8 Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 

III. Conclusion 

For the foregoing reasons, we find that 

this interpretation is consistent with 

Section 28(e) of the Exchange Act and 

the requirements of that section.

List of Subjects in 17 CFR Part 241 

Securities.

Amendments to the Code of Federal 

Regulations

■ For the reasons set forth above, the 

Commission is amending title 17, 

chapter II of the Code of Federal 

Regulations as set forth below:

PART 241—INTERPRETATIVE 

RELEASES RELATING TO THE 

SECURITIES EXCHANGE ACT OF 1934 

AND GENERAL RULES AND 

REGULATIONS THEREUNDER

■ 1. Part 241 is amended by adding 

Release No. 34–45194 and the release 

date of December 27, 2001 to the list of 

interpretative releases.

Dated: December 27, 2001.

By the Commission. 

Margaret H. McFarland, 

Deputy Secretary.

[FR Doc. 01–32199 Filed 12–31–01; 8:45 am] 

BILLING CODE 8010–01–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service 

26 CFR Parts 1 and 602 

[TD 8975] 

RIN 1545–BA21 

Certain Transfers of Property to 

Regulated Investment Companies 

[RICs] and Real Estate Investment 

Trusts [REITs]

AGENCY: Internal Revenue Service (IRS), 

Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains 

temporary regulations that apply to 

certain transactions or events that result 

in a Regulated Investment Company 

[RIC] or a Real Estate Investment Trust 

[REIT] owning property that has a basis 

determined by reference to a C 

corporation’s basis in the property. 

These regulations affect RICs, REITs, 

and C corporations and clarify the tax 

treatment of transfers of C corporation 

property to a RIC or REIT. The text of 

the temporary regulations also serves as 

the text of the proposed regulations set 

forth in the notice of proposed 

rulemaking on this subject in the 

Proposed Rules section of this issue of 

the Federal Register.

DATES: Effective Date: These regulations 

are effective January 2, 2002. 

Applicability Dates: For dates of 

applicability, see §§ 1.337(d)–6T(e) and 

1.337(d)–7T(f).

FOR FURTHER INFORMATION CONTACT: Lisa 

A. Fuller, (202) 622–7750 (not a toll-free 

number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act 

These temporary regulations are being 

issued without prior notice and public 

procedure pursuant to the 

Administrative Procedure Act (5 U.S.C. 

553). For this reason, the collection of 

information contained in these 

regulations has been reviewed and, 

pending receipt and evaluation of 

public comments, approved by the 

Office of Management and Budget under 

control number 1545–1672. Responses 

to this collection of information are 

required to obtain a benefit, i.e., to elect 

to recognize gain as if the C corporation 

had sold the property at fair market 

value or to elect section 1374 treatment. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless the collection of information 

displays a valid control number. 

For further information concerning 

this collection of information, and 

where to submit comments on the 

collection of information and the 

accuracy of the estimated burden, and 

suggestions for reducing this burden, 

please refer to the preamble to the crossreferencing notice of proposed 

rulemaking published in the Proposed 

Rules section of this issue of the Federal 

Register. 

Books or records relating to a 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. section 6103. 

Background 

Sections 631 and 633 of the Tax 

Reform Act of 1986 (the 1986 Act) 

(Public Law 99–514, 100 Stat. 2085, 

2272), as amended by section 1006(e) 

and (g) of the Technical and 

Miscellaneous Revenue Act of 1988 (the 

1988 Act) (Public Law 100–647, 102 

Stat. 3342, 3400–01), amended the 

Internal Revenue Code (Code) to repeal 

the General Utilities doctrine. In 

particular, the 1986 Act amended 

sections 336 and 337 to require 

corporations to recognize gain or loss on 

the distribution of property in 

connection with complete liquidations 

other than certain subsidiary 

liquidations. Section 337(d) directs the 

Secretary to prescribe regulations as 

may be necessary to carry out the 

purposes of General Utilities repeal, 

including rules to ‘‘ensure that such 

purposes may not be circumvented 

* * * through the use of a regulated 

investment company, a real estate 

investment trust, or tax-exempt entity 

***’’ Absent special rules, the transfer 

of property owned by a C corporation to 

a RIC or REIT could result in 

permanently removing the property’s 

built-in gain from tax at the corporate 

level, because RICs and REITs generally 

are not subject to tax on income that is 

distributed to their shareholders. 

On February 4, 1988, the IRS issued 

Notice 88–19 (1988–1 C.B. 486) 

announcing its intention to promulgate 

regulations under the authority of 

section 337(d) with respect to 

transactions or events that result in a 

RIC or REIT owning property that has a 

basis determined by reference to a C 

corporation’s basis (a carryover basis). 

Notice 88–19 provided that the 

regulations would apply with respect to 

the net built-in gain of C corporation 

assets that become assets of a RIC or 

REIT by the qualification of a C 

corporation as a RIC or REIT or by the 

transfer of assets of a C corporation to 

a RIC or REIT (a conversion transaction). 

The Notice further provided that, where 

the regulations apply, the C corporation 

would be treated, for all purposes, as if 

it had sold all of its assets at their 

respective fair market values and 

immediately liquidated. The Notice 

provided, however, that the regulations 

would not allow the recognition of a net 

loss and that, except as provided in the 

Notice, the regulations would not affect 

the characterization for tax purposes of, 

or the tax treatment of parties to, any 

transactions to which they apply. For 

example, shareholders of a C 

corporation who received RIC shares in 

a transaction that qualified as a 

reorganization under section 

368(a)(1)(C) would not recognize gain or 

loss solely because the C corporation 

was subject to tax. The Notice also 

provided that immediate gain 

recognition could be avoided if the C 

corporation that qualified as a RIC or 

REIT or the transferee RIC or REIT, as 

the case may have been, elected to be 

subject to tax under section 1374 with 

respect to the C corporation property. 

Notice 88–19 also indicated that the 

regulations would apply retroactively to 

June 10, 1987. Notice 88–96 (1988–2 

C.B. 420), amplifies Notice 88–19 by 

Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 9

providing that the regulations described 

in Notice 88–19 would provide an 

exception to the general gain 

recognition rules for any C corporation 

that qualified to be taxed as a RIC for at 

least one taxable year, then failed to so 

qualify for one taxable year, and then 

requalified to be taxed as a RIC in the 

next taxable year. 

On February 7, 2000, Treasury and 

the IRS published temporary regulations 

[TD 8872] (the 2000 temporary 

regulations) reflecting the principles set 

forth in Notice 88–19 and Notice 88–96, 

a notice of proposed rulemaking by 

cross-reference to temporary 

regulations, and a notice of public 

hearing [REG–209135–88]. The 2000 

temporary regulations apply 

retroactively to June 10, 1987. 

Treasury and the IRS have received a 

number of comments, both written and 

oral, on the 2000 temporary regulations. 

A public hearing was held on May 10, 

2000. After considering these 

comments, Treasury and the IRS have 

decided to issue two new sets of 

temporary regulations, one that will 

apply to conversion transactions 

occurring on or after June 10, 1987 and 

before January 2, 2002 (the –6T 

regulations), and another that will apply 

to conversion transactions occurring on 

or after January 2, 2002 (the –7T 

regulations). Alternatively, taxpayers 

generally may apply the 2000 temporary 

regulations in lieu of the –6T 

regulations to any conversion 

transaction that occurred on or after 

June 10, 1987 and before January 2, 

2002. However, RICs and REITs that rely 

on the 2000 temporary regulations and 

that are subject to section 1374 

treatment may not rely on certain 

provisions in the 2000 temporary 

regulations, but instead must apply 

certain provisions of the –6T 

regulations, with respect to built-in 

gains and losses recognized in taxable 

years beginning on or after January 2, 

2002. Furthermore, taxpayers are not 

prevented from relying on the 2000 

temporary regulations merely because 

they elect section 1374 treatment in the 

manner described in the –6T regulations 

rather than in the manner described in 

the 2000 temporary regulations. 

Explanation of Provisions 

This preamble first discusses the –6T 

regulations and how the –6T regulations 

differ from the 2000 temporary 

regulations. This preamble then 

explains the differences between the 

–7T regulations and the –6T regulations. 

Summary of –6T Regulations 

The –6T regulations provide that, if 

property of a C corporation that is not 

a RIC or REIT becomes the property of 

a RIC or REIT in a conversion 

transaction, then the C corporation is 

subject to deemed sale treatment, unless 

the RIC or REIT elects to be subject to 

section 1374 treatment. Thus, the C 

corporation generally recognizes gain 

and loss as if it sold the property 

converted to RIC or REIT property or 

transferred to the RIC or REIT (the 

converted property) to an unrelated 

party at fair market value immediately 

before the conversion transaction. If the 

C corporation recognizes net gain on the 

deemed sale, then the basis of the 

converted property in the hands of the 

RIC or REIT is adjusted to its fair market 

value immediately before the 

conversion transaction. The –6T 

regulations do not permit a C 

corporation to recognize a net loss on 

the deemed sale. For this purpose, net 

loss is defined as the excess of aggregate 

losses over aggregate gains (including 

items of income), without regard to 

character. Where there is a net loss, the 

C corporation recognizes no gain or loss 

on the deemed sale, and the C 

corporation’s basis in the converted 

property carries over to the RIC or REIT. 

