, except that M 
only sells 20 S shares to X. M's sale of the 20 S shares is a 
transfer of loss shares and therefore subject to this section. See 
paragraph (f)(10)(i)(A) and (f)(10)(i)(C) of this section. (There is 
no transfer of the remaining shares because S and M remain members 
of the same group.)
    (B) Application of paragraphs (b) and (c) of this section. No 
adjustment is required under paragraph (b) or paragraph (c) of this 
section for the reasons set forth in paragraph (i)(B) of this 
Example 1. Thus, after the application of paragraph (c) of this 
section, M's transfer of the S shares is still a transfer of loss 
shares and, accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). Under this 
paragraph (d), S's attributes are reduced by S's attribute reduction 
amount. Paragraph (d)(3) of this section provides that S's attribute 
reduction amount is the lesser of the net stock loss and S's 
aggregate inside loss. The net stock loss is $20, the excess of the 
$40 aggregate bases of the transferred shares over the $20 aggregate 
value of the transferred shares. S's aggregate inside loss is $120, 
the excess of its $220 net inside attribute amount (the sum of the 
$100 basis in the land and the $120 loss carryover) over the $100 
value of all outstanding S shares. The attribute reduction amount is 
therefore $20, the lesser of the $20 net stock loss and the $120 
aggregate inside loss. Under paragraph (d)(4) of this section, S's 
$20 attribute reduction amount is allocated and applied to reduce 
S's $120 loss carryover to $100.

    Example 2. Proportionate allocation of attribute reduction 
amount. (i) Facts. M owns the sole outstanding share of S stock with 
a basis of $150. S owns land with a basis of $60, a factory with a 
basis of $30, publicly traded property with a basis of $30 and 
goodwill with a basis of $30. M sells its S share for $90. M's sale 
of the S share is a transfer of a loss share and therefore subject 
to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and 
(f)(10)(i)(C) of this section.
    (ii) Application of paragraphs (b) and (c) of this section. 
Although the transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
paragraph (c) of this section. No adjustment is required under 
paragraph (c) of this section because both the disconformity amount 
and the net positive adjustment are $0. See paragraph (c)(3) of this 
section. Thus, after the application of paragraph (c) of this 
section, M's sale of the S share is still a transfer of a loss share 
and, accordingly, subject to this paragraph (d).
    (iii) Attribute reduction under this paragraph (d). Under 
paragraph (d)(3) of this section, S's attribute reduction amount is 
determined to be $60, the lesser of the $60 net stock loss ($150 
basis over $90 value) and S's $60 aggregate inside loss (the excess 
of S's $150 net inside attribute amount (the $60 basis of the land, 
plus the $30 basis of the factory, plus the $30 basis of the 
publicly traded property, plus the $30 basis of the goodwill) over 
the $90 value of the S share). Under paragraph (d)(4)(ii)(B)(2) of 
this section, the $60 attribute reduction amount is allocated and 
applied to reduce S's bases in its Category D assets, S's only 
attributes available for reduction, as follows:

----------------------------------------------------------------------------------------------------------------
                                                                              Allocable portion of     Adjusted
       Available attributes, basis in Category D assets         Attribute     attribute reduction     attribute
                                                                  amount             amount             amount
----------------------------------------------------------------------------------------------------------------
Class VII, Goodwill..........................................          $30                      $30           $0
Class V:
    Land.....................................................           60          (60/90 x 60) 40           20
    Factory..................................................           30          (30/90 x 60) 20           10
                                                              --------------------------------------------------
        Total Class V........................................           90                       60           30
Class II, publicly traded property...........................           30                        0           30
                                                              --------------------------------------------------

[[Page 53969]]

 
        Totals...............................................          150                       60           90
----------------------------------------------------------------------------------------------------------------


    Example 3. Attribute reduction amount less than total attributes 
in Category A, Category B, and Category C. (i) No election to 
prescribe the allocation of S's attribute reduction amount. (A) 
Facts. P owns the sole outstanding share of M stock with a basis of 
$1,000 and M owns the sole outstanding share of S stock with a basis 
of $210. M sells its S share to X for $100. M's sale of the S share 
is a transfer of a loss share and therefore subject to this section. 
See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of 
this section. At the time of the sale, S has no liabilities and the 
following attributes:

 
------------------------------------------------------------------------
           Category                  Attribute         Attribute amount
------------------------------------------------------------------------
Category A...................  Capital loss                          $10
                                carryover.
Category B...................  NOL carryover........                 200
Category C...................  Deferred deductions..                  40
Category D, Class V..........  Basis in Land........                  50
                                                     -------------------
    Total Attributes.........  .....................                 300
------------------------------------------------------------------------

    (B) Application of paragraphs (b) and (c) of this section. 
Although the transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
paragraph (c) of this section. No adjustment is required under 
paragraph (c) of this section because both the disconformity amount 
and the net positive adjustment are $0. See paragraph (c)(3) of this 
section. Thus, after the application of paragraph (c) of this 
section, M's transfer of the S share is still a transfer of a loss 
share and, accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of the 
$110 net stock loss ($210 basis over $100 value) and S's aggregate 
inside loss. S's aggregate inside loss is $200 (S's $300 net inside 
attribute amount (the $10 capital loss carryover, plus the $200 NOL 
carryover, plus the $40 deferred deductions, plus the $50 basis in 
land) less the $100 value of all outstanding S shares). Thus, the 
attribute reduction amount is $110, the lesser of the $110 net stock 
loss and S's $200 aggregate inside loss. Under paragraph 
(d)(4)(ii)(A)(1) of this section, the $110 attribute reduction 
amount is allocated and applied to reduce S's attributes as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                 Allocation  of
                                                                  Attribute        attribute         Adjusted
              Category                       Attribute              amount         reduction        attribute
                                                                                     amount           amount
----------------------------------------------------------------------------------------------------------------
Category A..........................  Capital loss carryover.              $10              $10               $0
Category B..........................  NOL carryover..........              200              100              100
Category C..........................  Deferred deductions....               40                0               40
Category D, Class V.................  Basis in land..........               50                0               50
                                                              --------------------------------------------------
    1Totals.........................  .......................              300              110              190
----------------------------------------------------------------------------------------------------------------

    (ii) Election to prescribe the allocation of attribute reduction 
amount. (A) Facts. The facts are the same as in paragraph (i)(A) of 
this Example 3, except that P elects to allocate the attribute 
reduction amount to eliminate the Category C attributes, preserve 
the capital loss carryover, and reduce Category B attributes.
    (B) Application of paragraphs (b) and (c) of this section. No 
adjustment is required under paragraph (b) or paragraph (c) of this 
section for the reasons set forth in paragraph (i)(B) of this 
Example 3. Thus, after the application of paragraph (c) of this 
section, M's sale of the S share is still a transfer of a loss 
share, and accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). For the 
reasons set forth in paragraph (i)(C) of this Example 3, under this 
paragraph (d)(3), S's attribute reduction amount is determined to be 
$110. M elects to apply S's $110 attribute reduction amount as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                                  Allocation  of
                                                                     Attribute       attribute       Adjusted
               Category                         Attribute             amount         reduction       attribute
                                                                                      amount          amount
----------------------------------------------------------------------------------------------------------------
Category A............................  Capital loss carryover..             $10              $0             $10
Category B............................  NOL carryover...........             200              70             130
Category C............................  Deferred deductions.....              40              40               0
Category D, Class V...................  Basis of land...........              50               0              50
                                                                 -----------------------------------------------
    Totals............................  ........................             300             110             190
----------------------------------------------------------------------------------------------------------------



[[Page 53970]]

    Example 4. Attributes attributable to liability not taken into 
account. (i) S operates one business. (A) Facts. On January 1, year 
1, M forms S by exchanging $150 for the sole outstanding share of S 
stock. In year 1, S earns $500, purchases land for $50, spends $100 
to build a factory on that land, and then purchases publicly traded 
property for $250. In year 2, S earns a section 38 general business 
credit of $50. However, pollution generated by S's business gives 
rise to an environmental remediation liability under Federal law 
that would be required to be capitalized if a person purchased S's 
assets and assumed the liability. Before any amounts have been taken 
into account with respect to the environmental remediation 
liability, when the liability has a present value of $500, M sells 
its S share to X for $150. After giving effect to all other 
provisions of law, M's basis in the S share is $650 (the original 
basis of $150 increased under Sec.  1.1502-32 by $500 for the income 
earned). The sale is therefore a transfer of a loss share of 
subsidiary stock and subject to this section. See paragraphs 
(f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.
    (B) Application of paragraphs (b) and (c) of this section. 
Although the transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
paragraph (c) of this section. No adjustment to basis is made under 
paragraph (c) of this section because, although the net positive 
adjustment is $500, the disconformity amount is $0. See paragraph 
(c)(3) of this section. Thus, after the application of paragraph (c) 
of this section, M's sale of the S share is still a transfer of a 
loss share and, accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) Under 
paragraph (d)(3) of this section, S's attribute reduction amount is 
the lesser of the $500 net stock loss ($650 basis over $150 value) 
and the aggregate inside loss. The aggregate inside loss is $500, 
computed as the excess of S's $650 net inside attribute amount (the 
sum of S's $100 basis in the factory, $50 basis in the land, $250 
basis in the publicly traded property, and $250 cash remaining after 
the purchases) over the $150 value of the S share. Thus, S's 
attribute reduction amount is $500, the lesser of the $500 net stock 
loss and the $500 aggregate inside loss. Under paragraph 
(d)(4)(ii)(B)(2) of this section, S's $500 attribute reduction 
amount is allocated and applied to reduce S's attributes as follows:

----------------------------------------------------------------------------------------------------------------
                                                                               Allocable portion     Adjusted
                    Available attributes                         Attribute       of  attribute       attribute
                                                                  amount       reduction amount       amount
----------------------------------------------------------------------------------------------------------------
Category D:
    Class V Assets:
        Basis of factory....................................            $100                $100              $0
        Basis of land.......................................              50                  50               0
    Class II Assets:
        Publicly traded property............................             250                 250               0
----------------------------------------------------------------------------------------------------------------

    (2) The remaining $100 attribute reduction amount is not applied 
to S's $250 cash (Class I asset) or to S's $50 general business tax 
credit. Under the general rule of this paragraph (d), that remaining 
$100 attribute reduction amount would have no further effect on S's 
attributes. However, S has a $500 liability that has not been taken 
into account. Therefore, under paragraph (d)(4)(ii)(C)(1) of this 
section, the remaining $100 attribute reduction amount is suspended 
and will be allocated and applied to reduce any amounts that become 
deductible or capitalizable as a result of the environmental 
remediation liability later being taken into account. If the 
liability is satisfied for an amount that is less than $100, under 
paragraph (d)(4)(ii)(C)(2) of this section the remaining portion of 
that $100 suspended attribute reduction amount is disregarded and 
has no further effect.
    (ii) Lower-tier subsidiary with additional liability. (A) Facts. 
The facts are the same as in paragraph (i)(A) of Example 4, except 
that, in addition, S exchanged $50 for the sole outstanding share of 
stock of S1. S1 has $50 and equipment with an aggregate basis of $0. 
S1 also has employee medical expense liabilities that have not been 
taken into account and that would be required to be capitalized if a 
person purchased S1's assets and assumed the liabilities. At the 
time of the sale, S's environmental remediation liability had a 
present value of $475 and S1's employee medical expenses had a 
present value of $25. For the reasons set forth in paragraph (i)(A) 
of this Example 4, M's sale of the S share is a transfer of a loss 
share and therefore subject to this section.
    (B) Application of paragraphs (b) and (c) of this section. No 
adjustment is made under paragraph (b) or paragraph (c) of this 
section for the reasons set forth in paragraph (i)(B) of this 
Example 4. Thus, after the application of paragraph (c) of this 
section, M's sale of the S share is still a transfer of a loss share 
and, accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of the 
$500 net stock loss ($650 basis over $150 value) and the aggregate 
inside loss. The aggregate inside loss is the excess of S's net 
inside attribute amount over the value of the S share. Under 
paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this section, S's net 
inside attribute amount is determined by using S's $50 deemed basis 
in the S1 share (the greater of S's $50 actual basis in the share 
and S1's $50 net inside attribute amount). Accordingly, S's net 
inside attribute amount is $650 (the sum of its $100 basis in the 
factory, $50 basis in the land, $250 basis in the publicly traded 
property, $200 cash, and $50 deemed basis in its S1 share). The 
aggregate inside loss is $500, the excess of S's $650 net inside 
attribute amount over the $150 value of the S share. Thus, S's 
attribute reduction amount is $500, the lesser of the $500 net stock 
loss and S's $500 aggregate inside loss.
    (2) Allocation, apportionment, and application of attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $500 attribute reduction amount is allocated 
proportionately (by basis) between its S1 share and its non-stock 
Category D asset (consisting of all S's Category D assets other than 
its share of S1 stock, with a basis equal to $600, the aggregate 
basis of S's non-stock assets). However, under paragraph (d)(5)(ii) 
of this section, for purposes of allocating S's attribute reduction 
amount between its non-stock Category D asset and the S1 share, S's 
$50 deemed basis in its S1 share is treated as reduced by S1's $25 
net non-loss assets (its Class I asset, $50 cash over S1's 
liabilities (which, for this purpose include the $25 of employee 
medical expense liabilities not taken into account as of the 
transfer)). As a result, S's attribute reduction amount is allocated 
$480 (600/625 x 500) to S's non-stock Category D asset and $20 (25/
625 x 500) to the S1 share. The $480 attribute reduction amount 
allocated to S's non-stock Category D asset produces the same 
reduction in the bases of S's assets (other than the S1 stock) as in 
paragraph (i)(C) of this Example 4; in addition, the $80 attribute 
reduction amount not applied to reduce S's attributes is suspended 
and applied to reduce any amounts that become deductible or 
capitalizable as a result of the environmental remediation liability 
later being taken into account. If the liability is satisfied for an 
amount that is less than $80, under paragraph (d)(4)(ii)(C)(2) of 
this section the remaining portion of that $80 suspended attribute 
reduction amount is disregarded and has no further effect. Because 
the S1 share is not transferred within the meaning of paragraph 
(f)(10) of this section, the allocated attribute reduction amount 
apportioned to the S1 share is applied fully to reduce the basis of 
the S1 share to $30. See paragraph (d)(5)(iii) of this section.

[[Page 53971]]

