Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 3509 

indistinguishable from sales of property 

to a partnership or another partner, and 

believed that these transactions should 

be treated for tax purposes in a manner 

consistent with their underlying 

economic substance. See H.R. Rep. No. 

432, 98th Cong. 2nd Sess. 1218 (1984) 

(H.R. Rep.), and S. Prt. No. 169 (Vol. I), 

98th Cong. 2nd Sess. 225 (1984) (S. Prt.) 

(discussing Communications Satellite 

Corp. v. United States, 625 F.2d 997 (Ct. 

Cl. 1980), and Jupiter Corp. v. United 

States, 2 Cl. Ct. 58 (1983), both of which 

involved disguised sales of a 

partnership interest). 

On October 9, 2001, the IRS and the 

Treasury Department issued Notice 

2001–64 (2001–2 CB 316), (see 

§ 601.601(d)(2)(ii)(b)), announcing that 

the IRS and the Treasury Department 

were considering issuing proposed 

regulations under section 707(a)(2)(B), 

relating to disguised sales of partnership 

interests. The IRS and the Treasury 

Department requested comments on the 

scope and substance of guidance 

concerning disguised sales of 

partnership interests, including any 

applicable safe harbors or exceptions. 

Written comments in response to Notice 

2001–64 were received and considered 

in drafting proposed regulations. 

In response to requests, on November 

26, 2004, the Treasury Department and 

the IRS published in the Federal 

Register (69 FR 68838) a notice of 

proposed rulemaking under section 

707(a)(2)(B), (REG–149519–03) relating 

to disguised sales of partnership 

interests. The proposed regulations 

sought to amend the existing regulations 

for disguised sales of property (existing 

property regulations) by adding rules for 

disguised sales of partnership interests 

and by revising the rules relating to 

disguised sales of property. The 

proposed regulations for disguised sales 

of partnership interests include a 

framework similar to that in the existing 

property regulations, with a general rule 

that would apply based on all of the 

facts and circumstances. 

The Treasury Department and the IRS 

received written comments on the 

proposed regulations from interested 

parties. The Treasury Department and 

the IRS, having now thoroughly 

considered those comments, have 

decided to withdraw the proposed 

regulations. The Treasury Department 

and the IRS will continue to study this 

area and may issue guidance in the 

future. Until new guidance is issued, 

any determination of whether transfers 

between a partner or partners and a 

partnership is a transfer of a partnership 

interest will be based on the statutory 

language, guidance provided in 

legislative history, and case law. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Withdrawal of Notice of Proposed 

Rulemaking 

Accordingly, under the authority of 

26 U.S.C. 7805, the notice of proposed 

rulemaking (REG–149519–03) that was 

published in the Federal Register on 

November 26, 2004 (69 FR 68838) is 

withdrawn. 

L.E. Stiff, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. E9–1101 Filed 1–16–09; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–143686–07] 

RIN 1545–BH35 

The Allocation of Consideration and 

Allocation and Recovery of Basis in 

Transactions Involving Corporate 

Stock or Securities 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations under sections 

301, 302, 304, 351, 354, 356, 358, 368, 

861, 1001, and 1016 of the Internal 

Revenue Code (Code). The proposed 

regulations provide guidance regarding 

the recovery of stock basis in 

distributions under section 301 and 

transactions that are treated as 

dividends to which section 301 applies, 

as well as guidance regarding the 

determination of gain and the basis of 

stock or securities received in exchange 

for, or with respect to, stock or 

securities in certain transactions. The 

proposed regulations affect shareholders 

and security holders of corporations. 

These proposed regulations are 

necessary to provide such shareholders 

and security holders with guidance 

regarding the allocation and recovery of 

basis on distributions of property. 

DATES: Written or electronic comments, 

and a request for a public hearing, must 

be received by April 21, 2009. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–143686–07), room 

5203, Internal Revenue Service, P.O. 

Box 7604, Ben Franklin Station, 

Washington, DC 20044. Submissions 

may be hand-delivered Monday through 

Friday between the hours of 8 a.m. and 

4 p.m. to CC:PA:LPD:PR (REG–143686– 

07), Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC, or sent 

electronically, via the Federal 

eRulemaking Portal at 

www.regulations.gov (IRS#REG– 

143686–07). 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations 

under sections 301, 302, and 304, 

Theresa M. Kolish, (202) 622–7530; 

concerning the proposed regulations 

under sections 351, 354, 356, 358, 368, 

1001, and 1016, Rebecca O. Burch, (202) 

622–7550; concerning the proposed 

regulations under section 861, Jeffrey L. 

Parry, (202) 622–4476; concerning 

submission of comments or to request a 

hearing, Richard Hurst (202) 622–7180 

(not toll free numbers). 

Background 

The primary objective of these 

proposed regulations is to provide a 

single model for stock basis recovery by 

a shareholder that receives a 

constructive or actual distribution to 

which section 301 applies and a single 

model for sale and exchange 

transactions to which section 302(a) 

applies, including certain elements of a 

reorganization exchange. Further to this 

objective, these proposed regulations 

define the scope of the exchange that 

must be analyzed under particular Code 

provisions, and provide a methodology 

for determining gain realized under 

section 356 and stock basis under 

section 358. 

In addition, these proposed 

regulations respond to comments 

received by the IRS and Treasury 

Department regarding the current 

section 358 regulations, such as 

suggestions to expand the tracing rules 

to stock transfers that are subject to 

section 351 but do not qualify as 

reorganizations, questions regarding 

whether (and, if so, to what extent) 

shareholder elections constitute terms of 

an exchange, and whether the terms of 

an exchange control for purposes of 

qualifying a transaction as a 

reorganization under section 368. 

Finally, these proposed regulations 

include amendments to the section 304 

regulations that import the statutory 

amendments to that section. See section 

226 of the Tax Equity and Fiscal 

Responsibility Act of 1982, Public Law 

97–248 (96 Stat. 325, 490) (September 3, 

1982), section 712(l) of the Deficit 

Reduction Act of 1984, Public Law 98– 

369 (98 Stat. 494, 953–55) (July 18, 

1984), section 1875(b) of the Tax Reform 

Act of 1986, Public Law 99–514 (100 

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3510 Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 

Stat. 2085, 2894) (October 22, 1986), and 

section 1013 of the Taxpayer Relief Act 

of 1997, Public Law 105–34 (111 Stat. 

788, 918) (August 5, 1997). 

Explanation of Provisions 

I. Introduction—Exchanges and 

Distributions to Which Sections 301 and 

302 Apply 

Section 301 provides rules for the 

treatment of a distribution with respect 

to stock but does not specify how to 

identify the shares upon which a 

distribution is made. Furthermore, the 

tax law does not provide rules 

concerning whether a shareholder 

recovers its stock basis in the aggregate, 

or alternatively, whether a shareholder 

is required to recover stock basis shareby-share. Finally, the tax law does not 

provide specifically that transactions 

treated as section 301 distributions (i.e., 

redemptions under section 302(d), 

certain section 304 transactions, and 

certain reorganizations) should be 

subject to the same rules as actual 

section 301 distributions. In the 

reorganization context, the Code 

provides consequences resulting from 

different types of exchanges, but does 

not specify whether the exchange is 

based on a shareholder’s aggregate stock 

holdings, or alternatively, based on 

particular elements of the overall 

exchange. 

Rules related to stock basis recovery 

and stock basis determinations have 

evolved independently over many years 

on a transactional basis. Ad hoc 

development of these authorities has 

lead to the possibility of variant 

treatment of economically similar 

transactions to which section 301 or 

302(a) applies either directly or through 

the operation of other Code provisions. 

Moreover, because there has not been a 

comprehensive review of these issues, 

many questions lack definitive answers. 

Prior guidance attempted to address 

particular areas of uncertainty within 

the subject matter of basis recovery and 

basis identification. Without the benefit 

of addressing all related issues, 

however, certain of this prior guidance 

was needed reconsidered. See REG– 

150313–01. Other guidance built the 

framework for basis identification that 

has encouraged the development of 

these proposed regulations. 

Building on themes developed in 

§ 1.358–2 and comments received from 

the tax community, this proposal is 

intended to be a comprehensive 

approach to stock basis recovery and 

stock basis identification to produce 

consistent results among economically 

similar transactions, regardless of the 

transaction type or the specific Code 

provision that results in the application 

of section 301 or 302(a). 

The cornerstone of this proposal is 

that a share of stock is the basic unit of 

property that can be disposed of and, 

accordingly, the results of a transaction 

should generally derive from the 

consideration received in respect of that 

share. This guiding principle has 

section 1012 as its underpinning and 

has become fundamental to the tax 

treatment of shareholders, regardless of 

the specific nature of a shareholder’s 

exchange. See § 1.358–2 and § 1.367(b)– 

13. A corollary to this basic premise is 

that a reorganization exchange is not an 

event that justifies alteration of a 

shareholder’s tax position beyond what 

is necessary to reflect the results of the 

reorganization. 

To harmonize the tax treatment of 

economically similar transactions, these 

proposed regulations adopt a single 

model for section 301 distributions 

(dividend equivalent transactions) and a 

single model for sale or exchange 

transactions to which section 302(a) 

applies (non-dividend equivalent 

transactions), regardless of whether 

section 301 or section 302(a) applies 

directly or by reason of section 302(d), 

304 or 356. 

II. Distributions With Respect to Stock 

and Dividend Equivalent Transactions 

A. Section 301 Distributions 

Consistent with the fundamental 

notion that a share of stock is the basic 

unit of property, the results of a section 

301 distribution should derive from the 

consideration received in respect of 

each share of stock, notwithstanding 

designations otherwise. Johnson v. 

United States, 435 F.2d 1257 (4th Cir. 

1971). Accordingly, these proposed 

regulations treat a section 301 

distribution as received on a pro rata, 

share-by-share basis with respect to the 

class of stock upon which the 

distribution is made. Thus, a 

distribution that is not a dividend 

within the meaning of section 301(c)(1) 

can result in gain with respect to some 

shares of a class while other shares have 

unrecovered basis. 

B. Dividend Equivalent Redemptions 

To promote consistency among 

transactions treated as section 301 

distributions under the Code, these 

proposed regulations apply the same 

basis recovery rules described above to 

both dividend equivalent redemptions 

and certain section 304 transactions. 

Accordingly, under these proposed 

regulations, a dividend equivalent 

redemption results in a pro rata, shareby-share distribution to all shares of the 

‘‘redeemed class’’ held by the redeemed 

shareholder immediately before the 

redemption. The proposed regulations 

define the term ‘‘redeemed class’’ to 

mean all of the shares of that class held 

by the redeemed shareholder. Similar to 

an actual section 301 distribution, the 

proportional approach to basis recovery 

in dividend equivalent redemptions can 

produce gain with respect to some 

shares while other shares have 

unrecovered basis. 

The constructive section 301 

distribution is limited to the shares of 

the redeemed class (instead of 

constructing a pro rata distribution 

among all shares of various classes held 

by the redeemed shareholder) because 

different classes of stock have distinct 

legal entitlements that are respected for 

federal income tax purposes. H.K. Porter 

Co., 87 T.C. 689 (1986); Comm’r v. 

Spaulding Bakeries, 252 F.2d 693 (2d 

Cir. 1958). Accordingly, a constructive 

section 301 distribution is conformed to 

an actual section 301 distribution by 

identifying those shares with respect to 

which an actual section 301 distribution 

would have been received, and by 

reducing the basis of only those shares. 

i. Basis Adjustments in Dividend 

Equivalent Redemptions if Less Than 

All of the Shares of a Single Class Held 

by the Taxpayer Are Redeemed 

If less than all of the shares of a class 

of stock held by the taxpayer are 

redeemed, the proposed regulations 

provide that in a hypothetical 

recapitalization described in section 

368(a)(1)(E), the redeemed shareholder 

is deemed to exchange all its shares in 

the class, including the redeemed 

shares, for the actual number of shares 

held after the redemption transaction. 

The tracing rules of the section 358 

regulations apply to preserve the basis 

of the shares exchanged in the 

recapitalization in the remaining shares 

of the redeemed class held by the 

shareholder. Thus, under these 

proposed regulations, a dividend 

equivalent redemption is generally 

treated in the same manner, and its 

results are the same as, a section 301 

distribution in which no shares were 

cancelled. 

ii. Basis Recovery in Dividend 

Equivalent Redemptions in Which the 

Taxpayer Surrenders All of Its Shares in 

a Single Class 

Under current law, if all of the shares 

of a single class held by a shareholder 

are redeemed in a dividend equivalent 

redemption, any unrecovered basis in 

the redeemed shares is permitted to 

shift to other shares in certain 

circumstances. See § 1.302–2(c). The 

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IRS and Treasury Department believe 

that the shifting of stock basis is 

inconsistent with the fundamental 

principle that each share is a separate 

unit of property, and can lead to 

inappropriate results. Accordingly, 

these proposed regulations do not 

permit the shifting of basis to other 

shares held (directly or by attribution) 

by the redeemed shareholder. Instead, 

the proposed regulations preserve the 

tax consequences of the unrecovered 

basis for the redeemed shareholder by 

treating the amount of the unrecovered 

basis as a deferred loss of the redeemed 

shareholder that can be accessed when 

the conditions of sections 302(b)(1), (2), 

or (3) are satisfied, or alternatively, 

when all the shares of the issuing 

corporation (or its successor) become 

worthless within the meaning of section 

165(g). 

C. Dividend Equivalent Reorganization 

Exchanges 

If, pursuant to a reorganization, a 

shareholder receives qualifying property 

and boot in exchange for its target 

corporation stock, the tax consequences 

of the receipt of the boot under these 

proposed regulations will depend upon 

whether the reorganization exchange is 

dividend equivalent or not. See section 

III. of this Preamble for a description of 

the proposed rules that would apply if 

the reorganization is not dividend 

equivalent. 

In general, the determination of 

whether an exchange has the effect of 

the distribution of a dividend for 

purposes of section 356(a)(2) is 

determined by examining the effect of 

the shareholder’s ‘‘overall exchange.’’ 

Commissioner v. Clark, 489 U.S. 726, 

738 (1989). Thus, the key to this 

determination is the scope of the 

exchange. For example, if the 

shareholder exchanges shares of 

preferred stock solely for boot and 

shares of common stock solely for 

qualifying property pursuant to a plan 

of reorganization, is the determination 

of whether the exchange of the preferred 

stock for boot is dividend equivalent 

based solely on that particular exchange 

or on the overall exchange of the 

preferred and common stock for the 

qualifying property and the boot? The 

same question would arise with respect 

to each particular exchange if the 

shareholder exchanged the preferred 

and common stock for a combination of 

qualifying property and boot. The Clark 

decision examined a reorganization 

exchange involving a single class of 

stock, and does not provide guidance in 

the context of multiple classes of stock. 

In the case of a section 302 

redemption, the exchanging shareholder 

determines dividend equivalency based 

on all the facts and circumstances. See 

Zenz v. Quinlivan, 213 F.2d 914 (C.A.6 

1954). To promote consistency between 

sale or exchange transactions, these 

proposed regulations provide that the 

overall reorganization exchange shall be 

taken into account in determining 

whether a particular exchange is 

dividend equivalent. Thus, a 

shareholder that exchanges a class of 

stock solely for boot and another class 

of stock solely for nonqualifying 

property shall consider the overall 

exchange (the exchange of the two 

classes of stock for boot and qualifying 

property) in determining whether each 

particular exchange is dividend 

equivalent. 

If it is determined that a 

reorganization exchange is dividend 

equivalent, because different classes of 

stock have distinct legal entitlements 

that are respected for federal income tax 

purposes, the proposed regulations 

provide that an exchange of a class of 

stock solely of boot is an exchange to 

which section 302(d) (and not section 

356(a)(2)) applies. 

To ensure similar tax treatment of 

dividend equivalent reorganization 

exchanges and dividend equivalent 

redemptions, if the reorganization 

exchange is dividend equivalent the 

proposed regulations limit the ability of 

the exchanging shareholder to specify 

the terms of the exchange. Specifically, 

if the shareholder receives more than 

one class of stock or surrenders one 

class of stock and securities, the 

shareholder may specify the terms of the 

exchange between the classes of stock 

surrendered (or between one or more 

classes of stock and securities 

surrendered), provided the designation 

is economically reasonable, but not 

between particular shares of the same 

class of stock. 

