1.1502-36—Unified loss rule.
(a) In general—
(1) Scope.
This section provides rules for adjusting members' bases in stock of a subsidiary (S) and for reducing S's attributes when a member (M) transfers a loss share of S stock. See paragraph (f) of this section for definitions of the terms used in this section, including transfer and value.
(2) Purpose.
The rules in this section have two principal purposes. The first is to prevent the consolidated return provisions from reducing a group's consolidated taxable income through the creation and recognition of noneconomic loss on S stock. The second is to prevent members (including former members) of the group from collectively obtaining more than one tax benefit from a single economic loss. Additional purposes are set forth in other paragraphs of this section. The rules of this section must be interpreted and applied in a manner that is consistent with and reasonably carries out the purposes of this section.
(3) Overview—
(i) General application of section.
This section applies when M transfers a share of S stock and, after taking into account the effects of all applicable rules of law (even if the adjustments required by such provisions are not deemed effective until after the transfer, such as certain adjustments required under sections 108 and 1017 and § 1.1502-28 ), the share is a loss share. When this section applies, paragraph (b) of this section applies first and may redetermine members' bases in their shares of S stock. If the transferred share is a loss share after any basis redetermination under paragraph (b) of this section, paragraph (c) of this section applies and may reduce M's basis in the transferred loss share. If the transferred share is a loss share after any basis reduction required by paragraph (c) of this section, paragraph (d) of this section applies and may reduce attributes of S and subsidiaries that are lower-tier to S. Although the determination of whether there is a transfer of a loss share is made as of the transfer, this section applies, and any adjustments it requires are given effect, immediately before the transfer. Paragraphs (e), (f), and (g) of this section provide general operating rules (including rules for transfers of S stock between members), definitions, and an anti-abuse rule, respectively.
(ii) Stock of multiple subsidiaries transferred in the transaction—
(A) Initial application of section to transferred shares in lowest tier.
If shares of stock of more than one subsidiary are transferred in a transaction, the application of this section begins at the lowest tier. If no transferred shares of stock of the lowest-tier subsidiary (S2) are loss shares, any gain recognized with respect to the S2 shares immediately tiers up and adjusts members' bases in subsidiary stock under § 1.1502-32. However, if any of the transferred S2 shares are loss shares, paragraph (b) of this section applies with respect to those shares. If, after the application of paragraph (b) of this section, any transferred S2 shares are still loss shares, paragraph (c) of this section applies with respect to those shares. If, after the application of paragraph (c) of this section, any transferred S2 shares are still loss shares and P makes an election under paragraph (d)(6) of this section with respect to those S2 shares, then paragraph (d) of this section applies with respect to those shares, but only to the extent necessary to give effect to the election. After taking into account the effects of any adjustments required by this initial application of this section, recognized gain or loss is computed on all transferred S2 shares. Any adjustments under paragraph (b) or (c) of this section, the effect of any election under paragraph (d)(6) of this section, any gain or loss recognized on the transferred S2 shares (whether allowed or disallowed), and any other related or resulting adjustments then tier-up and apply to adjust members' bases in subsidiary stock under § 1.1502-32.
(B) Initial application of section to transferred shares in higher tiers.
After taking into account the effects of any adjustments described in paragraph (a)(3)(ii)(A) of this section, transferred shares in the next higher tier, and then in each next higher tier successively, other than the transferred loss shares at the highest tier, are treated in the manner described in paragraph (a)(3)(ii)(A) of this section.
(C) Application of section to transferred shares in highest tier.
After paragraphs (b) and (c) of this section, and, to the extent necessary to give effect to any election under paragraph (d)(6) of this section, paragraph (d) of this section, have been applied to or with respect to all lower-tier transferred loss shares, and after all lower-tier adjustments have been taken into account (whether resulting from the application of paragraph (b) or (c) of this section, an election under paragraph (d)(6) of this section, the recognition of gain or loss on a transfer, or otherwise), paragraphs (b), then (c), and then (d) of this section apply with respect to the highest-tier shares that are transferred loss shares.