    (D) Tier down of S's attribute reduction amount. The $20 portion 
of S's attribute reduction amount allocated to the S1 share is an 
attribute reduction amount of S1. Because S1 holds only cash, it has 
no attributes available for reduction under this paragraph (d). 
However, because S1 has a $25 liability not taken into account for 
tax purposes, paragraph (d)(4)(ii)(C)(1) of this section requires 
that $20 of the unapplied attribute reduction amount be suspended 
and then allocated and applied to reduce any amounts that become 
deductible or capitalizable as a result of the employee medical 
expense liabilities later being taken into account. If these 
liabilities are satisfied for an amount that is less than $20, under 
paragraph (d)(4)(ii)(C)(2) of this section the remaining portion of 
that $20 suspended attribute reduction amount is disregarded and has 
no further effect.
    Example 5. Wholly owned lower-tier subsidiary (no lower-tier 
transfer). (i) Application of conforming limitation. (A) Facts. M 
owns the sole outstanding share of S stock with a basis of $250. S 
owns Asset with a basis of $100 and the only two outstanding shares 
of S1 stock (Share A has a basis of $40 and Share B has a basis of 
$60). S1 owns Asset 1 with a basis of $50. M sells its S share to 
P1, the common parent of another consolidated group, for $50. The 
sale is a transfer of a loss share and therefore subject to this 
section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and 
(f)(10)(i)(C) of this section.
    (B) Application of paragraphs (b) and (c) of this section. 
Although the transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
paragraph (c) of this section. No adjustment is required under 
paragraph (c) of this section because, although there is a $50 
disconformity amount, the net positive adjustment is $0. See 
paragraph (c)(3) of this section. Thus, after the application of 
paragraph (c) of this section, M's sale of the S share is still a 
transfer of a loss share and, accordingly, subject to this paragraph 
(d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of M's 
net stock loss and S's aggregate inside loss. M's net stock loss is 
$200 ($250 basis over $50 value). S's aggregate inside loss is the 
excess of S's net inside attribute amount over the value of the S 
share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this 
section, S's net inside attribute amount is $200, computed as the 
sum of S's $100 basis in Asset and its $100 deemed basis in the 
deemed single share of S1 stock (computed as the greater of S's $100 
aggregate basis in the S1 shares and S1's $50 basis in Asset 1). S's 
aggregate inside loss is therefore $150, $200 net inside attribute 
amount over the $50 value of the S share. Accordingly, S's attribute 
reduction amount is $150, the lesser of the $200 net stock loss and 
the $150 aggregate inside loss.
    (2) Allocation, apportionment, and application of S's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $150 attribute reduction amount is allocated 
proportionately (by basis) between Asset (non-stock Category D 
asset) with a basis of $100, and the S1 stock (treated as a single 
share with a deemed basis of $100). Accordingly, $75 of the 
attribute reduction amount ($100/$200 x $150) is allocated to Asset 
and $75 of the attribute reduction amount ($100/$200 x $150) is 
allocated to the S1 stock. The $75 of the attribute reduction amount 
allocated to Asset is applied to reduce S's basis in Asset from $100 
to $25. The $75 of the attribute reduction amount allocated to the 
S1 stock is first apportioned between the shares in a manner that 
reduces disparity to the greatest extent possible. Thus, of the 
total $75 allocated to the S1 stock, $27.50 is apportioned to Share 
A and $47.50 is apportioned to Share B. Because neither of the S1 
shares is transferred within the meaning of paragraph (f)(10) of 
this section, the allocated attribute reduction amount apportioned 
to each of the individual S1 shares is applied fully to reduce the 
basis of each share to $12.50. See paragraph (d)(5)(iii) of this 
section. As a result, immediately after the allocation, 
apportionment, and application of S's attribute reduction amount, 
S's basis in Asset is $25 and S's basis in each of the S1 shares is 
$12.50.
    (3) Tier down of S's attribute reduction amount, application of 
conforming limitation. Under paragraph (d)(5)(v)(A) of this section, 
the $75 portion of S's attribute reduction amount allocated to the 
S1 stock is an attribute reduction amount of S1 (regardless of the 
extent, if any, to which it is apportioned and applied to reduce the 
basis of any shares of S1 stock). Under the general rules of this 
paragraph (d), the $75 tier-down attribute reduction amount would be 
allocated and applied to reduce S1's basis in Asset 1 from $50 to 
$0. However, under paragraph (d)(5)(v)(B) of this section, S1's 
attributes can be reduced by only $25, the excess of the $50 portion 
of S1's net inside attribute amount that is allocable to all S1 
shares held by members as of the transaction over $25, the aggregate 
amount of members' bases in nontransferred S1 shares after reduction 
under this paragraph (d). Thus, of S1's $75 tier-down attribute 
reduction amount, only $25 is applied to reduce S1's basis in Asset 
1, from $50 to $25. The $50 unapplied portion of the tier-down 
attribute reduction amount subject to the conforming limitation has 
no further effect.
    (ii) Application of basis restoration rule. (A) Facts. The facts 
are the same as in paragraph (i)(A) of this Example 5, except that 
S's basis in Share A is $15 and S's basis in Share B is $35, and 
S1's basis in Asset 1 is $100.
    (B) Basis redetermination and basis reduction under paragraphs 
(b) and (c) of this section. No adjustment is required under 
paragraph (b) or paragraph (c) of this section for the reasons set 
forth in paragraph (i)(B) of this Example 5. Thus, after the 
application of paragraph (c) of this section, M's transfer of the S 
share is still a transfer of a loss share and, accordingly, subject 
to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of M's 
net stock loss and S's aggregate inside loss. M's net stock loss is 
$200 ($250 basis over $50 value). S's aggregate inside loss is the 
excess of S's net inside attribute amount over the value of the S 
share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this 
section, S's net inside attribute amount is $200, the sum of S's 
$100 basis in Asset and its $100 deemed basis in the deemed single 
share of S1 stock (computed as the greater of S's $50 aggregate 
basis in the S1 shares and S1's $100 basis in Asset 1). S's 
aggregate inside loss is therefore $150, $200 net inside attribute 
amount over the $50 value of the S share. Accordingly, S's attribute 
reduction amount is $150, the lesser of the $200 net stock loss and 
the $150 aggregate inside loss.
    (2) Allocation, apportionment, and application of S's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $150 attribute reduction amount is allocated 
proportionately (by basis) between Asset (non-stock Category D 
asset) with a basis of $100, and the S1 stock (treated as a single 
share with a deemed basis of $100). Accordingly, $75 of the 
attribute reduction amount ($100/$200 x $150) is allocated to Asset 
and $75 of the attribute reduction amount ($100/$200 x $150) is 
allocated to the S1 stock. The $75 of the attribute reduction amount 
allocated to Asset is applied to reduce S's basis in Asset from $100 
to $25. The $75 of the attribute reduction amount allocated to the 
S1 stock is first apportioned between the shares in a manner that 
reduces disparity to the greatest extent possible. Thus, of the 
total $75 allocated to the S1 stock, $27.50 is apportioned to Share 
A and $47.50 is apportioned to Share B. Because neither of the S1 
shares is transferred within the meaning of paragraph (f)(10) of 
this section, the allocated attribute reduction amount apportioned 
to each of the individual S1 shares is applied fully to reduce the 
basis of each share to an excess loss account of $12.50. See 
paragraph (d)(5)(iii) of this section. As a result, immediately 
after the allocation, apportionment, and application of S's 
attribute reduction amount, S's basis in Asset is $25 and S's basis 
in each of the S1 shares is an excess loss account of $12.50.
    (3) Tier down of S's attribute reduction amount. Under paragraph 
(d)(5)(v)(A) of this section, the $75 portion of S's attribute 
reduction amount allocated to S1 stock is an attribute reduction 
amount of S1 (regardless of the extent, if any, to which it is 
apportioned and applied to reduce the basis of any shares of S1 
stock). Accordingly, under the general rules of this paragraph (d), 
the $75 tier-down attribute reduction amount is applied to reduce 
S1's basis in Asset 1 from $100 to $25.
    (4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this 
section, after this

[[Page 53972]]

paragraph (d) has been applied with respect to all transfers of 
subsidiary stock, any reduction made to the basis of a share of 
lower-tier subsidiary stock under paragraph (d)(5)(iii) of this 
section is reversed to the extent necessary to conform the basis of 
that share to the share's allocable portion of the subsidiary's net 
inside attribute amount (after reduction). S1's net inside attribute 
amount after the application of this paragraph (d) is $25 and thus 
each of the two S1 share's allocable portion of S1's net inside 
attribute amount is $12.50. Accordingly, the reductions to Share A 
and to Share B under paragraph (d)(5)(iii) of this section are 
reversed to the extent necessary to restore the basis of each share 
to $12.50. Thus, $25 of the $27.50 of reduction to the basis of 
Share A, and $25 of the $47.50 of reduction to the basis of share B, 
is reversed, restoring the basis of each share to $12.50.
    Example 6. Multiple blocks of lower-tier subsidiary stock 
outstanding. (i) Excess loss account taken into account (transfer of 
upper-tier share causes disposition within the meaning of Sec.  
1.1502-19(c)(1)(ii)(B)). (A) Facts. M owns the sole outstanding 
share of S stock with a basis of $200. S holds all five outstanding 
shares of S1 common stock (Shares A, B, C, D, and E). S has an 
excess loss account of $20 in Share A and a positive basis of $20 in 
each of the other shares. The only investment adjustment applied to 
any S1 share was a negative $20 investment adjustment applied to 
Share A when it was the only outstanding share, and this amount 
tiered up and adjusted M's basis in the S share. S1 owns one asset 
with a basis of $250. M sells its S share to P1, the common parent 
of a consolidated group, for $20. The sale of the S share is a 
disposition of Share A under Sec.  1.1502-19(c)(1)(ii)(B) (S1 
becomes a nonmember because it will have a separate return year as a 
member of the P1 group). Accordingly, under Sec.  1.1502-19(b)(1)(i) 
and paragraph (a)(3)(i) of this section, before the application of 
this section, S's excess loss account in Share A is taken into 
account, increasing S's basis in Share A to $0 and M's basis in its 
S share to $220. After giving effect to the recognition of the 
excess loss account, M's sale of the S share is a transfer of a loss 
share and therefore subject to this section. See paragraphs 
(f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.
    (B) Basis redetermination and basis reduction under paragraphs 
(b) and (c) of this section. Although the transfer is subject to 
this section, there is no basis redetermination under paragraph (b) 
of this section because there is only one share of S stock 
outstanding (and so there can be no disparity among members' bases 
in common shares and there are no outstanding preferred shares with 
respect to which there can be unrecognized gain or loss). See 
paragraph (b)(1)(ii)(A) of this section. Therefore, after the 
application of paragraph (b) of this section, the share is still a 
loss share and, as such, subject to paragraph (c) of this section. 
No adjustment is made under paragraph (c) of this section because, 
even though there is a disconformity amount of $140, the net 
positive adjustment is $0. See paragraph (c)(3) of this section. 
Thus, after the application of paragraph (c) of this section, M's 
sale of the S share remains a transfer of a loss share and, 
accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of M's 
net stock loss and S's aggregate inside loss. M's net stock loss is 
$200 ($220 basis over $20 value). S's aggregate inside loss is the 
excess of S's net inside attribute amount over the value of the S 
share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this 
section, S's net inside attribute amount is $250, S's $250 deemed 
basis in the deemed single share of S1 stock (computed as the 
greater of S's $80 aggregate basis in the S1 shares ($0 basis in 
Share A plus $20 basis in each of the four other shares) and S1's 
$250 basis in its asset). S's aggregate inside loss is therefore 
$230, $250 net inside attribute amount over the $20 value of the S 
share. Accordingly, S's attribute reduction amount is $200, the 
lesser of the $200 net stock loss and the $230 aggregate inside 
loss.
    (2) Allocation, apportionment, and application of S's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $200 attribute reduction amount is allocated entirely 
to the S1 stock (treated as a single share) and then apportioned 
among the shares in a manner that reduces disparity to the greatest 
extent possible. Thus, $24 is apportioned to Share A and $44 is 
apportioned to each of the other shares. Because none of the S1 
shares are transferred within the meaning of paragraph (f)(10) of 
this section (notwithstanding that there is a disposition under 
Sec.  1.1502-19(c)(1)(ii)(B)), the allocated attribute reduction 
amount apportioned to each of the individual S1 shares is applied 
fully to reduce the basis of each share to an excess loss account of 
$24. See paragraph (d)(5)(iii) of this section.
    (3) Tier down of S's attribute reduction amount. Under paragraph 
(d)(5)(v)(A) of this section, the $200 of S's attribute reduction 
amount allocated to the S1 shares is an attribute reduction amount 
of S1 (regardless of the extent, if any, to which it is apportioned 
and applied to reduce the basis of any shares of S1 stock). Under 
the general rules of this paragraph (d), S1's $200 tier-down 
attribute reduction amount is allocated and applied to reduce S1's 
basis in its asset from $250 to $50.
    (4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this 
section, after this paragraph (d) has been applied with respect to 
all transfers of subsidiary stock, any reduction made to the basis 
of a share of lower-tier subsidiary stock under paragraph 
(d)(5)(iii) of this section is reversed to the extent necessary to 
conform the basis of that share to the share's allocable portion of 
the subsidiary's net inside attribute amount (after reduction). S1's 
net inside attribute amount after the application of this paragraph 
(d) is $50 and thus each of the five S1 share's allocable portion of 
S1's net inside attribute amount is $10. Accordingly, the reductions 
to the bases of S1 shares under paragraph (d)(5)(iii) of this 
section are reversed to the extent necessary to restore (to the 
extent possible) the basis of each share to $10. Thus, $24 of the 
$24 of reduction to the basis of Share A is reversed, restoring the 
basis of Share A to $0, and $34 of the $44 of reduction to the basis 
of each other share is reversed, restoring the basis of each of 
those shares to $10.
    (ii) Sale of gain share to member. (A) Facts. The facts are the 
same as in paragraph (i)(A) of this Example 6, except that M owns 
Shares A, B, C, and D, S owns Share E, S has a liability of $20, and 
S1's basis in its asset is $500. Also, as part of the transaction, S 
sells Share E to M for $40. Unlike under the facts of paragraph 
(i)(A) of this Example 6, there is no disposition of Share A within 
the meaning of Sec.  1.1502-19(c)(1)(ii)(B) (S1 continues to be a 
member of the group, and thus does not have a separate return year). 
As a result, the Share A excess loss account is not taken into 
account. Although S's sale of Share E is a transfer of that share, 
the share is not a loss share and thus the transfer is not subject 
to this section. M's sale of the S share, however, is a transfer of 
a loss share and therefore subject to this section. See paragraphs 
(f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.
    (B) Transfer in lowest tier (gain share). S's sale of Share E is 
the lowest-tier transfer in the transaction. Under paragraph 
(a)(3)(ii)(A) of this section, because there are no transfers of 
loss shares at that tier, no adjustments are required under 
paragraph (b) or (c) of this section. However, S's gain recognized 
on the transfer Share E is computed and immediately adjusts members 
bases in subsidiary stock under Sec.  1.1502-32 (because M and S are 
not members of the same group immediately after the transaction the 
sale is not an intercompany transaction subject to Sec.  1.1502-13). 
Accordingly, M's basis in its S share is increased by $20, from $200 
to $220.
    (C) Transfers in next higher tier, application of paragraphs (b) 
and (c) of this section. The next higher tier transfer is M's sale 
of the S stock. The sale is a transfer of a loss share and therefore 
subject to this section. Although the transfer is subject to this 
section, there is no basis redetermination under paragraph (b) of 
this section because there is only one share of S stock outstanding 
(and so there can be no disparity among members' bases in common 
shares and there are no outstanding preferred shares with respect to 
which there can be unrecognized gain or loss). See paragraph 
(b)(1)(ii)(A) of this section. Therefore, after the application of 
paragraph (b) of this section, the share is still a loss share and, 
as such, subject to paragraph (c) of this section. Under paragraph 
(c) of this section, M's basis in its S share is decreased by $20, 
the lesser of S's $200 disconformity amount (computed as the excess 
of M's $220 basis in the S stock over S's $20 net inside attribute 
amount (computed as the $20 basis in Share E, increased by $20 to 
reflect the gain recognized with respect to the share, less the $20 
liability)), and the $20 net positive adjustment. Thus, after the 
application of paragraph (c) of this section, M's basis in the S 
share is $200, and the sale remains a transfer of a loss share. 
There are no higher tier transfers and, therefore, M's transfer of 
the S share is then subject to this paragraph (d).

[[Page 53973]]

    (D) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of M's 
net stock loss and S's aggregate inside loss. M's net stock loss is 
$180 ($200 basis over $20 value). S's aggregate inside loss is the 
excess of S's net inside attribute amount over the value of the S 
share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this 
section, S's net inside attribute amount is $80, computed as $100 
(S's deemed basis in Share E (the greater of $40 (S's $20 basis in 
Share E, adjusted for the $20 gain recognized with respect to the 
share), and Share E's allocable portion of S1's net inside attribute 
amount of $100 (1/5 of S1's $500 basis in its asset)), less S's $20 
liability. Accordingly, S's aggregate inside loss is $60 ($80 net 
inside attribute amount over the $20 value of the S stock). S's 
attribute reduction amount is therefore $60, the lesser of $180 net 
stock loss and $60 aggregate inside loss.
    (2) Allocation, apportionment, and application of S's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $60 attribute reduction amount is allocated entirely to 
its S1 stock, Share E. However, because Share E was transferred 
within the meaning of paragraph (f)(10) of this section and gain was 
recognized on its transfer, none of the allocated amount is 
apportioned to, or applied to reduce the basis of Share E. See 
paragraph (d)(5)(iii)(A) of this section. Under paragraph (d)(5)(iv) 
of this section, the $60 allocated attribute reduction amount not 
apportioned or applied to Share E has no effect on S or S's 
attributes.
    (3) Tier down of S's attribute reduction amount. Notwithstanding 
the fact that no portion of the allocated attribute reduction amount 
was apportioned to or applied to reduce the basis of Share E, the 
entire $60 allocated attribute reduction amount is an attribute 
reduction amount of S1. See paragraphs (d)(5)(v)(A) of this section. 
Under the general rules of this paragraph (d), S1's $60 tier-down 
attribute reduction amount is allocated and applied to reduce S1's 
basis in its asset from $500 to $440.
    (4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this 
section, after this paragraph (d) has been applied with respect to 
all transfers of subsidiary stock, any reduction made to the basis 
of a share of subsidiary stock under paragraph (d)(5)(iii) of this 
section is reversed to the extent necessary to conform the basis of 
that share to the share's allocable portion of the subsidiary's net 
inside attribute amount. No reduction was made to the basis of the 
S1 stock under paragraph (d)(5)(iii) of this section. Therefore, no 
stock basis is increased under the basis restoration rule in 
paragraph (d)(5)(vi)(A) of this section.