As with the redemption of shares of 

a redeemed class in a dividend 

equivalent redemption, a shareholder’s 

receipt solely of boot with respect to a 

class of stock in a reorganization 

exchange is treated as received pro rata, 

on a share-by-share basis, with respect 

to each share in the class—under the 

principles of Johnson, the shareholder 

cannot specify that the boot is received 

with respect to particular shares within 

the class. Consequently, such an 

exchange could result in gain 

recognition with respect to some shares 

while other shares in the class could 

have recovered basis. 

In formulating the proposed 

regulations, the IRS and Treasury 

Department considered different 

alternatives. For example, in a dividend 

equivalent reorganization exchange 

pursuant to section 356(a)(2), the IRS 

and Treasury Department considered 

whether gain realized with respect to a 

class should be determined in the 

aggregate (for example, with respect to 

all shares within a class). Under this 

approach, no gain would be realized 

with respect to a class that has a block 

of built-in gain stock and block of builtin loss stock where the built-in loss is 

at least equal to the built-in gain. The 

IRS and Treasury Department rejected 

such an approach because it would 

contradict the fundamental principle 

that a share is a discrete unit of 

property, and also would compromise 

the principle that a reorganization 

exchange is not an event that justifies 

stock basis averaging. The IRS and 

Treasury Department also considered 

eliminating a shareholder’s ability to 

specify the terms of a dividend 

equivalent reorganization exchange 

based on the premise that under 

Johnson, all consideration received in 

such an exchange should be considered 

received pro rata among all shares, 

regardless of whether more than one 

class is surrendered. The IRS and 

Treasury Department rejected this 

approach in favor of the approach of the 

proposed regulations that is analogous 

to the proposed treatment of dividend 

equivalent redemptions, under which 

each share of the redeemed class is 

treated as receiving a pro rata share of 

the proceeds, and shares outside of the 

redeemed class are not treated as 

receiving any part of the distribution. 

D. Special Rules Related to 

Apportionment of Interest and Other 

Expenses 

Under section 864(e), taxpayers 

apportion interest expense between 

statutory and residual groupings on the 

basis of the relative values of their assets 

in each grouping. For this purpose, 

taxpayers may choose to value their 

assets using either fair market value or 

tax book value (adjusted basis). The 

proposed regulations provide that for 

purposes of apportioning expenses on 

the basis of the tax book value of assets, 

the adjusted basis in any remaining 

shares of the redeemed class owned by 

the redeemed shareholder, any shares 

that are not in the redeemed class, or 

any shares owned by certain affiliated 

corporations shall be increased by the 

amount of the unrecovered basis of 

redeemed shares. Thus, under the 

proposed regulations, the interest 

expense allocation and apportionment 

consequences of a dividend equivalent 

redemption are the same as an actual 

section 301 distribution. 

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3512 Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 

E. Section 1059 

Section 1059(a) provides that if a 

corporation receives an extraordinary 

dividend with respect to any share of 

stock and such corporation has not held 

such stock for more than two years 

before the dividend announcement date, 

then the corporation’s basis in such 

stock shall be reduced (but not below 

zero) by the non-taxed portion of such 

dividends. 

Except as provided in regulations, in 

the case of any redemption of stock 

which would not have been treated (in 

whole or in part) as a dividend if any 

options had not been taken into account 

under section 318(a)(4), or section 

304(a) had not applied, any amount 

treated as a dividend is treated as an 

extraordinary dividend, without regard 

to the taxpayer’s holding period in the 

stock. Section 1059(e)(1)(A)(iii). In the 

case of these types of redemptions, 

section 1059(e)(1)(A) (flush language) 

provides that only the basis of the stock 

redeemed shall be taken into account 

under section 1059(a). These proposed 

regulations do not affect the basis 

reduction provided for in section 

1059(e)(1)(A) if section 1059(e)(1)(A)(iii) 

otherwise applies. Accordingly, to the 

extent of an extraordinary dividend 

described in section 1059(e)(1)(A)(iii), a 

redeeming shareholder would first 

reduce basis as prescribed by section 

1059(e)(1)(A). These proposed 

regulations would then apply to the 

extent the distribution is not a dividend 

within the meaning of section 301(c)(1). 

F. Redemptions of Stock Held by 

Partnerships, Trusts, and S Corporations 

The treatment of unrecovered basis as 

a deferred loss raises special issues 

where the redeemed shareholder is an S 

corporation, a partnership, or a trust 

(each a flow-through entity). These 

proposed regulations reserve with 

respect to the issues relating to 

redeemed shareholders that are flowthrough entities pending further study 

and comment. The primary issue under 

study is whether an ‘‘outside’’ basis 

adjustment that reflects the deferred loss 

should occur at the time of the dividend 

equivalent redemption, or alternatively, 

when there is an inclusion date with 

respect to the deduction. 

In general, a deferred loss is reflected 

in the outside basis of an interest in a 

flow-through entity when the deduction 

can be accessed by the entity. 

Accordingly, as a general matter, 

disconformity can exist between inside 

attributes and outside basis where an 

inside attribute is a deferred loss. 

Conversely, a net operating loss of a 

flow-through entity reduces the outside 

basis of an interest in the entity in the 

year that the net operating loss arises. 

Although disconformity generally can 

exist where a flow-through entity has a 

deferred loss, the IRS and Treasury 

Department are concerned that deferred 

losses arising from unrecovered basis 

presents an opportunity to separate the 

deferred loss from the dividend income 

resulting from the redemption. The IRS 

and Treasury Department question 

whether such a separation would be 

appropriate, and believe that treating 

the deferred loss as a net operating loss 

in the year of the redemption for basis 

adjustment purposes may be the better 

approach. However, the IRS and 

Treasury Department acknowledge that 

it may be inappropriate to require the 

owners of a flow-through entity to 

reduce outside basis before the deferred 

loss can be accessed, simply because the 

owners of the flow-through entity 

cannot access the deferred loss. The IRS 

and Treasury Department request 

comments on this issue. 

Flow-through entities also present the 

question of when it is appropriate to 

treat an owner of the flow-through 

entity as the redeemed shareholder, and 

when it is appropriate to treat the flowthrough entity itself as the redeemed 

shareholder. For example, where the 

owner completely divests of its interest 

in the flow-through entity, it may be 

appropriate to treat the owner as the 

redeemed shareholder for determining 

whether the sale of the flow-through 

entity interest is an inclusion date with 

respect to that owner. This treatment 

may be more appropriate if the deferred 

loss is treated as a net operating loss 

that already has reduced the outside 

basis of the entity’s owner. Conversely, 

if the deferred loss is not treated as a net 

operating loss, it may be more 

appropriate to treat the flow-through 

entity as the redeemed shareholder in 

all cases. The IRS and Treasury 

Department request comments on this 

issue. 

G. Consolidated Groups and Basis 

Recovery in Dividend Equivalent 

Redemptions 

The IRS and Treasury Department 

continue to study the issues raised 

when a redeemed shareholder with a 

deferred loss files a consolidated return. 

The IRS and Treasury Department 

believe that certain of the concerns 

raised by REG–150313–01 are addressed 

in these proposed regulations by the 

deemed recapitalization mechanic 

described in section II.B.i. of this 

Preamble. 

III. Redemptions Treated as a Sale or 

Exchange Pursuant to Section 302(a) 

A. In General 

Under current law for redemptions 

characterized under section 302(a), a 

shareholder that owns shares of stock 

with different bases can decide whether 

to surrender for redemption high basis 

shares, low basis shares or any 

combination thereof. See § 1.1012–1(c). 

Consistent with treating a share as a 

discrete unit of property, the proposed 

regulations do not limit this electivity. 

Additionally, as further discussed 

below, these proposed regulations 

affirm the ability of a shareholder to 

specify the terms of a reorganization 

exchange where the receipt of boot 

results in sale or exchange treatment. 

B. Reorganization Exchanges That 

Result in Sale or Exchange Treatment 

If it is determined that the 

reorganization exchange is not dividend 

equivalent (as described in section II.C. 

of this Preamble), section 302(a) will 

apply to the extent shares are exchanged 

solely for boot. Just as a shareholder can 

elect to surrender high basis shares, low 

basis shares or any combination thereof 

in a non-dividend equivalent 

redemption, a shareholder engaging in a 

reorganization exchange that is not 

dividend equivalent can specify the 

receipt solely of boot for a share, 

provided that the terms of the exchange 

are economically reasonable. In such 

case, the shareholder will recognize gain 

or loss with respect to that share 

pursuant to section 302(a), and section 

356(a)(1) will not apply. 

IV. Extension of Tracing Principles To 

Determine Basis in Certain Stock 

Transfers That Are Not Reorganizations, 

and Other Proposals in Response to 

Specific Comments 

A. Application of Tracing Principles to 

Certain Section 351 Exchanges and 

Capital 

The current section 358 regulations 

apply tracing principles to determine 

the basis of stock received in a section 

351 exchange only where the section 

351 exchange also qualifies as a 

reorganization and no liabilities was 

assumed in the exchange. The principal 

reason for this limitation is the 

interaction of the basis tracing rules 

with the aggregate approach to gain 

determination under section 357(c). The 

IRS and Treasury Department continue 

to study this issue, but have concluded 

that the resolution of this issue is not 

necessary to broaden the application of 

the tracing rules to transfers of stock in 

section 351 exchanges in which no 

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Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 3513 

liabilities are assumed. Thus, for 

example, in an exchange to which 

section 351 applies where the transferor 

transfers two blocks of stock with 

disparate basis and other property, the 

separate bases will be preserved under 

section 358, provided that liabilities are 

not assumed in the exchange. 

In addition, these proposed 

regulations incorporate the deemed 

issuance and recapitalization approach 

of the current section 358 regulations to 

section 351 exchanges to preserve basis 

if insufficient shares, or no shares at all, 

are actually issued in the exchange. 

These proposed regulations also extend 

the deemed issuance and 

recapitalization approach to shareholder 

capital contributions to which section 

118 applies. 

B. Miscellaneous 

The IRS and Treasury Department 

have received a number of comments on 

the current section 358 regulations. 

These proposed regulations make a 

number of clarifying, but 

nonsubstantive, modifications to the 

current section 358 regulations. 

Specifically, the proposed regulations 

add headings throughout the existing 

final §§ 1.358–1 and 1.358–2 regulations 

without substantive change. In addition, 

the proposed regulations address the 

following comments received with 

respect to the current section 358 

regulations. 

Commentators questioned how 

shareholder elections factor into the 

terms of the exchange. These proposed 

regulations include two new examples 

illustrating the effect of such elections. 

Commentators questioned the effect of 

the terms of an exchange on the 

determination of whether a transaction 

qualifies as a reorganization, and 

therefore is not subject to the general 

rule of section 1001. These proposed 

regulations include cross-references in 

the regulations under sections 368 and 

1001 to clarify that, to the extent the 

terms of the exchange specify that a 

particular property is received in 

exchange for a particular property, such 

terms shall control for purposes of 

determining whether a transaction 

qualifies as a reorganization provided 

such terms are economically reasonable. 

Finally, in addition to provisions 

relating to the determination of basis, 

these proposed regulations add a rule 

that addresses certain issues considered 

in Rev. Rul. 68–55 (1968–1 CB 140). 

Specifically, consistent with Rev. Rul. 

68–55, these regulations provide that, 

for purposes of determining gain under 

section 351(b), the fair market value of 

each category of consideration received 

in a section 351 exchange is allocated 

between the transferred assets in based 

on relative fair market values. 

V. Specifically Requested Comments 

In addition to the comments 

requested throughout this Preamble, the 

IRS and Treasury request comments on 

the following areas. 

The proposed regulations under 

section 302 do not apply to a 

redemption of stock described in section 

306(c). Pursuant to section 306(a)(2), a 

redemption of stock described in section 

306(c) is treated as a distribution of 

property to which section 301 applies. 

Example 2 of § 1.306–1 suggests that the 

unrecovered basis of redeemed section 

306 stock is added to the basis of the 

stock with respect to which the section 

306 stock was distributed. The IRS and 

Treasury Department request comments 

on whether such treatment is 

appropriate or whether an alternative 

regime should apply when such a 

section 306(c) redemption is treated as 

a section 301 distribution. 

Comments are also requested 

regarding whether, after a section 355 

pro rata split-up, the controlled 

corporations are the same as or different 

from the distributing corporation for 

purposes of determining whether the 

date of distribution would be an 

inclusion date for a deferred loss 

attributable to unrecovered basis. 

Finally, the IRS and Treasury 

Department recognize that the proposed 

regulations may not address all related 

issues arising in all cash ‘‘D’’ 

reorganizations. Specifically, these 

proposed regulations may heighten the 

importance of whether the nominal 

share deemed issued in such a 

reorganization is received in respect of 

particular shares surrendered by the 

exchanging shareholder. The IRS and 

Treasury Department request comments 

with respect to this issue. 

Special Analyses 

It has been determined that this notice 

of proposed rulemaking is not a 

significant regulatory action as defined 

in Executive Order 12866. Therefore, a 

regulatory assessment is not required. 

Further, it is hereby certified that these 

proposed 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 provide clarifying 

guidance of existing law and do not 

create additional obligations for, or 

impose an economic impact on small 

entities. Accordingly, a Regulatory 

Flexibility Analysis under the 

Regulatory Flexibility Act (5 U.S.C. 

chapter 6) is not required. Pursuant to 

section 7805(f) of the Code, this notice 

of proposed rulemaking will be 

submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on its 

impact on small business. 

Comments and Public Hearing 

Before these proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

written (a signed original and eight (8) 

copies) or electronic comments that are 

submitted timely to the IRS. All 

comments will be available for public 

inspection and copying. If a public 

hearing is scheduled, notice of the date, 

time, and place for the public hearing 

will be published in the Federal 

Register. 

Drafting Information 

The principal authors of these 

regulations are Theresa M. Kolish and 

Rebecca O. Burch of the Office of 

Associate Chief Counsel (Corporate). 

Other personnel from offices of the IRS 

and Treasury Department participated 

in their development. 

Availability of IRS Documents 

IRS revenue rulings, procedures, and 

notices cited in this preamble are made 

available by the Superintendent of 

Documents, U.S. Government Printing 

Office, Washington, DC 20402. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR Part 1 is 

proposed to be amended as follows: 

PART 1—INCOME TAXES 

Paragraph 1. The authority citation 

for part 1 continues to read, in part, as 

follows: 

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

Par. 2. Section 1.301–2 is added to 

read as follows: 

§ 1.301–2 Application to basis. 

(a) Application to basis. That portion 

of a distribution which is not a dividend 

shall be applied pro rata, on a share-byshare basis, to reduce the adjusted basis 

of each share of stock held by the 

shareholder within the class of stock 

upon which the distribution is made. 

The following example illustrates this 

paragraph (a): 

Example. (i) Facts. Corporation X, a 

calendar year taxpayer, has only common 

stock outstanding. A, an individual, owns all 

100 shares; 25 were acquired on Date 1 for 

$25 (Block 1) and 75 were acquired on Date 

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2 for $175 (Block 2). On December 31, when 

Corporation X had earnings and profits of 

$100, it made a $3 distribution on each share 

of common stock. 

(ii) Analysis. A is treated as receiving $75 

of the distribution on block 1 and $225 on 

block 2. On Block 1, A will have a $25 

dividend under section 301(c)(1), a $25 

return of capital under section 301(c)(2) and 

a $25 gain under section 301(c)(3). On Block 

2, A will have a $75 dividend under section 

301(c)(1), a $150 return of capital under 

section 301(c)(2) and will have a remaining 

basis of $25 in the shares of block 2. 

(b) Effective/applicability date. This 

section applies to transactions that 

occur after the date these regulations are 

published as final regulations in the 

Federal Register. 

§ 1.302–2 [Amended] 

Par. 3. In § 1.302–2, paragraph (c) is 

removed and reserved. 

Par. 4. Section 1.302–5 is added to 

read as follows: 

§ 1.302–5 Redemptions under section 

302(d). 

(a) In general—(1) Share-by-share 

basis reduction. In any case in which an 

amount received in redemption of stock 

(as defined in section 317(b)) is treated 

as a distribution to which section 301 

applies, that portion of a distribution 

that is not a dividend shall be applied 

to reduce the adjusted basis of each 

share held by the redeemed shareholder 

(as defined in paragraph (b) of this 

section) in the redeemed class (as 

defined in paragraph (b) of this section). 