Clarification of Deemed Sale Treatment 

The 2000 temporary regulations 

provide that, unless a section 1374 

election is made, a C corporation that 

elects RIC or REIT status or transfers 

property to a RIC or REIT is ‘‘treated for 

all purposes, including recognition of 

net built-in gain, as if it had sold all of 

its assets at their respective fair market 

values on the deemed liquidation date 

* * * and immediately liquidated.’’

Commentators objected to this provision 

on two grounds. First, they argued that 

the provision is overly broad, because it 

treats the C corporation that is 

transferring property to a RIC or REIT as 

having sold all of its property, even 

where all of its property may not have 

been transferred to the RIC or REIT. 

Second, they argued that the ‘‘for all 

purposes’’ language could be read to 

suggest that the deemed liquidation 

results in the imposition of a 

shareholder tax, a result that they view 

as inconsistent with Notice 88–19 and 

the purposes of section 337(d). 

Commentators also argued that deemed 

liquidation treatment would 

inappropriately eliminate the C 

corporation’s tax attributes, such as net 

operating loss carryforwards and 

earnings and profits, to which the RIC 

or REIT might otherwise succeed. 

Treasury and the IRS agree with these 

comments. Accordingly, the –6T 

regulations clarify that the C corporation 

is treated as having sold only that 

property actually transferred to the RIC 

or REIT and that a shareholder-level tax 

is not imposed. In addition, the deemed 

liquidation construct has been 

eliminated. 

Deemed Sale Loss Disallowance 

The 2000 temporary regulations do 

not permit a C corporation to recognize 

a net loss on a conversion transaction. 

Some commentators argued that loss 

disallowance is inappropriate, noting 

that a net loss can be recognized under 

section 336 and § 1.337(d)–4, which 

governs certain transfers of property 

from taxable to tax-exempt entities. 

Treasury and the IRS believe that loss 

disallowance is appropriate in the 

context of the –6T regulations for two 

reasons. First, Treasury and the IRS are 

concerned that a C corporation may 

selectively contribute loss property to a 

RIC or REIT in a section 351 transaction, 

generating an immediate loss. Because 

section 336 and § 1.337(d)–4 apply only 

where a C corporation transfers 

substantially all of its assets, selective 

contribution concerns are minimal in 

those contexts. Second, section 336 and 

§ 1.337(d)–4 require C corporations to 

recognize both gains and losses 

immediately, whereas the –6T 

regulations allow taxpayers to defer the 

recognition of net gain on a conversion 

transaction by making an election to be 

subject to tax under section 1374. 

Allowing immediate net loss 

recognition while allowing deferral of 

net gain would provide C corporations 

engaging in conversion transactions 

with an inappropriate degree of 

selectivity. Taxpayers that otherwise 

would recognize a net gain on a 

conversion transaction would likely 

elect section 1374 treatment. Taxpayers 

that would recognize a net loss on a 

conversion transaction would likely 

choose deemed sale treatment. For these 

reasons, the –6T regulations disallow 

recognition of a net loss on a conversion 

transaction. 

Section 1374 Double Tax Issue 

Some commentators argued that 

conversion transactions do not 

implicate concerns regarding avoidance 

of General Utilities repeal to the extent 

that the RIC or REIT has C corporations 

as shareholders after the conversion 

transaction. The commentators 

explained that, if a C corporation 

continues to own stock in the RIC or 

REIT after a conversion transaction, 

then the built-in gain attributable to the 

transferred property is preserved in the 

basis of the C corporation’s RIC or REIT 

stock. Further, the C corporation 

generally will be fully taxable on 

dividends distributed by the RIC or 

REIT, even where the RIC or REIT pays 

10 Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 

tax on built-in gains. Accordingly, the 

commentators requested that the 2000 

temporary regulations be modified to 

mitigate the combined impact of tax at 

the RIC or REIT level under section 

1374 and tax at the C corporation 

shareholder level on RIC and REIT 

dividends. 

Treasury and the IRS considered 

several approaches suggested by 

commentators for mitigating this double 

corporate tax. These approaches 

include: (1) Exempting section 351 

transfers of property by a C corporation 

to a RIC or REIT from the scope of these 

regulations, (2) removing the 

requirement that RICs and REITs 

distribute recognized built-in gains, and 

(3) allowing C corporation shareholders 

of RICs and REITs to claim a dividends 

received deduction for built-in gains 

distributed by the RIC or REIT. 

After consideration, Treasury and the 

IRS decided that it could not accept any 

of these approaches. The first two 

approaches were not accepted because 

they could create opportunities to avoid 

corporate-level tax on built-in gains. 

The third approach was not accepted 

because the dividends received 

deduction is only available for 

distributions characterized as ordinary 

income, not distributions characterized 

as capital gains. As explained below, 

under the –6T regulations, RICs and 

REITs may characterize most 

distributions of built-in gains as capital 

gain dividends. Moreover, all three 

approaches would give rise to 

administrative difficulties that could be 

addressed only through extensive 

rulemaking. 

Section 1374 Operational Rules 

The 2000 temporary regulations 

provide that the built-in gain of a RIC or 

REIT electing section 1374 treatment 

and the corporate-level tax imposed on 

that gain are subject to rules similar to 

the rules relating to net income from 

foreclosure property (NIFP) of REITs. 

The comments pointed out certain 

differences between the section 1374 

rules and the NIFP rules. For example, 

under section 1374, any recognized 

built-in gain retains its character as 

capital gain or ordinary income. In 

contrast, NIFP is always treated as 

ordinary income. In addition, net 

operating losses of a C corporation can 

offset recognized built-in gains of an S 

corporation but cannot offset NIFP. 

Similarly, business credit carryforwards 

from a C corporation can reduce the tax 

on the net recognized built-in gain of an 

S corporation but cannot reduce the tax 

on NIFP. 

In light of these differences, Treasury 

and the IRS have adopted an alternative 

approach that does not rely on the NIFP 

rules for coordinating the built-in gains 

tax imposed by this section with the 

provisions of subchapter M. Unlike the 

NIFP rules, this approach generally 

preserves the character of recognized 

built-in gains and recognized built-in 

losses. Under this approach, recognized 

built-in gains and recognized built-in 

losses that have been taxed in 

accordance with these regulations are 

treated like other gains and losses of 

RICs and REITs that are not subject to 

tax under these regulations. Thus, they 

are included in computing investment 

company taxable income for purposes of 

section 852(b)(2), real estate investment 

trust taxable income for purposes of 

section 857(b)(2), net capital gain for 

purposes of sections 852(b)(3) and 

857(b)(3), gross income derived from 

sources within any foreign country or 

possession of the United States for 

purposes of section 853, and the 

dividends paid deduction for purposes 

of sections 852(b)(2)(D), 852(b)(3)(A), 

857(b)(2)(B), and 857(b)(3)(A). 

In addition, consistent with section 

1374, the –6T regulations generally 

allow RICs and REITs to use loss 

carryforwards and credits and credit 

carryforwards arising in taxable years 

for which the corporation that generated 

the attribute was a C corporation (and 

not a RIC or REIT) to reduce net 

recognized built-in gain and the tax 

thereon, subject to the limitations 

imposed by sections 1374(b)(2) and 

(b)(3) and §§ 1.1374–5 and 1.1374–6. In 

addition, the –6T regulations provide an 

ordering rule for applying loss 

carryforwards, credits, and credit 

carryforwards to reduce net recognized 

built-in gain (and the tax thereon) and 

RIC or REIT taxable income (and the tax 

thereon). Under this ordering rule, loss 

carryforwards of a RIC or REIT must be 

used to reduce net recognized built-in 

gain for a taxable year to the greatest 

extent possible before such losses can be 

used to reduce investment company 

taxable income for purposes of section 

852(b) or real estate investment trust 

taxable income for purposes of section 

857(b) for that taxable year. Similarly, 

credits and credit carryforwards of a RIC 

or REIT must be used to reduce the tax 

on net recognized built-in gain imposed 

under this section for the taxable year to 

the greatest extent possible before such 

credits and credit carryforwards can be 

used to reduce the tax, if any, on 

investment company taxable income for 

purposes of section 852(b) or on real 

estate investment trust taxable income 

for purposes of section 857(b) for that 

taxable year. 

The –6T regulations also make 

adjustments to the taxable income 

limitation of section 1374 to take into 

account items that are unique to REITs. 

Under the –6T regulations, taxable 

income of a RIC or REIT is initially 

computed under sections 1374(d)(2) and 

1375(b)(1)(B) as if the RIC or REIT were 

an S corporation. Thus, the RIC’s or 

REIT’s taxable income is its taxable 

income under section 63(a) without 

regard to—(i) deductions allowed by 

part VIII of subchapter B (other than the 

deduction allowed by section 248, 

relating to organizational expenditures), 

and (ii) the deduction under section 

172. In addition, the RIC or REIT would 

not be allowed a deduction for 

dividends paid, as the dividends paid 

deduction is not available to S 

corporations. Under the –6T regulations, 

this amount is then reduced for REITs 

by certain items that are subject to a 

100-percent penalty tax. Items subject to 

a 100-percent penalty tax, along with 

net income from foreclosure property, 

are also excluded in computing a REIT’s 

net recognized built-in gain. 