    Example 7. Allocation of attribute reduction if lower-tier 
subsidiary has non-loss assets or liabilities. (i) S1 holds cash. 
(A) Facts. M owns the sole outstanding share of S stock with a basis 
of $800. S owns Asset with a basis of $400 and the sole outstanding 
share of S1 stock with a basis of $300. S1 holds Asset 1 with a 
basis of $50, and $100 cash. M sells its S share to P1, the common 
parent of a consolidated group, for $100. The sale is not a transfer 
of the S1 share because S and S1 are members of the same group 
following the transaction. However, the sale is a transfer of the S 
share, a loss share, and therefore subject to this section. See 
paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this 
section.
    (B) Application of paragraphs (b) and (c) of this section. 
Although the transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
only one share of S stock outstanding (and so there can be no 
disparity among members' bases in common shares and there are no 
outstanding preferred shares with respect to which there can be 
unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this 
section. Therefore, after the application of paragraph (b) of this 
section, the share is still a loss share and, as such, subject to 
the provisions of this paragraph (c). No adjustment is required 
under paragraph (c) of this section because, even though there is a 
disconformity amount of $100, the net positive adjustment is $0. See 
paragraph (c)(3) of this section. Thus, after the application of 
paragraph (c) of this section, M's sale of the S share is still a 
transfer of a loss share and, accordingly, subject to this paragraph 
(d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of M's 
net stock loss and S's aggregate inside loss. M's net stock loss is 
$700 ($800 basis over $100 value). S's aggregate inside loss is the 
excess of S's net inside attribute amount over the value of the S 
share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this 
section, S's net inside attribute amount is $700, the sum of its 
$400 basis in Asset and its $300 deemed basis in the S1 share 
(computed as the greater of S's $300 basis in the S1 share and S1's 
$150 net inside attribute amount (reflecting the sum of S1's $50 
basis in Asset 1 and S1's $100 cash)). Therefore, S's aggregate 
inside loss is $600 ($700 net inside attribute amount over the $100 
value of the S stock). S's attribute reduction amount is $600, the 
lesser of the $700 net stock loss and the $600 aggregate inside 
loss.
    (2) Allocation, apportionment, and application of S's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $600 attribute reduction amount is allocated 
proportionately (by basis) between S's $400 basis in Asset (non-
stock Category D asset) and its deemed basis in the S1 share. 
However, under paragraph (d)(5)(ii) of this section, for purposes of 
allocating the attribute reduction amount, S's $300 deemed basis in 
the S1 share is treated as reduced by S1's net non-loss assets (its 
Class I asset, $100 cash) to $200. Thus, the $600 is allocated $400 
to Asset ($400/$600 x $600) and $200 to the S1 share ($200/$600 x 
$600). The $400 allocated to Asset is applied to reduce S's basis in 
Asset from $400 to $0. Because the S1 share is not transferred 
within the meaning of paragraph (f)(10) of this section, the 
allocated attribute reduction amount apportioned to the S1 share is 
applied fully to reduce the basis of the S1 share to $100. See 
paragraph (d)(5)(iii) of this section.
    (3) Tier down of S's attribute reduction amount. Under paragraph 
(d)(5)(v)(A) of this section, the $200 portion of S's attribute 
reduction amount allocated to the S1 stock is an attribute reduction 
amount of S1 (regardless of the extent, if any, to which it is 
apportioned and applied to reduce the basis of any shares of S1 
stock). Under the general rules of this paragraph (d), S1's $200 
tier-down attribute reduction amount is allocated and applied to 
reduce S1's basis in Asset 1 (S1's only attribute available for 
reduction) from $50 to $0. The $150 unapplied attribute reduction 
amount is disregarded and has no further effect.
    (4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this 
section, after this paragraph (d) has been applied with respect to 
all transfers of subsidiary stock, any reduction made to the basis 
of a share of subsidiary stock under paragraph (d)(5)(iii) of this 
section is reversed to the extent necessary to conform the basis of 
that share to the share's allocable portion of the subsidiary's net 
inside attribute amount. There is only one share of S1 stock 
outstanding and so S1's entire $100 net inside attribute amount is 
allocable to that share. Because S's $100 basis in the S1 share (as 
reduced under this paragraph (d)) is already conformed with its $100 
allocable portion of S1's net inside attribute amount, there is no 
restoration under paragraph (d)(5)(vi)(A) of this section.
    (ii) S1 borrows cash. The facts are the same as in paragraph 
(i)(A) of this Example 7 except that, in addition, S1 borrows $50 
from X immediately before M sells the S share. The computation of 
the attribute reduction amount is the same as in paragraph (i)(C) of 
this Example 7 (the $50 cash from the loan proceeds and the $50 
liability offset in the computation of S1's net inside attribute 
amount and so the net amount is unaffected, and the computation of 
S's deemed basis in the S1 stock is unaffected). Similarly, for 
purposes of allocating the attribute reduction amount between the 
non-stock Category D asset and the S1 stock, paragraph (d)(5)(ii) of 
this section requires S's deemed basis in the S1 share to be treated 
as reduced by S1's net non-loss assets (S1's non-loss assets over 
S1's liabilities). Accordingly, the additional $50 cash proceeds is 
offset by the $50 liability and there is no effect on the allocation 
of the attribute reduction amount. The results are the same as in 
paragraph (i) of this Example 7.
    (iii) S1 has a liability not taken into account for tax 
purposes. (A) Facts. The facts are the same as in paragraph (ii) of 
this Example 7 except that, in addition, S1 has a $40 liability that 
is not taken into account for tax purposes as of the transfer and 
that would be required to be capitalized if a person purchased S1's 
assets and assumed the liability.
    (B) Application of paragraphs (b) and (c) of this section. No 
adjustment is required under paragraph (b) or paragraph (c) of this 
section for the reasons set forth in paragraph (i)(B) of this 
Example 7. Thus, after the application of paragraph (c) of this 
section, P's sale of the S share is still a transfer of a

[[Page 53974]]

loss share and, accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. The attribute reduction 
amount is the same as computed in paragraph (i)(C)(1) of this 
Example 7 (under paragraph (f)(5) of this section, the term 
liability does not include liabilities not taken into account for 
tax purposes and so the additional $40 liability not yet taken into 
account for tax purposes does not affect the computation of S's 
attribute reduction amount).
    (2) Allocation, apportionment, and application of S's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $600 attribute reduction amount is allocated 
proportionately (by basis) between S's $400 basis in Asset 1 (non-
stock Category D asset) and its deemed basis in the S1 share. 
However, under paragraph (d)(5)(ii) of this section, for purposes of 
allocating the attribute reduction amount, S's $300 deemed basis in 
the S1 share is treated as reduced by S1's net non-loss assets (S1's 
non-loss assets over S1's liabilities). For this purpose, the term 
liabilities includes liabilities not taken into account for tax 
purposes, as described in paragraph (d)(4)(ii)(C)(1) of this section 
(generally, liabilities that, if assumed in a purchase, would give 
rise to a capitalized amount when satisfied). Thus, for this 
purpose, S's $300 deemed basis in the S1 share is reduced by S1's 
$60 net non-loss assets (the excess of S1's $150 non-loss assets 
(its Class I asset, $150 cash) over S1's $90 liabilities ($50 loan 
and $40 liability not yet taken into account for tax purposes)), to 
$240. Accordingly, S's $600 attribute reduction amount is allocated 
and applied $375 ($400/$640 x $600) to Asset (reducing S's basis in 
Asset from $400 to $25) and $225 ($240/$640 x $600) to the S1 share. 
Because the S1 share is not transferred within the meaning of 
paragraph (f)(10) of this section, the allocated attribute reduction 
amount apportioned to the S1 share is applied fully to reduce the 
basis of the S1 share to $75. See paragraph (d)(5)(iii) of this 
section.
    (3) Tier down of S's attribute reduction amount, application of 
conforming limitation. Under paragraph (d)(5)(v)(A) of this section, 
the $225 portion of S's attribute reduction amount allocated to the 
S1 stock is an attribute reduction amount of S1 (regardless of the 
extent, if any, to which it is apportioned and applied to reduce the 
basis of any shares of S1 stock). Under the general rules of this 
paragraph (d), S1's $225 tier-down attribute reduction amount would 
be allocated and applied to reduce S1's attributes. However, under 
paragraph (d)(5)(v)(B) of this section, S1's attributes can be 
reduced by only $75, the excess of the $150 portion of S1's net 
inside attribute amount that is allocable to all S1 shares held by 
members as of the transaction over $75, the aggregate amount of 
members' bases in nontransferred S1 shares, after reduction under 
this paragraph (d). Thus, of S1's $225 tier-down attribute reduction 
amount, $50 is applied to reduce S1's basis in Asset 1, from $50 to 
$0. Although the $25 unapplied attribute reduction amount not 
subject to the conforming limitation would generally be disregarded 
without further effect, because S1 has a $40 liability not taken 
into account for tax purposes, paragraph (d)(4)(ii)(C)(1) of this 
section requires that the $25 of the unapplied attribute reduction 
amount not subject to the conforming limitation be suspended and 
then allocated and applied to reduce any amounts that become 
deductible or capitalizable as a result of that liability later 
being taken into account. If the liability is satisfied for an 
amount that is less than $25, under paragraph (d)(4)(ii)(C)(2) of 
this section the remaining portion of that $25 suspended attribute 
reduction amount is disregarded and has no further effect. The $150 
unapplied portion of the tier-down attribute reduction amount 
subject to the conforming limitation has no further effect.
    (4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this 
section, after this paragraph (d) has been applied with respect to 
all transfers of subsidiary stock, any reduction made to the basis 
of a share of lower-tier subsidiary stock under paragraph 
(d)(5)(iii) of this section is reversed to the extent necessary to 
conform the basis of that share to the share's allocable portion of 
the subsidiary's net inside attribute amount. Paragraph 
(d)(5)(vi)(A) provides that, for this purpose, S1's net inside 
attribute amount is its net inside attribute amount, taking into 
account any reductions under this paragraph (d) and treating it as 
reduced by any attribute reduction amount suspended under paragraph 
(d)(4)(ii)(C)(1) of this section. Because S's $75 basis in its S1 
stock (after application of this paragraph (d)) is already conformed 
with its $75 allocable portion of S1's net inside attribute amount 
($100 net inside attributes after reduction, reduced by S1's $25 
suspended attribute reduction amount), there is no restoration under 
paragraph (d)(5)(vi)(A) of this section.

    Example 8. Election to reduce stock basis or reattribute 
attributes under paragraph (d)(6) of this section. (i) 
Deconsolidating sale. (A) Facts. P owns the sole outstanding share 
of M stock with a basis of $1,000. M owns all 100 outstanding shares 
of S stock with a basis of $2.10 per share ($210 total). M sells all 
its S shares to X for $1 per share ($100 total). M's sale of the S 
shares is a transfer of loss shares and therefore subject to this 
section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and 
(f)(10)(i)(C) of this section. At the time of the sale, S has no 
liabilities and the following:

------------------------------------------------------------------------
                                                              Attribute
              Category                      Attribute           amount
------------------------------------------------------------------------
Category A.........................  Capital loss carryover          $10
Category B.........................  NOL carryover.........           90
Category C.........................  Deferred deduction....           40
                                                            ------------
    Total Category A, Category B,    ......................          140
     and Category C Attributes.
Category D, Class V................  Basis in land.........           70
                                                            ------------
    Total Attributes...............  ......................          210
------------------------------------------------------------------------

    (B) Application of paragraphs (b) and (c) of this section. 
Although the transfer is subject to this section, there is no basis 
redetermination under paragraph (b) of this section because there is 
no disparity among M's bases in shares of S common stock and there 
are no shares of S preferred stock outstanding (so there can be no 
unrecognized gain or loss with respect to preferred shares). See 
paragraph (b)(1)(ii)(A) of this section. No adjustment is required 
under paragraph (c) of this section because both the disconformity 
amount and the net positive adjustment are $0. See paragraph (c)(3) 
of this section. Thus, after the application of paragraph (c) of 
this section, M's transfer of the S shares is still a transfer of 
loss shares and, accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of the 
$110 net stock loss ($210 aggregate basis over the $100 aggregate 
value) and S's aggregate inside loss. S's aggregate inside loss is 
$110 (S's $210 net inside attribute amount (the $10 capital loss 
carryover, plus the $90 NOL carryover, plus the $40 deferred 
deduction, plus the $70 basis in the land) over the $100 value of 
all outstanding S shares). S's attribute reduction amount is $110, 
the lesser of the $110 net stock loss and the $110 aggregate inside 
loss.
    (2) Application of attribute reduction amount. (i) S's $110 
attribute reduction amount is applied as follows:

[[Page 53975]]



----------------------------------------------------------------------------------------------------------------
                                                                                 Allocation of
                                                                    Attribute      attribute         Adjusted
               Category                         Attribute             amount       reduction        attribute
                                                                                     amount           amount
----------------------------------------------------------------------------------------------------------------
Category A............................  Capital loss carryover...          $10              $10               $0
Category B............................  NOL carryover............           90               90                0
Category C............................  Deferred deduction.......           40               10               30
Category D, Class V...................  Basis in land............           70                0               70
                                                                  ----------------------------------------------
    Totals............................  .........................          210              110              100
----------------------------------------------------------------------------------------------------------------

    (ii) Alternatively, under paragraph (d)(4)(ii)(A)(1) of this 
section, P could specify the allocation of S's $110 attribute 
reduction amount among S's $10 capital loss carryover, S's $90 NOL 
carryover, and S's $40 deferred deduction.
    (D) Results. The P group recognizes a $110 loss on M's sale of 
the S shares that is absorbed by the group, which reduces P's basis 
in the M share under Sec.  1.1502-32 from $1,000 to $890. 
Immediately after the transaction, the entities own the following:

------------------------------------------------------------------------
           Entity                           Asset                 Basis
------------------------------------------------------------------------
P...........................  M share..........................     $890
X...........................  100 S shares.....................      100
S...........................  Category C, deferred deduction...       30
                              Category D, Class V Asset (land).       70
------------------------------------------------------------------------

    (E) Election to reduce stock basis. The facts are the same as in 
paragraph (i)(A) of this Example 8 except that P elects under 
paragraph (d)(6) of this section to reduce M's basis in the S shares 
by the full attribute reduction amount of $110, in lieu of S 
reducing its attributes. The election is effective for all 
transferred loss shares and is allocated to those shares in 
proportion to the loss in each. See paragraph (d)(6)(v)(A) of this 
section. Accordingly, the basis of each of the 100 transferred 
shares is reduced from $2.10 to $1.00. After giving effect to the 
election, the S shares are not loss shares and this section has no 
further application to the transfer. The $110 reduction in M's basis 
in the S shares pursuant to the election under paragraph (d)(6) of 
this section is a noncapital, nondeductible expense of M that will 
reduce P's basis in the M share. See paragraph (d)(6)(v)(A) of this 
section. Immediately after the transaction, the entities own the 
following:

------------------------------------------------------------------------
                                                                Basis/
         Entity                         Asset                 attribute
------------------------------------------------------------------------
P.......................  M share..........................         $890
X.......................  100 S shares.....................          100
S.......................  Category A, capital loss                    10
                           carryover.
                          Category B, NOL carryover........           90
                          Category C, deferred deduction...           40
                          Category D, Class V Asset (land).           70
------------------------------------------------------------------------

    (F) Election to reattribute losses. The facts are the same as in 
paragraph (i)(A) of this Example 8 except that P elects under 
paragraph (d)(6) of this section to reattribute S's attributes. S's 
attribute reduction amount is $110, and P can reattribute all or any 
portion of the attributes in Category A, Category B, and Category C 
to the extent of $110. P elects to reattribute the $90 NOL, and, as 
a result, S's NOL is $0. Under paragraph (d)(6)(iv)(A) of this 
section, the reattribution of the $90 NOL is a noncapital, 
nondeductible expense of S. Under Sec.  1.1502-32(c)(1)(ii)(A)(1) 
this $90 expense is allocated to the transferred loss shares of S 
stock in proportion to the loss in the shares, or $.90 per share. 
Further, this expense tiers up under Sec.  1.1502-32 and reduces P's 
basis in the M stock by $90. After giving effect to the election, 
the P group would recognize a $20 loss on M's sale of the S shares, 
S would have an aggregate inside loss of $20 (S's $120 net inside 
attribute amount (the $10 capital loss carryover, plus the $40 
deferred deduction, plus the $70 basis in the land) over the $100 
value of all outstanding S shares), and S's attribute reduction 
amount would be $20 (applied $10 to the $10 capital loss carryover 
and $10 to the $40 deferred deduction). (Alternatively, under 
paragraph (d)(4)(ii)(A)(1) of this section, P could specify the 
allocation of S's $20 attribute reduction amount between S's $10 
capital loss carryover and S's $40 deferred deduction. Further, P 
could elect to reduce M's remaining basis in the S shares by any 
amount up to the $20 attribute reduction amount, thereby reducing or 
eliminating S's attribute reduction amount.)
    (ii) Nondeconsolidating sale. (A) Facts. The facts are the same 
as in paragraph (i)(A) of this Example 8, except that M only sells 
20 S shares ($20 total).
    (B) Application of paragraphs (b) and (c) of this section. No 
adjustment is required under paragraph (b) or paragraph (c) of this 
section for the reasons set forth in paragraph (i)(B) of this 
Example 8. Thus, after the application of paragraph (c) of this 
section, M's sale of the S shares is still a transfer of loss shares 
and, accordingly, subject to this paragraph (d).
    (C) Attribute reduction under this paragraph (d). (1) 
Computation of attribute reduction amount. Under paragraph (d)(3) of 
this section, S's attribute reduction amount is the lesser of the 
$22 net stock loss ($42 aggregate basis over $20 aggregate value) 
and S's $110 aggregate inside loss (as calculated in paragraph 
(i)(C)(1) of this Example 8). S's attribute reduction amount is $22, 
the lesser of the $22 net stock loss and the $110 aggregate inside 
loss.
    (2) Application of attribute reduction amount. (i) S's $22 
attribute reduction amount is applied as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                     Allocation of
                                                                        Attribute      attribute       Adjusted
                Category                           Attribute              amount       reduction      attribute
                                                                                         amount         amount
----------------------------------------------------------------------------------------------------------------
Category A..............................  Capital loss carryover.....          $10              $10           $0
Category B..............................  NOL carryover..............           90               12           78
Category C..............................  Deferred deduction.........           40                0           40
Category D, Class V.....................  Land.......................           70                0           70
----------------------------------------------------------------------------------------------------------------


[[Page 53976]]

    (ii) Alternatively, under paragraph (d)(4)(ii)(A)(1) of this 
section, P could specify the allocation of S's $22 attribute 
reduction amount among S's $10 capital loss carryover, S's $90 NOL 
carryover, and S's $40 deferred deduction.
    (D) Results. The P group recognizes a $22 loss on M's sale of 
the S shares that is absorbed by the group, which reduces P's basis 
in the M share under Sec.  1.1502-32 from $1,000 to $978. 
Immediately after the transaction, the entities have the following:

------------------------------------------------------------------------
          Entity                           Asset                  Basis
------------------------------------------------------------------------
P.........................  M share............................     $978
X.........................  20 S shares........................       20
S.........................  Category B, NOL carryover..........       78
                            Category C, deferred deduction.....       40
                            Category D, Class V Asset (land)...       70
------------------------------------------------------------------------