Such reduction shall be applied pro 

rata, on a share-by-share basis, to all 

shares of the redeemed class held by the 

redeemed shareholder. Gain, if any, on 

a share shall be determined under 

section 301(c)(3). 

(2) Deemed recapitalization. Except as 

provided in paragraph (a)(3) of this 

section, immediately following the 

reduction of basis as provided in section 

301(c)(2) and paragraph (a)(1) of this 

section, all shares of the redeemed class, 

including the redeemed shares, held by 

the redeemed shareholder will be 

treated as surrendered in a 

reorganization described in section 

368(a)(1)(E) in exchange for the number 

of shares of the redeemed class directly 

held by the redeemed shareholder after 

the redemption. The basis of the shares 

deemed received in the reorganization 

described in section 368(a)(1)(E) will be 

determined under the rules of section 

358 and § 1.358–2. 

(3) Redemption of all shares of 

redeemed class—(i) Remaining basis 

treated as loss. If all the shares of the 

redeemed class held by the redeemed 

shareholder are redeemed, an amount 

equal to the basis of the redeemed stock, 

after adjusting such basis to reflect the 

application of section 301(c)(2) as 

provided in paragraph (a)(1) of this 

section, will be treated as a loss on a 

disposition of the redeemed stock on the 

date of the redemption. Such loss is 

taken into account on the inclusion date 

as defined in paragraph (b) of this 

section. 

(ii) Attributes of loss. Notwithstanding 

that a loss described in paragraph 

(a)(3)(i) of this section may be deferred 

and taken into account on a date later 

than the date of the redemption, the 

attributes (for example, character and 

source) of such loss are determined on 

the date of the redemption that gave rise 

to such loss. 

(b) Definitions—(1) Redeemed 

shareholder. Except as provided in 

paragraph (c) of this section, the term 

redeemed shareholder means the person 

whose stock is redeemed in a 

transaction. If the redeemed shareholder 

is a corporation, and the assets of the 

redeemed shareholder are acquired in a 

transaction described in section 381(a) 

(other than transactions described in 

paragraph (b)(4)(ii) of this section), the 

acquiring corporation (within the 

meaning of section 381) thereafter is 

treated as the redeemed shareholder. 

(2) Redeemed class. With respect to a 

shareholder whose stock has been 

redeemed, the term redeemed class 

means all of the shares of that class held 

by the redeemed shareholder. For this 

purpose, a class is defined with respect 

to economic rights to distributions 

rather than the labels attached to shares 

or rights with respect to corporate 

governance. 

(3) Redeeming corporation. The term 

redeeming corporation means the 

corporation that issued the stock that is 

redeemed. 

(4) Inclusion date—(i) Definition. The 

term inclusion date means the earlier 

of— 

(A) The first date on which the 

redeemed shareholder would satisfy the 

criteria of section 302(b)(1), (2), or (3), 

if the facts and circumstances that exist 

at the end of such day had existed 

immediately after the redemption; or 

(B) The first date on which all classes 

of stock of the redeeming corporation 

become worthless within the meaning of 

section 165(g). Solely for purposes of 

this paragraph, if the assets of the 

redeeming corporation (or its successor) 

are acquired by another corporation in 

a transaction described in section 

381(a), the inclusion date for the 

redeemed shareholder is determined by 

treating all of the facts and 

circumstances that exist at the end of 

the day that includes the section 381 

transaction (including the acquisition of 

the assets of the redeeming corporation 

or its successor) as existing immediately 

after the redemption. A successor for 

this purpose means a corporation that 

acquires the assets of the redeeming 

corporation in a transaction to which 

section 381(a) applies. 

(ii) Special rules for corporate 

shareholders. If the redeemed 

shareholder is a corporation, the 

inclusion date includes the date such 

corporation has disposed of all of its 

assets in a transaction in which all gain 

and loss with respect to its assets is 

recognized in whole, and the 

corporation ceases to exist for tax 

purposes. If the redeemed shareholder is 

a foreign corporation, the inclusion date 

includes the date such corporation 

transfers its assets to a domestic 

corporation in either a liquidation 

described in section 332 or a 

reorganization described in section 

368(a)(1) to which section 381 applies. 

If the redeemed shareholder is a foreign 

corporation that is not a controlled 

foreign corporation within the meaning 

of section 957(a) on the date of the 

redemption, the inclusion date includes 

the date such corporation transfers its 

assets to a controlled foreign 

corporation in a liquidation described in 

section 332 or a reorganization 

described in section 368(a)(1) to which 

section 381 applies. 

(c) Rules for special shareholders—(1) 

Redeemed shareholder is a partnership. 

[Reserved] 

(2) Redeemed shareholder is an S 

corporation. [Reserved] 

(3) Redeemed shareholder is an estate 

or trust. [Reserved] 

(d) Operating rules for treatment of 

loss attributable to basis of redeemed 

stock— 

(1) Treatment as a deferred loss. Any 

loss attributable to the basis of 

redeemed stock under paragraph (a) of 

this section that has not been permitted 

to be taken into account under such 

section shall be treated as a deferred 

loss. The character of the deferred loss 

as ordinary or capital is determined at 

the time of the redemption. 

(2) Effect of loss attributable to basis 

of redeemed stock on earnings and 

profits. If the redeemed shareholder is a 

corporation, any deferred loss 

attributable to the basis of redeemed 

stock is not reflected in such 

corporation’s earnings and profits before 

it is taken into account pursuant to the 

rules of paragraph (a)(3) of this section. 

See, for example, §§ 1.312–6(a) and 

1.312–7. 

(e) Examples. For the purposes of the 

examples in this section, Corporations 

X, Y and Z are domestic corporations 

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that file U.S. tax returns on a calendaryear basis. The examples are as follows: 

Example 1. (i) Facts. A and B, husband and 

wife, each own 100 shares (50 percent) of the 

common stock of Corporation X which they 

hold as a capital asset. On Date 1, A acquired 

50 shares for $100 (block 1) and 50 shares on 

Date 2 for $200 (block 2). On December 31, 

Corporation X, which has no current or 

accumulated earnings and profits, redeems 

all of A’s block 2 shares for $300. Under 

section 302(d), the redemption proceeds are 

treated under section 301 as a recovery of 

basis. 

(ii) Analysis. Under this section, 

immediately before the redemption, the 

distribution of property is applied on a pro 

rata, share-by-share basis with respect to each 

of the shares in the redeemed class held 

directly by A, the redeemed shareholder. 

Accordingly, A will have a $50 capital gain 

on block 1 ($150–100) under section 

301(c)(3) and $50 of basis remaining on block 

2 ($150–200). To reflect the actual number of 

shares held by A after the redemption, A’s 

shares in the redeemed class, including the 

shares actually surrendered, will be treated 

as exchanged in a recapitalization under 

section 368(a)(1)(E). The basis in A’s 

recapitalized shares will be determined 

under § 1.358–2. Accordingly, A will have 25 

shares with a zero basis (attributable to block 

1) and 25 shares with a basis of $50 

(attributable to block 2). 

Example 2. (i) Facts. The facts are the same 

as in Example 1, except that, Corporation X, 

on the following December 31, when it has 

no current or accumulated earnings and 

profits, redeems all of A’s remaining 50 

shares for $40. A does not file an agreement 

described in section 302(c)(2)(A)(iii) waiving 

family attribution under section 318. 

(ii) Analysis. Since A is treated under 

section 318(a)(1) as owning B’s shares, the 

redemption is described in section 302(d) 

and is treated as a distribution to which 

section 301 applies. As in Example 1, 

immediately before the redemption, the 

distribution is applied on a pro rata, shareby-share basis with respect to each of the 

shares in the redeemed class held by A. 

Accordingly, A recognizes a $20 gain and a 

$30 loss. The $30 deferred loss under 

§ 1.302–5(a)(3) may be taken into account by 

A on the inclusion date (see § 1.302– 

5(a)(3)(ii)). 

Example 3. (i) Facts. Corporation X has 

both common and preferred stock 

outstanding. A, an individual, has 100 shares 

of common stock with a basis of $100 and 

100 shares of preferred stock with a basis of 

$200. The 100 shares of common stock 

represent voting control of Corporation X. 

Corporation X, when it has no current or 

accumulated earnings and profits, redeems 

all of A’s preferred stock for $150. Section 

302(d) applies to the redemption, and 

therefore the distribution is treated as a 

distribution of property to which section 301 

applies. 

(ii) Analysis. If Corporation X had declared 

a distribution under section 301 with respect 

to the redeemed preferred stock, the 

distribution would have been limited to the 

shares of common stock. Therefore, the only 

basis recovered under section 301(c)(2) is the 

basis of A’s preferred stock. A has $50 in 

excess basis after the redemption of all its 

preferred stock which will not shift to the 

common stock held by A. Under § 1.302– 

5(a)(3), the excess basis will be treated as a 

deferred loss until the inclusion date. 

Example 4. (i) Facts. Corporation Z has 100 

shares of stock outstanding, 50 shares of 

which are owned by each of A and his son, 

B. A’s basis in each of his shares of 

Corporation Z stock is $1. In Year 1, 

Corporation Z redeems all of A’s shares of 

Corporation Z stock for $200. A does not file 

an agreement described in section 

302(c)(2)(A)(iii) waiving family attribution 

under section 318. At the end of Year 1, 

Corporation Z has current and accumulated 

earnings and profits in excess of $200. 

Section 302(d) applies to the redemption, 

and therefore the distribution is treated as a 

distribution to which section 301 applies. A 

recognizes dividend income of $200. In Year 

6, Corporation Y, a publicly traded 

corporation acquires all of Corporation Z’s 

assets in exchange solely for voting stock in 

a reorganization described in section 

368(a)(1)(C). In the reorganization, B 

surrenders his shares of Corporation Z stock 

which, at the time of the reorganization have 

an aggregate fair market value of $200, and 

receives in exchange 5,000 shares of common 

stock of Corporation Y representing less than 

one percent of the fair market value of all the 

stock of Y. 

(ii) Analysis. Under this section, an amount 

equal to A’s basis in the redeemed stock after 

the Year 1 redemption, $50, is treated as a 

deferred loss on a disposition of the 

redeemed stock on the date of the 

redemption. Under paragraph (b)(3) of this 

section, solely for purposes of determining 

whether a particular date on or after the date 

of the reorganization is the inclusion date, 

Corporation Y, the acquiring corporation, is 

treated as the redeeming corporation. If the 

facts and circumstances that exist at the end 

of the day of the reorganization had existed 

on the date of the redemption, the 

redemption would have been treated as a 

distribution in part or full payment in 

exchange for the redeemed stock pursuant to 

section 302(a). Therefore, the date of the 

reorganization is the inclusion date and A is 

permitted to take into account the deferred 

loss of $50 attributable to his basis in the 

redeemed stock in Year 6. 

(f) Effective/applicability date. This 

section applies to transactions that 

occur after the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 5. Section 1.304–1 is revised to 

read as follows: 

§ 1.304–1 In general. 

(a) In general. Section 304 is 

applicable where a shareholder sells 

stock of one corporation to a related 

corporation as defined in section 304. 

Sales to which section 304 is applicable 

shall be treated as redemptions subject 

to sections 302 and 303. 

(b) Effective/applicability date. This 

section applies to transactions that 

occur after the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 6. Section 1.304–2 is amended by 

revising paragraphs (a) and (c), and 

adding paragraph (d) to read as follows: 

§ 1.304–2 Acquisition by related 

corporation (other than a subsidiary). 

(a) In general (1) If a corporation (the 

acquiring corporation), in return for 

property, acquires the stock of another 

corporation (the issuing corporation) 

from one or more persons, and such 

person or persons from whom the stock 

was acquired were in control of both 

such corporations, then such property 

shall be treated as received in 

redemption of the common stock of the 

acquiring corporation. As to each person 

transferring stock, the amount received 

shall be treated as a distribution to 

which section 301 applies, if section 

302(a) or 303 does not apply. For the 

amount constituting a dividend in such 

cases, see § 1.304–6. 

(2) Section 302(b). In applying section 

302(b), reference shall be made to the 

ownership of stock in the issuing 

corporation and not to the ownership of 

the acquiring corporation (except for the 

purposes of applying section 318(a)). 

Section 318(a) shall be applied without 

regard to the 50 percent limitation 

contained in section 318(a)(2)(C) and 

(3)(C). 

(3) Section 302(d). If, pursuant to 

section 302(d), section 301 applies to 

the property received in redemption of 

the common stock of the acquiring 

corporation pursuant to paragraph (a)(1) 

of this section, the transferor and the 

acquiring corporation shall be treated, 

for all Federal income tax purposes, in 

the same manner as if the transferor had 

transferred the stock of the issuing 

corporation to the acquiring corporation 

in exchange for the common stock of the 

acquiring corporation in a transaction to 

which section 351 applies, and then the 

acquiring corporation had redeemed the 

common stock it was treated as issuing 

in an exchange for property. 

Accordingly, the acquiring corporation’s 

basis in the stock of the issuing 

corporation is determined under section 

362, and, under section 358, the 

transferor’s basis in the common stock 

of the acquiring corporation deemed 

issued to the transferor in the deemed 

section 351 transaction is equal to the 

transferors basis in the stock of the 

issuing corporation it surrendered. 

(4) Basis of redeemed shares. To the 

extent that section 301(c)(2) applies to 

the redemption of the common stock of 

the acquiring corporation issued in the 

deemed section 351 exchange, the 

amount distributed in such redemption 

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shall be applied to reduce the adjusted 

basis of each share of common stock 

directly held or deemed held by the 

transferor on a pro rata, share-by-share 

basis. See § 1.302–5(a). 

(5) Sale or exchange treatment. If 

section 301 does not apply to the 

property treated as received in 

redemption of the common stock of the 

acquiring corporation pursuant to 

paragraph (a)(1) of this section, the 

property received by the transferor shall 

be treated as received in a distribution 

in full payment in exchange for such 

common stock of the acquiring 

corporation under section 302(a). The 

basis and the holding period of the 

common stock of the acquiring 

corporation that is treated as redeemed 

will be the same as the basis and 

holding period of the stock of the 

issuing corporation actually 

surrendered. The acquiring corporation 

shall take a cost basis in the stock of the 

issuing corporation that it acquires 

under section 1012. 

* * * * * 

(c) Examples. For purposes of the 

examples in this section, each of 

corporation is a domestic corporation 

that files a U.S. tax return on a calendaryear basis and in each instance the fair 

market value of the issuing corporation 

stock is in excess of its adjusted basis. 

The principles of this section are 

illustrated by the following examples: 

Example 1. (i) Facts. Corporation X and 

Corporation Y each has 100 shares of 

common stock outstanding. A, an individual, 

owns one-half of the stock of each 

corporation, B owns one-half of the stock of 

Corporation X, and C owns one-half of the 

stock of Corporation Y. A, B, and C are 

unrelated. A sells 30 shares of the stock of 

Corporation X, which have an adjusted basis 

of $10, to Corporation Y for $50. 

(ii) Analysis. Section 304(a)(1) applies to 

A’s sale of 30 shares of Corporation X stock 

to Corporation Y because A controls both 

Corporation X and Corporation Y within the 

meaning of section 304(c), and Corporation Y 

acquires the 30 shares of Corporation X stock 

from A in exchange for property ($50 of 

cash). Pursuant to section 304(a)(1), the cash 

received by A is treated as a redemption of 

the stock of Corporation Y. Because before 

the sale A owns 50 percent of the stock of 

Corporation X and after the sale A owns only 

35 percent of such stock (20 shares directly 

and 15 constructively because one-half of the 

30 shares owned by Corporation Y are 

attributed to A), the redemption is 

substantially disproportionate as to A 

pursuant to the provisions of section 

302(b)(2). A, therefore, recognizes a gain of 

$40 ($50 minus $10). If the stock surrendered 

is a capital asset, such gain is long-term or 

short-term capital gain depending on the 

period of time that A held such stock. A’s 

basis in the stock of Corporation Y is not 

changed as a result of the sale. Under section 

1012, the basis that Corporation Y takes in 

the acquired stock of Corporation X is its cost 

of $50. 

Example 2. (i) Facts. Corporation X and 

Corporation Y each has 200 shares of 

common stock outstanding, all of which are 

owned by H, an individual. H has a basis 

$100 in his Corporation X stock and $30 in 

his Corporation Y stock. Corporation X has 

$40 and Corporation Y has $20 of current and 

accumulated earnings and profits. H sells his 

200 shares of Corporation X stock to 

Corporation Y for $150 at a time when 

Corporation Y stock also has a fair market 

value of $150. 