In response to comments, the –6T 

regulations also provide that the entitylevel tax imposed on net recognized 

built-in gain is treated as a loss that 

reduces the RIC’s or REIT’s taxable 

income and earnings and profits. The 

character of the loss attributable to the 

tax on net recognized built-in gain is 

determined by allocating the tax 

proportionately (based on recognized 

built-in gain) among the items of 

recognized built-in gain included in net 

recognized built-in gain. With respect to 

RICs, the tax imposed on net recognized 

built-in gain is treated as attributable to 

the portion of the RIC’s taxable year 

occurring after October 31. 

Commentators also requested that 

built-in gain recognized by a RIC or 

REIT that is subject to section 1374 

treatment generate subchapter M 

earnings and profits. They explained 

that a RIC or REIT cannot qualify as 

such under subchapter M if it retains 

any subchapter C earnings and profits. 

Thus, if earnings and profits attributable 

to recognized built-in gain were 

subchapter C earnings and profits, a RIC 

or REIT would retain its qualification 

only if it distributed 100 percent of the 

net recognized built-in gain in excess of 

the entity-level tax. In response to these 

comments, the examples in the –6T 

regulations clarify that earnings and 

profits attributable to built-in gain 

recognized by a RIC or REIT are 

subchapter M earnings and profits. 

Electing Section 1374 Treatment 

The 2000 temporary regulations 

provide that a RIC or REIT makes a 

section 1374 election by attaching a 

statement to its Federal income tax 

Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 11

return for the first taxable year in which 

the assets of a C corporation become 

assets of the RIC or REIT. The 2000 

temporary regulations also provide a 

special rule for making a section 1374 

election where the first taxable year in 

which the assets of a C corporation 

became the assets of a RIC or REIT ends 

after June 10, 1987, but before March 8, 

2000 (an interim period election). Under 

the 2000 temporary regulations, a RIC or 

REIT may file an interim period election 

with its first Federal income tax return 

filed after March 8, 2000. 

Commentators expressed concern that 

the rule applicable to interim period 

elections required a RIC or REIT to make 

an election on its first Federal income 

tax return filed after March 8, 2000, 

even if the RIC or REIT previously had 

made a section 1374 election. They also 

expressed concern that RICs and REITs 

were not given sufficient time after the 

promulgation of the 2000 temporary 

regulations to make interim period 

elections. In response to these 

comments, the –6T regulations allow a 

RIC or REIT that converted from a C 

corporation or acquired property with a 

carryover basis from a C corporation 

before January 2, 2002, to make a 

section 1374 election with any Federal 

income tax return filed by the RIC or 

REIT on or before March 15, 2003, 

provided that the RIC or REIT has 

reported consistently with such election 

for all periods. In addition, under the 

–6T regulations, an interim period 

election is not necessary if the RIC or 

REIT can demonstrate that it has 

previously informed the IRS of its intent 

to make a section 1374 election. 

Some commentators also requested 

that Treasury and the IRS clarify that a 

RIC or REIT must make a separate 

section 1374 election for each 

conversion transaction in which it 

participates. The –6T regulations make 

this clarification. Thus, a RIC or REIT 

can elect section 1374 treatment for one 

conversion transaction and not elect 

section 1374 treatment for another 

conversion transaction. 

Exception for Re-Election of RIC or REIT 

Status 

Under the 2000 temporary 

regulations, the rule requiring 

recognition of gain on a conversion 

transaction does not apply to a C 

corporation that qualified to be a RIC for 

at least one taxable year, then failed to 

so qualify for a period not in excess of 

one taxable year, and then requalifies as 

a RIC. Although this exception 

implements Notice 88–96, the language 

of the 2000 temporary regulations 

differs slightly from the language used 

in Notice 88–96. Some commentators 

have noted that the change in language 

might be misinterpreted as a substantive 

change where none was intended. In 

response to these comments, this 

language has been clarified in the –6T 

regulations. 

In addition, some commentators 

requested that the exception be 

expanded to cover periods longer than 

one taxable year. They argued that a 

corporation that fails to meet the RIC 

qualification requirements for as short a 

period as 6 months could be taxed as a 

C corporation for two taxable years. This 

could happen where a RIC fails the 

quarterly diversification test for the last 

quarter of one calendar year and the first 

quarter of the subsequent calendar year. 

Other commentators requested that 

this exception be expanded to cover 

REITs. They noted that Congress 

generally treats RICs and REITs 

similarly and that there is no 

justification for excluding REITs from 

the benefit of this exception. 

The –6T regulations incorporate these 

comments by extending the exception to 

REITs and the maximum period for loss 

of RIC or REIT status from one taxable 

year to two taxable years. 

Retention of Retroactive Effective Date 

Commentators argued that, due to the 

12-year gap between the promulgation 

of Notice 88–19 and the issuance of the 

regulations implementing Notice 88–19, 

the regulations should not apply 

retroactively. 

Notice 88–19 notified taxpayers that 

the section 337(d) regulations would 

apply as of June 10, 1987. The 2000 

temporary regulations, which were 

published on February 7, 2000, do, in 

fact, apply as of June 10, 1987. 

Moreover, since February 7, 2000, 

taxpayers have relied on the 2000 

temporary regulations. For these 

reasons, the 2000 temporary regulations 

and the –6T regulations retain the June 

10, 1987, applicability date. 

Summary of –7T Regulations 

The –7T regulations follow the –6T 

regulations in most respects. However, 

certain changes were included in the 

–7T regulations that were not included 

in the –6T regulations, because Treasury 

and the IRS were concerned that these 

changes, if made retroactively, could 

have an adverse impact on taxpayers 

that have relied on the 2000 temporary 

regulations. The following sections 

highlight these differences between the 

–6T regulations and the –7T regulations. 

Section 1374 Treatment as Default 

Rule 

A number of commentators, 

particularly REIT commentators, 

expressed the view that, when a C 

corporation engages in a conversion 

transaction, section 1374 treatment 

should apply automatically and 

taxpayers that desire deemed sale 

treatment should be allowed to elect 

such treatment. They pointed out that 

the automatic application of a section 

1374 regime is consistent with the 

treatment of C corporations that elect S 

status. Further, they argued that most 

taxpayers would prefer to be subject to 

section 1374 treatment than to deemed 

sale treatment. If section 1374 treatment 

is the default treatment, then the 

incidence of inadvertent failures to 

make elections will be reduced. 

However, to protect the expectations of 

taxpayers that engaged in conversion 

transactions prior to the promulgation of 

these regulations, the commentators 

recommended that section 1374 

treatment be adopted as the default 

treatment on a prospective basis. In 

accordance with these comments, the 

–7T regulations provide that section 

1374 treatment applies unless the C 

corporation elects deemed sale 

treatment. 

Anti-Stuffing Rule for Taxpayers 

Electing Deemed Sale Treatment 

Treasury and the IRS are concerned 

that taxpayers electing deemed sale 

treatment might attempt to decrease net 

gains on conversion transactions by 

stuffing loss property into a C 

corporation prior to a conversion 

transaction. Treasury and the IRS note 

that section 336 and § 1.337(d)–4 both 

have anti-stuffing rules. Accordingly, 

the –7T regulations include an antistuffing rule applicable to transactions 

taxed under the deemed sale approach. 

The anti-stuffing rule is similar to those 

contained in section 336 and § 1.337(d)–

4. 

Aggregate Principles To Apply to 

Partnership Transactions 

Treasury and the IRS believe that a 

partnership with C corporation partners 

should be treated as an aggregate for 

purposes of applying these regulations. 

Accordingly, the –7T regulations 

provide that these regulations apply to 

property transferred by a partnership to 

a RIC or REIT to the extent of any C 

corporation partner’s proportionate 

share of the transferred property. For 

example, if a C corporation owns a 20 

percent interest in a partnership and 

that partnership contributes an asset to 

a REIT in a section 351 transaction, then 

the partnership shall be treated as a C 

corporation with respect to 20 percent 

of the asset contributed to the REIT. If 

the partnership were to elect deemed 

sale treatment with respect to such 

12 Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 

transfer, then any gain recognized by the 

partnership on the deemed sale must be 

specially allocated to the C corporation 

partner. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 12866. Therefore, a 

regulatory assessment is not required. It 

also has been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to these regulations. For the 

applicability of the Regulatory 

Flexibility Act (5 U.S.C. chapter 6) refer 

to the Special Analyses section of the 

preamble to the cross-reference notice of 

proposed rulemaking published in the 

Proposed Rules section in this issue of 

the Federal Register. Pursuant to 

section 7805(f) of the Code, these 

temporary regulations will be submitted 

to the Chief Counsel for Advocacy of the 

Small Business Administration for 

comment on their impact on small 

business. 