    (E) Election to reduce stock basis. The facts are the same as 
paragraph (ii)(A) of this Example 8, except that P elects under 
paragraph (d)(6) of this section to reduce M's basis in the S shares 
by the full attribute reduction amount of $22, in lieu of S reducing 
its attributes. The election is effective for all transferred loss 
shares and is allocated to such shares in proportion to the loss in 
each share. See paragraph (d)(6)(v)(A) of this section. Accordingly, 
the basis of each of the 20 transferred shares is reduced from $2.10 
to $1.00. After giving effect to the election, the transferred S 
shares are not loss shares and this section has no further 
application to the transfer. The $22 reduction in M's basis in the S 
shares pursuant to the election under paragraph (d)(6) of this 
section is a noncapital, nondeductible expense of M that will reduce 
P's basis in the M share. See paragraph (d)(6)(v)(A) of this 
section. Immediately after the transaction, the entities have the 
following:

------------------------------------------------------------------------
        Entity                      Asset               Basis/ attribute
------------------------------------------------------------------------
P....................  M share.......................               $978
M....................  80 S shares...................                168
X....................  20 S shares...................                 20
S....................  Category A, capital loss                       10
                        carryover.
                       Category B, NOL...............                 90
                       Category C, deferred deduction                 40
                       Category D Class V Asset                       70
                        (land).
------------------------------------------------------------------------

    (F) Election to reattribute attributes. The facts are the same 
as paragraph (ii)(A) of this Example 8. Because S remains a member 
of the same group as P following M's sale of S stock, P cannot elect 
under paragraph (d)(6) of this section to reattribute any portion of 
S's attributes in lieu of attribute reduction.
    Example 9. Transfers at multiple tiers, gain and loss shares. 
(i) Facts. M owns the sole outstanding share of S stock with a basis 
of $700. S owns Asset 1 (basis of $170) and all ten outstanding 
shares of S1 common stock ($170 basis in share 1, $10 basis in share 
2, and $15 basis in each of share 3 through share 10). S1 owns the 
sole outstanding share of S2 ($0 basis), the sole outstanding share 
of S3 ($60 basis), and the sole outstanding share of S4 ($100 
basis). S2's sole asset is Asset 2 ($75 basis). S3's sole asset is 
Asset 3 ($75 basis). S4's sole asset is Asset 4 ($80 basis). In one 
transaction, M sells its S share to P1 (the common parent of a 
consolidated group) for $240, S sells S1 share 1 to X for $20, S 
contributes S1 share 2 to a partnership in a section 721 
transaction, and S1 sells its S2 share to Y for $50. M's sale of the 
S share and S1's sale of the S2 share are transfers under paragraphs 
(f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section. S's 
sale of S1 share 1 to X is a transfer under paragraphs (f)(10)(i)(A) 
and (f)(10)(i)(C) of this section. S's contribution of S1 share 2 to 
the partnership is a transfer under paragraph (f)(10)(i)(C) of this 
section.
    (ii) Transfer in lowest tier (gain share). S1's sale of the S2 
share is the lowest-tier transfer in the transaction. Under 
paragraph (a)(3)(ii)(A) of this section, because there are no 
transfers of loss shares at that tier, no adjustments are required 
under paragraph (b) or (c) of this section. However, S1's gain 
recognized on the transfer of the S2 share is computed and 
immediately adjusts members bases in subsidiary stock under Sec.  
1.1502-32. Accordingly, $5 is allocated to each of 10 S1 shares, 
increasing the basis of share 1 to $175, the basis of share 2 to 
$15, and the basis of each other share to $20. The $50 applied to 
S's bases in the S1 shares then tiers up to increase P's basis in 
the S share from $700 to $750.
    (iii) Transfers in next highest tier (loss share). S's sale of 
the S1 share 1 and S's transfer of the S1 share 2 to a partnership 
are both transfers of stock in the next higher tier. However, only 
the S1 share 1 is a loss share and so this section only applies with 
respect to the transfer of that share.
    (A) Basis redetermination under paragraph (b) of this section. 
Under paragraph (b)(2)(i)(A) of this section, members' bases in S1 
shares are redetermined by first removing the positive investment 
adjustments applied to the bases of transferred loss common shares. 
Accordingly, the $5 positive investment adjustment applied to the 
basis of S1 share 1 is removed, reducing the basis of S1 share 1 
from $175 to $170. Because there were no negative adjustments 
applied to the bases of S1 shares, there are no negative adjustments 
that can be reallocated to further reduce the basis of S1 share 1 
under paragraph (b)(2)(i)(B) of this section. Finally, under 
paragraph (b)(2)(ii)(B) of this section, the $5 positive investment 
adjustment removed from S1 share 1 is reallocated and applied to 
increase the bases of other S1 common shares in a manner that 
reduces disparity to the greatest extent possible. Accordingly, the 
entire $5 investment adjustment removed from S1 share 1 is 
reallocated and applied to increase the basis of S1 share 2, from 
$15 to $20. After basis is redetermined under paragraph (b) of this 
section, the S1 share 1 is still a loss share and therefore subject 
to basis reduction under paragraph (c) of this section. (Because the 
S1 share 2 is not a loss share, this section does not apply with 
respect to the transfer of that share.)
    (B) Basis reduction under paragraph (c) of this section. No 
adjustment is required to the basis of S1 share 1 under paragraph 
(c) of this section. The S1 share 1 has a disconformity amount of 
$149. This $149 disconformity amount is computed as the excess of 
the $170 basis in the S1 share 1 over the S1 share 1's $21 allocable 
portion (1/10) of S1's $210 net inside attribute amount. S1's $210 
net inside attribute amount is determined under paragraph (c)(5) of 
this section as the sum of $50 (S1's $0 basis in the S2 share, 
adjusted for the $50 gain recognized with respect to that share), 
S1's $60 basis in the S3 stock, and S1's $100 basis in the S4 stock. 
(In computing the disconformity amount, the basis of the S2 share is 
not treated as tentatively reduced because that share is transferred 
in the transaction, and the bases of the S3 and S4 shares are not 
treated as tentatively reduced because no positive investment 
adjustments were applied to the bases of those shares.) However, the 
S1 share 1's net positive adjustment is $0 because the $5 positive 
investment adjustment originally allocated to S1 share 1 was 
reallocated to S1 share 2 under paragraph (b) of this section. See 
paragraph (c)(3) of this section. No adjustment is required to the 
basis of S1

[[Page 53977]]

share 2 under paragraph (c) of this section because S1 share 2 is 
not a loss share.
    (C) Computation of loss, adjustments to stock basis. S 
recognizes a loss of $150 on the sale of the S1 share 1 ($170 basis 
over $20 amount realized) that is absorbed by the group. Under Sec.  
1.1502-32, M's basis in its S share is therefore decreased by $100, 
the net of the $150 loss recognized by S on the sale of the S1 
share, and the $50 gain that tiered up from S1 (as a result of S1's 
sale of the S2 share). Following these adjustments, M's basis in the 
S share is $600 and the sale of the S share is still a transfer of a 
loss share.
    (iv) Transfer in highest tier (loss share). The sale of the S 
share is a transfer in the next higher tier, which is the highest 
tier in this transaction. Because the sale is a transfer of a loss 
share, it is subject to this section.
    (A) Basis redetermination and basis reduction under paragraphs 
(b) and (c) of this section. Although the transfer is subject to 
this section, there is no basis redetermination under paragraph (b) 
of this section because there is only one share of S stock 
outstanding (and so there can be no disparity among members' bases 
in common shares and there are no outstanding preferred shares with 
respect to which there can be unrecognized gain or loss). See 
paragraph (b)(1)(ii)(A) of this section. Therefore, after the 
application of paragraph (b) of this section, the share is still a 
loss share and, as such, subject to paragraph (c) of this section. 
In addition, no adjustment is required under paragraph (c) of this 
section. The S share has a disconformity amount of $230. This $230 
disconformity amount is computed as the excess of the $600 basis in 
the S share over the S share's $370 allocable portion (1/1) of S's 
$370 net inside attribute amount. S's $370 net inside attribute 
amount is determined under paragraph (c)(5) of this section as the 
sum of $200 (S's $170 basis in the S1 share 1, adjusted for the $150 
loss recognized with respect to that share, and S's $20 basis in 
each of S1 share 2 through share 10), and S's $170 basis in Asset 1. 
(In computing the disconformity amount, the bases of S1 share 1 and 
share 2 are not treated as tentatively reduced because those shares 
are transferred in the transaction, and the bases of S1 share 3 
through share 10 are not treated as tentatively reduced because none 
of those shares have a disconformity amount--each share has a basis 
of $20 and a $21 allocable portion (1/10) of S1's $210 net inside 
attribute amount, as determined in paragraph (iii)(B) of this 
Example 9.) However, the S share's net positive adjustment is $0 
(the S share's net adjustment is negative $100). See paragraph 
(c)(3) of this section. Accordingly, the sale of the S share is 
still a transfer of a loss share. Because there are no higher-tier 
loss shares transferred in the transaction, this paragraph (d) then 
applies with respect to the transfer of the S share.
    (B) Attribute reduction under this paragraph (d). (1) 
Computation of S's attribute reduction amount. Under paragraph 
(d)(3) of this section, S's attribute reduction amount is the lesser 
of P's net stock loss and S's aggregate inside loss. P's net stock 
loss is $360 ($600 basis over $240 amount realized). S's aggregate 
inside loss is the excess of S's net inside attribute amount over 
the value of the S share. S's net inside attribute amount is the sum 
of its bases in its assets, treating its S1 shares as a single share 
(the S1 stock) and treating S's deemed basis in the S1 stock as its 
basis in that stock. Under paragraph (d)(5)(i)(C) of this section, 
when subsidiaries are owned in multiple tiers, deemed basis is first 
determined for shares at the lowest tier, and then for stock in each 
next higher tier. Under paragraph (d)(5)(i)(B) of this section, S1's 
deemed basis in the S2 stock is $75 (computed as the greater of $50 
(S1's $0 basis in the S2 share, adjusted for the $50 gain recognized 
with respect to the share) and $75 (S2's net inside attribute 
amount, the basis in Asset 2)). S1's deemed basis in the S3 stock is 
$75 (computed as the greater of $60 (S1's basis in the S3 share) and 
$75 (S3's net inside attribute amount, the basis in Asset 3)). S1's 
deemed basis in the S4 stock is $100 (computed as the greater of 
$100 (S1's basis in the S4 share) and $80 (S4's net inside attribute 
amount, the basis in Asset 4)). Accordingly, S1's net inside 
attribute amount is $250 ($75 deemed basis in the S2 stock plus $75 
deemed basis in the S3 stock plus $100 deemed basis in the S4 
stock). S's deemed basis in the S1 stock is the greater of the sum 
of S's actual basis in each share of S1 stock (adjusted for any gain 
or loss recognized) and S1's net inside attribute amount. S's actual 
basis in the S1 stock, adjusted for the loss recognized, is $200 
(the sum of S's $170 basis in the S1 share 1, adjusted by the $150 
loss recognized with respect to the share, and S's $20 basis in each 
of S1 share 2 through share 10). Thus, S's deemed basis in the S1 
stock is $250, the greater of $200 (aggregate basis in S1 shares, 
adjusted for loss recognized) and $250 (S1's net inside attribute 
amount). As a result, S's net inside attribute amount is $420, the 
sum of S's $250 deemed basis in the S1 stock and S's $170 basis in 
Asset 1. Accordingly, the aggregate inside loss is $180, the excess 
of S's $420 net inside attribute amount over the $240 value of all 
of the S stock. S's attribute reduction amount is therefore $180, 
the lesser of the $360 net stock loss and the $180 aggregate inside 
loss.
    (2) Allocation, apportionment, and application of S's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S's $180 attribute reduction amount is allocated 
proportionately (by basis) between Asset 1 (non-stock Category D 
asset) and the S1 stock. However, under paragraph (d)(5)(ii) of this 
section, for purposes of allocating S's $180 attribute reduction 
amount between S's non-stock Category D asset and the S1 stock, S's 
$250 deemed basis in the S1 stock is reduced by the $40 value of the 
transferred S1 shares (S1 share 1 and share 2) and the 
nontransferred S1 shares' $40 allocable portion (8/10) of S1's $50 
net non-loss assets. S1's net non-loss assets is the $50 value of 
S1's transferred S2 shares. (S1 has no other non-loss assets, and 
there are no non-loss assets held by lower-tier subsidiaries.) 
Accordingly, for this purpose, S's deemed basis in the S1 stock is 
reduced by $80, from $250 to $170. Thus, $90 of the attribute 
reduction amount ($170/$340 x $180) is allocated to Asset 1 
(reducing S's basis in Asset 1 from $170 to $80) and $90 of the 
attribute reduction amount ($170/$340 x $180) is allocated to the S1 
stock. Under paragraph (d)(5)(iii)(A) of this section, none of the 
$90 allocated attribute reduction amount is apportioned to S1 share 
1 because loss is recognized on the transfer of S1 share 1. Under 
paragraph (d)(5)(iii)(B) of this section, the $90 allocated 
attribute reduction amount is apportioned among the other nine 
shares of S1 common stock in a manner that reduces disparity to the 
greatest extent possible. Accordingly, of the total $90 allocated 
amount, $10 is apportioned to each of the remaining nine shares of 
S1 stock. Under paragraph (d)(5)(iii)(C) of this section, the 
allocated attribute reduction amount apportioned to an individual 
share cannot be applied to reduce the basis of the share below its 
value if the share is transferred other than in a recognition 
transfer. Because the S1 share 2 is transferred (contributed to the 
partnership) and the basis of S1 share 2 is already equal to its 
value, none of the $10 allocated attribute reduction amount 
apportioned to S1 share 2 is applied to reduce its basis. Because 
none of S1 share 3 through share 10 are transferred within the 
meaning of paragraph (f)(10) of this section, the $10 allocated 
attribute reduction amount apportioned to each of S1 share 3 through 
share 10 is applied fully to reduce the basis of each of those 
shares from $20 to $10. As a result, immediately after the 
allocation and application of S's attribute reduction amount, S's 
basis in Asset 1 is $80 ($170 minus $90), its bases in S1 share 1 
and share 2 are not adjusted under paragraph (d)(5)(iii), and its 
basis in each of S1 share 3 through share 10 is $10. Under paragraph 
(d)(5)(v)(A) of this section, the entire $90 of S's attribute 
reduction amount that was allocated to the S1 stock is an attribute 
reduction amount of S1, regardless of the fact that none of the 
allocated amount was apportioned to S1 share 1 and none of the 
amount apportioned to S1 share 2 was applied to reduce the basis of 
S1 share 2.
    (v) Attribute reduction under this paragraph (d) in next lower 
tier. (A) Computation of S1's attribute reduction amount. S's sale 
of S1 share 1 is a transfer of a loss share and it is in the next 
lower tier. Thus, this paragraph (d) next applies with respect to 
S's transfer of S1 share 1. S1's attribute reduction amount will 
include both the $90 attribute reduction amount that tiered down 
from S and any attribute reduction amount resulting from the 
application of this paragraph (d) with respect to S's transfer of S1 
share 1 and share 2 (S1's direct attribute reduction amount). Under 
paragraph (d)(3) of this section, S1's direct attribute reduction 
amount is the lesser of the net stock loss on transferred S1 shares 
and S1's aggregate inside loss. The net stock loss on transferred S1 
shares is $150, computed as the excess of S's $190 adjusted bases in 
transferred shares of S1 stock ($170 in S1 share 1 plus $20 in S1 
share 2) over the $40 aggregate value of those shares. S1's 
aggregate inside loss is $50, the excess of S1's $250 net inside 
attribute amount (as calculated in paragraph (iv)(B)(1) of this 
Example 9) over the $200 value of all outstanding S1 shares. 
Therefore, S1's direct attribute reduction amount is $50, the lesser 
of the $150 net