(ii) Analysis. Section 304(a)(1) applies to 

H’s sale of his 200 shares of Corporation X 

stock to Corporation Y because H controls 

both Corporation X and Corporation Y within 

the meaning of section 304(c), and 

Corporation Y acquires the 200 shares of 

Corporation X stock from H in exchange for 

property. Pursuant to section 304(a)(1), the 

cash received by H is treated as a redemption 

of the stock of Corporation Y. Because before 

the sale H directly owns 100 percent of 

Corporation X and after the sale H is treated 

as owning 100 percent of Corporation X, 

section 302(a) does not apply to the deemed 

redemption distribution. Under section 

302(d), the proceeds of the deemed 

redemption are treated as a distribution to 

which section 301 applies. Therefore, H is 

treated as transferring the Corporation X 

stock to Corporation Y in exchange for 

Corporation Y common stock in a transaction 

to which section 351(a) applies. Corporation 

Y’s basis in the Corporation X stock acquired 

is $100 under section 362(a), the same basis 

that H had in the Corporation X stock 

surrendered. H takes a basis of $100 in the 

Corporation Y common stock H is treated as 

receiving in the deemed section 351 

exchange. Corporation Y is then treated as 

redeeming such Corporation Y common stock 

from H for $150 in a transaction to which 

section 301 applies. H is treated as receiving 

a dividend of $60 ($20 from the current and 

accumulated earnings and profits of 

Corporation Y and then $40 from the current 

and accumulated earnings and profits of 

Corporation X) (see section 304(b)). Under 

§ 1.302–5, the remaining $90 of the 

distribution will be applied to and reduce the 

basis of each share of Corporation Y stock 

held by H. Accordingly, H will have no gain 

on the shares deemed received in the section 

351 exchange which have a $100 basis, but 

will have a $15 gain on the Corporation Y 

shares with a $30 basis. After the redemption 

transaction, all of H’s shares in Corporation 

Y, including the deemed shares that are 

redeemed, are treated as exchanged in a 

recapitalization described in section 

368(a)(1)(E). The basis of the redeemed 

shares and the shares actually outstanding in 

Corporation Y are allocated pursuant to 

§ 1.358–2(a). Accordingly, of H’s 200 shares 

in Corporation Y common stock, 100 will 

have a basis of $55, and 100 will have a zero 

basis. 

Example 3. (i) Facts. Corporation W 

acquired all of the outstanding stock of 

Corporation X stock for $75 (100 shares of 

common) and then acquired all of the 

outstanding stock of Corporation Y (50 shares 

of common stock for $75 and 50 shares of 

common stock for $100). Only corporation Y 

has current or accumulated earnings and 

profits ($100). Corporation W sells all the 

shares in Corporation X to Corporation Y for 

$300. At the time of the transaction, the 

Corporation X and Corporation Y stock have 

the same fair market value. 

(ii) Analysis. Section 304(a)(1) applies to 

Corporation W’s sale of Corporation X to 

Corporation Y because Corporation W is in 

control of both Corporation X and 

Corporation Y within the meaning of section 

304(c), and Corporation Y acquires the 

Corporation X stock in exchange for property. 

Because before the sale Corporation W owns 

100 percent of Corporation X, and after the 

sale is treated as owning 100 percent of 

Corporation X, section 302(a) does not apply 

to the deemed redemption distribution. 

Under section 302(d), the proceeds of the 

deemed redemption are treated as a 

distribution to which section 301 applies. 

Section 1059(e)(1)(A)(iii) also applies. 

Corporation W is treated as transferring the 

Corporation X stock to Corporation Y in 

exchange for Corporation Y common stock in 

a transaction to which section 351(a) applies. 

Corporation Y’s basis in the Corporation X 

stock is $75 under section 362(a), the same 

basis that Corporation W had in the stock it 

surrendered. Corporation W takes a $75 basis 

in the Corporation Y common stock it is 

deemed to receive in the deemed section 351 

transaction. Corporation Y is then treated as 

redeeming such Corporation Y common stock 

from Corporation W for $300. In a 

redemption to which section 301 applies, 

Corporation W is treated as receiving a 

dividend of $100 (from the current and 

accumulated earnings and profits of 

Corporation Y) (see section 304(b)). Under 

section 1059, the $100 dividend is treated as 

an extraordinary dividend which, under the 

flush language of section 1059(e)(1)(A)(iii), 

reduces only the basis of the stock deemed 

redeemed, which has a basis of $75. 

Accordingly, Corporation W recognizes a $25 

gain. Under § 1.302–5, the remaining $200 of 

the distribution is applied to reduce the basis 

of the Corporation Y stock held by 

Corporation W on a pro rata, share-by-share 

basis, including the basis in the shares 

deemed redeemed. Accordingly, $100 is 

allocated to the Corporation Y stock that 

Corporation W deemed received in the 

section 351 transaction that now has a zero 

basis after the application of section 1059 

and the remaining $100 is allocated to 

Corporation W’s other two blocks of 

Corporation Y stock. Corporation W has a 

total gain of $125 on the Corporation Y stock 

deemed received and redeemed; and $25 and 

$50, respectively, of remaining basis in the 

other 2 blocks of corporation Y shares. After 

the redemption transaction, all of 

Corporation W’s shares in corporation Y, 

including the deemed shares that are 

redeemed, are treated as exchanged in a 

recapitalization described in section 

368(a)(1)(E). As a result, corporation W will 

have 100 shares in corporation Y, 50 shares 

will have a zero basis, 25 shares will have a 

$25 basis, and 25 shares will have a $50 

basis. 

(d) Effective/applicability date. This 

section applies to transactions that 

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occur after the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 7. Section 1.304–3 is amended by 

revising paragraph (a) and adding 

paragraph (c) to read as follows: 

§ 1.304–3 Acquisition by a subsidiary. 

(a) In general. If a subsidiary, in return 

for property, acquires stock of its parent 

corporation from a shareholder of the 

parent corporation, the acquisition of 

such stock will be treated as if the 

parent corporation had redeemed its 

own stock in exchange for the property. 

For the purposes of this section, a 

corporation is a parent corporation if it 

meets the 50 percent ownership 

requirements of section 304(c). The 

determination of whether the amount 

received shall be treated as received in 

payment in exchange for the stock will 

be made by applying section 302(b) with 

reference to the stock of the issuing 

parent corporation, or by applying 

section 303. 

* * * * * 

(c) Effective/applicability date. This 

section applies to transactions that 

occur after the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 8. Section 1.304–5 is amended by 

adding a sentence at the end of 

paragraph (a) and revising paragraph (c) 

to read as follows: 

§ 1.304–5 Control. 

(a) * * * Specifically, section 318(a) 

will be applied by substituting ‘‘5 

percent’’ for ‘‘50 percent’’ in section 

318(a)(2)(C) and by substituting ‘‘5 

percent’’ for ‘‘50 percent’’ in section 

318(a)(3)(C), except that if section 

318(a)(3)(C) would not have applied but 

for this substitution, by considering a 

corporation as owning the stock (other 

than stock in such corporation) owned 

by or for any shareholder of such 

corporation in that proportion which 

the value of the stock which such 

shareholder owned in such corporation 

bears to the value of all stock in such 

corporation. 

* * * * * 

(c) Effective/applicability date. This 

section applies to transactions that 

occur after the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 9. Section 1.351–2 is amended by 

redesignating paragraphs (b), (c), (d) and 

(e) as paragraphs (c), (d), (e) and (f), 

respectively and adding new paragraphs 

(b) and (g) to read as follows: 

§ 1.351–2 Receipt of property. 

* * * * * 

(b) To determine the amount of gain 

recognized under section 351(b), the fair 

market value of each category of 

consideration received by each 

transferor is allocated to the properties 

transferred in proportion to each 

property’s relative fair market value. 

The application of this paragraph (b) is 

illustrated by the following example: 

Example. C transfers $2,000 in exchange 

for 200 shares of stock. D transfers Asset I, 

Asset II, and Asset III in exchange for $100 

cash and 100 shares of stock. The exchange 

is subject to section 351. At the time of the 

exchange, Asset I has a fair market value of 

$220 and a basis of $400, Asset II has a fair 

market value of $330 and a basis of $200, and 

Asset III has a fair market value of $550 and 

a basis of $250. No gain or loss is recognized 

to C. Gain, but not loss, is recognized by D. 

To determine the gain recognized by D under 

section 351(b), the fair market value of each 

category of consideration received is 

allocated to the properties transferred in 

proportion to the relative fair market values 

of the properties transferred. Asset I 

represents 20 percent of the total fair market 

value of assets transferred (220/1100), Asset 

II represents 30 percent (330/1100), and 

Asset III represents 50 percent (550/1100). 

Under paragraph (b) of this section, the 

amount of gain recognized by D is 

determined by allocating a pro rata portion 

of each class of consideration received to 

each property transferred as follows: (A) $20 

cash and 20 shares of stock to Asset I (20 

percent of 100 shares of stock and 20 percent 

of $100 (B) $30 cash and 30 shares of stock 

to Asset II (30 percent of 100 shares of stock 

and 30 percent of $100); and (C) $50 cash and 

50 shares of stock to Asset III (50 percent of 

100 shares of stock and 50 percent of $100). 

D realizes a loss of $180 on Asset I, none of 

which is recognized, a gain of $130 on Asset 

II, $30 of which is recognized, and a gain of 

$300 on Asset III, $50 of which is recognized. 

* * * * * 

(g) This section applies to exchanges 

that occur after the date these 

regulations are published as final 

regulations in the Federal Register, 

except for exchanges which occur 

pursuant to a written agreement that is 

binding on or before the date these 

regulations are published as final in the 

Federal Register. For exchanges that 

occur on or before the date that these 

regulations are published as final 

regulations in the Federal Register, see 

this section as contained in 26 CFR part 

1 revised April 1, for the year before 

these regulations are published as final 

regulations in the Federal Register. 

Par. 10. Section 1.354–1 is amended 

by: 

1. Revising the section heading. 

2. Redesignating paragraphs (d), (e) 

and (f) as paragraphs (e), (f) and (g), 

respectively. 

3. Adding new paragraphs (d) and (h). 

4. Adding Example 5 to the end of 

newly designated paragraph (e). 

The additions and revisions read as 

follows: 

§ 1.354–1 Exchanges of stock, securities 

and other property in certain 

reorganizations. 

* * * * * 

(d) Exchanges solely or partly for 

money or other property—(1) 

Determination of consideration for a 

share of stock or a security. In 

determining the consideration received 

for a share of stock or a security, except 

as otherwise provided in this paragraph 

(d)(1), a pro rata portion of any other 

property and money received shall be 

treated as received in exchange for each 

share of stock and security surrendered, 

based on the fair market value of such 

surrendered share of stock or security. 

However, to the extent the terms of the 

exchange specify the other property or 

money that is received in exchange for 

a particular share of stock or security 

surrendered or a particular class of stock 

or securities surrendered, such terms 

shall control provided that the terms are 

economically reasonable, unless the 

shareholder’s exchange has the effect of 

a distribution of a dividend. If the 

exchange has the effect of a distribution 

of a dividend and the terms of an 

exchange specify the other property or 

money that is received with respect to 

a particular share of stock and such 

specification would otherwise be 

economically reasonable, such other 

property or money shall be treated as 

received pro rata in exchange for each 

share of stock within that class (as 

defined in section 1.302–5(b)(2)) held by 

the exchanging shareholder. 

Notwithstanding the preceding 

sentence, economically reasonable 

designations between classes of stock or 

securities (as opposed to within a class) 

shall generally control. All exchanges 

made by an exchanging shareholder, 

whether governed by section 354, 356, 

or 302, are taken into account to 

determine whether the shareholder’s 

exchange has the effect of a distribution 

of a dividend. 

(2) Treatment of exchanges of stock 

solely for money or other property. 

Neither section 354 nor so much of 

section 356 as relates to section 354 

applies to a shareholder’s surrender of 

a share of stock in exchange solely for 

money or other property that is not 

permitted to be received without the 

recognition of gain, even though such 

exchange is pursuant to a plan of 

reorganization described in section 

368(a), and even though section 354, 

section 356 or both sections 354 and 356 

apply to the exchange of other shares by 

that shareholder or other shareholders. 

See section 302 and the regulations 

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3518 Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 

under that section for the treatment of 

such an exchange. 

(e) * * * 

Example 5. D owns shares of Class A 

common stock, Series 1 preferred stock, and 

Series 2 preferred stock in Corporation T. 

The Series 1 preferred stock and the Series 

2 preferred stock are different classes of 

stock. Pursuant to a reorganization described 

in section 368(a) to which corporations T and 

V are parties, D surrenders all of D’s Class A 

common stock in Corporation T in exchange 

for common stock in Corporation V, all of D’s 

Series 1 preferred stock in Corporation T in 

exchange for both cash and common stock in 

Corporation V, and all of D’s Series 2 

preferred stock in Corporation T in exchange 

solely for cash. Section 354 applies to the 

exchange of the Class A common stock in 

Corporation T for Corporation V common 

stock. Section 356 applies to the exchange of 

Series 1 preferred stock for Corporation V 

common stock and cash. Neither section 354 

(nor so much of section 356 as relates to 

section 354) applies to the exchange of Series 

2 preferred stock in Corporation T solely for 

cash (see section 302 and regulations 

thereunder). 

* * * * * 

(h) This section applies to exchanges 

that occur after the date these 

regulations are published as final 

regulations in the Federal Register, 

except for exchanges which occur 

pursuant to a written agreement that is 

binding on or before the date these 

regulations are published as final in the 

Federal Register. For exchanges that 

occur on or before the date these 

regulations are published as final 

regulations in the Federal Register, see 

this section as contained in 26 CFR part 

1 revised April 1, for the year before 

these regulations are published as final 

regulations in the Federal Register. 

Par. 11. Section 1.355–1 is amended 

by adding new paragraph (e) to read as 

follows: 

§ 1.355–1 Distribution of stock and 

securities of a controlled corporation. 

* * * * * 

(e) Exchanges solely or partly for 

money and other property—(1) 

Determination of consideration for a 

share of stock or a security. In 

determining the consideration received 

for a share of stock or a security, except 

as otherwise provided in this paragraph 

(e)(1), a pro rata portion of any other 

property and money received shall be 

treated as received in exchange for each 

share of stock and security surrendered, 

based on the fair market value of such 

surrendered share of stock or security. 

However, to the extent the terms of the 

exchange specify the other property or 

money that is received in exchange for 

a particular share of stock or security 

surrendered or a particular class of stock 

or securities surrendered, such terms 

shall control provided that the terms are 

economically reasonable, unless the 

shareholder’s exchange has the effect of 

a distribution of a dividend. If the 

exchange has the effect of a distribution 

of a dividend and the terms of an 

exchange specify the other property or 

money that is received with respect to 

a particular share of stock and such 

specification would otherwise be 

economically reasonable, such other 

property or money shall be treated as 

received pro rata in exchange for each 

share of stock within that class (as 

defined in § 1.302–5(b)(2)) held by the 

exchanging shareholder. 

Notwithstanding the preceding 

sentence, economically reasonable 

designations among classes of stock (as 

opposed to within a class) shall 

generally control. All exchanges made 

by an exchanging shareholder, whether 

governed by section 355, 356, or 302, 

are taken into account to determine 

whether the shareholder’s exchange has 

the effect of a distribution of a dividend. 

(2) Treatment of exchanges of stock 

solely for money or other property. 

Neither section 355 nor so much of 

section 356 as relates to section 355 

applies to a shareholder’s surrender of 

a share of stock in exchange solely for 

money or other property that is not 

permitted to be received without the 

recognition of gain, even though such 

exchange is pursuant to a plan of 

reorganization described in section 

368(a), or even though section 355, 

section 356 or both sections 355 and 356 

apply to the exchange of other shares by 

that shareholder or other shareholders. 

See section 302 and the regulations 

under that section for the treatment of 

such an exchange. Any such exchange 

is treated as occurring immediately 

before any distribution of or exchange 

for the stock of the controlled 

corporation to which section 355 (or so 

much of section 356 as relates to section 

355) applies. 