Drafting Information 

The principal author of these 

regulations is Lisa A. Fuller of the Office 

of Associate Chief Counsel (Corporate). 

Other personnel from Treasury 

Department and the IRS participated in 

their development.

List of Subjects 

26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

26 CFR Part 602 

Reporting and recordkeeping 

requirements.

Adoption of Amendments to the 

Regulations

■ Accordingly, 26 CFR parts 1 and 602 

are amended as follows:

PART 1—INCOME TAXES

■ Paragraph 1. The authority citation for 

part 1 is amended by adding an entry in 

numerical order to read in part as 

follows:

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

Section 1.337(d)–6T also issued under 26 

U.S.C. 337. 

Section 1.337(d)–7T also issued under 26 

U.S.C. 337. * * *

■ Par. 2. § 1.337(d)–5T is amended by:

■ 1. Revising the section heading.

■ 2. Revising paragraph (d).

■ The revisions read as follows:

§ 1.337(d)–5T Old transitional rules 

imposing tax on property owned by a C 

corporation that becomes property of a RIC 

or REIT (temporary).

* * * * *

(d) Effective date. In the case of 

carryover basis transactions involving 

the transfer of property of a C 

corporation to a RIC or REIT, the 

regulations apply to transactions 

occurring on or after June 10, 1987, and 

before January 2, 2002. In the case of a 

C corporation that qualifies to be taxed 

as a RIC or REIT, the regulations apply 

to such qualifications that are effective 

for taxable years beginning on or after 

June 10, 1987, and before January 2, 

2002. However, RICs and REITs that are 

subject to section 1374 treatment under 

this section may not rely on § 1.337(d)–

5T(b)(1), but must apply paragraphs 

(c)(1)(i), (c)(2)(i), (c)(2)(ii), and (c)(3) of 

§ 1.337(d)–6T, with respect to built-in 

gains and losses recognized in taxable 

years beginning on or after January 2, 

2002. In lieu of applying this section, 

taxpayers may rely on § 1.337(d)–6T to 

determine the tax consequences (for all 

taxable years) of any conversion 

transaction. For transactions and 

qualifications that occur on or after 

January 2, 2002, see § 1.337(d)–7T.

■ Par. 3. Sections 1.337(d)–6T and 

1.337(d)–7T are added immediately after 

§ 1.337(d)–5T to read as follows:

§ 1.337(d)–6T New transitional rules 

imposing tax on property owned by a C 

corporation that becomes property of a RIC 

or REIT (temporary). 

(a) General Rule—(1) Property owned 

by a C corporation that becomes 

property of a RIC or REIT. If property 

owned by a C corporation (as defined in 

paragraph (a)(2)(i) of this section) 

becomes the property of a RIC or REIT 

(the converted property) in a conversion 

transaction (as defined in paragraph 

(a)(2)(ii) of this section), then deemed 

sale treatment will apply as described in 

paragraph (b) of this section, unless the 

RIC or REIT elects section 1374 

treatment with respect to the conversion 

transaction as provided in paragraph (c) 

of this section. See paragraph (d) of this 

section for exceptions to this paragraph 

(a). 

(2) Definitions—(i) C corporation. For 

purposes of this section, the term C 

corporation has the meaning provided 

in section 1361(a)(2) except that the 

term does not include a RIC or REIT. 

(ii) Conversion transaction. For 

purposes of this section, the term 

conversion transaction means the 

qualification of a C corporation as a RIC 

or REIT or the transfer of property 

owned by a C corporation to a RIC or 

REIT. 

(b) Deemed Sale Treatment—(1) In 

general. If property owned by a C 

corporation becomes the property of a 

RIC or REIT in a conversion transaction, 

then the C corporation recognizes gain 

and loss as if it sold the converted 

property to an unrelated party at fair 

market value on the deemed sale date 

(as defined in paragraph (b)(3) of this 

section). This paragraph (b) does not 

apply if its application would result in 

the recognition of a net loss. For this 

purpose, net loss is the excess of 

aggregate losses over aggregate gains 

(including items of income), without 

regard to character. 

(2) Basis adjustment. If a corporation 

recognizes a net gain under paragraph 

(b)(1) of this section, then the converted 

property has a basis in the hands of the 

RIC or REIT equal to the fair market 

value of such property on the deemed 

sale date. 

(3) Deemed sale date—(i) RIC or REIT 

qualifications. If the conversion 

transaction is a qualification of a C 

corporation as a RIC or REIT, then the 

deemed sale date is the end of the last 

day of the C corporation’s last taxable 

year before the first taxable year in 

which it qualifies to be taxed as a RIC 

or REIT. 

(ii) Other conversion transactions. If 

the conversion transaction is a transfer 

of property owned by a C corporation to 

a RIC or REIT, then the deemed sale 

date is the end of the day before the day 

of the transfer. 

(4) Example. The rules of this 

paragraph (b) are illustrated by the 

following example:

Example. Deemed sale treatment on merger 

into RIC. (i) X, a calendar-year taxpayer, has 

qualified as a RIC since January 1, 1991. On 

May 31, 1994, Y, a C corporation and 

calendar-year taxpayer, transfers all of its 

property to X in a transaction that qualifies 

as a reorganization under section 

368(a)(1)(C). X does not elect section 1374 

treatment under paragraph (c) of this section 

and chooses not to rely on § 1.337(d)–5T. As 

a result of the transfer, Y is subject to deemed 

sale treatment under this paragraph (b) on its 

tax return for the short taxable year ending 

May 31, 1994. On May 31, 1994, Y’s only 

assets are Capital Asset, which has a fair 

market value of $100,000 and a basis of 

$40,000 as of the end of May 30, 1994, and 

$50,000 cash. Y also has an unrestricted net 

operating loss carryforward of $12,000 and 

accumulated earnings and profits of $50,000. 

Y has no taxable income for the short taxable 

year ending May 31, 1994, other than gain 

recognized under this paragraph (b). In 1997, 

X sells Capital Asset for $110,000. Assume 

the applicable corporate tax rate is 35%. 

(ii) Under this paragraph (b), Y is treated 

as if it sold the converted property (Capital 

Asset and $50,000 cash) at fair market value 

on May 30, 1994, recognizing $60,000 of gain 

($150,000 amount realized—$90,000 basis). Y 

Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 13

must report the gain on its tax return for the 

short taxable year ending May 31, 1994. Y 

may offset this gain with its $12,000 net 

operating loss carryforward and will pay tax 

of $16,800 (35% of $48,000). 

(iii) Under section 381, X succeeds to Y’s 

accumulated earnings and profits. Y’s 

accumulated earnings and profits of $50,000 

increase by $60,000 and decrease by $16,800 

as a result of the deemed sale. Thus, the 

aggregate amount of subchapter C earnings 

and profits that must be distributed to satisfy 

section 852(a)(2)(B) is $93,200 ($50,000 + 

$60,000 ¥ $16,800). X’s basis in Capital 

Asset is $100,000. On X’s sale of Capital 

Asset in 1997, X recognizes $10,000 of gain, 

which is taken into account in computing X’s 

net capital gain for purposes of section 

852(b)(3). 

(c) Election of section 1374 treatment—(1) 

In general—(i) Property owned by a C 

corporation that becomes property of a RIC 

or REIT. Paragraph (b) of this section does 

not apply if the RIC or REIT that was 

formerly a C corporation or that acquired 

property from a C corporation makes the 

election described in paragraph (c)(4) of this 

section. A RIC or REIT that makes such an 

election will be subject to tax on the net 

built-in gain in the converted property under 

the rules of section 1374 and the regulations 

thereunder, as modified by this paragraph (c), 

as if the RIC or REIT were an S corporation. 

(ii) Property subject to the rules of section 

1374 owned by a RIC, REIT, or S corporation 

that becomes property of a RIC or REIT. If 

property subject to the rules of section 1374 

owned by a RIC, a REIT, or an S corporation 

(the predecessor) becomes the property of a 

RIC or REIT (the successor) in a continuation 

transaction, the rules of section 1374 apply 

to the successor to the same extent that the 

predecessor was subject to the rules of 

section 1374 with respect to such property, 

and the 10-year recognition period of the 

successor with respect to such property is 

reduced by the portion of the 10-year 

recognition period of the predecessor that 

expired before the date of the continuation 

transaction. For this purpose, a continuation 

transaction means the qualification of the 

predecessor as a RIC or REIT or the transfer 

of property from the predecessor to the 

successor in a transaction in which the 

successor’s basis in the transferred property 

is determined, in whole or in part, by 

reference to the predecessor’s basis in that 

property. 