(D) Final application of section to transferred shares in lower tiers.
After paragraph (d) of this section has been applied with respect to transferred loss shares in the highest tier, it is applied with respect to transferred shares in each next lower tier, successively, to the extent such shares are loss shares after the application of paragraph (d) of this section.
(4) Other rules of law and coordination with deferral and disallowance provisions.
In general, this section applies and has effect immediately upon the transfer of a loss share even if the loss is deferred, disallowed, or otherwise not taken into account under any other applicable rules of law. However, see paragraph (e)(3) of this section for special rules applicable to shares of S stock transferred in an intercompany transaction. See section § 1.1502-80(a) for the general applicability of other rules of law and a limitation on duplicative adjustments.
(5) Nomenclature, factual assumptions adopted in this section.
Unless otherwise stated, for purposes of this section, the following nomenclature and assumptions are adopted. P is the common parent of a consolidated group of which S, M, and M1 are members. X is not a member of the P group. If a corporation has preferred stock outstanding, it is stock described in section 1504(a)(4). The examples set forth the only facts, elections, and activities relevant to the example. All transactions are between unrelated persons and are independent of each other. Tax liabilities and their effect, and the application of any other loss disallowance or deferral provisions of the Internal Revenue Code (Code) or regulations, including but not limited to section 267, are disregarded. All persons report on a calendar year basis and use the accrual method of accounting. All parties comply with filing and other requirements of this section and all other provisions of the Code and regulations.
(b) Basis redetermination to reduce disparity—
(1) In general—
The rules of this paragraph (b) reduce the extent to which there is disparity in members' bases in shares of S stock. These rules supplement the operation of the investment adjustment system; their purpose is to prevent the realization of noneconomic loss and facilitate the elimination of duplicated loss when members hold S shares with disparate bases. The rules of this paragraph (b) only reallocate investment adjustments previously applied to members' bases in shares of S stock, thus they do not alter the aggregate amount of basis in shares of S stock held by members or the aggregate amount of investment adjustments applied to shares of S stock.
(ii) Special rules for applicability of redetermination rule.
Notwithstanding the general rule in paragraph (b)(2) of this section, members' bases in shares of S stock are not redetermined under this paragraph (b) if—
(A)
There is no disparity among members' bases in shares of S common stock and no member owns a share of S preferred stock with respect to which there is unrecognized gain or loss; or
(B)
All the shares of S stock held by members are transferred to one or more nonmembers, become worthless under section 165 (taking into account the provisions of § 1.1502-80(c) ), or a combination thereof, in one fully taxable transaction. However, in such a case, P may elect to redetermine such bases under this paragraph (b). Such an election is made in the manner provided in paragraph (e)(5) of this section. If stock of more than one subsidiary is transferred in the transaction, the election may be made with respect to one or more of such subsidiaries.
(iii) Investment adjustment.
For purposes of this paragraph (b), the term investment adjustment includes adjustments specially allocated under § 1.1502-32(c)(1)(ii)(B) and remaining adjustments described in § 1.1502-32(c)(1)(iii). In applying any provision of this section, the term includes all such adjustments reflected in the basis of the share as of the application of the provision, whether originally allocated under § 1.1502-32 or otherwise. The term therefore includes adjustments previously reallocated to the share, and it does not include adjustments previously reallocated from the share, whether pursuant to this section or any other provision of law. It also includes the proportionate amount of adjustments reflected in the exchanged basis of a share, such as the basis determined under section 358 in connection with a reorganization or a transaction qualifying under section 355.
(2) Basis redetermination rule.
If M transfers a loss share of S stock, all members' bases in all their shares of S stock are subject to redetermination under this paragraph (b). The determination of whether a share is a loss share is made as of the transfer, taking into account the effects of all applicable rules of law. The redeterminations are made immediately before applying paragraph (c) of this section and in accordance with the following:
(i) Decreasing the bases of transferred loss shares—
(A) Removing positive investment adjustments from transferred loss shares of common stock.