(3) Effective/applicability date. This 

paragraph (e) applies to transactions 

that occur after the date these 

regulations are published as final 

regulations in the Federal Register, 

except for exchanges which occur 

pursuant to a written agreement that is 

binding on or before the date these 

regulations are published as final in the 

Federal Register. 

Par. 12. Section 1.356–1 is amended 

by revising paragraph (b), Examples 3 

and 4 to paragraph (d), and paragraph 

(g) to read as follows: 

§ 1.356–1 Receipt of additional 

consideration in connection with an 

exchange. 

* * * * * 

(b) The rules of § 1.354–1(d)(1) or 

§ 1.355–1(e)(1), as the case may be, 

apply for purposes of computing the 

gain, if any, recognized pursuant to 

section 356(a) and paragraph (a)(1) of 

this section. 

* * * * * 

(d) * * * 

Example 3. (i) Facts. J, an individual, 

acquired 10 shares of stock of Corporation X 

on Date 1 for $3 each (Block 1) and 10 shares 

of stock of Corporation X on Date 2 for $9 

each (Block 2). On Date 3, Corporation Y 

acquires the assets of Corporation X in a 

reorganization under section 368(a)(1)(A). 

Pursuant to the terms of the plan of 

reorganization, J surrenders all of J’s shares 

of Corporation X stock for 10 shares of 

Corporation Y stock and $100 of cash. On the 

date of the exchange, the fair market value of 

each share of stock of Corporation X is $10 

and the fair market value of each share of 

Corporation Y stock is $10. The terms of the 

exchange do not specify that shares of 

Corporation Y stock or cash are received in 

exchange for particular shares of stock of 

Corporation X. In addition, the distribution 

of the $100 of cash does not have the effect 

of a distribution of a dividend. 

(ii) Analysis. Under paragraph (b) of this 

section, because the terms of the exchange do 

not specify that the cash is received in 

exchange for particular shares of stock of 

Corporation X, a pro rata portion of the cash 

received is treated as received in exchange 

for each share of stock of Corporation X 

based on the fair market value of the 

surrendered shares. Therefore, J is treated as 

receiving shares of Corporation Y stock with 

a fair market value of $100 and $100 of cash 

in exchange for each block of J’s stock of 

Corporation X. J realizes a gain of $70 on the 

exchange of the Block 1 shares of Corporation 

X stock, $50 of which is recognized under 

section 356 and paragraph (a) of this section, 

and J realizes a gain of $10 on the exchange 

of the Block 2 shares of Corporation X stock, 

all of which is recognized under section 356 

and paragraph (a) of this section. Because J’s 

gain recognized is not treated as a dividend 

under section 356(a)(2), such gain shall be 

treated as gain from the exchange of property. 

Example 4. (i) Facts. The facts are the same 

as in Example 3, except that the terms of the 

plan of reorganization specify that J receives 

10 shares of stock of Corporation Y in 

exchange for J’s Block 1 shares of stock of 

Corporation X and $100 of cash in exchange 

for J’s Block 2 shares of stock of corporation 

X. 

(ii) Analysis. Under paragraph (b) of this 

section, because the terms of the exchange 

specify that J receives 10 shares of stock of 

Corporation Y in exchange for J’s Block 1 

shares of stock of Corporation X and $100 of 

cash in exchange for J’s Block 2 shares of 

stock of Corporation X and such terms are 

economically reasonable, such terms control. 

J realizes a gain of $70 on the exchange of 

the Block 1 shares of stock, none of which 

is recognized under section 354. J realizes a 

gain of $10 on the exchange of the Block 2 

shares of stock of Corporation X, all of which 

is recognized under section 302(a). 

* * * * * 

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(g) This section applies to exchanges 

and distributions that occur after the 

date these regulations are published as 

final regulations in the Federal Register, 

except for exchanges which occur 

pursuant to a written agreement that is 

binding on or before the date these 

regulations are published as final in the 

Federal Register. For exchanges and 

distributions that occur on or before the 

date these regulations are published as 

final regulations in the Federal Register, 

see this section as contained in 26 CFR 

part 1 revised April 1, for the year 

before these regulations are published as 

final regulations in the Federal Register. 

Par. 13. Section 1.358–1 is revised to 

read as follows: 

§ 1.358–1 Basis to distributees. 

(a) Certain exchanges or distributions 

in which only nonrecognition property 

is received—(1) Exchanges to which 

section 354 or 355 applies. In the case 

of an exchange to which section 354 or 

355 applies in which only 

nonrecognition property is received, the 

sum of the basis of all of the stock and 

securities received in the transaction 

shall be the same as the basis of all of 

the stock and securities in such 

corporation surrendered in the 

transaction, allocated in the manner 

described in § 1.358–2. 

(2) Distributions to which section 355 

applies. In the case of a distribution to 

which section 355 applies in which 

only nonrecognition property is 

received, the sum of the basis of all of 

the stock and securities with respect to 

which the distribution is made plus the 

basis of all of the stock and securities 

received in the distribution with respect 

to such stock and securities shall be the 

same as the basis of the stock and 

securities with respect to which the 

distribution is made immediately before 

the transaction, allocated in the manner 

described in § 1.358–2. 

(3) Exchanges to which section 351 or 

361 applies. In the case of an exchange 

to which section 351 or 361 applies in 

which only nonrecognition property is 

received, the basis of all of the stock and 

securities received in the exchange shall 

be the same as the basis of all of the 

property exchanged for such stock and 

securities. 

(b) Certain exchanges or distributions 

in which both nonrecognition property 

and ‘‘other property’’ or money are 

received—(1) Exchanges or distributions 

to which section 351, 356, or 361 

applies. If in an exchange or distribution 

to which section 351, 356, or 361 

applies both nonrecognition property 

and ‘‘other property’’ or money are 

received, the basis of the nonrecognition 

property held after the transaction shall 

be determined as described in paragraph 

(a) of this section, decreased by the sum 

of the money and the fair market value 

of the ‘‘other property’’ (as of the date 

of the transaction) received and 

increased by the sum of the amount 

treated as a dividend (if any) and the 

amount of the gain recognized on the 

exchange (other than gain treated as a 

dividend). 

(2) Cases in which loss is recognized. 

In any case in which a taxpayer 

transfers property with respect to which 

loss is recognized, such loss shall be 

reflected in determining the basis of the 

property received in the exchange. 

(3) Basis of ‘‘other property’’ received. 

The basis of the ‘‘other property’’ is its 

fair market value as of the date of the 

transaction. 

(c) Other rules. See § 1.460– 

4(k)(3)(iv)(A) for rules relating to stock 

basis adjustments required where a 

contract accounted for using a long-term 

contract method of accounting is 

transferred in a transaction described in 

section 351 or a reorganization 

described in section 368(a)(1)(D) with 

respect to which the requirements of 

section 355 (or so much of section 356 

as relates to section 355) are met. 

(d) The application of this section 

may be illustrated by the following 

example: 

Example. A purchased a share of stock in 

Corporation X on Date 1 for $150. Since that 

date, A has received distributions under 

section 301(c)(2) totaling $60, so that A’s 

adjusted basis for the stock is $90. In a 

transaction qualifying under section 356, A 

exchanged this share for one share in 

Corporation Y, with a value of $100, cash of 

$10, and other property with a fair market 

value of $30. The exchange had the effect of 

the distribution of a dividend. A’s ratable 

share of the earnings and profits of 

Corporation X was $5. A realized a gain of 

$50 on the exchange ($140 ¥ $90), but the 

amount of gain recognized is limited to $40, 

the sum of the cash received and the fair 

market value of the other property. Of the 

gain recognized, $5 is taxable as a dividend, 

and $35 is taxable as a gain from the 

exchange of property. The basis to A of the 

one share of stock of Corporation Y is $90, 

that is the adjusted basis of the one share of 

stock of Corporation X ($90), decreased by 

the sum of the cash received ($10) and the 

fair market value of the other property 

received ($30) and increased by the sum of 

the amount treated as a dividend ($5) and the 

amount treated as a gain from the exchange 

of property ($35). The basis of the other 

property received is $30. 

(e) Effective/applicability date. This 

section applies to exchanges and 

distributions of stock and securities that 

occur after the date these regulations are 

published as final regulations in the 

Federal Register, except for exchanges 

which occur pursuant to a written 

agreement that is binding on or before 

the date these regulations are published 

as final in the Federal Register. For 

exchanges and distributions that occur 

on or before the date these regulations 

are published as final regulations in the 

Federal Register, see this section as 

contained in 26 CFR part 1 revised April 

1, for the year before these regulations 

are published as final regulations in the 

Federal Register. 

Par. 14. Section 1.358–2 is revised to 

read as follows: 

§ 1.358–2 Allocation of basis among 

nonrecognition property in certain 

exchanges or distributions. 

(a) Introduction—(1) Scope. This 

section prescribes rules for allocating 

basis in the case of an exchange or 

distribution to which section 354, 355 

or 356 applies. For rules that apply to 

transfers of stock and other property 

where the transfer of stock is described 

in section 351 but does not qualify as a 

reorganization, see § 1.358–2(g). For 

transfers of stock described in section 

361, see § 1.358–2(h). 

(2) Definitions. As used in this section 

the term stock means stock which is not 

‘‘other property’’ under sections 351, 

356, or 361, as applicable. The term 

securities means securities (including, 

where appropriate, fractional parts of 

securities) which are not ‘‘other 

property’’ under sections 356 or 361, as 

applicable. Stock, or securities, as the 

case may be, which differ either because 

they are in different corporations or 

because the rights attributable to them 

differ (although they are in the same 

corporation) are considered different 

classes of stock or securities, as the case 

may be, for purposes of this section. 

(b) Exchanges to which section 354, 

355, or 356 applies. If a shareholder or 

security holder surrenders one or more 

shares of stock or one or more securities 

in an exchange under the terms of 

section 354, 355 or 356, the following 

rules apply: 

(1) In general. Except as otherwise 

provided in this section, the basis of 

each share of stock or security received 

in the exchange shall be the same as the 

basis of the share or shares of stock or 

security or securities (or allocable 

portions thereof) exchanged therefor (as 

adjusted under § 1.358–1). 

(2) More shares of stock or securities 

received than surrendered. If more than 

one share of stock or security is received 

in exchange for one share of stock or 

one security, the basis of the share of 

stock or security surrendered shall be 

allocated to the shares of stock or 

securities received in proportion to the 

fair market value of the shares of stock 

or securities received. 

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3520 Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 

(3) Fewer shares of stock or securities 

received than surrendered—(i) In 

general. If one share of stock or security 

is received in exchange for more than 

one share of stock or security or if a 

fraction of a share of stock or security 

is received, then the basis of the shares 

of stock or securities surrendered must 

be allocated to the shares of stock or 

securities (or allocable portions thereof) 

received in a manner that reflects, to the 

greatest extent possible, that a share of 

stock or security received is received in 

respect of shares of stock or securities 

that were acquired on the same date and 

at the same price. To the extent it is not 

possible to allocate basis in this manner, 

the basis of the shares of stock or 

securities surrendered must be allocated 

to the shares of stock or securities (or 

allocable portions thereof) received in a 

manner that minimizes the disparity in 

the holding periods of the surrendered 

shares of stock or securities whose basis 

is allocated to any particular share of 

stock or security received. 

(ii) Surrendered shares of stock or 

securities acquired on different dates or 

at different prices. If a share of stock or 

a security is received in exchange for 

more than one share of stock or security 

and such shares of stock or securities 

were acquired on different dates or at 

different prices, the share of stock or 

security received shall be divided into 

segments based on the relative fair 

market values of the shares of stock or 

securities surrendered in exchange for 

such share or security. Each segment 

shall have a basis determined under the 

rules of this section and a corresponding 

holding period. 

(4) ‘‘Other property,’’ money, or more 

than one class of stock or securities 

received. If a shareholder or security 

holder receives shares of stock or 

securities of more than one class, or 

receives ‘‘other property’’ or money in 

addition to shares of stock or securities, 

the rules of §§ 1.354–1(d)(1) and 1.355– 

1(e)(1) apply for purposes of applying 

the rules of this section. 

(5) Pro rata exchanges to which 

section 355 or section 356(b) applies. If 

a shareholder or security holder 

surrenders stock in distributing (as 

defined in § 1.355–1(b)) for only stock in 

controlled and the receipt of the 

controlled stock would be treated, 

within the meaning of section 302(d), as 

a distribution of property to which 

section 301 applies if the controlled 

stock received were money or other 

property, then the basis of the shares 

received shall be determined under the 

rules of paragraph (c) of this section and 

not the rules of this paragraph (b). The 

rules of paragraph (c) and not the rules 

of this paragraph (b) also apply to 

distributions subject to section 356(b). 

(c) Distributions to which section 355 

applies. If a shareholder or security 

holder receives one or more shares of 

stock or one or more securities in a 

distribution under section 355 (or so 

much of section 356 as relates to section 

355), the following rules apply: 

(1) In general. Except as otherwise 

provided in this section, the basis of 

each share of stock or security of the 

distributing corporation (as defined in 

§ 1.355–1(b)), as adjusted under § 1.358– 

1, shall be allocated between the share 

of stock or security of the distributing 

corporation with respect to which the 

distribution is made and the share or 

shares of stock or security or securities 

(or allocable portions thereof) received 

in proportion to their fair market values. 

(2) Fewer shares of stock or securities 

received than with respect to which 

distributed—(i) In general. If one share 

of stock or security is received with 

respect to more than one share of stock 

or security or if a fraction of a share of 

stock or security is received, then the 

basis of each share of stock or security 

of the distributing corporation must be 

allocated to the shares of stock or 

securities (or allocable portions thereof) 

received in a manner that reflects that, 

to the greatest extent possible, a share of 

stock or security received is received 

with respect to shares of stock or 

securities acquired on the same date and 

at the same price. To the extent it is not 

possible to allocate basis in this manner, 

the basis of each share of stock or 

security of the distributing corporation 

must be allocated to the shares of stock 

or securities (or allocable portions 

thereof) received in a manner that 

minimizes the disparity in the holding 

periods of the shares of stock or 

securities with respect to which such 

shares of stock or securities are 

received. 

(ii) Distribution upon shares of stock 

or securities acquired on different dates 

or at different prices. If a share of stock 

or a security is received with respect to 

more than one share of stock or security 

and such shares or securities were 

acquired on different dates or at 

different prices, the share of stock or 

security received shall be divided into 

segments based on the relative fair 

market values of the shares of stock or 

securities with respect to which the 

share of stock or security is received. 

Each segment shall have a basis 

determined under the rules of this 

section and a corresponding holding 

period. 

(3) ‘‘Other property,’’ money, or more 

than one class of stock or securities 

received. If a shareholder or security 

holder receives shares of stock or 

securities of more than one class, or 

receives ‘‘other property’’ or money in 

addition to stock or securities, the rules 

of § 1.355–1(e)(1) apply for purposes of 

applying the rules of this section as 

though the distribution were an 

exchange. 

(d) Reorganizations in which stock is 

deemed received. For purposes of this 

section, if a shareholder or security 

holder surrenders a share of stock or a 

security in a transaction under the terms 

of section 354 (or so much of section 

356 as relates to section 354) in which 

such shareholder or security holder 

receives no property or receives 

property (including property permitted 

by section 354 to be received without 

the recognition of gain or ‘‘other 

property’’ or money) with a fair market 

value less than that of the stock or 

securities surrendered in the 

transaction, such shareholder or 

security holder shall be treated as 

provided in paragraphs (1) and (2) of 

this paragraph (d). 

(1) Step one: Deemed issuance. First, 

the shareholder or security holder shall 

be treated as receiving the stock, 

securities, other property, and money 

actually received by the shareholder or 

security holder in the transaction and an 

amount of stock of the issuing 

corporation (as defined in § 1.368–1(b)) 

that has a value equal to the excess of 

the value of the stock or securities the 

shareholder or security holder 

surrendered in the transaction over the 

value of the stock, securities, other 

property, and money the shareholder or 

security holder actually received in the 

transaction. If the shareholder owns 

only one class of stock of the issuing 

corporation the receipt of which would 

be consistent with the economic rights 

associated with each class of stock of 

the issuing corporation, the stock 

deemed received by the shareholder 

pursuant to the previous sentence shall 

be stock of such class. If the shareholder 

owns multiple classes of stock of the 

issuing corporation the receipt of which 

would be consistent with the economic 

rights associated with each class of 

stock of the issuing corporation, the 

stock deemed received by the 

shareholder shall be stock of each such 

class owned by the shareholder 

immediately prior to the transaction, in 

proportion to the value of the stock of 

each such class owned by the 

shareholder immediately prior to the 

transaction. The basis of each share of 

stock or security deemed received and 

actually received shall be determined 

under the rules of this section. 