[[Page 53978]]

stock loss and S1's $50 aggregate inside loss. S1's total attribute 
reduction amount is thus $140, the sum of the $90 tier-down 
attribute reduction amount and the $50 direct attribute reduction 
amount.
    (B) Allocation, apportionment, and application of S1's attribute 
reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this 
section, S1's $140 attribute reduction amount is allocated 
proportionately (by basis) among the S2 stock, the S3 stock, and the 
S4 stock. However, under paragraph (d)(5)(ii) of this section, for 
purposes of allocating S1's $140 attribute reduction amount among 
S1's lower-tier subsidiary stock, S1's $75 deemed basis in the S2 
stock is reduced by the $50 value of the transferred S2 share. 
Accordingly, for this purpose, S1's deemed basis in the S2 stock is 
reduced by $50, from $75 to $25. Thus, $17.50 of S1's attribute 
reduction amount ($25/$200 x $140) is allocated to the S2 stock, 
$52.50 of S1's attribute reduction amount ($75/$200 x $140) is 
allocated to the S3 stock, and $70 of S1's attribute reduction 
amount ($100/$200 x $140) is allocated to the S4 stock. Under 
paragraph (d)(5)(iii)(A) of this section, none of the $17.50 of S1's 
attribute reduction amount allocated to S2 stock is apportioned to 
the S2 share because gain was recognized on the transfer of the S2 
share. Because neither the S3 share nor the S4 share is transferred 
within the meaning of paragraph (f)(10) of this section, the $52.50 
of S1's attribute reduction amount allocated to the S3 stock, and 
the $70 of S1's attribute reduction amount allocated to the S4 
stock, is apportioned to and applied fully to reduce the basis of 
such shares. Thus, S1's basis in the S3 share is reduced by $52.50, 
from $60 to $7.50, and S1's basis in the S4 stock is reduced by $70, 
from $100 to $30. (Note: The conforming limitation in paragraph 
(d)(5)(v)(B) of this section limits the application of the $90 tier 
down attribute reduction amount to $80, the amount by which the 
portion (10/10) S1's $250 net inside attribute amount attributable 
to S1 shares held by members exceeds $170 (the sum of the $50 direct 
attribute reduction amount, the $20 value of the S1 share 1 
transferred in a recognition transfer, the $20 basis (after 
reduction) in the S1 share 2 transferred other than in a recognition 
transfer, and the $80 aggregate basis (after reduction) in the 
nontransferred S1 shares held by members). However, the conforming 
limitation does not limit the application of S1's $90 tier-down 
attribute reduction amount because none of the $17.50 of S1's total 
attribute reduction amount allocated to the S2 share was applied to 
reduce the basis of the share. Accordingly, only $78.75 ($90--
($17.50 x ($90/$140)) of the $90 tier-down attribute reduction was 
applied to reduce S1's attributes.) Under paragraph (d)(5)(v)(A) of 
this section, the attribute reduction amount allocated to the S2 
stock, the S3 stock, and the S4 stock becomes an attribute reduction 
amount of S2, S3, and S4, respectively (even though the amount 
allocated to S2 stock was not apportioned to or applied to reduce 
the basis of the S2 share).
    (vi) Attribute reduction under this paragraph (d) in lowest 
tier. Although the sale of the S2 share is a transfer of subsidiary 
stock at the next lower tier, the S2 share is not a loss share. 
Thus, this paragraph (d) does not apply with respect to that 
transfer. However, S2, S3, and S4 have attribute reduction amounts 
that tiered down from S1 and that are applied to reduce attributes 
under this paragraph (d).
    (A) Tier down of S1's attribute reduction amount to S2. Under 
the general rules of this paragraph (d), S2's $17.50 tier-down 
attribute reduction amount is allocated and applied to reduce S2's 
basis in Asset 2 from $75 to $57.50.
    (B) Tier down of S1's attribute reduction amount to S3. Under 
the general rules of this paragraph (d), S3's $52.50 tier-down 
attribute reduction amount is allocated and applied to reduce S3's 
basis in Asset 3 from $75 to $22.50.
    (C) Tier down of S1's attribute reduction amount to S4, 
application of conforming limitation. Under the general rules of 
this paragraph (d), S4's $70 tier-down attribute reduction amount is 
allocated to, and would be applied to reduce, S4's basis in Asset 4. 
However, under paragraph (d)(5)(v)(B) of this section, the reduction 
is limited to the excess of S4's $80 net inside attribute amount 
over the $30 basis of the S4 share (after reduction under this 
paragraph (d)). As a result, only $50 (the excess of $80 over $30) 
of S4's $70 attribute reduction amount is applied to S4's basis in 
Asset 4, reducing it from $80 to $30. The $20 unapplied portion of 
S4's tier-down attribute reduction amount subject to the conforming 
limitation is disregarded and has no further effect.
    (vii) Application of basis restoration rule. Under paragraph 
(d)(5)(vi)(A) of this section, after this paragraph (d) has been 
applied with respect to all transfers of subsidiary stock, any 
reduction made to the basis of a share of lower-tier subsidiary 
stock under paragraph (d)(5)(iii) of this section is reversed to the 
extent necessary to conform the basis of that share to the share's 
allocable portion of the subsidiary's net inside attribute amount. 
Restoration adjustments are first made at the lowest tier and then 
at each next higher tier successively.
    (A) Basis restoration at lowest tier. The basis of the S2 share 
was not reduced under paragraph (d)(5)(iii) of this section and so 
there is no restoration of any basis in the S2 share. S3's $22.50 
net inside attribute amount (after reduction under this paragraph 
(d)) exceeds S1's $7.50 basis in the S3 share (after reduction under 
this paragraph (d)) by $15. To conform S1's basis in the S3 share to 
S3's net inside attribute amount, the $52.50 reduction to the basis 
of the S3 share under paragraph (d)(5)(iii) of this section is 
reversed by $15 (restoring S1's basis in the S3 share to $22.50). 
The restoration of S1's basis in the S3 share does not tier up to 
affect the basis in stock of any other subsidiary. S1's $30 basis in 
the S4 share (after reduction under this paragraph (d)) is already 
conformed with S4's $30 net inside attribute amount (after reduction 
under this paragraph (d)) and so there is no restoration of any 
basis in the S4 share.
    (B) Basis restoration at next higher tier. Each share of S1 
stock has an allocable portion of S1's net inside attribute amount 
(after reduction) equal to $10.25 (1/10 x $102.50, the sum of S1's 
$0 basis in the S2 stock, adjusted for the $50 gain recognized with 
respect to the share, S1's $22.50 basis in the S3 stock (after 
restoration), and S1's $30 basis in the S4 stock). Neither S's basis 
in S1 share 1 nor S's basis in S1 share 2 was reduced under 
paragraph (d)(5)(iii) of this section. Accordingly, there is no 
restoration of any basis in either S1 share 1 or share 2. However, 
S's basis in each of S1 share 3 through share 10 was reduced under 
paragraph (d)(5)(iii) of this section by $10, from $20 to $10. 
Accordingly, the $10 reduction to the basis of each of those shares 
is reversed to the extent of $.25, to restore the basis of each such 
share to $10.25 (its allocable portion of S1's net inside attribute 
amount).
    (viii) Results. After the application of this section, P 
recognizes a loss of $360 on the sale of the S share, S recognizes a 
loss of $150 on the sale of S1 share 1, and S1 recognizes a $50 gain 
on the sale of the S2 share. Immediately after the transaction, the 
entities each directly own the following:

----------------------------------------------------------------------------------------------------------------
                    Entity                                      Asset                      Basis        Value
----------------------------------------------------------------------------------------------------------------
P1............................................  S share..............................         $240          $240
P.............................................  Proceeds of the sale of S share......          240           240
S.............................................  Proceeds of sale of S1 share 1.......           20            20
                                                Partnership interest received for S1            20            20
                                                 share 2.
                                                S1 share 3 through share 10..........   82 ($10.25   ...........
                                                                                        per share)
                                                Asset 1..............................           80   ...........
S1............................................  Proceeds of sale of S2 share.........           50            50
                                                The S3 share.........................        22.50   ...........
                                                The S4 share.........................           30   ...........
S2............................................  Asset 2..............................        57.50   ...........
S3............................................  Asset 3..............................        22.50   ...........
S4............................................  Asset 4..............................           30   ...........

[[Page 53979]]

 
X.............................................  S1 share 1...........................           20            20
Partnership...................................  S1 share 2...........................           20            20
Y.............................................  The S2 share.........................           50            50
----------------------------------------------------------------------------------------------------------------

    (e) Operating rules--(1) Predecessors, successors. This section 
applies to predecessor or successor persons, groups, and assets to the 
extent necessary to effectuate the purposes of this section.
    (2) Adjustments for prior transactions that altered stock basis or 
other attributes. In certain situations, M's basis in S stock or S's 
attributes may be adjusted in a manner that alters the relationship 
between stock basis and inside attributes and prevents that 
relationship from identifying the extent to which stock basis reflects 
unrecognized gain and duplicated loss. The provisions of this paragraph 
(e)(2) modify the computations in paragraphs (c) and (d) of this 
section to adjust for the effects of such adjustments.
    (i) Prior reductions to S's basis in assets or other attributes 
pursuant to section 362(e)(2)(A). If M transferred loss property to S 
in an intercompany transaction subject to section 362(e)(2) (for 
example, if the transfer was prior to September 17, 2008, no election 
was made to apply Sec.  1.1502-80(h), and, as a result, S's attributes 
were reduced under section 362(e)(2)), then the disconformity amount of 
the S shares received in the section 362(e)(2) transaction is reduced 
by the amount that the basis in such shares would have been reduced 
under section 362(e)(2)(C) had such an election been made. In addition, 
for purposes of determining the attribute reduction amount under 
paragraph (d) of this section resulting from the transfer of any S 
shares received (or deemed received) in such a transfer, and for 
purposes of applying paragraph (d)(5)(v)(B) of this section (conforming 
limitation) to S, the bases in such shares is treated as reduced by the 
amount the bases in such shares would have been reduced under section 
362(e)(2)(C) had such an election been made.
    (ii) Prior reductions to the basis of any share of S stock pursuant 
to an election under section 362(e)(2)(C). If M transferred loss 
property to S in an intercompany transaction subject to section 
362(e)(2) and the basis of any share of S stock was reduced as the 
result of an election under section 362(e)(2)(C) (including in the 
hands of a predecessor, to the extent that the effect of the election 
remains reflected in the basis of the S stock), then, for purposes of 
computing either any S share's disconformity amount or S's aggregate 
inside loss, and for purposes of applying paragraph (d)(5)(vi)(A) of 
this section (stock basis restoration) to S, S's net inside attribute 
amount is treated as reduced by the amount that S's attributes would 
have been reduced under section 362(e)(2)(A) in the absence of an 
election under section 362(e)(2)(C). Notwithstanding the general rule 
of this paragraph (e)(2)(ii), no reduction will be required to the 
extent that the group can establish that the net loss in the S shares 
transferred by M is no longer reflected in S's net inside attributes.
    (iii) Other adjustments. Appropriate adjustments will be made in 
any other case in which an adjustment to S's net inside attributes or 
to M's basis in a share of S stock alters the relationship between such 
amounts, and the adjustment does not relate to the extent to which loss 
reflected in M's basis in S stock is noneconomic or duplicated within 
the meaning of this section.
    (3) Special rules for subsidiary stock transferred in an 
intercompany transaction--(i) In general. This section applies with 
respect to M's transfer of a share of S stock to another member in an 
intercompany transaction in which M's intercompany item is deferred 
under Sec.  1.1502-13 (and to any subsequent transfer of that share by 
a member) as of the time M's intercompany item is taken into account 
under Sec.  1.1502-13. In determining the application of this section, 
all transferor-members are treated as divisions of a single 
corporation. Appropriate adjustments will be made to the intercompany 
item(s), any member's basis in an S share, to S's attributes, or any 
combination thereof, to further the purposes of this section and Sec.  
1.1502-13.
    (ii) Certain prior intercompany transactions. If M transferred a 
share of S stock to another member before September 17, 2008 and M's 
intercompany item related to the transfer is taken into account on or 
after September 17, 2008, P may elect to apply this paragraph (e)(3) to 
the transfer. The election is made in the manner provided in paragraph 
(e)(5) of this section.
    (iii) Examples. The application of this paragraph (e)(3) is 
illustrated by the following examples:

    Example 1. Intercompany sale with duplicated loss. (i) Buying 
member later sells at gain. (A) Facts. M owns the sole outstanding 
share of stock of S with a basis of $100. S has one asset with a 
basis of $100. M sells the S share to M1 for $70, recognizing a loss 
of $30. While owned by M1, S recognizes $10 of depreciation 
deductions that are absorbed by the group. S's basis in the asset is 
reduced by $10 (from $100 to $90), and M1's basis in the S stock is 
reduced under Sec.  1.1502-32 by $10 (from $70 to $60). Later, M1 
sells the S share to X, an unrelated person, for $80.
    (B) Analysis. M's sale of its S share to M1 is a transfer of the 
share, but this section applies as of the time M's intercompany item 
is taken into account under Sec.  1.1502-13, as if M and M1 were 
divisions of a single corporation. If M and M1 were divisions of a 
single corporation, the S share's basis would be $90 ($100 reduced 
by $10 for the depreciation deductions absorbed by the group) and 
the group would recognize a $10 loss on the sale of the share that 
is potentially subject to this section. Thus, the sale would be a 
transfer of a loss share (to the extent of $10) and would be subject 
to this section (to the extent of that $10). Although the transfer 
would be subject to this section, there would be no adjustment under 
paragraph (b) of this section (S has only one share outstanding and 
so there is no disparity in bases of common shares and no 
unrecognized gain or loss with respect to preferred) or under 
paragraph (c) of this section (S has no net positive adjustment). 
Thus, after the application of paragraph (c) of this section, the 
share would still be a loss share and would therefore be subject to 
paragraph (d) of this section. Under paragraph (d) of this section, 
S would be subject to $10 of attribute reduction (the lesser of the 
$10 net stock loss and S's $10 aggregate inside loss), allocable to 
the basis in S's asset. Accordingly, S's basis in its asset is 
reduced by $10, from $90 to $80, M takes its $30 intercompany stock 
loss into account, and M1 recognizes a $20 stock gain.
    (ii) Selling member deconsolidates. Assume the same facts as in 
paragraph (i)(A) of this Example 1, except that M1 does not sell the 
S share and M ceases to be a member of the group when the value of 
the S share is $80. Under Sec.  1.1502-13, M's deconsolidation 
causes M's intercompany loss to be taken into account and this 
section applies at that time. At the time that M deconsolidates, if 
M and M1 were divisions of a single corporation, the basis in the S 
share would be $90 ($100 reduced by $10 for the depreciation 
deductions absorbed by the group) and the group would recognize a 
$10 loss on the sale of the share that is potentially subject to 
this section. Such a sale would be a transfer of a loss share (to 
the extent of $10) and would be subject to this section (to the 
extent of that $10). The analysis is then the

[[Page 53980]]

same as in paragraph (i)(B) of this Example 1. As a result, S's 
basis in its asset is reduced from $90 to $80, M takes its $30 
intercompany stock loss into account, and M1 holds the S stock with 
a basis of $60 (and an unrecognized gain of $20).
    (iii) M1 sells the S share at a loss. Assume the same facts as 
in paragraph (i)(A) of this Example 1, except that S declines in 
value and M1 sells the S share to X for $50, realizing a $10 loss. 
In this case, if M and M1 were divisions of a single corporation, 
the share's basis would be $90 ($100 reduced by $10 for the 
depreciation deductions absorbed by the group) and the group would 
recognize a $40 loss on the sale of the share that is potentially 
subject to this section. Thus, the sale would be a transfer of a 
loss share (to the extent of $40) and would be subject to this 
section (to the extent of that $40). Although the transfer would be 
subject to this section, for the reasons set forth in paragraph 
(i)(B) of this Example 1, there would be no adjustment under either 
paragraph (b) or paragraph (c) of this section. Thus, after the 
application of paragraph (c), the share would still be a loss share 
and would therefore be subject to paragraph (d) of this section. 
Under paragraph (d) of this section, S would be subject to $40 of 
attribute reduction (the lesser of the $40 net stock loss and S's 
$40 aggregate inside loss), allocable to the basis in S's asset. 
Accordingly, S's basis in its asset is reduced by $40, from $90 to 
$50, M takes its $30 intercompany stock loss into account, and M1 
recognizes a $10 stock loss.
    Example 2. Intercompany sale of built-in gain stock. (i) Facts. 
M owns the sole outstanding share of stock of S with a basis of 
$100. S's sole asset has a basis of $0. S sells its asset for $100 
and recognizes a $100 gain that increases M's basis in its S share 
under Sec.  1.1502-32 to $200. M sells the S share to M1 for $100 
and recognizes a $100 intercompany loss. Later, M1 sells the S share 
to X, an unrelated person, for $120.
    (ii) Analysis. M's sale of the S share to M1 is a transfer of 
the share, but this section applies as of the time M's intercompany 
item is taken into account under Sec.  1.1502-13, as if M and M1 
were divisions of a single corporation. If M and M1 were divisions 
of a single corporation, the S share's basis would be $200 ($100 
increased by $100 for the gain recognized on the sale of the asset) 
and the group would recognize an $80 loss on the sale of the share 
that is potentially subject to this section. Thus, the sale would be 
a transfer of a loss share (to the extent of $80) and would be 
subject to this section (to the extent of that $80). Although the 
transfer would be subject to this section, there would be no 
adjustment under paragraph (b) of this section (S has only one share 
outstanding and so there is no disparity in bases of common shares 
and no unrecognized gain or loss with respect to preferred). Thus, 
after the application of paragraph (b), the share would still be a 
loss share and would therefore be subject to paragraph (c) of this 
section. Under paragraph (c) of this section, the basis in the S 
share would be reduced, but not below its $120 value, by the lesser 
of the $100 disconformity amount and the $100 net positive 
adjustment that was applied to the share when held by M. 
Accordingly, the basis in the S share would be reduced by $80, to 
$120. Because the S share would not be a loss share after the 
application of paragraph (c) of this section, paragraph (d) of this 
section would not apply to the transfer. As a result, because the 
positive adjustment was applied to the share when held by M, M's 
intercompany item is adjusted to reflect what it would have been had 
M's basis in its S share been reduced by $80 immediately before its 
sale to M1. Thus, M's intercompany loss is reduced to $20 and M 
takes this loss into account, and M1 recognizes a gain of $20.
    Example 3. Intercompany sale creates built-in gain stock. (i) 
Facts. M owns the sole outstanding share of stock of S with a basis 
of $0. S's sole asset has a basis of $0. M sells the S share to M1 
for $100 and recognizes a $100 intercompany gain. While owned by M1, 
S sells its asset for $100, recognizing a $100 gain that increases 
M1's basis in the S share under Sec.  1.1502-32 to $200. Later, M1 
sells the S share to X for $120.
    (ii) Analysis. M's sale of its S share to M1 is a transfer of 
the share, but this section applies as of the time M's intercompany 
item is taken into account under Sec.  1.1502-13, as if M and M1 
were divisions of a single corporation. If M and M1 were divisions 
of a single corporation, the S share's basis would be $100 ($0 
increased by $100 for the gain recognized on the sale of the asset) 
and the group would recognize a $20 gain on the sale of the share. 
Thus, the sale would not be a transfer of a loss share and this 
section would not apply to the transfer. Accordingly, under this 
paragraph (e)(3), no portion of M1's $80 loss is subject to this 
section. M takes its $100 intercompany stock gain into account, and 
M1 recognizes an $80 loss.
    Example 4. Disparate bases in members' shares. (i) Facts. M 
holds Share A, one of the two outstanding shares of S stock, with a 
basis of $50 and M1 holds Share B, the other outstanding share of S 
stock with a basis of $0. S has $50 cash and an asset with a basis 
of $0. S sells the asset for $50, recognizing a $50 gain that 
increases M's basis in its S share under Sec.  1.1502-32 by $25 
(from $50 to $75) and increases M1's basis under Sec.  1.1502-32 by 
$25 (from $0 to $25). Later, M sells its Share A to M1 for $50 and 
recognizes a $25 intercompany loss. Later, M1 sells both S shares to 
X for $100.
    (ii) Analysis. M's sale of its Share A to M1 is a transfer of 
the share, but this section applies as of the time M's intercompany 
item is taken into account under Sec.  1.1502-13, as if M and M1 
were divisions of a single corporation. If M and M1 were divisions 
of a single corporation, the basis of Share A would be $75 ($50 
increased by $25 for its share of the gain recognized on the sale of 
the asset), the basis of Share B would be $25, and the group would 
recognize a $25 loss on the sale of Share A that is potentially 
subject to this section and a $25 gain on the sale of Share B. Thus, 
the sale would be a transfer of a loss share (to the extent of $25) 
and would be subject to this section (to the extent of that $25). 
Although the transfer is subject to this section, there would be no 
adjustment under paragraph (b) of this section (all S shares held by 
members are transferred to a nonmember in one taxable transaction). 
Thus, after the application of paragraph (b), Share A would still be 
a loss share and therefore subject to paragraph (c) of this section. 
Under paragraph (c)(7) of this section, the basis of Share A would 
be treated as reduced by the gain recognized and taken into account 
with respect to the transfer of Share B in the same transaction, and 
so Share A would not be a loss share for purposes of paragraph (c) 
of this section. Although the share would be a loss share after the 
application of paragraph (c) of this section, no adjustment would be 
required under paragraph (d) of this section because there would be 
no net stock loss in the transaction. Because no adjustment would be 
made under this section if M and M1 were divisions of a single 
corporation, M takes its $25 intercompany stock loss into account 
and M1 recognizes a gain of $25. Alternatively, if the group elects 
to apply paragraph (b) of this section, M's intercompany item would 
be adjusted to reflect what it would have been had the $25 
investment adjustment applied to Share A been reallocated to Share 
B, and M1's basis in Share B would be increased by that amount. If 
so, M's $25 intercompany loss would be reduced to zero, M1's basis 
in Share B would be increased from $25 to $50, and there would be no 
gain or loss recognized on either share.
    Example 5. Subsidiary with built-in gain and built-in loss 
assets. (i) Facts. M owns the sole outstanding share of stock of S 
with a basis of $100. S has two assets, Asset 1 with a basis of $0 
and Asset 2 with a basis of $80. M sells the S share to M1 for $90 
and recognizes a $10 intercompany loss. While owned by M1, S sells 
Asset 1 for $60, recognizing a $60 gain that increases M1's basis in 
the S share under Sec.  1.1502-32 to $150. Later, M1 sells the S 
share to X for $90.
    (ii) Analysis. M's sale of the S share to M1 is a transfer of 
the share, but this section applies as of the time M's intercompany 
item is taken into account under Sec.  1.1502-13, as if M and M1 
were divisions of a single corporation. If M and M1 were divisions 
of a single corporation, the S share's basis would be $160 ($100 
increased by $60 for the gain recognized on the sale of Asset 1) and 
the group would recognize a $70 loss on the sale of the share that 
is potentially subject to this section. Thus, the sale would be a 
transfer of a loss share (to the extent of $70) and would be subject 
to this section (to the extent of that $70). Although the transfer 
is subject to this section, there would be no adjustment under 
paragraph (b) of this section (S has only one share outstanding and 
so there is no disparity in bases of common shares and no 
unrecognized gain or loss with respect to preferred). Thus, after 
the application of paragraph (b), the share would still be a loss 
share and would therefore be subject to paragraph (c) of this 
section. Under paragraph (c) of this section, the basis in the S 
share would be reduced, but not below its $90 value, by the lesser 
of the $20 disconformity amount ($160 stock basis over $140 net 
inside attribute amount) and the $60 net positive adjustment that 
was applied to the share when held by M1. Accordingly, the basis in 
the S share would be reduced by $20, to $140. Because the S share 
would still be