M's basis in each of its transferred loss shares of S common stock is first reduced, but not below value, by removing positive investment adjustments previously applied to the basis of the share. The positive investment adjustments removed from transferred loss shares of S common stock are reallocated under paragraph (b)(2)(ii) of this section after negative investment adjustments are reallocated under paragraph (b)(2)(i)(B) of this section.
(B) Reallocating negative investment adjustments from shares of S common stock.
If a transferred share is still a loss share after applying paragraph (b)(2)(i)(A) of this section, M's basis in the share is reduced, but not below value, by reallocating negative investment adjustments to the transferred loss share (whether common or preferred stock) from members' shares of S common stock that are not transferred loss shares. The adjustments reallocated under this paragraph (b)(2)(i)(B) are reallocated and applied first to M's bases in transferred loss shares of S preferred stock and then to M's bases in transferred loss shares of S common stock. Reallocations under this paragraph (b)(2)(i)(B) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all transferred loss shares of S preferred stock, and reduces the disparity among members' bases in all shares of S common stock.
(ii) Increasing the bases of gain preferred and all common shares—
(A) Preferred stock.
After the application of paragraph (b)(2)(i) of this section, the positive investment adjustments removed from transferred loss shares of S common stock under paragraph (b)(2)(i)(A) of this section are reallocated and applied to increase, but not above value, members' bases in shares of S preferred stock (without regard to whether such shares are transferred in the transaction). Reallocations under this paragraph (b)(2)(ii)(A) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all shares of S preferred stock.
(B) Common stock.
Any positive investment adjustments removed from transferred loss shares of S common stock under paragraph (b)(2)(i)(A) of this section and not reallocated and applied to S preferred shares are reallocated and applied to increase members' bases in shares of S common stock. Reallocations are made to shares of S common stock without regard to whether a particular share is a loss share or a transferred share, and without regard to the share's value. Reallocations under this paragraph (b)(2)(ii)(B) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all shares of S common stock.
(iii) Operating rules—
(A) Method.
In general, reallocations should be made first with respect to the earliest available adjustments. However, the overall application of this paragraph (b) to a transaction must be made in a manner that, to the greatest extent possible, reduces basis disparity (as provided in paragraphs (b)(2)(i)(B) and (b)(2)(ii) of this section). The specific reallocation of an investment adjustment under this paragraph (b) may be made using any reasonable method or formula that is consistent with the provisions of this paragraph (b)(2) and furthers the purposes of this section.
(B) Limits on reallocation—
(1) Restriction to members' outstanding shares. Investment adjustments can only be reallocated to shares that were held by members at the time the adjustment was originally applied.
(2) Limitation by prior use —(i) In general. In order to prevent the reallocation of investment adjustments from either increasing or decreasing members' aggregate bases in subsidiary stock, no investment adjustment (positive or negative) may be reallocated under this paragraph (b)(2) to the extent that it was (or would have been) used prior to the time that it would otherwise be reallocated under this paragraph (b)(2). For this purpose, an investment adjustment was used (or would have been used) to the extent that it was reflected in (or would have been reflected in) the basis of a share of subsidiary stock and the basis of that share has already been taken into account, directly or indirectly, in determining income, gain, deduction, or loss (including by affecting the application of this section to a prior transfer of subsidiary stock) or in determining the basis of any property that is not subject to § 1.1502-32. However, if the prior use was in an intercompany transaction, an investment adjustment may be reallocated to the extent that § 1.1502-13 has prevented the gain or loss on the transaction from being taken into account. (In that case, appropriate adjustments must be made to the intercompany item from the prior intercompany transaction that has not yet been taken into account.) Further, if an investment adjustment was reflected in (or would have been reflected in) the basis of a share that has been taken into account, the limitation on reallocation under this paragraph (b)(2)(iii)(B)(2) does not apply to the extent the basis of that share would not change as a result of the reallocation (for example, because the reallocation is between shares that are both lower-tier to the share with the previously used basis). See § 1.1502-32(c)(1)(ii)(B) regarding special allocations applicable to the tier-up of the reallocated investment adjustment if the reallocation is limited under this paragraph (b)(2)(iii)(B)(2) due to prior use at a higher tier.