(2) Modification of section 1374 

treatment—(i) Net recognized built-in gain 

for REITs—(A) Prelimitation amount. The 

prelimitation amount determined as 

provided in § 1.1374–2(a)(1) is reduced by 

the portion of such amount, if any, that is 

subject to tax under section 857(b)(4), (5), (6), 

or (7). For this purpose, the amount of a 

REIT’s recognized built-in gain that is subject 

to tax under section 857(b)(5) is computed as 

follows: 

(1) Where the tax under section 857(b)(5) 

is computed by reference to section 

857(b)(5)(A), the amount of a REIT’s 

recognized built-in gain that is subject to tax 

under section 857(b)(5) is the tax imposed by 

section 857(b)(5) multiplied by a fraction the 

numerator of which is the amount of 

recognized built-in gain (without regard to 

recognized built-in loss and recognized builtin gain from prohibited transactions) that is 

not derived from sources referred to in 

section 856(c)(2) and the denominator of 

which is the gross income (without regard to 

gross income from prohibited transactions) of 

the REIT that is not derived from sources 

referred to in section 856(c)(2). 

(2) Where the tax under section 857(b)(5) 

is computed by reference to section 

857(b)(5)(B), the amount of a REIT’s 

recognized built-in gain that is subject to tax 

under section 857(b)(5) is the tax imposed by 

section 857(b)(5) multiplied by a fraction the 

numerator of which is the amount of 

recognized built-in gain (without regard to 

recognized built-in loss and recognized builtin gain from prohibited transactions) that is 

not derived from sources referred to in 

section 856(c)(3) and the denominator of 

which is the gross income (without regard to 

gross income from prohibited transactions) of 

the REIT that is not derived from sources 

referred to in section 856(c)(3). 

(B) Taxable income limitation. The taxable 

income limitation determined as provided in 

§ 1.1374–2(a)(2) is reduced by an amount 

equal to the tax imposed under sections 

857(b)(5), (6), and (7). 

(ii) Loss carryforwards, credits and credit 

carryforwards—(A) Loss carryforwards.

Consistent with paragraph (c)(1)(i) of this 

section, net operating loss carryforwards and 

capital loss carryforwards arising in taxable 

years for which the corporation that 

generated the loss was not subject to 

subchapter M of chapter 1 of the Code are 

allowed as a deduction against net 

recognized built-in gain to the extent allowed 

under section 1374 and the regulations 

thereunder. Such loss carryforwards must be 

used as a deduction against net recognized 

built-in gain for a taxable year to the greatest 

extent possible before such losses can be 

used to reduce investment company taxable 

income for purposes of section 852(b) or real 

estate investment trust taxable income for 

purposes of section 857(b) for that taxable 

year. 

(B) Credits and credit carryforwards.

Consistent with paragraph (c)(1)(i) of this 

section, minimum tax credits and business 

credit carryforwards arising in taxable years 

for which the corporation that generated the 

credit was not subject to subchapter M of 

chapter 1 of the Internal Revenue Code are 

allowed to reduce the tax imposed on net 

recognized built-in gain under this paragraph 

(c) to the extent allowed under section 1374 

and the regulations thereunder. Such credits 

and credit carryforwards must be used to 

reduce the tax imposed under this paragraph 

(c) on net recognized built-in gain for a 

taxable year to the greatest extent possible 

before such credits and credit carryforwards 

can be used to reduce the tax, if any, on 

investment company taxable income for 

purposes of section 852(b) or on real estate 

investment trust taxable income for purposes 

of section 857(b) for that taxable year. 

(iii) 10-year recognition period. In the case 

of a conversion transaction that is a 

qualification of a C corporation as a RIC or 

REIT, the 10-year recognition period 

described in section 1374(d)(7) begins on the 

first day of the RIC’s or REIT’s first taxable 

year. In the case of other conversion 

transactions, the 10-year recognition period 

begins on the day the property is acquired by 

the RIC or REIT. 

(3) Coordination with subchapter M rules—

(i) Recognized built-in gains and losses 

subject to subchapter M. Recognized built-in 

gains and losses of a RIC or REIT are 

included in computing investment company 

taxable income for purposes of section 

852(b)(2), real estate investment trust taxable 

income for purposes of section 857(b)(2), 

capital gains for purposes of sections 

852(b)(3) and 857(b)(3), gross income derived 

from sources within any foreign country or 

possession of the United States for purposes 

of section 853, and the dividends paid 

deduction for purposes of sections 

852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and 

857(b)(3)(A). 

(ii) Treatment of tax imposed. The amount 

of tax imposed under this paragraph (c) on 

net recognized built-in gain for a taxable year 

is treated as a loss sustained by the RIC or 

the REIT during such taxable year. The 

character of the loss is determined by 

allocating the tax proportionately (based on 

recognized built-in gain) among the items of 

recognized built-in gain included in net 

recognized built-in gain. With respect to 

RICs, the tax imposed under this paragraph 

(c) on net recognized built-in gain is treated 

as attributable to the portion of the RIC’s 

taxable year occurring after October 31. 

(4) Making the section 1374 election—(i) In 

general. A RIC or REIT makes a section 1374 

election with the following statement: 

‘‘[Insert name and employer identification 

number of electing RIC or REIT] elects under 

§ 1.337–6T(c) to be subject to the rules of 

section 1374 and the regulations thereunder 

with respect to its property that formerly was 

held by a C corporation, [insert name and 

employer identification number of the C 

corporation, if different from name and 

employer identification number of the RIC or 

REIT].’’ However, a RIC or REIT need not file 

an election under this paragraph (c), but will 

be deemed to have made such an election if 

it can demonstrate that it informed the IRS 

prior to January 2, 2002, of its intent to make 

a section 1374 election. An election under 

this paragraph (c) is irrevocable. 

(ii) Time for making the election. An 

election under this paragraph (c) may be filed 

by the RIC or REIT with any Federal income 

tax return filed by the RIC or REIT on or 

before March 15, 2003, provided that the RIC 

or REIT has reported consistently with such 

election for all periods. 

(5) Example. The rules of this paragraph (c) 

are illustrated by the following example:

Example. Section 1374 treatment on REIT 

election. (i) X, a C corporation that is a 

calendar-year taxpayer, elects to be taxed as 

a REIT on its 1994 tax return, which it files 

on March 15, 1995. As a result, X is a REIT 

for its 1994 taxable year and would be subject 

to deemed sale treatment under paragraph (b) 

of this section but for X’s timely election of 

section 1374 treatment under this paragraph 

(c). X chooses not to rely on § 1.337(d)–5T. 

As of the beginning of the 1994 taxable year, 

X’s property consisted of Real Property, 

which is not section 1221(a)(1) property and 

14 Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 

which had a fair market value of $100,000 

and an adjusted basis of $80,000, and 

$25,000 cash. X also had accumulated 

earnings and profits of $25,000, unrestricted 

net operating loss carryforwards of $3,000, 

and unrestricted business credit 

carryforwards of $2,000. On July 1, 1997, X 

sells Real Property for $110,000. For its 1997 

taxable year, X has net income other than 

recognized built-in gain. Assume the highest 

corporate tax rate is 35%. 

(ii) Upon its election to be taxed as a REIT, 

X retains its $80,000 basis in Real Property 

and its $25,000 accumulated earnings and 

profits. X retains its $3,000 of net operating 

loss carryforwards and its $2,000 of business 

credit carryforwards. To satisfy section 

857(a)(2)(B), X must distribute $25,000, an 

amount equal to its earnings and profits 

accumulated in non-REIT years, to its 

shareholders by the end of its 1994 taxable 

year. 

(iii) Upon X’s sale of Real Property in 1997, 

X recognizes gain of $30,000 ($110,000–

$80,000). X’s recognized built-in gain for 

purposes of applying section 1374 is $20,000 

($100,000 fair market value as of the 

beginning of X’s first taxable year as a REIT—

$80,000 basis). Because X has net income 

other than recognized built-in gain for its 

1997 taxable year, the taxable income 

limitation does not apply. X, therefore, has 

$20,000 net recognized built-in gain for the 

year. Assuming that X has not used its $3,000 

of net operating loss carryforwards in a prior 

taxable year and that their use is allowed 

under section 1374(b)(2) and § 1.1374–5, X is 

allowed a $3,000 deduction against the 

$20,000 net recognized built-in gain. X 

would owe tax of $5,950 (35% of $17,000) on 

its net recognized built-in gain, except that X 

may use its $2,000 of business credit 

carryforwards to reduce this tax, assuming 

that X has not used the credit carryforwards 

in a prior taxable year and that their use is 

allowed under section 1374(b)(3) and 

§ 1.1374–6. Thus, X owes tax of $3,950 under 

this paragraph (c). For purposes of 

subchapter M, X’s earnings and profits for the 

year increase by $26,050 ($30,000 capital 

gain on the sale of Real Property—$3,950 tax 

under this paragraph (c)). 

(iv) To compute X’s net capital gain for 

purposes of section 857(b)(3) for the taxable 

year, the $20,000 of net recognized built-in 

gain less the $3,950 of tax imposed on that 

gain is added to X’s capital gain (or loss), if 

any, that is not recognized built-in gain (or 

loss).

(d) Exceptions—(1) Gain otherwise 

recognized. Paragraph (a) of this section 

does not apply to any conversion 

transaction to the extent that gain or loss 

otherwise is recognized on such 

conversion transaction. See, for 

example, sections 336, 351(b), 356, 

357(c), 367, and 1001. 