[[Page 53981]]

a loss share after the application of paragraph (c) of this section, 
paragraph (d) of this section would apply to the transfer. Under 
paragraph (d) of this section, S would have an attribute reduction 
amount of $50, the lesser of the $50 net stock loss ($140 basis over 
$90 value) and S's $50 aggregate inside loss (the excess of the sum 
of S's $80 basis in Asset 2 and S's $60 cash from the sale of Asset 
1, over the $90 value of the S share). The adjustments required 
under this section are applied as follows: because the positive 
adjustment was applied to the share when held by M1, the $20 basis 
reduction required under paragraph (c) of this section is applied to 
M1's basis in its S share immediately before its sale to X, reducing 
it from $150 to $130. In addition, pursuant to paragraph (d) of this 
section, S's basis in Asset 2 is reduced by $50, from $80 to $30. M 
takes its $10 intercompany stock loss into account and M1 recognizes 
a loss of $40.
    (iii) Allocation of basis reduction. Assume the same facts as in 
paragraph (i) of this Example 5, except that, while S is held by M, 
S earns $30 (consuming a portion of Asset 1) and, while S is held by 
M1, S earns $20 (consuming a portion of Asset 1) and sells Asset 1 
for $10. Thus, M's basis in the S share immediately before the sale 
to M1 is $130, and M recognizes a $40 intercompany stock loss, and 
M1's basis in the S share immediately before the sale to X is $120. 
The analysis regarding the application of this section is the same 
as in paragraph (ii) of this Example 5. On a separate entity basis, 
M's basis in the S share would be subject to a $20 reduction under 
paragraph (c) of this section (at the time M transferred the S share 
the share had a $30 net positive adjustment and a $20 disconformity 
amount), and M1's basis in the S share would not be subject to 
reduction under paragraph (c) of this section (at the time M1 
transferred the S share the share had a $30 net positive adjustment 
and a $20 negative disconformity amount). Therefore, the $20 basis 
reduction required under paragraph (c) of this section is allocated 
entirely to M. Accordingly, M's intercompany item is adjusted to 
reflect what it would have been had the entire $20 basis reduction 
been applied to the S share while held by M, and M1's basis in the S 
share is not reduced. Thus, M's intercompany stock loss is reduced 
by $20 to $20 and M takes this loss into account, and M1 recognizes 
a $30 loss. S's basis in Asset 2 is reduced by $50, from $80 to $30.

    (4) Limited application to multiple-member section 332 
liquidations. If more than one member owns shares of S stock, 
paragraphs (c) and (d) of this section do not apply to any transfer of 
S shares resulting from a liquidation of S to which section 332 
applies.
    (5) Form and manner of election(s) under this section. The 
elections provided in this section are irrevocable and made in the form 
of a statement titled ``Section 1.1502-36 Statement.'' The statement 
must be included on or with the group's timely filed return (original 
or amended, if filed by the due date for the return, including 
extensions) for the taxable year of the transfer of the subsidiary 
stock to which the election relates or, in the case of an intercompany 
transfer, the year in which the intercompany item from the transfer is 
taken into account. The statement must include--
    (i) The name and employer identification number (E.I.N.) of each 
subsidiary with respect to which an election is being made;
    (ii) If P is electing under paragraph (b)(1)(ii) of this section to 
redetermine basis with respect to the transfer of stock of one or more 
subsidiaries, a statement that members' bases in shares of [name of 
subsidiary or subsidiaries] stock are being redetermined 
notwithstanding that all members' shares of [name of subsidiary or 
subsidiaries] are being transferred to one or more nonmembers in one 
fully taxable transaction;
    (iii) If P is electing under paragraph (d)(2)(ii) of this section 
(attribute reduction amount less than five percent of value) to apply 
the attribute reduction provisions, a statement that paragraph (d) of 
this section is being applied to the transfer of shares of stock of 
[names of all subsidiaries whose shares are transferred] 
notwithstanding that the aggregate attribute reduction amount in the 
transaction is less than five percent of the aggregate value of the 
stock of [names of all subsidiaries whose shares are transferred] 
transferred by members in the transaction;
    (iv) If P is electing under paragraph (d)(4)(ii)(A)(1) of this 
section to specify the allocation of the attribute reduction amount, a 
statement (for each subsidiary for which the election is being made) 
that the attribute reduction amount of [name of subsidiary] is being 
applied (or not applied) to reduce [identify the attributes in Category 
A, Category B, and Category C, and the amount of each, with respect to 
which the election is being made];
    (v) If P is electing under paragraph (d)(5)(v)(B) of this section 
not to apply the conforming limitation on tier-down attribute reduction 
with respect to one or more subsidiaries, a statement that the 
conforming limitation in paragraph (d)(5)(v)(B) of this section is not 
being applied with respect to [name of subsidiary or subsidiaries];
    (vi) If P is electing under paragraph (d)(5)(vi)(B) of this section 
not to restore lower-tier subsidiary stock basis with respect to one or 
more subsidiaries, a statement that members' bases in [name of 
subsidiary or subsidiaries] is not being restored under paragraph 
(d)(5)(vi)(A) of this section;
    (vii) If P is electing under paragraph (d)(6) of this section to 
reattribute attributes, a statement (for each subsidiary for which the 
election is being made) that [identify the attributes in Category A, 
Category B, and Category C, and the amount of each or the amount in 
excess of an amount, with respect to which the election is being made] 
of [name of subsidiary] are being reattributed (or not) to P;
    (viii) If P is electing under paragraph (d)(6) of this section to 
reduce stock basis, a statement (for each subsidiary for which the 
election is being made) that members' bases in shares of stock of [name 
of subsidiary] are being reduced by [specify amount or the amount in 
excess of an amount];
    (ix) If P is electing under paragraph (e)(3)(ii) of this section to 
apply paragraph (e)(3) of this section to an intercompany transfer that 
occurred before September 17, 2008, a statement that paragraph (e)(3) 
of this section is being elected to apply to the transfer of stock of 
[name of subsidiary] by [name of transferor subsidiary] to [name of 
transferee subsidiary] on [date of transfer]; and
    (x) If P is electing under Sec.  1.1502-96(d)(5) to reattribute to 
itself all or any part of a section 382 limitation, a statement that P 
is electing to reattribute a section 382 limitation with respect to 
losses of [name of subsidiary or, if two or more subsidiaries are 
members of a loss subgroup, the name of each subsidiary in the loss 
subgroup]. A separate statement is made for each subsidiary or loss 
subgroup for which an election is being made. Each statement must 
include--
    (A) The date of the ownership change giving rise to the separate 
section 382 limitation or subgroup section 382 limitation that is being 
apportioned;
    (B) The amount of the separate (or subgroup) section 382 limitation 
for the taxable year in which the reattribution occurs (determined 
without reference to any apportionment under this section or Sec.  
1.1502-95(c)); and
    (C) The amount of each net operating loss carryover, capital loss 
carryover, or deferred deduction, and the year in which it arose, of 
the subsidiary (or subsidiaries) that is subject to the separate 
section 382 limitation or subgroup section 382 limitation that is being 
apportioned to the common parent, and the amount of the value element 
and adjustment element of that limitation that is apportioned to the 
common parent.
    (f) Definitions. In addition to the definitions in other paragraphs 
of this section and in other provisions of the regulations under 
section 1502, the following definitions apply for purposes of this 
section.

[[Page 53982]]

    (1) Allocable portion has the same meaning as in Sec.  1.1502-
32(b)(4)(iii)(B). Thus, for example, within a class of stock, each 
share has the same allocable portion of the net inside attribute amount 
and, if there is more than one class of stock, the net inside attribute 
amount is allocated to each class by taking into account the terms of 
each class and all other facts and circumstances relating to the 
overall economic arrangement.
    (2) Deferred deduction means any deduction for expenses or loss 
that would be taken into account under general tax accounting 
principles as of the time of the transfer of the share, but that is 
nevertheless not taken into account immediately after the transfer by 
reason of the application of a deferral provision. Such provisions 
include, for example, sections 267(f) and 469, and Sec.  1.1502-13. 
``Deferred deduction'' also includes S's portion of such consolidated 
tax attributes, for example consolidated excess charitable 
contributions that would be apportioned to S under the principles of 
Sec.  1.1502-79(e) if S had a separate return year. Additionally, it 
includes amounts equivalent to deductions, such as negative adjustments 
under section 475 (mark to market accounting method for dealers in 
securities) and section 481 (adjustments required by changes in method 
of accounting).
    (3) Distribution has the same meaning as in Sec.  1.1502-
32(b)(3)(v).
    (4) Higher-tier, lower-tier. A subsidiary (S1) (and its shares of 
stock) is ``higher-tier'' with respect to another subsidiary (S2) (and 
its shares of stock) if investment adjustments made to the bases of 
shares of S2 stock under Sec.  1.1502-32 affect the investment 
adjustments made to the bases of shares of S1 stock. A subsidiary (S1) 
(and its shares of stock) is ``lower-tier'' with respect to another 
subsidiary (S) (and its shares of stock) if investment adjustments made 
to the bases of shares of S1 stock affect the investment adjustments 
made to the bases of shares of S stock. The term lowest-tier subsidiary 
generally refers to a subsidiary that owns no stock of another 
subsidiary. The term highest-tier subsidiary generally refers to a 
subsidiary the stock of which is not lower tier to any shares 
transferred in the transaction.
    (5) Liability means a liability that has been incurred within the 
meaning of section 461(h), except to the extent otherwise provided in 
paragraph (d)(4)(ii)(C)(1) of this section.
    (6) Loss carryover means any net operating or capital loss 
carryover that is attributable to S, including any losses that would be 
apportioned to S under the principles of Sec.  1.1502-21(b)(2) if S had 
a separate return year. However, solely for purposes of applying 
paragraph (d) of this section, loss carryovers do not include the 
amount of any losses waived under Sec.  1.1502-32(b)(4).
    (7) Loss share, gain share. A loss share is a share of stock with a 
basis that exceeds its value. A gain share is a share of stock with a 
value that exceeds its basis.
    (8) Preferred stock, common stock. Preferred stock and common stock 
have the same meanings as in Sec.  1.1502-32(d)(2) and (3), 
respectively.
    (9) Transaction includes all the steps taken pursuant to the same 
plan or arrangement.
    (10) Transfer--(i) Definition. Except as provided in paragraph 
(f)(10)(ii) of this section, for purposes of this section, M transfers 
a share of S stock on the earliest of--
    (A) The date that M ceases to own the share as a result of a 
transaction in which, but for the application of this section (and 
notwithstanding the deferral of any amount recognized on the transfer, 
other than by reason of Sec.  1.1502-13), M would recognize income, 
gain, loss or deduction with respect to the share (see paragraph (e)(3) 
of this section in the case of a transfer in an intercompany 
transaction);
    (B) The date that M and S cease to be members of the same group;
    (C) The date that a nonmember acquires the share from M; and
    (D) The last day of the taxable year during which the share becomes 
worthless under section 165 (taking into account the provisions of 
Sec.  1.1502-80(c)) if the share is treated as a capital asset, or the 
date the share becomes worthless (taking into account the provisions of 
Sec.  1.1502-80(c)) if the share is not treated as a capital asset.
    (ii) Excluded transactions. Notwithstanding paragraph (f)(10)(i) of 
this section, M does not transfer a share of S stock if--
    (A) M ceases to own the share as a result of a transaction to which 
section 381(a) applies and in which either a member acquires assets 
from S or S acquires assets from M, provided that--
    (1) M recognizes no income, gain, loss, or deduction with respect 
to the share, and
    (2) If the transaction is a liquidation to which section 332 
applies, M is the only member that owns shares of S stock (if another 
member owns shares of S stock, see paragraph (e)(4) of this section for 
a limitation on the application of this section); or
    (B) M ceases to own the share as a result of a distribution of the 
share to a nonmember in a transaction to which section 355 applies, and 
in which the share is treated as qualified property for purposes of 
section 355(c) or section 361(c).
    (11) Value means the amount realized, if any, or otherwise the fair 
market value.
    (g) Anti-abuse rule--(1) General rule. If a taxpayer acts with a 
view to avoid the purposes of this section or to apply the rules of 
this section to avoid the purposes of any other rule of law, 
appropriate adjustments will be made to carry out the purposes of this 
section or such other rule of law.
    (2) Examples. The following examples illustrate the principles of 
the anti-abuse rule in this paragraph (g). No implication is intended 
regarding the potential applicability of any other anti-abuse rules:

    Example 1. Loss Trafficking. (i) Facts. M purchases the sole 
outstanding share of S stock for $100. At that time, S owns Asset 1 
with a basis of $0. S sells Asset 1 for $100. Later, S purchases the 
sole outstanding share of X stock, a corporation with losses, with a 
view to liquidating X in a transaction to which section 332 applies 
in order to reduce S's disconformity amount. S purchases the X share 
for $1, and X has a $100 NOL and an asset with a basis of $1. 
Subsequently, M sells its S share for $100. After taking into 
account the effects of all applicable rules of law, M's basis in the 
S share is $200 (M's original $100 basis, increased under Sec.  
1.1502-32 to reflect the $100 gain recognized on the sale of Asset 
1). M's sale of the S share is a transfer of a loss share and 
therefore subject to this section.
    (ii) Analysis. Although M's transfer of the S share is subject 
to this section, there is no adjustment under paragraph (b) of this 
section (S has only one share outstanding and so there is no 
disparity in bases of common shares and no shares of S preferred 
stock outstanding (and so there is no unrecognized gain or loss on S 
preferred stock)). See paragraph (b)(1)(ii)(A) of this section. 
Accordingly, after the application of paragraph (b) of this section, 
M's sale of the S share is still a transfer of a loss share and 
therefore subject to paragraph (c) of this section. Under paragraph 
(c) of this section, M's $200 basis in the S share is reduced, but 
not below the share's $100 value, by the lesser of the share's net 
positive adjustment and disconformity amount. The share's net 
positive adjustment is $100, the positive adjustment attributable to 
the gain recognized on the sale of Asset 1. The share's 
disconformity amount is $0, the excess of M's $200 basis in the S 
share over S's $200 net inside attribute amount. Thus, the reduction 
to basis under paragraph (c) of this section would be $0. However, 
because S purchased the X stock and liquidated X with a view to 
avoiding the purposes of this section (by using X's attributes to 
minimize the disconformity amount of the S share), the