(ii) Example. The application of this paragraph (b)(2)(iii)(B)(2) is illustrated by the following example:
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Example.
(i) Facts. P owns all 20 shares of M stock, and 10 shares of S stock. M owns the remaining 10 shares of S stock. In year 1, S recognizes $200 of income that results in a $10 positive investment adjustment being allocated to each share of S stock. The group does not recognize any other items. The $100 positive adjustment to M's basis in the S stock tiers up, and results in a $5 positive adjustment to each share of M stock. In year 2, P sells one share of M stock and recognizes a gain. In year 3, M sells one loss share of S stock, and this paragraph (b) applies and requires a reallocation of the year 1 positive investment adjustment applied to the basis of the transferred S share.
(ii) Application of limitation by prior use. M's basis in the transferred loss share of S stock reflects a $10 positive investment adjustment attributable to S's year 1 income. Under the general rule of this paragraph (b), that $10 would be subject to reallocation to reduce basis disparity. However, that $10 adjustment had originally tiered up to adjust P's basis in its M shares and, as a result, $.50 of that adjustment was reflected in P's basis in each share of M stock. When P sold the share of M stock, the basis of that share (which included the tiered-up $.50) was used in determining the gain on the sale. Thus, $.50 of the $10 investment adjustment originally allocated to the transferred S share that tiered-up to the sold M share was previously used and, as such, cannot be reallocated in a manner that would (if it were the original allocation) affect the basis of the sold M share. Accordingly, no more than $9.50 of the adjustment to M's transferred S share could be reallocated to P's shares of S stock. If so, under the special allocation rule in § 1.1502-32(c)(1)(ii)(B)
, the tier-up of this $9.50 would only be allocated among P's remaining 19 shares of M stock. Alternatively, all $10 of the investment adjustment could be reallocated to M's other S shares (because the tier-up to P's M shares would have been the same regardless which of M's shares of S stock were adjusted).
(iii) Application of limitation where adjustment would have been used. The facts are the same as in paragraph (i) of this Example except that M does not sell any shares of S stock and, in year 3, P sells a loss share of S stock. As in paragraph (i) of this Example, when P sold the share of M stock, the basis of that share was used in determining the gain on the share. When P sells the loss share of S stock, the $10 positive investment adjustment from S's year 1 income cannot be reallocated in a manner that would (if it were the original adjustment) affect the basis of the sold M share. If this $10 positive investment adjustment had originally been allocated to the S shares held by M, $.50 of the $10 investment adjustment would have tiered up to the M share that P sold, would have been reflected in P's basis in that M share, and would have been used in determining P's gain or loss on the sale. Accordingly, up to $9.50 of the $10 investment adjustment applied to the basis of P's transferred S share could be reallocated to M's shares of S stock. If so, under the special allocation rule in § 1.1502-32(c)(1)(ii)(B)
, the tier-up of this $9.50 would only be allocated among P's remaining 19 shares of M stock. Alternatively, all $10 of the investment adjustment could be reallocated to P's other S shares.
(3) Examples.
The general application of this paragraph (b) is illustrated by the following examples:
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Example 1.
Transfer of stock received in section 351 exchange. (i) Redetermination to prevent noneconomic loss. (A) Facts. For many years, M has owned two assets, Asset 1 and Asset 2. On January 1, year 1, M receives the only four outstanding shares of S common stock (Block 1 shares) in exchange for Asset 1, which has a basis and value of $80. Section 351 applies to the exchange and, therefore, under section 358, M's aggregate basis in the Block 1 shares is $80 ($20 per share). On July 1, year 2, M receives another share of S common stock (Block 2 share) in exchange for Asset 2, which has a basis of $0 and value of $20. Section 351 applies to this exchange and, under section 358, M's basis in the Block 2 share is $0. On October 1, year 3, S sells Asset 2 for $20, recognizing a $20 gain. On December 31, year 3, M sells one of its Block 1 shares to X for $20. After taking into account the effects of all applicable rules of law, M's basis in each Block 1 share is $24 (M's original $20 basis increased under § 1.1502-32
by $4, the share's allocable portion of the $20 gain recognized on the sale of Asset 2). In addition, M's basis in its Block 2 share is $4 (M's original $0 basis increased under § 1.1502-32
by $4 (the share's allocable portion of the $20 gain recognized on the sale of Asset 2)). M's sale of the Block 1 share is a transfer of a loss share and therefore subject to this section.