(2) Step two: Deemed section 

368(a)(1)(E) exchange. Second, the 

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shareholder or security holder shall 

then be treated as surrendering all of its 

shares of stock and securities in the 

issuing corporation, including those 

shares of stock or securities held 

immediately prior to the transaction, 

those shares of stock or securities 

actually received in the transaction, and 

those shares of stock deemed received 

pursuant to paragraph (d)(1) of this 

section, in a reorganization under 

section 368(a)(1)(E) in exchange for the 

shares of stock and securities of the 

issuing corporation that the shareholder 

or security holder actually holds 

immediately after the transaction. The 

basis of each share of stock and security 

deemed received in the reorganization 

under section 368(a)(1)(E) shall be 

determined under the rules of this 

section. 

(e) Designating which stock or 

securities were received for, or with 

respect to, the stock or securities 

surrendered or distributed upon—(1) In 

general. If a shareholder or security 

holder that purchased or acquired 

shares of stock or securities in a 

corporation on different dates or at 

different prices exchanges such shares 

of stock or securities under the terms of 

section 354, 355, or 356, or receives a 

distribution of shares of stock or 

securities under the terms of section 355 

(or so much of section 356 as relates to 

section 355), and the shareholder or 

security holder is not able to identify 

which particular share of stock or 

security (or allocable portion of a share 

of stock or security) is received (or 

deemed received) in exchange for, or 

with respect to, a particular share of 

stock or security, the shareholder or 

security holder may designate subject to 

the limitations of this section, which 

share of stock or security is received in 

exchange for, or with respect to, a 

particular share of stock or security, 

provided that such designation is 

consistent with the terms of the 

exchange or distribution (or an 

exchange deemed to have occurred 

pursuant to paragraph (d) of this 

section), and the other rules of this 

section. The designation will be binding 

for purposes of determining the Federal 

tax consequences of any sale or transfer 

of, or distribution with respect to, the 

shares or securities received. 

(2) Timing for designation—(i) In 

exchanges under section 354 or 356. In 

the case of an exchange under the terms 

of section 354 or 356 (including a 

deemed exchange as a result of the 

application of paragraph (d) of this 

section), the designation must be made 

on or before the first date on which the 

basis of a share of stock or a security 

received (or deemed received in the 

reorganization under section 

368(a)(1)(E) in the case of a transaction 

to which paragraph (d) of this section 

applies) is relevant. The basis of the 

shares or securities received in an 

exchange under the terms of section 354 

or section 356, for example, is relevant 

when such shares or securities are sold 

or otherwise transferred. 

(ii) In exchanges or distributions 

under section 355. In the case of an 

exchange or distribution under the 

terms of section 355 (or so much of 

section 356 as relates to section 355), 

the designation must be made on or 

before the first date on which the basis 

of a share of stock or a security of the 

distributing corporation or the 

controlled corporation (as defined in 

§ 1.355–1(b)) is relevant. 

(3) Failure to designate. If the 

shareholder fails to make a designation 

in a case in which the shareholder is not 

able to identify which share of stock is 

received in exchange for, or with respect 

to, a particular share of stock, then the 

shareholder will not be able to identify 

which shares are sold or transferred for 

purposes of determining the basis of 

property sold or transferred under 

section 1012 and § 1.1012–1(c) and, 

instead, will be treated as selling or 

transferring the share received in 

respect of the earliest share purchased 

or acquired. 

(f) Applicability of section to certain 

overlap situations—(1) Exchanges 

described in both section 1036 and 

section 354 or 356. The rules of 

paragraphs (a) through (e) of this section 

shall apply to determine the basis of a 

share of stock or security received by a 

shareholder or security holder in an 

exchange described in both section 1036 

and section 354 or 356. 

(2) Exchanges described in both 

section 351 and section 354 or 356. The 

rules of paragraphs (a) through (e) of 

this section shall apply to determine the 

basis of a share of stock or security 

received by a shareholder or security 

holder in an exchange described in both 

section 351 and section 354 or 356, 

unless liabilities of the shareholder or 

security holder are assumed in 

connection with the exchange. 

(g) Section 351 exchanges—(1) In 

general. Except as provided in 

paragraph (g)(2) of this section, if in an 

exchange to which section 351 applies 

property is transferred to a corporation 

and the transferor receives more than 

one share of stock, then the aggregate 

basis of the property transferred (as 

adjusted under § 1.358–1) shall be 

allocated among all of the shares of 

stock received in proportion to the fair 

market values of each share of stock. 

(2) Stock and property transferred in 

an exchange without a liability 

assumption. If in an exchange to which 

section 351 applies stock or stock and 

property is transferred to a corporation 

and no liability is assumed by the 

transferee in the exchange, then the 

basis of the stock transferred (as 

adjusted under § 1.358–1) shall be 

allocated pursuant to paragraphs (b)(1) 

through (b)(3) of this section. Such rules 

also apply to other property, money or 

more than one class of stock or 

securities received. 

(3) Transactions in which stock is 

deemed received. For purposes of this 

paragraph (g), if a shareholder transfers 

property to a corporation in a 

transaction to which section 351 

applies, and such shareholder receives 

no property or property (including 

property permitted by section 351 to be 

received without the recognition of gain 

or ‘‘other property’’ or money) in such 

corporation with a fair market value less 

than that of the property transferred in 

the transaction, such shareholder shall 

be treated as provided in paragraphs 

(3)(i) and (ii) of this paragraph (g). 

(i) Step one: Deemed issuance. First, 

the shareholder shall be treated as 

receiving the stock, other property, and 

money actually received by the 

shareholder in the transaction and an 

amount of stock of the transferee 

corporation that has a value equal to the 

excess of the value of the property the 

shareholder transferred in the 

transaction over the value of the stock, 

other property, and money the 

shareholder actually received in the 

transaction. If the shareholder owns 

only one class of stock of the transferee 

corporation the receipt of which would 

be consistent with the economic rights 

associated with each class of stock of 

the transferee corporation, the stock 

deemed received by the shareholder 

pursuant to the previous sentence shall 

be stock of such class. If the shareholder 

owns multiple classes of stock of the 

transferee corporation the receipt of 

which would be consistent with the 

economic rights associated with each 

class of stock of the transferee 

corporation, the stock deemed received 

by the shareholder shall be stock of each 

such class owned by the shareholder 

immediately prior to the transaction, in 

proportion to the value of the stock of 

each such class owned by the 

shareholder immediately prior to the 

transaction. 

(ii) Step two: Deemed section 

368(a)(1)(E) exchange. Second, the 

shareholder shall then be treated as 

surrendering all of its shares of stock in 

the transferee corporation, including 

those shares of stock held immediately 

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prior to the transaction, those shares of 

stock actually received in the 

transaction, and those shares of stock 

deemed received pursuant to paragraph 

(3)(i) of this paragraph (g), in a 

reorganization under section 

368(a)(1)(E) in exchange for the shares 

of stock of the transferee corporation 

that the shareholder actually holds 

immediately after the transaction. The 

basis of each share of stock deemed 

received in the reorganization under 

section 368(a)(1)(E) shall be determined 

under the rules of this section. 

(h) Section 361 exchanges. If in an 

exchange to which section 361 applies 

property is transferred to a corporation 

and the transferor receives stock or 

securities of more than one class or 

receives both stock and securities, then 

the basis of the property transferred (as 

adjusted under § 1.358–1) shall be 

allocated among all of the stock and 

securities received in proportion to the 

fair market values of the stock of each 

class and the securities of each class. 

(i) Examples. The application of this 

section is illustrated by the following 

examples: 

Example 1. More shares of stock received 

than surrendered. (i) Facts. J, an individual, 

acquired 20 shares of Corporation X stock on 

Date 1 for $3 each and 10 shares of 

Corporation X stock on Date 2 for $6 each. 

On Date 3, Corporation Y acquires the assets 

of Corporation X in a reorganization under 

section 368(a)(1)(A). Pursuant to the terms of 

the plan of reorganization, J receives 2 shares 

of Corporation Y stock in exchange for each 

share of Corporation X stock. Therefore, J 

receives 60 shares of Corporation Y stock. 

Pursuant to section 354, J recognizes no gain 

or loss on the exchange. J is not able to 

identify which shares of Corporation Y stock 

are received in exchange for each share of 

Corporation X stock. 

(ii) Analysis. Under paragraph (b)(2) of this 

section, J has 40 shares of Corporation Y 

stock each of which has a basis of $1.50 and 

is treated as having been acquired on Date 1 

and 20 shares of Corporation Y stock each of 

which has a basis of $3 and is treated as 

having been acquired on Date 2. Under 

paragraph (e) of this section, on or before the 

date on which the basis of a share of 

Corporation Y stock received becomes 

relevant, J may designate which of the shares 

of corporation Y stock have a basis of $1.50 

and which have a basis of $3. 

Example 2. More shares of stock received 

than surrendered. (i) Facts. The facts are the 

same as in Example 1, except that instead of 

receiving 2 shares of Corporation Y stock in 

exchange for each share of Corporation X 

stock, J receives 11⁄2 shares of Corporation Y 

stock in exchange for each share of 

Corporation X stock. Therefore, J receives 45 

shares of corporation Y stock. Again, J is not 

able to identify which shares (or portions of 

shares) of Corporation Y stock are received in 

exchange for each share of Corporation X 

stock. 

(ii) Analysis. Under paragraph (b)(2) of this 

section, J has 30 shares of Corporation Y 

stock each of which has a basis of $2 and is 

treated as having been acquired on Date 1 

and 15 shares of Corporation Y stock each of 

which has a basis of $4 and is treated as 

having been acquired on Date 2. Under 

paragraph (e) of this section, on or before the 

date on which the basis of a share of 

Corporation Y stock received becomes 

relevant, J may designate which of the shares 

of Corporation Y stock received have a basis 

of $2 and which have a basis of $4. 

Example 3. More than one class of stock 

received. (i) Facts. J, an individual, acquired 

10 shares of Class A stock of Corporation X 

on Date 1 for $3 each, 10 shares of Class A 

stock of Corporation X on Date 2 for $9 each, 

and 10 shares of Class B stock of Corporation 

X on Date 3 for $3 each. On Date 4, J 

surrenders all of J’s shares of Class A stock 

in exchange for 20 shares of new Class C 

stock and 20 shares of new Class D stock in 

a reorganization under section 368(a)(1)(E). 

Pursuant to section 354, J recognizes no gain 

or loss on the exchange. On the date of the 

exchange, the fair market value of each share 

of Class A stock is $6, the fair market value 

of each share of Class C stock is $2, and the 

fair market value of each share of Class D 

stock is $4. The terms of the exchange do not 

specify that shares of Class C stock or shares 

of Class D stock of Corporation X are received 

in exchange for particular shares of Class A 

stock of Corporation X. 

(ii) Analysis. Under paragraph (b)(4) of this 

section, because the terms of the exchange do 

not specify that shares of Class C stock or 

shares of Class D stock of Corporation X are 

received in exchange for particular shares of 

Class A stock of Corporation X, a pro rata 

portion of the shares of Class C stock and 

shares of Class D stock received will be 

treated as received in exchange for each share 

of Class A stock based on the fair market 

value of the surrendered shares of Class A 

stock. Therefore, J is treated as receiving one 

share of Class C stock and one share of Class 

D stock in exchange for each share of Class 

A stock. Under paragraph (b)(2) of this 

section, J has 10 shares of Class C stock, each 

of which has a basis of $1 and is treated as 

having been acquired on Date 1 and 10 shares 

of Class C stock, each of which has a basis 

of $3 and is treated as having been acquired 

on Date 2. In addition, J has 10 shares of 

Class D stock, each of which has a basis of 

$2 and is treated as having been acquired on 

Date 1 and 10 shares of Class D stock, each 

of which has a basis of $6 and is treated as 

having been acquired on Date 2. J’s basis in 

each share of Class B stock remains $3. 

Under paragraph (e) of this section, on or 

before the date on which the basis of a share 

of Class C stock or Class D stock received 

becomes relevant, J may designate which of 

the shares of Class C stock have a basis of $1 

and which have a basis of $3, and which of 

the shares of Class D stock have a basis of $2 

and which have a basis of $6. 

Example 4. Money received in addition to 

stock. (i) Facts. J, an individual, acquired 10 

shares of stock of Corporation X on Date 1 

for $2 each (Block 1), 10 shares of stock of 

Corporation X on Date 2 for $4 each (Block 

2), and 20 shares of stock of Corporation X 

on Date 3 for $6 each (Block 3). On Date 4, 

Corporation Y acquires the assets of 

Corporation X in a reorganization under 

section 368(a)(1)(A). Pursuant to the terms of 

the plan of reorganization, J surrenders all of 

J’s shares of Corporation X stock for 40 shares 

of Corporation Y stock and $200 of cash. The 

distribution of $200 of cash does not have the 

effect of a distribution of a dividend. On the 

date of the exchange, the fair market value of 

each share of stock of Corporation X is $10, 

and the fair market value of each share of 

Corporation Y stock is $5. The terms of the 

exchange do not specify that shares of 

Corporation Y stock or cash are received in 

exchange for particular shares of stock of 

Corporation X. 

(ii) Analysis. Under paragraph (b)(4) of this 

section and under § 1.356–1(b), because the 

terms of the exchange do not specify that 

shares of Corporation Y stock or cash are 

received in exchange for particular shares of 

stock of Corporation X, a pro rata portion of 

the shares of Corporation Y stock and cash 

received will be treated as received in 

exchange for each share of stock of 

Corporation X surrendered based on the fair 

market value of such stock. Therefore, J is 

treated as receiving one share of Corporation 

Y stock and $5 of cash in exchange for each 

share of stock of Corporation X. J realizes a 

gain of $80 on the exchange of Block 1, $50 

of which is recognized under § 1.356–1(a). J 

realizes a gain of $60 of the exchange of 

Block 2, $50 of which is recognized under 

§ 1.356–1(a). J realizes a gain of $80 on the 

exchange of the Block 3 shares of stock of 

Corporation X, all of which is recognized 

under § 1.356–1(a). Under paragraph (b)(1) of 

this section, J has 10 shares of Corporation 

Y stock, each of which has a basis of $2 and 

is treated as having been acquired on Date 1, 

10 shares of Corporation Y stock, each of 

which has a basis of $4 and is treated as 

having been acquired on Date 2, and 20 

shares of Corporation Y stock, each of which 

has a basis of $5 and is treated as having been 

acquired on Date 3. Under paragraph (e) of 

this section, on or before the date on which 

the basis of a share of Corporation Y stock 

received becomes relevant, J may designate 

which of the shares of Corporation Y stock 

received have a basis of $2, which have a 

basis of $4, and which have a basis of $5. 

Example 5. Money received in addition to 

stock. (i) Facts. The facts are the same as in 

Example 4, except that the terms of the plan 

of reorganization specify that J receives 40 

shares of stock of Corporation Y in exchange 

for J’s Block 1 and Block 2 shares of stock 

of Corporation X and $200 of cash in 

exchange for J’s Block 3 shares of stock of 

Corporation X. 

(ii) Analysis. Under paragraph (b)(4) of this 

section and under § 1.356–1(b), because the 

terms of the exchange specify that J receives 

40 shares of stock of Corporation Y in 

exchange for J’s Block 1 and Block 2 shares 

of stock of Corporation X and $200 of cash 

in exchange for J’s Block 3 shares of stock of 

Corporation X and such terms are 

economically reasonable and the distribution 

is not dividend equivalent, such terms 

control. J realizes a gain of $80 on the 

exchange of Block 1, none of which is 

recognized under section 354. J realizes a 

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gain of $60 on the exchange of Block 2, none 

of which is recognized under section 354. J 

realizes a gain of $80 on the exchange of the 

Block 3 shares of stock of Corporation X, all 

of which is recognized under section 302(a). 

Under paragraph (b)(2) of this section, J has 

20 shares of Corporation Y stock, each of 

which has a basis of $1 and is treated as 

having been acquired on Date 1, and 20 

shares of Corporation Y stock, each of which 

has a basis of $2 and is treated as having been 

acquired on Date 2. Under paragraph (e) of 

this section, on or before the date on which 

the basis of a share of Corporation Y stock 

received becomes relevant, J may designate 

which of the shares of Corporation Y stock 

received have a basis of $1 and which have 

a basis of $2. 