[[Page 53983]]

attributes acquired from X are disregarded for purposes of applying 
this section. Accordingly, S's net inside attribute amount is 
limited to the $100 of attributes S would have had absent the 
purchase of the X stock, S's money ($100 from the sale of Asset 1). 
The loss share's disconformity amount is therefore the excess of 
$200 over $100, or $100. The lesser of the share's $100 net positive 
adjustment and $100 disconformity amount is $100. As a result, M's 
$200 basis in the S share is reduced by $100, to $100, and M 
recognizes no gain or loss on the sale of the S share.
    Example 2. Use of a partnership to prevent current attribute 
reduction. (i) Facts. M owns all 5 outstanding shares of S common 
stock with a basis of $200 each. S owns Asset 1 with a basis of 
$1000. In year 1, with a view to preventing a current reduction in 
the basis of Asset 1, S contributes Asset 1 to a partnership in a 
transaction in which S recognizes no gain or loss. On December 31, 
year 2, M sells one S share for $20. After taking into account the 
effects of all applicable rules of law, M's basis in each S share is 
$200. M's sale of the S share is a transfer of a loss share and 
therefore subject to this section.
    (ii) Analysis. Although M's transfer of the S share is subject 
to this section, there is no basis redetermination under paragraph 
(b) of this section because there is no disparity among M's bases in 
its shares of S common stock and there are no shares of S preferred 
stock outstanding (and so there is no unrecognized gain or loss on S 
preferred stock). See paragraph (b)(1)(ii)(A) of this section. 
Accordingly, after the application of paragraph (b) of this section, 
M's sale of the S share is still a transfer of a loss share and 
therefore subject to paragraph (c) of this section. However, no 
adjustment is required under paragraph (c) of this section because 
both the disconformity amount and the net positive adjustment are 
$0. See paragraph (c)(3) of this section. Under paragraph (d) of 
this section, S's attribute reduction amount is $180 (the lesser of 
the $180 net stock loss and S's $900 aggregate inside loss ($1000 of 
attributes over $100 value of all of the S shares)). Absent the 
application of this paragraph (g), the $180 attribute reduction 
amount would be applied to reduce S's basis in the partnership 
interest. However, because S acted with a view to avoiding a current 
reduction in the basis of Asset 1 under paragraph (d) of this 
section, this section is applied by treating S as if it held Asset 1 
at the time of the stock sale. The basis of Asset 1 is reduced by 
$180, to $820, effective immediately before the transfer to the 
partnership and, as a result, S's basis in its partnership interest 
is $820.
    Example 3. Creation of an intercompany receivable to mitigate 
attribute reduction. (i) Facts. M owns all five outstanding shares 
of S common stock each with equal basis that exceeds value. S holds 
cash and Asset 1 with a basis that exceeds value. In year 1, with a 
view to mitigating a reduction in the basis of Asset 1, S lends the 
cash to M1. Asset 1 and the intercompany note received from M1 are 
assets of the same class under Sec.  1.338-6(b)(2). On December 31, 
year 2, M sells one of its S shares and, without regard to this 
section, recognizes a loss. M's sale of the S share is a transfer of 
a loss share and therefore subject to this section.
    (ii) Analysis. Although M's transfer of the S share is subject 
to this section, no adjustment is required under paragraph (b) of 
this section because there is no disparity among M's bases in shares 
of S common stock and there are no shares of S preferred stock 
outstanding (and so there is no unrecognized gain or loss on S 
preferred stock). See paragraph (b)(1)(ii)(A) of this section. 
Accordingly, after the application of paragraph (b) of this section, 
M's sale of the S shares is still a transfer of a loss share and 
therefore subject to paragraph (c) of this section. However, there 
is no adjustment under paragraph (c) of this section because the net 
positive adjustment is $0. See paragraph (c)(3) of this section. 
Under paragraph (d) of this section, S's attribute reduction amount 
would be applied to reduce S's basis in Asset 1 and the intercompany 
receivable in proportion to basis. However, because S acted with a 
view to mitigating the reduction in the basis of Asset 1 under 
paragraph (d) of this section, this section is applied without 
regard to the intercompany receivable. Accordingly, S's basis in 
Asset 1 is reduced by the full attribute reduction amount.
    Example 4. Use of a partnership to reduce net stock loss. (i) 
Facts. M owns all ten outstanding shares of S common stock, one 
share (Share 1) has a basis of $0, and one share (Share 2) has a 
basis of $160. S has an aggregate inside loss of $80. In one 
transaction and with a view to mitigating a reduction in S's 
attributes, M contributes Share 1 to a partnership, recognizing no 
gain or loss, and sells Share 2 for $80. M's contribution of Share 1 
to the partnership is a transfer, but the share is not a loss share 
and so the transfer is not subject to this section. M's sale of 
Share 2 is a transfer of a loss share and is therefore subject to 
this section.
    (ii) Analysis. Although M's transfer of Share 2 is subject to 
this section, there is no adjustment under paragraph (b) of this 
section because there are no investment adjustments that have been 
applied to the shares. Accordingly, after the application of 
paragraph (b) of this section, M's sale of Share 2 is still a 
transfer of a loss share and therefore subject to paragraph (c) of 
this section. There is no adjustment under paragraph (c) of this 
section because the net positive adjustment is $0. See paragraph 
(c)(3) of this section. Accordingly, after the application of 
paragraph (c) of this section, M's sale of Share 2 is still a 
transfer of loss shares and therefore subject to paragraph (d) of 
this section. Under paragraph (d) of this section, the net stock 
loss would be determined to be $0, the excess of the $160 aggregate 
basis in all of the transferred shares over the $160 aggregate value 
of those shares. S's attribute reduction amount would be determined 
to be $0, the lesser of the $0 net stock loss and S's $80 aggregate 
inside loss. Thus, there would be no reduction of attributes under 
this paragraph (d) of this section. However, because M acted with a 
view to reducing the attribute reduction amount by transferring a 
gain share to a partnership while avoiding the recognition of the 
gain on the share, this section is applied without regard to the 
transfer of the gain share. Accordingly, the net stock loss is 
determined to be $80, and the attribute reduction amount is 
determined to be $80.
    Example 5. Stuffing gain asset. (i) Facts. M owns the sole 
outstanding share of S stock (Share 1) with a basis of $100. S owns 
Asset 1 a basis of $100 and a value of $20. With a view to avoid the 
purposes of this section, M transfers Asset 2 with a basis of $0 and 
a value of $80 to S in exchange for four additional shares of S 
stock (Share 2 through Share 5) in a transaction to which section 
351 applies. M later sells Share 1 to X for $20. M's sale of Share 1 
is a transfer of a loss share and therefore subject to this section.
    (ii) Analysis. Although M's transfer of the Share 1 is subject 
to this section, there is no adjustment under paragraph (b) of this 
section because no investment adjustments have been applied to the 
basis of any S shares. Thus, after the application of paragraph (b) 
of this section, M's sale of the S share is still a transfer of a 
loss share and therefore subject to paragraph (c) of this section. 
There is no adjustment under paragraph (c) of this section because 
the net positive adjustment is $0. Accordingly, after the 
application of paragraph (c) of this section, M's sale of the S 
share is still a transfer of a loss share and therefore subject to 
paragraph (d) of this section. Under paragraph (d) of this section, 
S's attribute reduction amount would be $0, the lesser of the $80 
net stock loss and S's $0 aggregate inside loss ($100 of attributes 
does not exceed the $100 value of all of the S shares). However, 
because M transferred Asset 2 to S with a view to avoid the purposes 
of this section, the application of this section to M's transfer of 
Share 1 is made without regard to the transfer of Asset 2. 
Accordingly, under paragraph (d) of this section, S's attribute 
reduction amount is $80, the lesser of the $80 net stock loss and 
S's $80 aggregate inside loss (computed without regard to Asset 2). 
S's basis in Asset 1 is therefore reduced by $80, from $100 to $20, 
under paragraph (d) of this section.
    (iii) Transfer of all S shares. Assume the same facts as in 
paragraph (i) of this Example 5, except that M sells all five S 
shares to X, recognizing both the gain and the loss on the S shares. 
The transfer of Share 1 is still a transfer of a loss share and 
therefore subject to this section. However, because all the shares 
are transferred the group's income is clearly reflected. Therefore, 
the purposes of this section are not avoided and this section 
applies without modification. S's attribute reduction amount is $0, 
the lesser of the $0 net stock loss and S's $0 aggregate inside 
loss.

    (h) Effective/applicability date. This section applies to transfers 
of shares of subsidiary stock on or after September 17, 2008 unless the 
transfer was made pursuant to a binding agreement that was in effect 
prior to September 17, 2008 and at all times thereafter. For transfers 
of shares of subsidiary stock that are not subject to this section, see 
Sec. Sec.  1.337(d)-2 and 1.1502-35.

[[Page 53984]]


0
Par. 19. Section 1.1502-75 is amended by:
0
1. Revising paragraph (d)(1).
0
2. Adding paragraph (l).
    The revision and addition read as follows:


Sec.  1.1502-75  Filing of consolidated returns.

* * * * *
    (d) When a group remains in existence--(1) General rule. A group 
remains in existence for a tax year if the common parent remains as the 
common parent and at least one subsidiary that was affiliated with it 
at the end of the prior year remains affiliated with it at the 
beginning of the year, whether or not one or more corporations have 
ceased to be subsidiaries at any time after the group was formed. Thus, 
for example, assume that corporation P acquires the sole outstanding 
share of stock of S on January 1, year 1, and that P and S file a 
consolidated return for the year 1 calendar year. On May 1, year 2, P 
acquires the sole outstanding share of stock of S1 and, on July 1, year 
2, P sells the S share. The group (consisting originally of P and S) 
remains in existence in year 2 because P remained the common parent 
and, S, a subsidiary that was affiliated with P at the end of year 1, 
remained affiliated with P at the beginning of year 2.
* * * * *
    (l) Effective/applicability dates. Paragraph (d)(1) of this section 
applies to taxable years for which the due date of the original return 
(without regard to extensions) is on or after September 17, 2008.

0
Par. 20. Section 1.1502-80 is amended by:
0
1. Revising paragraph (a) and (c)(2).
0
2. Adding paragraph (h).
    The revisions and addition reads as follows:


Sec.  1.1502-80  Applicability of other provisions of law.

    (a) In general--(1) Application of other provisions. The Internal 
Revenue Code (Code), or other law, shall be applicable to the group to 
the extent the regulations do not exclude its application. To the 
extent not excluded, other rules operate in addition to, and may be 
modified by, these regulations. Thus, for example, in a transaction to 
which section 381(a) applies, the acquiring corporation will succeed to 
the tax attributes described in section 381(c). Furthermore, sections 
269 and 482 apply for any consolidated return year. However, in a 
recognition transaction otherwise subject to section 1001, for example, 
the rules of section 1001 continue to apply, but may be modified by the 
intercompany transaction regulations under Sec.  1.1502-13.
    (2) No duplicative adjustments. Nothing in these regulations shall 
be interpreted or applied to require an adjustment, inclusion, or other 
item to the extent it would have the effect of duplicating any other 
adjustment, inclusion, or other item required under the Code or other 
rule of law, including other provisions of these regulations.
    (3) Application of single-entity principles. If two or more 
adjustments, inclusions, or other items are subject to paragraph (a)(2) 
of this section, the determination of which adjustment, inclusion, or 
other item is treated as applied or taken into account is made by 
taking into account the purposes of the provisions and applying single-
entity principles as appropriate.
    (4) Effective/applicability dates. This paragraph (a) is applicable 
with respect to transactions and determinations on or after September 
17, 2008.
* * * * *
    (c) * * *
    (2) Cross reference. See Sec.  1.1502-36 for additional rules 
relating to worthlessness of subsidiary stock on or after September 17, 
2008.
* * * * *
    (h) Non-applicability of section 362(e)(2)--(1) General rule. 
Section 362(e)(2) does not apply to any intercompany transaction 
occurring on or after September 17, 2008. Taxpayers may apply this 
paragraph (h) to intercompany transactions occurring on or after 
October 22, 2004, and in such case, any election made under section 
362(e)(2)(C) will have no effect. The purpose of this paragraph (h) is 
to facilitate the application of the consolidated return provisions 
addressing the duplication of loss between members of a consolidated 
group.
    (2) Anti-abuse rule--(i) General rule. If a taxpayer engages in a 
transaction to which section 362(e)(2) would apply but for the 
application of paragraph (h)(1) of this section, and acts with a view 
to prevent the consolidated return provisions from properly addressing 
loss duplication, appropriate adjustments will be made to clearly 
reflect the income of the group.
    (ii) Example. The following example illustrates the principle of 
the anti-abuse rule in this paragraph (h)(2).

    Example. (A) Facts. P, the common parent of a consolidated 
group, owns the four outstanding shares of S stock (Share 1 through 
Share 4) with an aggregate basis of $0 and value of $80. S owns 
Asset 1 with a basis of $0 and a value of $80. With a view to 
prevent the consolidated return provisions from addressing the 
duplication of loss, P transfers Asset 2 with a basis of $100 and a 
value of $20 to S in exchange for an additional share of S stock 
(Share 5) in a transaction to which section 351 applies. P later 
sells Share 5 to X, an unrelated person, for $20 at a time when S's 
basis in Asset 2 was still $100. The sale is a transfer of a loss 
share and therefore subject to Sec.  1.1502-36.
    (B) Analysis. Although the sale would be subject to Sec.  
1.1502-36, that section would not prevent the stock loss or reduce 
S's attributes (to prevent duplication of the stock loss) because 
neither Sec.  1.1502-36(b) nor Sec.  1.1502-36(c) would adjust the 
basis of the transferred share (because there are no investment 
adjustments) and Sec.  1.1502-36(d) would not reduce S's attributes 
(because S's aggregate inside loss is $0). However, because P acted 
with a view to prevent the consolidated return provisions from 
addressing the duplication of the loss on Asset 2, P's transfer of 
Asset 2 to S is subject to the anti-abuse rule in this paragraph 
(h)(2). Accordingly, effective immediately before the transfer of 
Share 5 to X, either P's basis in Share 5 or S's basis in Asset 2 
must be adjusted to reflect what it would have been had section 
362(e)(2) been applied at the time P transferred Asset 2 to S 
(taking into account the interim facts and circumstances). 
Accordingly, S must either reduce its basis in Asset 2 by $80 to $20 
(eliminating the duplicated loss) or P must reduce its basis in 
Share 5 by $80 to $20 (eliminating the duplicated loss).
    (C) Transfer of all S shares. Assume the same facts as those in 
paragraph (A) of this Example, except that P sells all five S shares 
to X. Although P's transfer of Asset 2 to S results in the 
duplication of an $80 loss, because all the shares are transferred, 
the transaction does not prevent the consolidated return provisions 
from properly addressing loss duplication. P's $80 duplicated loss 
is offset by an $80 duplicated gain, and the group recognizes the 
offsetting stock gain and loss. Accordingly, this paragraph (h)(2) 
does not apply to P's transfer of Asset 2 to S.


0
Par. 21. Section 1.1502-91 is amended by revising paragraph (h)(2) to 
read as follows:


Sec.  1.1502-91  Application of section 382 with respect to a 
consolidated group.

* * * * *
    (h) * * *
    (2) Disposition of stock or an intercompany obligation of a member. 
Gain or loss recognized by a member on the disposition of stock 
(including stock described in section 1504(a)(4) and Sec.  1.382-
2T(f)(18)(ii) and (iii)) of another member is treated as a recognized 
gain or loss for purposes of section 382(h)(2) (unless disallowed) even 
though gain or loss on such stock was not included in the determination 
of a net unrealized built-in gain or loss under paragraph (g)(1) of 
this section. Gain or loss recognized by a member with respect to an 
intercompany obligation is treated as recognized gain or loss only to 
the extent (if any) the transaction gives rise

[[Page 53985]]

to aggregate income or loss within the consolidated group. The first 
sentence of this paragraph (h)(2) is applicable on or after September 
17, 2008.
* * * * *

0
Par. 22. Section 1.1502-95 is amended by revising paragraph (d)(3), 
Example 6 to read as follows:


Sec.  1.1502-95  Rules on ceasing to be a member of a consolidated 
group (or loss subgroup).

* * * * *
    (d) * * *
    (3) * * *

    Example 6. Reattribution of net operating loss carryover under 
Sec.  1.1502-36(d)(6). The facts are the same as in Example 3, 
except that, instead of distributing the L2 stock to M, P sells that 
stock to B, and, under Sec.  1.1502-36(d)(6), M reattributes $10 of 
L2's net operating loss carryover to itself. Under Sec.  1.1502-
36(d)(6)(iv)(A), M succeeds to the reattributed loss as if the loss 
were succeeded to in a transaction to which section 381(a) applies. 
M, as successor to L2, does not cease to be a member of the P loss 
subgroup.
* * * * *

0
Par. 23. Section 1.1502-96 is amended by revising paragraph (d) to read 
as follows:


Sec.  1.1502-96  Miscellaneous rules.