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(B) Basis redetermination under this paragraph (b). Under this paragraph (b), M's bases in all its shares of S stock are subject to redetermination. First, paragraph (b)(2)(i)(A) of this section applies to reduce M's basis in the transferred loss share, but not below value, by removing positive investment adjustments applied to the basis of the share. Accordingly, M's basis in the transferred Block 1 share is reduced by $4 (the amount of the positive investment adjustment applied to the share), from $24 to $20. Even if there were negative investment adjustments applied to adjust the bases of nontransferred common shares, no further reduction to the basis of the share would be required under this paragraph (b) because the basis of the transferred share is then equal to the share's value. Under paragraph (b)(2)(ii)(B) of this section, the positive investment adjustment removed from the transferred loss share is reallocated and applied to increase M's bases in its S common shares in a manner that reduces disparity in M's bases in all the S common shares, to the greatest extent possible. Accordingly, the $4 positive investment adjustment removed from the Block 1 share is reallocated and applied to the basis of the Block 2 share, increasing it from $4 to $8.
(C) Application of paragraphs (c) and (d) of this section. Because M's sale of the Block 1 share is not a transfer of a loss share after the application of this paragraph (b), neither paragraph (c) of this section nor paragraph (d) of this section applies to the transfer.
(ii) Redetermination to eliminate duplicated loss. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 1, except that, at the time of the second contribution, the value of Asset 1 had declined to $20 and so, instead of contributing Asset 2, M contributed Asset 3 to S in exchange for the Block 2 share. At the time of that exchange, Asset 3 had a basis and value of $5. On October 1, year 3, S sells Asset 1 for $20, recognizing a $60 loss that is absorbed by the group. On December 31, year 3, M sells one of its Block 1 shares to X for $5. After taking into account the effects of all applicable rules of law, M's basis in each Block 1 share is $8 (M's original $20 basis decreased under § 1.1502-32
by $12 (the share's allocable portion of the $60 loss recognized on the sale of Asset 1)). M's basis in its Block 2 share is an excess loss account of $7 (M's original basis of $5 reduced under § 1.1502-32
by $12, the share's allocable portion of the loss recognized on the sale of Asset 1). M's sale of the Block 1 share is a transfer of a loss share and therefore subject to this section.
(B) Basis redetermination under this paragraph (b). Under this paragraph (b), M's bases in all its shares of S stock are subject to redetermination. There are no positive investment adjustments and so there is no adjustment under paragraph (b)(2)(i)(A) of this section. However, under paragraph (b)(2)(i)(B) of this section, M's basis in the transferred Block 1 share is reduced, but not below value, by reallocating negative investment adjustments from common shares that are not transferred loss shares. In total, there were $48 of negative investment adjustments applied to common shares that are not transferred loss shares. Accordingly, M's basis in the Block 1 share is reduced by $3, from $8 to its value of $5. Under paragraph (b)(2)(i)(B) of this section, the negative investment adjustments applied to the transferred share are reallocated from (and therefore cause an increase in the basis of) S common shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all S common shares to the greatest extent possible. Accordingly, the $3 negative investment adjustment reallocated and applied to the transferred Block 1 share is reallocated entirely from the Block 2 share, increasing the basis in the Block 2 share from an excess loss account of $7 to an excess loss account of $4.
(C) Application of paragraphs (c) and (d) of this section. Because M's sale of the Block 1 share is not a transfer of a loss share after the application of this paragraph (b), neither paragraph (c) of this section nor paragraph (d) of this section applies to the transfer.