Example 6. Stock and securities received 

as nonrecognition property. (i) Facts. J, an 

individual, acquired 10 shares of stock of 

Corporation X on Date 1 for $2 each, and a 

security issued by Corporation X to J on Date 

2 with a principal amount of $100 and a basis 

of $100. On Date 3, Corporation Y acquires 

the assets of Corporation X in a 

reorganization under section 368(a)(1)(A). 

Pursuant to the terms of the plan of 

reorganization, J surrenders all of J’s shares 

of Corporation X stock in exchange for 10 

shares of Corporation Y stock and surrenders 

J’s Corporation X security in exchange for a 

Corporation Y security. The distribution of 

neither the Y stock nor the Y security has the 

effect of a distribution of a dividend. On the 

date of the exchange, the fair market value of 

each share of stock of Corporation X is $10, 

the fair market value of J’s Corporation X 

security is $100, the fair market value of each 

share of Corporation Y stock is $10, and the 

fair market value and principal amount of the 

Corporation Y security received by J is $100. 

(ii) Analysis. Under paragraph (b)(4) of this 

section and under § 1.354–1(d), because the 

terms of the exchange specify that J receives 

10 shares of stock of Corporation Y in 

exchange for J’s shares of Class A stock of 

Corporation X and a Corporation Y security 

in exchange for its Corporation X security 

and such terms are economically reasonable, 

such terms control. Pursuant to section 354, 

J recognizes no gain on either exchange. 

Under paragraph (b)(1) of this section, J has 

10 shares of Corporation Y stock, each of 

which has a basis of $2 and is treated as 

having been acquired on Date 1, and a 

security that has a basis of $100 and is 

treated as having been acquired on Date 2. 

Example 7. Fewer shares of stock received 

than surrendered. (i) Facts. J, an individual, 

acquired 10 shares of Corporation X stock on 

Date 1 for $2 each and 10 shares of 

Corporation X stock on Date 2 for $5 each. 

On Date 3, Corporation Y acquires the stock 

of Corporation X in a reorganization under 

section 368(a)(1)(B). Pursuant to the terms of 

the plan of reorganization, J receives one 

share of Corporation Y stock in exchange for 

every 2 shares of Corporation X stock. 

Pursuant to section 354, J recognizes no gain 

or loss on the exchange. J is not able to 

identify which portion of each share of 

Corporation Y stock is received in exchange 

for each share of Corporation X stock. 

(ii) Analysis. Under paragraph (b)(3) of this 

section, J has 5 shares of Corporation Y stock 

each of which has a basis of $4 and is treated 

as having been acquired on Date 1 and 5 

shares of Corporation Y stock each of which 

has a basis of $10 and is treated as having 

been acquired on Date 2. Under paragraph (e) 

of this section, on or before the date on 

which the basis of a share of Corporation Y 

stock received becomes relevant, J may 

designate which of the shares of Corporation 

Y stock received have a basis of $4 and 

which have a basis of $10. 

Example 8. Exchange described in sections 

351 and 354. (i) Facts. J, an individual, 

acquired 10 shares of Corporation X stock on 

Date 1 for $3 each and 10 shares of 

Corporation X stock on Date 2 for $6 each. 

On Date 3, Corporation Z, a newly formed, 

wholly owned subsidiary of Corporation Y, 

merges with and into Corporation X with 

Corporation X surviving. As part of the plan 

of merger, J receives one share of Corporation 

Y stock in exchange for each share of 

Corporation X stock. In connection with the 

transaction, Corporation Y assumes a liability 

of J. In addition, after the transaction, J owns 

stock of Corporation Y satisfying the 

requirements of section 368(c). J’s transfer of 

the Corporation X stock to Corporation Y is 

an exchange described in sections 351 and 

354. 

(ii) Analysis. Under paragraph (f)(2) of this 

section, because, in connection with the 

transfer of the Corporation X stock to 

Corporation Y, Corporation Y assumed a 

liability of J, the rules of paragraph (g) this 

section apply to determine J’s basis in the 

Corporation Y stock received in the 

transaction. 

Example 9. Reorganization in which stock 

is deemed received. (i) Facts. Each of 

Corporation X and Corporation Y has a single 

class of stock outstanding, all of which is 

owned by J, an individual. J acquired 100 

shares of Corporation X stock on Date 1 for 

$1 each and 100 shares of Corporation Y 

stock on Date 2 for $2 each. On Date 3, 

Corporation Y acquires the assets of 

Corporation X in a reorganization under 

section 368(a)(1)(D). Pursuant to the terms of 

the plan of reorganization, J surrenders J’s 

100 shares of Corporation X stock but does 

not receive any additional Corporation Y 

stock. Immediately before the effective time 

of the reorganization, the fair market value of 

each share of Corporation X stock and each 

share of Corporation Y stock is $1. Pursuant 

to section 354, J recognizes no gain or loss. 

(ii) Analysis. Under paragraph (d) of this 

section, J is deemed to have received shares 

of Corporation Y stock with an aggregate fair 

market value of $100 in exchange for J’s 

Corporation X shares. Given the number of 

outstanding shares of stock of Corporation Y 

and their value immediately before the 

effective time of the reorganization, J is 

deemed to have received 100 shares of stock 

of Corporation Y in the reorganization. Under 

paragraph (b)(1) of this section, each of those 

shares has a basis of $1 and is treated as 

having been acquired on Date 1. Then, the 

stock of Corporation Y is deemed to be 

recapitalized in a reorganization under 

section 368(a)(1)(E) in which J receives 100 

shares of Corporation Y stock in exchange for 

those shares of Corporation Y stock that J 

held immediately prior to the reorganization 

and those shares J is deemed to have received 

in the reorganization. Under paragraph (b)(3) 

of this section, immediately after the 

reorganization, J holds 50 shares of 

Corporation Y stock each of which has a 

basis of $2 and is treated as having been 

acquired on Date 1 and 50 shares of 

Corporation Y stock each of which has a 

basis of $4 and is treated as having been 

acquired on Date 2. Under paragraph (e) of 

this section, on or before the date on which 

the basis of any share of J’s Corporation Y 

stock becomes relevant, J may designate 

which of the shares of Corporation Y have a 

basis of $2 and which have a basis of $4. 

Example 10. Reorganization in which stock 

is deemed received. (i) Facts. Corporation X 

has a single class of stock outstanding, all of 

which is owned by J, an individual. J 

acquired 100 shares of Corporation X stock 

on Date 1 for $1 each. Corporation Y has two 

classes of stock outstanding, common stock 

and nonvoting preferred stock. On Date 2, J 

acquired 100 shares of Corporation Y 

common stock for $2 each and 100 shares of 

Corporation Y preferred stock for $4 each. On 

Date 3, Corporation Y acquires the assets of 

Corporation X in a reorganization under 

section 368(a)(1)(D). Pursuant to the terms of 

the plan of reorganization, J surrenders J’s 

100 shares of Corporation X stock but does 

not receive any additional Corporation Y 

stock. Immediately before the effective time 

of the reorganization, the fair market value of 

each share of Corporation X stock is $10, the 

fair market value of each share of Corporation 

Y common stock is $10, and the fair market 

value of each share of Corporation Y 

preferred stock is $20. Pursuant to section 

354, J recognizes no gain or loss. 

(ii) Analysis. Under paragraph (d) of this 

section, J is deemed to have received shares 

of Corporation Y stock with an aggregate fair 

market value of $1,000 in exchange for J’s 

Corporation X shares. Consistent with the 

economics of the transaction and the rights 

associated with each class of stock of 

Corporation Y owned by J, J is deemed to 

receive additional shares of Corporation Y 

common stock. Because the value of the 

common stock indicates that the liquidation 

preference associated with the Corporation Y 

preferred stock could be satisfied even if the 

reorganization did not occur, it is not 

appropriate to deem the issuance of 

additional Corporation Y preferred stock. 

Given the number of outstanding shares of 

common stock of Corporation Y and their 

value immediately before the effective time 

of the reorganization, J is deemed to have 

received 100 shares of common stock of 

Corporation Y in the reorganization. Under 

paragraph (b)(1) of this section, each of those 

shares has a basis of $1 and is treated as 

having been acquired on Date 1. Then, the 

common stock of Corporation Y is deemed to 

be recapitalized in a reorganization under 

section 368(a)(1)(E) in which J receives 100 

shares of Corporation Y common stock in 

exchange for those shares of Corporation Y 

common stock that J held immediately prior 

to the reorganization and those shares of 

Corporation Y common stock that J is 

deemed to have received in the 

reorganization. Under paragraph (b)(3) of this 

section, immediately after the reorganization, 

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J holds 50 shares of Corporation Y common 

stock, each of which has a basis of $2 and 

is treated as having been acquired on Date 1, 

and 50 shares of Corporation Y common 

stock, each of which has a basis of $4 and 

is treated as having been acquired on Date 2. 

Under paragraph (e) of this section, on or 

before the date on which the basis of any 

share of J’s Corporation Y common stock 

becomes relevant, J may designate which of 

those shares have a basis of $2 and which 

have a basis of $4. 

Example 11. Distribution to which section 

355 applies. (i) Facts. J, an individual, 

acquired 5 shares of Corporation X stock on 

Date 1 for $4 each and 5 shares of 

Corporation X stock on Date 2 for $8 each. 

Corporation X owns all of the outstanding 

stock of Corporation Y. The fair market value 

of the stock of Corporation X is $1,800. The 

fair market value of the stock of Corporation 

Y is $900. In a distribution to which section 

355 applies, Corporation X distributes all of 

the stock of Corporation Y pro rata to its 

shareholders. In the distribution, J receives 2 

shares of Corporation Y stock with respect to 

each share of Corporation X stock. Pursuant 

to section 355, J recognizes no gain or loss 

on the receipt of the shares of Corporation Y 

stock. J is not able to identify which share of 

Corporation Y stock is received in respect of 

each share of Corporation X stock. 

(ii) Analysis. Under paragraph (c)(1) of this 

section, because J receives 2 shares of 

Corporation Y stock with respect to each 

share of Corporation X stock, the basis of 

each share of Corporation X stock is allocated 

between such share of Corporation X stock 

and two shares of Corporation Y stock in 

proportion to the fair market value of those 

shares. Therefore, each of the 5 shares of 

Corporation X stock acquired on Date 1 will 

have a basis of $2 and each of the 10 shares 

of Corporation Y stock received with respect 

to those shares will have a basis of $1. In 

addition, each of the 5 shares of Corporation 

X stock acquired on Date 2 will have a basis 

of $4 and each of the 10 shares of 

Corporation Y stock received with respect to 

those shares will have a basis of $2. Under 

paragraph (e) of this section, on or before the 

date on which the basis of a share of 

Corporation Y stock received becomes 

relevant, J may designate which of the shares 

of Corporation Y stock have a basis of $1 and 

which have a basis of $2. 

Example 12. Designation of stock 

surrendered and received. (i) Facts. J, an 

individual, acquired 20 shares of Corporation 

X stock on Date 1 for $2 each and 20 shares 

of Corporation X stock on Date 2 for $4 each. 

Corporation X has 80 shares of stock 

outstanding. Corporation X owns 40 shares of 

stock of Corporation Y, which represents all 

of the outstanding stock of Corporation Y. 

The fair market value of the stock of 

Corporation X is $80. The fair market value 

of the stock of Corporation Y is $40. 

Corporation X distributes all of the stock of 

Corporation Y in a transaction to which 

section 355 applies. In the transaction, J 

surrenders 20 shares of stock of Corporation 

X in exchange for 20 shares of stock of 

Corporation Y. J retains 20 shares of 

Corporation X stock. Pursuant to section 355, 

J recognizes no gain or loss on the receipt of 

the shares of Corporation Y stock. J is not 

able to identify which shares of Corporation 

X stock are surrendered. In addition, J is not 

able to identify which shares of Corporation 

Y stock are received in exchange for each 

surrendered share of Corporation X. In 

addition, the receipt of Y stock is not 

dividend equivalent. 

(ii) Analysis. Under paragraph (b)(1) of this 

section, J has 20 shares of Corporation Y 

stock each of which is treated as received in 

exchange for one share of Corporation X 

stock. The basis of the 20 shares of 

Corporation X stock that are retained by J 

will remain unchanged. Under paragraph (e) 

of this section, on or before the date on 

which the basis of a share of Corporation X 

or Corporation Y stock becomes relevant, J 

may designate which shares of Corporation X 

stock J surrendered in the exchange and 

which share of the Corporation Y stock 

received is received for each share of 

Corporation X stock surrendered. Therefore, 

it is possible that a share of Corporation Y 

stock would have a basis of $2 and be treated 

as having been acquired on Date 1, or would 

have a basis of $4 and be treated as having 

been acquired on Date 2. 

Example 13. Surrendered shares of stock or 

securities acquired on different dates or at 

different prices. (i) Facts. J, an individual, 

acquired 10 shares of Corporation X stock on 

Date 1 for $3 each, 10 shares of Corporation 

X stock on Date 2 for $18 each, 10 shares of 

Corporation X stock on Date 3 for $6 each, 

and 10 shares of Corporation X stock on Date 

4 for $9 each. On Date 5, Corporation Y 

acquires the assets of Corporation X in a 

reorganization under section 368(a)(1)(A). 

Pursuant to the terms of the plan of 

reorganization, J receives a 3⁄4 share of 

Corporation Y stock in exchange for each 

share of Corporation X stock. Therefore, J 

receives 30 shares of Corporation Y stock. 

Pursuant to section 354, J recognizes no gain 

or loss on the exchange. J is not able to 

identify which shares of Corporation Y stock 

are received in exchange for each share (or 

portions of shares) of Corporation X stock. 

(ii) Analysis. Under paragraph (b)(3) of this 

section, J has 7 shares of Corporation Y stock 

each of which has a basis of $4 and is treated 

as having been acquired on Date 1, 7 shares 

of Corporation Y stock each of which has a 

basis of $24 and is treated as having been 

acquired on Date 2, 7 shares of Corporation 

Y stock each of which has a basis of $8 and 

is treated as having been acquired on Date 3, 

and 7 shares of Corporation Y stock each of 

which has a basis of $12 and is treated as 

having been acquired on Date 4. In addition, 

J has two shares of Corporation Y stock, each 

of which is divided into two equal segments 

under paragraph (b)(3) of this section. The 

first of those two shares has one segment 

with a basis of $2 that is treated as having 

been acquired on Date 1 and a second 

segment with a basis of $12 that is treated as 

having been acquired on Date 2. The second 

of those two shares has one segment with a 

basis of $4 that is treated as having been 

acquired on Date 3 and a second segment 

with a basis of $6 that is treated as having 

been acquired on Date 4. Under paragraph (e) 

of this section, on or before the date on 

which a share of Corporation Y stock 

received becomes relevant, J may designate 

which of the shares of Corporation Y stock 

have a basis of $4, which have a basis of $24, 

which have a basis of $8, which have a basis 

of $12, and which share has a split basis of 

$2 and $12, and which share has a split basis 

of $4 and $6. 

Example 14. Shareholder election and 

terms of the exchange. (i) Facts. J, an 

individual, acquired 10 shares of stock of 

widely-held Corporation X on Date 1 for $2 

each, 10 shares of stock of Corporation X on 

Date 2 for $4 each, and 10 shares of stock of 

Corporation X on Date 3 for $6. On Date 5, 

Corporation X and Corporation Y sign a 

binding contract pursuant to which, in a 

reorganization under section 368(a)(1)(A), 

Corporation X will be merged with and into 

Corporation Y on Date 6. The fair market 

value of each share of Corporation X stock is 

$10 and the fair market value of each share 

of Corporation Y stock is $5. In exchange for 

each share of stock of Corporation X, the 

shareholders of Corporation X may elect to 

receive 2 shares of stock of Corporation Y or 

$10 cash. If, however, the elected 

consideration is oversubscribed, by default a 

pro-rata mix of consideration will be received 

for the corresponding shares of stock of 

Corporation X (the default pro-rata term). J 

elects to receive 2 shares of stock of 

Corporation Y in exchange for each of the 10 

shares of stock of Corporation X acquired on 

Date 1, and $10 cash for each of the 

remaining 20 shares of stock of Corporation 

X. Neither of the elections is oversubscribed 

by the shareholders of Corporation X. The 

distribution of cash does not have the effect 

of a distribution of a dividend. 