* * * * *
    (d) Losses reattributed under Sec.  1.1502-36(d)(6)--(1) In 
general. This paragraph (d) contains rules relating to net operating 
carryovers, capital loss carryovers, and deferred deductions 
(collectively, loss or losses) that are reattributed to the common 
parent under Sec.  1.1502-36(d)(6). References in this paragraph (d) to 
a subsidiary are references to the subsidiary (or lower-tier 
subsidiary) whose loss is reattributed to the common parent.
    (2) Deemed section 381(a) transaction. Under Sec.  1.1502-
36(d)(6)(iv)(A), the common parent succeeds to the reattributed losses 
as if the losses were succeeded to in a transaction to which section 
381(a) applies. In general, Sec. Sec.  1.1502-91 through 1.1502-95, 
this section, and Sec.  1.1502-98 are applied to the reattributed 
losses in accordance with that characterization. See generally, Sec.  
1.382-2(a)(1)(ii) (relating to distributor or transferor loss 
corporations in transactions under section 381), Sec.  1.1502-1(f)(4) 
(relating to the definition of predecessor and successor) and Sec.  
1.1502-91(j) (relating to predecessor and successor corporations). For 
example, if the reattributed loss is a pre-change attribute subject to 
a section 382 limitation, it remains subject to that limitation 
following the reattribution. In certain cases, the limitation 
applicable to the reattributed loss is zero unless the common parent 
apportions all or part of the limitation to itself. (See paragraph 
(d)(4) of this section.)
    (3) Rules relating to owner shifts--(i) In general. Any owner shift 
of the subsidiary (including any deemed owner shift resulting from 
section 382(g)(4)(D) or 382(l)(3)) in connection with the disposition 
of the stock of the subsidiary is not taken into account in determining 
whether there is an ownership change with respect to the reattributed 
loss. However, any owner shift with respect to the successor 
corporation that is treated as continuing in existence under Sec.  
1.382-2(a)(1)(ii) must be taken into account for such purpose if such 
owner shift is effected by the reattribution and an owner shift of the 
stock of the subsidiary not held directly or indirectly by the common 
parent would have been taken into account if such shift had occurred 
immediately before the reattribution. See paragraph (d)(3)(ii) Example 
2 of this section.
    (ii) Examples. The following examples illustrate the principles of 
this paragraph (d)(3):

    Example 1. No owner shift for reattributed loss. (i) Facts. P, 
the common parent of a consolidated group, owns 60% of the stock of 
L, and B owns the remaining 40%. L has a net operating loss 
carryover of $100 from year 1 that it carries over to years 2, 3, 
and 4. At the beginning of year 2, P purchases 40% of the L stock 
from B, which does not cause an ownership change of L. On December 
31, year 3, P sells all of the L stock to M. Pursuant to Sec.  
1.1502-36(d)(6), P reattributes $10 of L's $100 net operating loss 
carryover to itself, and L carries $90 of its net operating loss 
carryover to its year 4.
    (ii) Analysis. The sale of the L stock to M does not cause an 
owner shift that is taken into account in determining if there is an 
ownership change with respect to the $10 reattributed loss. 
Following the reattribution, Sec.  1.1502-94(b) continues to apply 
to determine if there is an ownership change with respect to the $10 
reattributed loss, until, under paragraph (a) of this section, the 
loss is treated as described in Sec.  1.1502-91(c)(1)(i). In 
applying Sec.  1.1502-94(b), the 40 percentage point increase by the 
P shareholders prior to the reattribution is taken into account. The 
sale of the L stock to M does cause an ownership change of L with 
respect to the $90 of its net operating loss that it carries over to 
year 4.
    Example 2. Owner shift for reattributed loss. The facts are the 
same as in Example 1, except that P only purchases 20% of the L 
stock from B and sells 80% of the L stock to M. L is a new loss 
member, and, under Sec.  1.1502-94(b)(1), an owner shift of the 
stock of L not held directly or indirectly by the common parent (the 
20% of L stock still held by B) would have been taken into account 
if such shift had occurred immediately before the reattribution. 
Following the reattribution, Sec.  1.1502-94(b) continues to apply 
to determine if there is an ownership change with respect to the $10 
reattributed loss, until, under paragraph (a) of this section, the 
loss is treated as described in Sec.  1.1502-91(c)(1)(i). With 
respect to the $10 reattributed loss, the P shareholders have 
increased their percentage ownership interest by 40 percentage 
points. The P shareholders have increased their ownership interests 
by 20 percentage points as a result of P's purchase of stock from B, 
and, under Sec.  1.382-2(a)(1)(ii), are treated as increasing their 
interests by an additional 20 percentage points as a result of the 
reattribution. (The acquisition of the L stock by M does not, 
however, effect an owner shift for the $10 of reattributed loss.) 
The sale of the L stock to M causes an ownership change of L with 
respect to the $90 of net operating loss that L carries over to Year 
4.

    (4) Rules relating to the section 382 limitation--(i) Reattributed 
loss is a pre-change separate attribute of a new loss member. If the 
reattributed loss is a pre-change separate attribute of a new loss 
member that is subject to a separate section 382 limitation prior to 
the disposition of subsidiary stock, the common parent's limitation 
with respect to that loss is zero, except to the extent that the common 
parent apportions to itself, under paragraph (d)(5) of this section, 
all or part of such limitation. A separate section 382 limitation is 
the limitation described in Sec.  1.1502-94(b) that applies to a pre-
change separate attribute.
    (ii) Reattributed loss is a pre-change subgroup attribute. If the 
reattributed loss is a pre-change subgroup attribute subject to a 
subgroup section 382 limitation prior to the disposition of subsidiary 
stock, and, immediately after the reattribution, the common parent is 
not a member of the loss subgroup, the section 382 limitation with 
respect to that loss is zero, except to the extent that the common 
parent apportions to itself, under paragraph (d)(5) of this section, 
all or part of the subgroup section 382 limitation. See, however, Sec.  
1.1502-95(d)(3) Example 6, for an illustration of a case where the 
common parent, as successor to the subsidiary, is a member of the loss 
subgroup immediately after the reattribution.
    (iii) Potential application of section 382(l)(1). In general, the 
value of the stock of the common parent is used to determine the 
section 382 limitation for an ownership change with respect to the 
reattributed loss that occurs at the time of, or after, the 
reattribution. For example, if the loss is a pre-change consolidated 
attribute, the value of the stock of the common parent is used to 
determine the section 382 limitation, and no adjustment to that value 
is required because of the deemed section

[[Page 53986]]

381(a) transaction. However, if the loss is a pre-change separate 
attribute of a new loss member (or is a pre-change attribute of a loss 
subgroup member and the common parent was not the loss subgroup parent 
immediately before the reattribution), the deemed section 381(a) 
transaction is considered to constitute a capital contribution with 
respect to the new loss member (or loss subgroup member) for purposes 
of section 382(l)(1). Accordingly, if that section applies because the 
deemed capital contribution is (or is considered under section 
382(l)(1)(B) to be) part of a plan described in section 382(l)(1)(A), 
the value of the stock of the common parent after the deemed section 
381(a) transaction must be adjusted to reflect the capital 
contribution. Ordinarily, this will require the value of the stock of 
the common parent to be reduced to an amount that represents the value 
of the stock of the subsidiary (or loss subgroup of which the 
subsidiary was a member) when the reattribution occurred.
    (iv) Duplication or omission of value. In determining any section 
382 limitation with respect to the reattributed loss and with respect 
to other pre-change losses, appropriate adjustments must be made so 
that value is not improperly omitted or duplicated as a result of the 
reattribution. For example, if the subsidiary has an ownership change 
upon its departure, and the common parent (as successor) has an 
ownership change with respect to the reattributed pre-change separate 
attribute upon its reattribution under paragraph (d)(3)(i) of this 
section, proper adjustments must be made so that the value of the 
subsidiary is not taken into account more than once in determining the 
section 382 limitation for the reattributed loss and the loss that is 
not reattributed.
    (v) Special rule for continuity of business requirement. If the 
reattributed loss is a pre-change attribute of new loss member and the 
reattribution occurs within the two-year period beginning on the change 
date, then, starting immediately after the reattribution, the 
continuity of business requirement of section 382(c)(1) is applied with 
respect to the business enterprise of the common parent. Similar 
principles apply if the reattributed loss is a pre-change subgroup 
attribute and, on the day after the reattribution, the common parent is 
not a member of the loss subgroup.
    (5) Election to reattribute section 382 limitation--(i) Effect of 
election. The common parent may elect to apportion to itself all or 
part of any separate section 382 limitation or subgroup section 382 
limitation to which the loss is subject immediately before the 
reattribution. However, no net unrealized built-in gain of the member 
(or loss subgroup) whose loss is reattributed can be apportioned to the 
common parent. The principles of Sec.  1.1502-95(c) apply to the 
apportionment, treating, as the context requires, references to the 
former member as references to the common parent, and references to the 
consolidated section 382 limitation as references to the separate 
section 382 limitation (or subgroup section 382 limitation) that is 
being apportioned. Thus, for example, the common parent can reattribute 
to itself all or part of the value element or adjustment element of the 
limitation, and any part of such element that is apportioned requires a 
corresponding reduction in such element of the separate section 382 
limitation of the subsidiary whose loss is reattributed (or in the 
subgroup section 382 limitation if the reattributed loss is a pre-
change subgroup attribute). Appropriate adjustments must be made to the 
separate section 382 limitation (or subgroup section 382 limitation) 
for the consolidated return year in which the reattribution is made to 
reflect that the reattributed loss is an attribute acquired by the 
common parent during the year in a transaction to which section 381(a) 
applies. The election is made by the common parent as part of the 
election to reattribute the loss. See Sec.  1.1502-36(e)(5)(x) for the 
time and manner of making the election.
    (ii) Examples. The following examples illustrate the principles of 
this paragraph (d)(5):

    Example 1. Consequence of apportionment. (i) Facts. P, the 
common parent of a consolidated group, purchases all of the stock of 
L on December 31, year 1. L carries over a net operating loss 
arising in year 1 to each of the next 5 taxable years. The purchase 
of the L stock causes an ownership change of L, and results in a 
separate section 382 limitation of $10 for L's net operating loss 
carryover based on the value of the L stock. On July 2, year 3, P 
sells 30% of the L stock to A. Under Sec.  1.1502-36(d)(6), P elects 
to reattribute to itself $110 of L's $200 net operating loss 
carryover. P also elects to apportion to itself $6 of the $10 value 
element of the separate section 382 limitation.
    (ii) Analysis. (A) P's separate section 382 limitation. For the 
consolidated return years ending after December 31, year 3, P's 
separate section 382 limitation with respect to the reattributed net 
operating loss carryover is $6, adjusted as appropriate for any 
short taxable year, unused section 382 limitation, or other 
adjustment. For the P group's consolidated return year ending 
December 31, year 3, the separate section 382 limitation for L's net 
operating loss carryover is $8, the sum of $5 and $3. Five dollars 
of the limitation is the amount that bears the same relationship to 
$10 as the number of days in the period ending with the deemed 
section 381(a) transaction, 183 days, bears to 365. Three dollars of 
the limitation is the amount that bears the same relationship to $6 
as the number of days in the period between July 3 and December 31, 
182, bears to 365.
    (B) L's separate section 382 limitation. For L's taxable years 
ending after December 31, year 3, L's separate section 382 
limitation for its $90 of net operating loss carryover that was not 
reattributed to P is $4, adjusted as appropriate for any short 
taxable year, unused section 382 limitation, or other adjustment. 
For L's short taxable year ending December 31, year 3, the section 
382 limitation for its $90 of net operating loss carryover is $2, 
the amount that bears the same relationship to $4 (the portion of 
the value element that was not apportioned to P), as the number of 
days during the short taxable year, 182 days, bears to 365. See 
Sec.  1.382-5(c).
    Example 2. No apportionment required for consolidated pre-change 
attribute. (i) Facts. P, the common parent of a consolidated group, 
forms L. For year 1, L has an operating loss of $70 that is not 
absorbed and is included in the group's consolidated net operating 
loss that is carried over to subsequent years. On January 1 of year 
3, A buys all of the P stock and the P group has an ownership 
change. The consolidated section 382 limitation based on the value 
of the P stock is $10.
    (ii) Analysis. On April 13 of year 4, P sells all of the stock 
of L to B and, under Sec.  1.1502-36(d)(6), elects to reattribute to 
itself $45 of L's net operating loss carryover. Following the 
reattribution, the $45 portion of the year 1 net operating loss 
carryover retains its character as a pre-change consolidated 
attribute, and remains subject to so much of the $10 consolidated 
section 382 limitation as P does not elect to apportion to L under 
Sec.  1.1502-95(c).
* * * * *

0
Par. 24. Section 1.1502-99 is amended by revising the section heading 
and paragraph (b)(4) to read as follows:


Sec.  1.1502-99  Effective/applicability dates.

* * * * *
    (b) * * *
    (4) Reattribution of losses under Sec.  1.1502-36(d)(6). Section 
1.1502-96(d) applies to reattributions of net operating loss 
carryovers, capital loss carryovers, and deferred deductions in 
connection with a transfer of stock to which Sec.  1.1502-36 applies, 
and the election under Sec.  1.1502-96(d)(5) (relating to an election 
to reattribute section 382 limitation) can be made with an election 
under Sec.  1.1502-36(d)(6) to reattribute a loss to the common parent 
that is filed at the time and in the manner provided in Sec.  1.1502-
36(e)(5)(x).
* * * * *

0
Par. 25. For each section listed in the tables, remove the language in 
the

[[Page 53987]]

``Remove'' column and add in its place the language in the ``Add'' 
column as set forth below:

------------------------------------------------------------------------
           Section                   Remove                  Add
------------------------------------------------------------------------
Sec.   1.267(f)-1(k)........  For additional rules  For additional rules
                               applicable to the     applicable to the
                               disposition or        disposition,
                               deconsolidation of    deconsolidation, or
                               the stock of          transfer of the
                               members of            stock of members of
                               consolidated          consolidated
                               groups, see Sec.      groups, see Sec.
                               Sec.   1.337(d)-2,    Sec.   1.337(d)-2,
                               1.1502-13(f)(6),      1.1502-13(f)(6),
                               and 1.1502-35..       1.1502-35, and
                                                     1.1502-36.
Sec.   1.597-4(g)(2)(v),      Sec.  Sec.            Sec.   1.337(d)-2,
 second parenthetical.         1.337(d)-2 and        Sec.   1.1502-
                               1.1502-35(f).         35(f), and Sec.
                                                     1.1502-36.
Sec.   1.1502-11(b)(3)(ii),   Sec.  Sec.            Sec.  Sec.
 paragraph (c) in Example.     1.337(d)-2 and        1.337(d)-2, 1.1502-
                               1.1502-35.            35, and 1.1502-36.
Sec.   1.1502-12(r).........  Sec.  Sec.            Sec.  Sec.
                               1.337(d)-2 and        1.337(d)-2, 1.1502-
                               1.1502-35(f) for      35, and 1.1502-36
                               rules relating to     for rules relating
                               basis adjustments     to basis
                               and allowance of      adjustments and
                               stock loss on         allowance of stock
                               dispositions of       loss on
                               stock of a            dispositions or
                               subsidiary member.    transfers of
                                                     subsidiary stock.
Sec.   1.1502-15(b)(2)(iii).  Sec.  Sec.            Sec.   1.337(d)-2,
                               1.337(d)-2, 1.1502-   Sec.   1.1502-35,
                               35, or.               Sec.   1.1502-36,
                                                     or
Sec.   1.1502-                (b)(2)(iv)(B)(2)(iv)  (b)(2)(iv)(B)(2)(v).
 21(b)(2)(iv)(B)(2)(i).
Sec.   1.1502-                (b)(2)(iv)(B)(2)(iv)  (b)(2)(iv)(B)(2)(v).
 21(b)(2)(iv)(B)(2)(ii).
Sec.   1.1502-                (b)(2)(iv)(B)(2)(iv)  (b)(2)(iv)(B)(2)(v).
 21(b)(2)(iv)(B) (2)(iii).
Sec.   1.1502-90 Table of     Sec.   1.1502-20(g).  Sec.   1.1502-
 Contents, under Sec.                                36(d)(6).
 1.1502-96(d).
Sec.   1.1502-90 Table of     Sec.   1.1502-20(g).  Sec.   1.1502-
 Contents, under Sec.                                36(d)(6).
 1.1502-99(b)(4).
------------------------------------------------------------------------

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 26. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 27. In Sec.  602.101, paragraph (b) is amended as follows:
0
1. The following entries to the table are removed:


Sec.  602.101  OMB Control Numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       Control no.
------------------------------------------------------------------------
 
                                * * * * *
Sec.   1.1502-20........................................      1545-1160;
                                                               1545-1218
Sec.   1.1502-20T.......................................       1545-1774
Sec.   1.1502-32T.......................................       1545-1774
Sec.   1.1502-35T.......................................       1545-2019
------------------------------------------------------------------------


0
2. The following entry is added in numerical order to the table:


Sec.  602.101  OMB Control Numbers.

* * * * *
    (b) * * *

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                                                            Current OMB
   CFR part or section where identified and described       Control No.
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                                * * * * *
Sec.   1.1502-36........................................       1545-2096
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* * * * *

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
    Approved: September 4, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E8-21006 Filed 9-9-08; 4:15 pm]
BILLING CODE 4830-01-P