(2) Re-election of RIC or REIT status—

(i) Generally. Except as provided in 

paragraphs (d)(2)(ii) and (iii) of this 

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

does not apply to any corporation that—

(A) Immediately prior to qualifying to 

be taxed as a RIC or REIT was subject 

to tax as a C corporation for a period not 

exceeding two taxable years; and 

(B) Immediately prior to being subject 

to tax as a C corporation was subject to 

tax as a RIC or REIT for a period of at 

least one taxable year. 

(ii) Property acquired from another 

corporation while a C corporation. The 

exception described in paragraph 

(d)(2)(i) of this section does not apply to 

property acquired by the corporation 

while it was subject to tax as a C 

corporation from another corporation 

(whether or not a C corporation) in a 

transaction that results in the acquirer’s 

basis in the property being determined 

by reference to a C corporation’s basis 

in the property. 

(iii) RICs and REITs previously subject 

to section 1374 treatment. If the RIC or 

REIT had property subject to paragraph 

(c) of this section before the RIC or REIT 

became subject to tax as a C corporation 

as described in paragraph (d)(2)(i) of 

this section, then paragraph (c) of this 

section applies to the RIC or REIT upon 

its requalification as a RIC or REIT, 

except that the 10-year recognition 

period with respect to such property is 

reduced by the portion of the 10-year 

recognition period that expired before 

the RIC or REIT became subject to tax 

as a C corporation and by the period of 

time that the corporation was subject to 

tax as a C corporation. 

(e) Effective date. This section applies 

to conversion transactions that occur on 

or after June 10, 1987, and before 

January 2, 2002. In lieu of applying this 

section, taxpayers generally may apply 

§ 1.337(d)–5T to determine the tax 

consequences (for all taxable years) of 

any conversion transaction that occurs 

on or after June 10, 1987 and before 

January 2, 2002, except that RICs and 

REITs that are subject to section 1374 

treatment with respect to a conversion 

transaction may not rely on § 1.337(d)–

5T(b)(1), but must apply paragraphs 

(c)(1)(i), (c)(2)(i), (c)(2)(ii), and (c)(3) of 

this section, with respect to built-in 

gains and losses recognized in taxable 

years beginning on or after January 2, 

2002. Taxpayers are not prevented from 

relying on § 1.337(d)–5T merely because 

they elect section 1374 treatment in the 

manner described in paragraph (c)(4) of 

this section instead of in the manner 

described in § 1.337(d)–5T(b)(3) and (c). 

For conversion transactions that occur 

on or after January 2, 2002, see 

§ 1.337(d)–7T. This section expires on 

December 31, 2004.

§ 1.337(d)–7T Tax on property owned by a 

C corporation that becomes property of a 

RIC or REIT (temporary). 

(a) General Rule—(1) Property owned 

by a C corporation that becomes 

property of a RIC or REIT. If property 

owned by a C corporation (as defined in 

paragraph (a)(2)(i) of this section) 

becomes the property of a RIC or REIT 

(the converted property) in a conversion 

transaction (as defined in paragraph 

(a)(2)(ii) of this section), then section 

1374 treatment will apply as described 

in paragraph (b) of this section, unless 

the C corporation elects deemed sale 

treatment with respect to the conversion 

transaction as provided in paragraph (c) 

of this section. See paragraph (d) of this 

section for exceptions to this paragraph 

(a). 

(2) Definitions—(i) C corporation. For 

purposes of this section, the term C 

corporation has the meaning provided 

in section 1361(a)(2) except that the 

term does not include a RIC or REIT. 

(ii) Conversion transaction. For 

purposes of this section, the term 

conversion transaction means the 

qualification of a C corporation as a RIC 

or REIT or the transfer of property 

owned by a C corporation to a RIC or 

REIT. 

(b) Section 1374 treatment—(1) In 

general—(i) Property owned by a C 

corporation that becomes property of a 

RIC or REIT. If property owned by a C 

corporation becomes the property of a 

RIC or REIT in a conversion transaction, 

then the RIC or REIT will be subject to 

tax on the net built-in gain in the 

converted property under the rules of 

section 1374 and the regulations 

thereunder, as modified by this 

paragraph (b), as if the RIC or REIT were 

an S corporation. 

(ii) Property subject to the rules of 

section 1374 owned by a RIC, REIT, or 

S corporation that becomes property of 

a RIC or REIT. If property subject to the 

rules of section 1374 owned by a RIC, 

a REIT, or an S corporation (the 

predecessor) becomes the property of a 

RIC or REIT (the successor) in a 

continuation transaction, the rules of 

section 1374 apply to the successor to 

the same extent that the predecessor 

was subject to the rules of section 1374 

with respect to such property, and the 

10-year recognition period of the 

successor with respect to such property 

is reduced by the portion of the 10-year 

recognition period of the predecessor 

that expired before the date of the 

continuation transaction. For this 

purpose, a continuation transaction 

means the qualification of the 

predecessor as a RIC or REIT or the 

transfer of property from the 

predecessor to the successor in a 

transaction in which the successor’s 

basis in the transferred property is 

determined, in whole or in part, by 

reference to the predecessor’s basis in 

that property. 

Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 15

(2) Modification of section 1374 

treatment—(i) Net recognized built-in 

gain for REITs—(A) Prelimitation 

amount. The prelimitation amount 

determined as provided in § 1.1374–

2(a)(1) is reduced by the portion of such 

amount, if any, that is subject to tax 

under section 857(b)(4), (5), (6), or (7). 

For this purpose, the amount of a REIT’s 

recognized built-in gain that is subject 

to tax under section 857(b)(5) is 

computed as follows: 

(1) Where the tax under section 

857(b)(5) is computed by reference to 

section 857(b)(5)(A), the amount of a 

REIT’s recognized built-in gain that is 

subject to tax under section 857(b)(5) is 

the tax imposed by section 857(b)(5) 

multiplied by a fraction the numerator 

of which is the amount of recognized 

built-in gain (without regard to 

recognized built-in loss and recognized 

built-in gain from prohibited 

transactions) that is not derived from 

sources referred to in section 856(c)(2) 

and the denominator of which is the 

gross income (without regard to gross 

income from prohibited transactions) of 

the REIT that is not derived from 

sources referred to in section 856(c)(2). 

(2) Where the tax under section 

857(b)(5) is computed by reference to 

section 857(b)(5)(B), the amount of a 

REIT’s recognized built-in gain that is 

subject to tax under section 857(b)(5) is 

the tax imposed by section 857(b)(5) 

multiplied by a fraction the numerator 

of which is the amount of recognized 

built-in gain (without regard to 

recognized built-in loss and recognized 

built-in gain from prohibited 

transactions) that is not derived from 

sources referred to in section 856(c)(3) 

and the denominator of which is the 

gross income (without regard to gross 

income from prohibited transactions) of 

the REIT that is not derived from 

sources referred to in section 856(c)(3). 

(B) Taxable income limitation. The 

taxable income limitation determined as 

provided in § 1.1374–2(a)(2) is reduced 

by an amount equal to the tax imposed 

under section 857(b)(5), (6), and (7). 

(ii) Loss carryforwards, credits and 

credit carryforwards—(A) Loss 

carryforwards. Consistent with 

paragraph (b)(1)(i) of this section, net 

operating loss carryforwards and capital 

loss carryforwards arising in taxable 

years for which the corporation that 

generated the loss was not subject to 

subchapter M of chapter 1 of the Code 

are allowed as a deduction against net 

recognized built-in gain to the extent 

allowed under section 1374 and the 

regulations thereunder. Such loss 

carryforwards must be used as a 

deduction against net recognized builtin gain for a taxable year to the greatest 

extent possible before such losses can be 

used to reduce investment company 

taxable income for purposes of section 

852(b) or real estate investment trust 

taxable income for purposes of section 

857(b) for that taxable year. 

(B) Credits and credit carryforwards.

Consistent with paragraph (b)(1)(i) of 

this section, minimum tax credits and 

business credit carryforwards arising in 

taxable years for which the corporation 

that generated the credit was not subject 

to subchapter M of chapter 1 of the 

Internal Revenue Code are allowed to 

reduce the tax imposed on net 

recognized built-in gain under this 

paragraph (b) to the extent allowed 

under section 1374 and the regulations 

thereunder. Such credits and credit 

carryforwards must be used to reduce 

the tax imposed under this paragraph 

(b) on net recognized built-in gain for a 

taxable year to the greatest extent 

possible before such credits and credit 

carryforwards can be used to reduce the 

tax, if any, on investment company 

taxable income for purposes of section 

852(b) or on real estate investment trust 

taxable income for purposes of section 

857(b) for that taxable year. 

(iii) 10-year recognition period. In the 

case of a conversion transaction that is 

a qualification of a C corporation as a 

RIC or REIT, the 10-year recognition 

period described in section 1374(d)(7) 

begins on the first day of the RIC’s or 

REIT’s first taxable year. In the case of 

other conversion transactions, the 10-

year recognition period begins on the 

day the property is acquired by the RIC 

or REIT. 

(3) Coordination with subchapter M 

rules—(i) Recognized built-in gains and 

losses subject to subchapter M.