(ii) Analysis. Under paragraph (b)(4) of this 

section and under § 1.356–1(b), because the 

receipt does not have the effect of dividend, 

and the terms of the exchange specify that J 

receives 2 shares of stock of Corporation Y 

in exchange for each of the 10 shares of stock 

of Corporation X acquired on Date 1, and $10 

cash for each of the remaining 20 shares of 

stock of Corporation X, and such terms are 

economically reasonable, such terms control. 

J realizes a gain of $80 on the exchange of 

the 10 shares of stock of Corporation X 

acquired on Date 1, none of which is 

recognized under § 1.356–1(a). J realizes a 

gain of $60 on the exchange of the 10 shares 

of stock of Corporation X acquired on Date 

2 and realizes $40 on the exchange of the 10 

shares of stock of Corporation X acquired on 

Date 3, all of which is recognized under 

§ 1.356–1(a). Under paragraph (b)(2) of this 

section, J has 20 shares of stock of 

Corporation Y, each of which has a basis of 

$1 and is treated as having been acquired on 

Date 1. 

Example 15. Shareholder election and 

terms of the exchange. (i) Facts. The facts are 

the same as in Example 14, except that the 

cash election is oversubscribed and, pursuant 

to the default pro-rata term, for each of the 

shares of stock of Corporation X that J 

acquired on Date 2 and Date 3, J receives 1 

share of stock of Corporation Y and $5 cash. 

(ii) Analysis. Under paragraph (b)(4) of this 

section and under § 1.356–1(b), because the 

terms of the exchange specify that J receives 

2 shares of stock of Corporation Y in 

exchange for each of the 10 shares of stock 

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Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 3525 

of Corporation X acquired on Date 1, and 1 

share of stock of Corporation Y and $5 cash 

for each of the remaining 20 shares of stock 

of Corporation X, and such terms are 

economically reasonable, such terms control. 

J realizes a gain of $80 on the exchange of 

the 10 shares of stock of Corporation X 

acquired on Date 1, none of which is 

recognized under § 1.356–1(a). J realizes a 

gain of $60 on the exchange of the 10 shares 

of stock of Corporation X acquired on Date 

2, $50 of which is recognized under § 1.356– 

1(a), and $40 on the exchange of the 10 

shares of stock of Corporation X acquired on 

Date 3, all of which is recognized under 

§ 1.356–1(a). Of the 40 shares of stock of 

Corporation Y received by J, 20 of the shares 

each has a basis of $1 and is treated as having 

been acquired on Date 1 under paragraph 

(b)(2) of this section, and 10 of the shares 

each has a basis of $4 and is treated as having 

been acquired on Date 2 and 10 of the shares 

each has a basis of $6 and is treated as having 

been acquired on Date 3 under paragraph 

(b)(1) of this section. 

Example 16. Exchange described in section 

351 in which only stock is received. (i) Facts. 

J transfers Asset I, Asset II, and 50 shares of 

Corporation X stock in exchange for 110 

shares of Corporation Y in an exchange to 

which section 351 applies. At the time of the 

exchange, Asset I has a fair market value of 

$220 and a basis of $400, Asset II has a fair 

market value of $330 and a basis of $200, and 

the 50 shares of Corporation X stock each 

have a fair market value of $22 ($550 total) 

and a basis of $10 ($250 total). The fair 

market value of each share of Corporation Y 

stock is $10. 

(ii) Analysis. Pursuant to section 351(a), J 

recognizes no gain or loss on the exchange. 

Under paragraph (g)(2) of this section, J has 

55 shares of Corporation Y stock each of 

which has a basis of $10.91 ($600 total, the 

aggregate basis of Asset I and Asset II). Under 

paragraph (g)(2) of this section, J has 55 

shares of Corporation Y stock each of which 

has a basis of $4.55 ($250 total). 

Example 17. Exchange described in section 

351 in which ‘‘other property’’ is received. (i) 

Facts. The facts are the same as Example 1, 

except J receives 100 shares of Corporation Y 

stock and $100 in the exchange. 

(ii) Analysis. Pursuant to section 351(b), J 

recognizes gain, but no loss, on the exchange, 

but not in excess of the amount of money 

received. Under § 1.351–2, J realizes a loss of 

$180 on Asset I, none of which is recognized, 

a gain of $130 on Asset II, $30 of which is 

recognized, and a gain of $300 on shares of 

Corporation X stock, $50 of which is 

recognized. Under paragraph (g)(2) of this 

section, J has 50 shares of Corporation Y 

stock each of which has a basis of $11.60 

($580 total), and 50 shares of Corporation Y 

stock each of which has a basis of $5.00 

($250 total). 

(j) Effective/applicability date. This 

section applies to exchanges and 

distributions of stock and securities that 

occur after the date these regulations are 

published as final regulations in the 

Federal Register, except for exchanges 

which occur pursuant to a written 

agreement that is binding on or before 

the date these regulations are published 

as final in the Federal Register. For 

exchanges and distributions of stock 

and securities that occur on or before 

the date these regulations are published 

as final regulations in the Federal 

Register, see this section as contained in 

26 CFR part 1 revised April 1, for the 

year before these regulations were 

published as final regulations in the 

Federal Register. 

Par. 15. Section 1.358–6 is amended 

by revising paragraphs (c)(1)(i)(B), 

(c)(3)(ii), and (f)(3) to read as follows: 

§ 1.358–6 Stock basis in certain triangular 

reorganizations. 

* * * * * 

(c) * * * 

(1) * * * 

(i) * * * 

(B) P transferred the T assets (and 

liabilities which S assumed or to which 

the T assets acquired by S were subject) 

to S in a transaction in which P received 

no property and P ’s basis in S stock was 

determined under section 358. See 

§ 1.358–2(g)(3) (allocation of basis in a 

section 351 transaction in which stock 

is deemed received). 

* * * * * 

(3) * * * 

(ii) P transferred the T stock to S in 

a transaction in which P received no 

property and P’s basis in its S stock was 

determined under section 358. See 

§ 1.358–2(g)(3) (allocation of basis in a 

section 351 transaction in which stock 

is deemed received). 

* * * * * 

(f) * * * 

(3) This section applies to exchanges 

that occur after the date these 

regulations are published as final 

regulations in the Federal Register, 

except for exchanges which occur 

pursuant to a written agreement that is 

binding on or before the date these 

regulations are published as final in the 

Federal Register. For exchanges that 

occur on or before the date these 

regulations are published as final 

regulations in the Federal Register, see 

this section as contained in 26 CFR part 

1 revised April 1, 2008, for the year 

before the date these regulations are 

published as final regulations in the 

Federal Register. 

Par. 16. Section 1.368–1 is amended 

by adding a sentence to the end of 

paragraph (a) and by revising paragraph 

(e)(9) to read as follows: 

§ 1.368–1 Purpose and scope of exception 

of reorganization exchanges. 

(a) * * * For purposes of determining 

whether a transaction qualifies as a 

reorganization under section 368(a), to 

the extent the terms of the exchange 

specify that a particular property is 

received in exchange for a particular 

property, such terms shall control 

provided such terms are economically 

reasonable. 

* * * * * 

(e) * * * 

(9) This section applies to exchanges 

that occur after the date these 

regulations are published as final 

regulations in the Federal Register, 

except for exchanges which occur 

pursuant to a written agreement that is 

binding on or before the date these 

regulations are published as final in the 

Federal Register. For effective dates for 

transactions that occur on or before the 

date these regulations are published as 

final regulations in the Federal Register, 

see paragraph (e) of this section, as 

contained in 26 CFR part 1 revised April 

1, for the year before these regulations 

are published as final regulations in the 

Federal Register. 

* * * * * 

Par. 17. Section 1.861–12 is added to 

read as follows: 

§ 1.861–12 Characterization rules and 

adjustments for certain assets. 

(a) through (c)(2)(v) [Reserved]. For 

further guidance, see § 1.861–12T(a) 

through (c)(2)(v). 

(c)(2)(vi) Adjustments in respect of 

redeemed stock for taxpayers using the 

tax book value method. Solely for 

purposes of apportioning expenses on 

the basis of the tax book value of assets, 

the adjusted basis of any other class of 

stock in a 10 percent owned corporation 

owned directly by a taxpayer that is a 

redeemed shareholder (as defined in 

§ 1.302–5(b)(1)) with respect to such 

corporation shall be increased by the 

amount of any loss that has not been 

taken into account under § 1.302–5(a)(3) 

as of the close of the redeemed 

shareholder’s taxable year (unrecovered 

loss). If the redeemed shareholder does 

not own directly any shares in the 10 

percent owned corporation as of the end 

of the taxable year, but is treated for 

purposes of section 302(b) as owning 

shares actually owned by another 

member of the redeemed shareholder’s 

affiliated group, as defined in section 

§ 1.861–11(d)(1) and § 1.861–11T(d)(6) 

with respect to the redeemed 

shareholder, then, solely for purposes of 

this paragraph (c)(2)(vi), the adjusted 

basis of the shares in the 10 percent 

owned corporation, if any, that are 

owned by such other corporation or 

corporations shall be increased by the 

amount of the redeemed shareholder’s 

unrecovered loss (and allocated among 

such corporations, if applicable, in 

proportion to their relative adjusted 

bases (as adjusted pursuant to this 

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3526 Federal Register / Vol. 74, No. 12 / Wednesday, January 21, 2009 / Proposed Rules 

1Except for the grimace exercise, which currently 

lasts 15 seconds and would remain at 15 seconds 

in both of the proposed protocols. However, neither 

the current nor proposed protocols include the fit 

factor obtained from this exercise in determining 

the overall fit factor for a respirator tested using a 

quantitative fit test. 

paragraph and § 1.861–12T(c)(2)) in the 

stock of the redeeming corporation). 

These adjustments are to be made 

annually and are noncumulative. 

(vii) Examples. Certain of the rules of 

this paragraph (c)(2) may be illustrated 

by the following examples: 

Examples 1 and 2. [Reserved]. For 

further guidance, see § 1.861– 

12T(c)(2)(vii), Examples 1 and 2. 

Example 3. X, an unaffiliated domestic 

corporation that was organized on January 1, 

2000, owns all of the stock of Y, a foreign 

corporation with a functional currency other 

than the U.S. dollar since January 1, 2000. 

The Y stock held by X includes Class A and 

Class B common stock. X’s adjusted basis in 

the Class A and Class B common stock is 

$25,000 and $50,000, respectively. Y has 

earnings and profits for the 2008 taxable year 

of $40,000. During the 2008 taxable year, Y 

redeems all of the Class A common stock 

held by X for $40,000. Because X still owns 

all of the outstanding stock of Y, the 

redemption is treated as a distribution with 

respect to the stock of Y under section 301. 

Under § 1.302–5(a)(3), X’s $ 25,000 adjusted 

basis in the redeemed shares of Class A 

common stock is treated as a loss recognized 

on the date of the redemption, none of which 

is taken into account in 2008. Under 

paragraph (c)(2)(vi) of this section, solely for 

purposes of apportioning expenses on the 

basis of the tax book value of assets, X’s 

adjusted basis in its remaining Class B 

common stock of Y is considered to be 

$75,000 ($50,000 adjusted basis in the Class 

B common stock plus $ 25,000 unrecovered 

basis in the redeemed Class A common 

stock). 

(c)(2)(viii) Effective/applicability date. 

Paragraph (c)(2)(vi) and Example 3 

apply to transactions that occur after the 

date these regulations are published as 

final regulations in the Federal Register. 

(c)(3) through (j) [Reserved]. For 

further guidance, see § 1.861–12T(c)(3) 

through (j). 

§ 1.1002–1 [Redesignated as § 1.1001–6] 

Par. 18. Section 1.1002–1 is 

redesignated as 1.1001–6 and amended 

by revising paragraph (c) and adding a 

new paragraph (e) to read as follows: 

§ 1.1001–6 Sales or exchanges. 

* * * * * 

(c) Certain exceptions to general rule. 

Exceptions to the general rule are made, 

for example, by sections 351(a), 354, 

361(a), 721, 1031, 1035, and 1036. These 

sections describe certain specific 

exchanges of property in which at the 

time of the exchange particular 

differences exist between the property 

parted with and the property acquired, 

but such differences are more formal 

than substantial. As to these, the 

Internal Revenue Code provides that 

such differences shall not be deemed 

controlling, and that gain or loss shall 

not be recognized at the time of the 

exchange. The underlying assumption 

of these exceptions is that the new 

property is substantially a continuation 

of the old investment still unliquidated; 

and, in the case of reorganizations, that 

the new enterprise, the new corporate 

structure and the new property are 

substantially continuations of the old 

still unliquidated. Solely for purposes of 

determining whether the exceptions to 

the general rule under sections 354 and 

361 apply to an exchange, to the extent 

the terms of the exchange specify that a 

particular property is received in 

exchange for a particular property, such 

terms shall control provided such terms 

are economically reasonable. 

* * * * * 

(e) Effective/applicability date. This 

section applies to exchanges that occur 

after the date these regulations are 

published as final regulations in the 

Federal Register. For exchanges that 

occur on or before the date these 

regulations are published as final 

regulations in the Federal Register, see 

this section as contained in 26 CFR part 

1 revised April 1, for the year before 

these regulations are published as final 

regulations in the Federal Register. 

Par. 19. Section 1.1016–2 is amended 

by adding paragraphs (e) and (f) to read 

as follows: 

§ 1.1016–2 Items properly chargeable to 

capital account. 

* * * * * 

(e) Solely for purposes of determining 

basis in stock, in the case of a 

shareholder capital contribution to 

which section 118 applies, the 

principles of § 1.358–2(g)(3) (allocation 

of basis in a section 351 transaction in 

which stock is deemed received) shall 

apply. 

(f) This section applies to transactions 

that occur after the date these 

regulations are published as final 

regulations in the Federal Register. For 

exchanges that occur on or before the 

date these regulations are published as 

final regulations in the Federal Register, 

see this section as contained in 26 CFR 

part 1 revised April 1, for the year 

before these regulations are published as 

final regulations in the Federal Register. 

Par. 20. Section 1.1374–10, the first 

sentence of paragraph (a) is revised to 

read as follows: 

§ 1.1374–10 Effective date and additional 

rules. 

(a) In general. For transactions to 

which § 1.302–5 applies [Reserved]. 

Sections 1.1374–1 through 1.1374–9, 

other than § 1.1374–3(b) and (c) 

Examples 2 through 4, apply for taxable 

years ending on or after December 27, 

1994, but only in cases where the S 

corporation’s return for the taxable year 

is filed pursuant to an S election or a 

section 1374(d)(8) transaction occurring 

on or after December 27, 1994. * * * 

* * * * * 

Linda M. Kroening, 

(Acting) Deputy Commissioner for Services 

and Enforcement. 

[FR Doc. E9–1100 Filed 1–16–09; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF LABOR 

Occupational Safety and Health 

Administration 

29 CFR Part 1910 

[Docket No. OSHA–2007–0007] 

RIN 1218–AC39 

Additional Quantitative Fit-Testing 

Protocols for the Respiratory 

Protection Standard 

AGENCY: Occupational Safety and Health 

Administration (OSHA); Labor. 

ACTION: Notice of proposed rulemaking; 

request for comments. 

SUMMARY: OSHA is proposing to add 

two PortaCount® quantitative fit-testing 

protocols to its Respiratory Protection 

Standard (29 CFR 1910.134); the 

proposed protocols would apply to 

employers in general industry, shipyard 

employment, and the construction 

industry. The first of the two proposed 

protocols consists of the eight fit-testing 

exercises described in Part I.A.14 of 

Appendix A of the Respiratory 

Protection Standard, except each 

exercise would last 30 seconds instead 

of the currently required 60 seconds.1

The second proposed protocol would 

eliminate two of the eight fit-testing 

exercises, and each of the remaining six 

exercises would last 40 seconds; in 

addition, this proposed protocol would 

increase the current minimum pass-fail 

fit-testing criterion from a fit factor of 

100 to 200 for half masks, and from 500 

to 1,000 for full facepieces. 

DATES: Submit comments to this 

proposal, including comments to the 

information collection (paperwork) 

determination described under the 

section this preamble titled 

SUPPLEMENTARY INFORMATION, as well as 

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