Recognized built-in gains and losses of 

a RIC or REIT are included in 

computing investment company taxable 

income for purposes of section 

852(b)(2), real estate investment trust 

taxable income for purposes of section 

857(b)(2), capital gains for purposes of 

sections 852(b)(3) and 857(b)(3), gross 

income derived from sources within any 

foreign country or possession of the 

United States for purposes of section 

853, and the dividends paid deduction 

for purposes of sections 852(b)(2)(D), 

852(b)(3)(A), 857(b)(2)(B), and 

857(b)(3)(A). 

(ii) Treatment of tax imposed. The 

amount of tax imposed under this 

paragraph (b) on net recognized built-in 

gain for a taxable year is treated as a loss 

sustained by the RIC or the REIT during 

such taxable year. The character of the 

loss is determined by allocating the tax 

proportionately (based on recognized 

built-in gain) among the items of 

recognized built-in gain included in net 

recognized built-in gain. With respect to 

RICs, the tax imposed under this 

paragraph (b) on net recognized built-in 

gain is treated as attributable to the 

portion of the RIC’s taxable year 

occurring after October 31. 

(4) Example. The rules of this 

paragraph (b) are illustrated by the 

following example:

Example. Section 1374 treatment on REIT 

election. (i) X, a C corporation that is a 

calendar-year taxpayer, elects to be taxed as 

a REIT on its 2004 tax return, which it files 

on March 15, 2005. As a result, X is a REIT 

for its 2004 taxable year and is subject to 

section 1374 treatment under this paragraph 

(b). X does not elect deemed sale treatment 

under paragraph (c) of this section. As of the 

beginning of the 2004 taxable year, X’s 

property consisted of Real Property, which is 

not section 1221(a)(1) property and which 

had a fair market value of $100,000 and an 

adjusted basis of $80,000, and $25,000 cash. 

X also had accumulated earnings and profits 

of $25,000, unrestricted net operating loss 

carryforwards of $3,000, and unrestricted 

business credit carryforwards of $2,000. On 

July 1, 2007, X sells Real Property for 

$110,000. For its 1997 taxable year, X has net 

income other than recognized built-in gain. 

Assume the highest corporate tax rate is 35%. 

(ii) Upon its election to be taxed as a REIT, 

X retains its $80,000 basis in Real Property 

and its $25,000 accumulated earnings and 

profits. X retains its $3,000 of net operating 

loss carryforwards and its $2,000 of business 

credit carryforwards. To satisfy section 

857(a)(2)(B), X must distribute $25,000, an 

amount equal to its earnings and profits 

accumulated in non-REIT years, to its 

shareholders by the end of its 2004 taxable 

year. 

(iii) Upon X’s sale of Real Property in 2007, 

X recognizes gain of $30,000 ($110,000—

$80,000). X’s recognized built-in gain for 

purposes of applying section 1374 is $20,000 

($100,000 fair market value as of the 

beginning of X’s first taxable year as a REIT—

$80,000 basis). Because X has net income 

other than recognized built-in gain for its 

2007 taxable year, the taxable income 

limitation does not apply. X, therefore, has 

$20,000 net recognized built-in gain for the 

year. Assuming that X has not used its $3,000 

of net operating loss carryforwards in a prior 

taxable year and that their use is allowed 

under section 1374(b)(2) and § 1.1374–5, X is 

allowed a $3,000 deduction against the 

$20,000 net recognized built-in gain. X 

would owe tax of $5,950 (35% of $17,000) on 

its net recognized built-in gain, except that X 

may use its $2,000 of business credit 

carryforwards to reduce the tax, assuming 

that X has not used the credit carryforwards 

in a prior taxable year and that their use is 

allowed under section 1374(b)(3) and 

§ 1.1374–6. Thus, X owes tax of $3,950 under 

this paragraph (b). For purposes of 

subchapter M, X’s earnings and profits for the 

year increase by $26,050 ($30,000 capital 

gain on the sale of Real Property—$3,950 tax 

under this paragraph (b)). 

(iv) To compute X’s net capital gain for 

purposes of section 857(b)(3) for the taxable 

year, the $20,000 of net recognized built-in 

16 Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 

gain less the $3,950 of tax imposed on that 

gain is added to X’s capital gain (or loss), if 

any, that is not recognized built-in gain (or 

loss).

(c) Election of deemed sale 

treatment—(1) In general. Paragraph (b) 

of this section does not apply if the C 

corporation that qualifies as a RIC or 

REIT or transfers property to a RIC or 

REIT makes the election described in 

paragraph (c)(5) of this section. A C 

corporation that makes such an election 

recognizes gain and loss as if it sold the 

converted property to an unrelated party 

at fair market value on the deemed sale 

date (as defined in paragraph (c)(3) of 

this section). See paragraph (c)(4) of this 

section concerning limitations on the 

use of loss in computing gain. This 

paragraph (c) does not apply if its 

application would result in the 

recognition of a net loss. For this 

purpose, net loss is the excess of 

aggregate losses over aggregate gains 

(including items of income), without 

regard to character. 

(2) Basis adjustment. If a corporation 

recognizes a net gain under paragraph 

(c)(1) of this section, then the converted 

property has a basis in the hands of the 

RIC or REIT equal to the fair market 

value of such property on the deemed 

sale date. 

(3) Deemed sale date—(i) RIC or REIT 

qualifications. If the conversion 

transaction is a qualification of a C 

corporation as a RIC or REIT, then the 

deemed sale date is the end of the last 

day of the C corporation’s last taxable 

year before the first taxable year in 

which it qualifies to be taxed as a RIC 

or REIT. 

(ii) Other conversion transactions. If 

the conversion transaction is a transfer 

of property owned by a C corporation to 

a RIC or REIT, then the deemed sale 

date is the end of the day before the day 

of the transfer. 

(4) Anti-stuffing rule. A C corporation 

must disregard converted property in 

computing gain or loss recognized on 

the conversion transaction under this 

paragraph (c), if—

(i) The converted property was 

acquired by the C corporation in a 

transaction to which section 351 

applied or as a contribution to capital; 

(ii) Such converted property had an 

adjusted basis immediately after its 

acquisition by the C corporation in 

excess of its fair market value on the 

date of acquisition; and 

(iii) The acquisition of such converted 

property by the C corporation was part 

of a plan a principal purpose of which 

was to reduce gain recognized by the C 

corporation in connection with the 

conversion transaction. For purposes of 

this paragraph (c)(4), the principles of 

section 336(d)(2) apply. 

(5) Making the deemed sale election.

A C corporation makes the deemed sale 

election with the following statement: 

‘‘[Insert name and employer 

identification number of electing 

corporation] elects deemed sale 

treatment under § 1.337(d)–7T(c) with 

respect to its property that was 

converted to property of, or transferred 

to, a RIC or REIT, [insert name and 

employer identification number of the 

RIC or REIT, if different from the name 

and employer identification number of 

the C corporation].’’ This statement 

must be attached to the Federal income 

tax return of the C corporation for the 

taxable year in which the deemed sale 

occurs. An election under this 

paragraph (c) is irrevocable. 

(6) Examples. The rules of this 

paragraph (c) are illustrated by the 

following examples:

Example 1. Deemed sale treatment on 

merger into RIC. (i) X, a calendar-year 

taxpayer, has qualified as a RIC since January 

1, 2001. On May 31, 2004, Y, a C corporation 

and calendar-year taxpayer, transfers all of its 

property to X in a transaction that qualifies 

as a reorganization under section 

368(a)(1)(C). As a result of the transfer, Y 

would be subject to section 1374 treatment 

under paragraph (b) of this section but for its 

timely election of deemed sale treatment 

under this paragraph (c). As a result of such 

election, Y is subject to deemed sale 

treatment on its tax return for the short 

taxable year ending May 31, 2004. On May 

31, 2004, Y’s only assets are Capital Asset, 

which has a fair market value of $100,000 

and a basis of $40,000 as of the end of May 

30, 2004, and $50,000 cash. Y also has an 

unrestricted net operating loss carryforward 

of $12,000 and accumulated earnings and 

profits of $50,000. Y has no taxable income 

for the short taxable year ending May 31, 

2004, other than gain recognized under this 

paragraph (c). In 2007, X sells Capital Asset 

for $110,000. Assume the applicable 

corporate tax rate is 35%. 

(ii) Under this paragraph (c), Y is treated 

as if it sold the converted property (Capital 

Asset and $50,000 cash) at fair market value 

on May 30, 2004, recognizing $60,000 of gain 

($150,000 amount realized¥$90,000 basis). Y 

must report the gain on its tax return for the 

short taxable year ending May 31, 2004. Y 

may offset this gain with its $12,000 net 

operating loss carryforward and will pay tax 

of $16,800 (35% of $48,000). 

(iii) Under section 381, X succeeds to Y’s 

accumulated earnings and profits. Y’s 

accumulated earnings and profits of $50,000 

increase by $60,000 and decrease by $16,800 

as a result of the deemed sale. Thus, the 

aggregate amount of subchapter C earnings 

and profits that must be distributed to satisfy 

section 852(a)(2)(B) is $93,200 ($50,000 + 

$60,000 ¥ $16,800). X’s basis in Capital 

Asset is $100,000. On X’s sale of Capital 

Asset in 2007, X recognizes $10,000 of gain 

which is taken into account in computing X’s 

net capital gain for purposes of section 

852(b)(3).

Example 2. Loss limitation. (i) Assume the 

facts are the same as those described in 

Example 1, but that, prior to the 

reorganization, a shareholder of Y 

contributed to Y a capital asset, Capital Asset 

2, which has a fair market value of $10,000 

and a basis of $20,000, in a section 351 

transaction. 

(ii) Assuming that Y’s acquisition of 

Capital Asset 2 was made pursuant to a plan 

a principal purpose of which was to reduce 

the amount of gain that Y would recognize 

in connection with the conversion 

transaction, Capital Asset 2 would be 

disregarded in computing the amount of Y’s 

net gain on the conversion transaction.

(d) Exceptions—(1) Gain otherwise 

recognized. Paragraph (a) of this section 

does not apply to any conversion 

transaction to the extent that gain or loss 

otherwise is recognized on such 

conversion transaction. See, for 

example, sections 336, 351(b), 356, 

357(c), 367, and 1001. 

(2) Re-election of RIC or REIT status—

(i) Generally. Except as provided in 

paragraphs (d)(2)(ii) and (d)(2)(iii) of 

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

section does not apply to any 

corporation that—

(A) Immediately prior to qualifying to 

be taxed as a RIC or REIT was subject 

to tax as a C corporation for a period not 

exceeding two taxable years; and 

(B) Immediately prior to being subject 

to tax as a C corporation was subject to 

tax as a RIC or REIT for a period of at 

least one taxable year. 

(ii) Property acquired from another 

corporation while a C corporation. The 

exception described in paragraph 

(d)(2)(i) of this section does not apply to 

property acquired by the corporation 

while it was subject to tax as a C 

corporation from another corporation 

(whether or not a C corporation) in a 

transaction that results in the acquirer’s 

basis in the property being determined 

by reference to a C corporation’s basis 

in the property. 

(iii) RICs and REITs previously subject 

to section 1374 treatment. If the RIC or 

REIT had property subject to paragraph 

(b) of this section before the RIC or REIT 

became subject to tax as a C corporation 

as described in paragraph (d)(2)(i) of 

this section, then paragraph (b) of this 

section applies to the RIC or REIT upon 

its requalification as a RIC or REIT, 

except that the 10-year recognition 

period with respect to such property is 

reduced by the portion of the 10-year 

recognition period that expired before 

the RIC or REIT became subject to tax 

as a C corporation and by the period of 

time that the corporation was subject to 

tax as a C corporation. 

Federal Register / Vol. 67, No. 1 / Wednesday, January 2, 2002 / Rules and Regulations 17

(e) Special rule for partnerships. The 

principles of this section apply to 

property transferred by a partnership to 

a RIC or REIT to the extent of any C 

corporation partner’s proportionate 

share of the transferred property. For 

example, if a C corporation owns a 20 

percent interest in a partnership and 

that partnership contributes an asset to 

a REIT in a section 351 transaction, then 

the partnership shall be treated as a C 

corporation with respect to 20 percent 

of the asset contributed to the REIT. If 

the partnership were to elect deemed 

sale treatment under paragraph (c) of 

this section with respect to such 

transfer, then any gain recognized by the 

partnership on the deemed sale must be 

specially allocated to the C corporation 

partner. 

(f) Effective date. This section applies 

to conversion transactions that occur on 

or after January 2, 2002. For conversion 

transactions that occurred on or after 

June 10, 1987 and before January 2, 

2002, see § 1.337(d)–5T and § 1.337(d)–

6T. This section expires on December 

31, 2004.

PART 602—OMB CONTROL NUMBERS 

UNDER THE PAPERWORK 

REDUCTION ACT

■ Par. 4. The authority citation for part 

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

■ Par. 5. In § 602.101, paragraph (b) is 

amended by adding an entry in 

numerical order to the table to read as 

follows:

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section where 

identified or described 

Current OMB 

control No. 

* * * * * 

1.337(d)–6T .......................... 1545–1672 

1.337(d)–7T .......................... 1545–1672 

* * * * * 

Approved: December 20, 2001. 

Robert E. Wenzel, 

Deputy Commissioner of Internal Revenue. 

Mark Weinberger, 

Assistant Secretary of the Treasury.

[FR Doc. 01–31969 Filed 12–31–01; 8:45 am] 

BILLING CODE 4830–01–P

DEPARTMENT OF TRANSPORTATION

Coast Guard 

33 CFR Part 110 

[CGD09–01–122] 

RIN 2115–AA98 

Special Anchorage Area: Henderson 

Harbor, NY

AGENCY: Coast Guard, DOT.

ACTION: Final rule; request for additional 

comments. 

SUMMARY: The purpose of this document 

is to solicit comments on the 

appropriate size of the Henderson 

Harbor Special Anchorage Area. On 

March 7, 2000, the Coast Guard 

published a final rule that substantially 

increased the size of the special 

anchorage area. Due to concerns from 

the local community, the Coast Guard is 

soliciting additional comments 

regarding the appropriate size of the 

Special Anchorage Area.

DATES: Comments must be received by 

April 2, 2002.

ADDRESSES: You may mail comments to 

Commander (mco–1), Ninth Coast 

Guard District, 1240 E. Ninth Street, 

Cleveland, Ohio 44199–2060, or deliver 

them to room 2069 at the same address 

between 9 a.m. and 2 p.m., Monday 

through Friday, except Federal holidays. 

The telephone number is (216) 902–

6056. 

The Ninth Coast Guard District 

Marine Safety Office maintains the 

public docket. Comments, and 

documents indicated in this preamble, 

will become part of this docket and will 

be available for inspection or copying at 

room 2069, Ninth Coast Guard District, 

between 9 a.m. and 2 p.m., Monday 

through Friday, except Federal holidays.

FOR FURTHER INFORMATION CONTACT:

Commander Ronald Branch, Chief, 

Marine Safety Compliance Operations 

Branch, Ninth Coast Guard District 

Marine Safety Office, 1240 E. Ninth 

Street, Cleveland, Ohio 44199–2060. 

The phone number is (216) 902–6056.

SUPPLEMENTARY INFORMATION: 

Request for Comments 

The Coast Guard encourages 

interested persons to submit data, 

views, or arguments. Persons submitting 

comments should include their names 

and addresses, identify this docket 

(CGD09–01–122) and the specific 

section of this document to which each 

comment applies, and give the reason 

for each comment. Please submit two 

copies of all comments and attachments 

in an unbound format, no larger than 

81⁄2 by 11 inches, suitable for copying 

and electronic filing. Persons wanting 

acknowledgment of receipt of comments 

should enclose stamped, self-addressed 

postcards or envelopes. 

Background Information 

The Coast Guard published a Notice 

of Proposed Rulemaking (NPRM) in the 

Federal Register on November 5, 1999 

(64 FR 60399). During the comment 

period for the NPRM, the Coast Guard 

received several positive comments 

from the community regarding the 

proposed enlargement of the anchorage 

area. Following the close of the 

comment period on January 4, 2000, the 

Coast Guard published a final rule in 

the Federal Register on March 7, 2000 

(65 FR 11892). 

The final rule extended anchorage 

area A approximately 1000 feet while 

keeping the width approximately the 

same as the existing anchorage area. The 

additional anchorage area was requested 

to compensate for the loss of safe 

anchorage area due to lower water 

levels. Since vessels must request 

permission from the Henderson Harbor 

Town Harbormaster before anchoring or 

mooring in the special anchorage area, 

the additional area gave the Town 

Harbormaster increased deepwater areas 

in which to direct vessels for safe 

anchorage. 

The Coast Guard has received letters 

and requests from members of the 

community, as well as town leaders, 

indicating that they would like to see an 

additional change to the anchorage area. 

Persons submitting comments should do 

as directed under request for comments 

above, and reply to the following 

specific suggested anchorage areas. 

Form letters simply citing anecdotal 

evidence or stating support for or 

opposition to regulations, without 

providing substantive data or arguments 

do not supply support for regulations. 

The following two options are being 

considered: 

1. Continue To Use Current Enlarged 

Anchorage Area 

(a) Area A. The area in the southern 

portion of Henderson Harbor west of the 

Henderson Harbor Yacht Club bounded 

by a line beginning at latitude 43°51′

08.8′′ N, longitude 76°12′ 08.9′′ W, 

thence to 43°51′09.0 N, 76°12.19.0 W, 

thence to 43°51′33.4′′ N, 76°12′19.0′′ W, 

thence to 43°51′33.4′′ N, 76°12′09.6′′ W, 

thence to the point of the beginning. 

These coordinates are based upon North 

American Datum 1983 (NAD 83). 

(b) Area B. The area in the southern 

portion of Henderson Harbor north of 

Graham Creek Entrance Light bounded 

by a line beginning at latitude