(iii) Nonapplicability of redetermination rule to sale of entire interest. The facts are the same as in paragraph (ii)(A) of this Example 1, except that, on December 31, year 3, M sells all its shares of S stock to X for $25. M's sale of the S stock to X is a transfer of all of the shares of S stock held by members to one or more nonmembers in one fully taxable transaction and, therefore, basis is not redetermined under this paragraph (b). Accordingly, the sale of the Block 1 shares remains a transfer of loss shares and, as such, subject to paragraphs (c) and (d) of this section. However, paragraphs (c)(7) and (d)(3)(i)(A) of this section apply netting principles to prevent adjustments under either paragraph (c) or paragraph (d) of this section, respectively. Alternatively, the group could elect to apply this paragraph (b). In that case, the $12 negative adjustment applied to the Block 2 shares would be reallocated to the Block 1 shares with the result that there would be no loss (or gain) on any of the transferred shares following the application of this paragraph (b). In that case, there would be no further application of this section to the transfer.
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(iv) Transfer of entire interest, partially taxable. The facts are the same as in paragraph (iii) of this Example 1, except that, instead of selling the Block 2 share to X, M contributes the share to a nonmember in a section 351 exchange that is part of the same transaction. Although all the S shares held by members are transferred in the transaction, not all the shares are transferred to one or more nonmembers in one fully taxable transaction. Therefore, paragraph (b)(1)(ii)(B) of this section does not apply and M must redetermine its bases in its shares of S stock under this paragraph (b). In total, there were $12 of negative investment adjustments applied to common shares that are not transferred loss shares (the Block 2 share, a gain share). Accordingly, M's basis in each of the Block 1 shares is reduced by $3, from $8 to its value of $5. Under paragraph (b)(2)(i)(B) of this section, the negative investment adjustments applied to the transferred shares are reallocated from (and therefore cause an increase in the basis of) S shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all S common shares to the greatest extent possible. Accordingly, the $12 negative investment adjustment reallocated and applied to the transferred Block 1 shares is reallocated entirely from the Block 2 share, increasing the basis in the Block 2 share from an excess loss account of $7 to a basis of $5. Because M's transfer is not a transfer of loss shares after the application of this paragraph (b), neither paragraph (c) of this section nor paragraph (d) of this section applies to the transfer.
Code of Federal Regulations
Example 2.
Redetermination increases basis of transferred loss share. (i) Facts. On January 1, year 1, M owns all 10 outstanding shares of S common stock. Five of the shares have a basis of $20 per share (Block 1 shares) and five of the shares have a basis of $10 per share (Block 2 shares). S's only asset, Asset 1, has a basis of $50. S has no other attributes. On October 1, year 1, S sells Asset 1 for $100, recognizing a $50 gain. On December 31, year 2, M sells one Block 1 share and one Block 2 share to X for $10 per share. After taking into account the effects of all applicable rules of law, M's basis in each Block 1 share is $25 (M's original $20 basis increased under § 1.1502-32
by $5, the share's allocable portion of the $50 gain recognized on the sale of Asset 1), and M's basis in each Block 2 share is $15 (M's original $10 basis increased under § 1.1502-32
by $5, the share's allocable portion of the $50 gain recognized on the sale of Asset 1). M's sale of the Block 1 and Block 2 shares is a transfer of loss shares and therefore subject to this section.
(ii) Basis redetermination under this paragraph (b). Under this paragraph (b), M's bases in all its shares of S stock are subject to redetermination. First, paragraph (b)(2)(i)(A) of this section applies to reduce M's basis in the transferred Block 1 and Block 2 shares, but not below value, by removing the positive investment adjustments applied to the bases of the transferred loss shares. Accordingly, the basis of the transferred Block 1 share is reduced by $5, from $25 to $20. The basis of the transferred Block 2 share is also reduced by $5, from $15 to $10. (Although the transferred Block 1 share is still a loss share, there is no reduction to its basis under paragraph (b)(2)(i)(B) of this section because there were no negative investment adjustments applied to the bases of the S common shares that are not transferred loss shares.) Next, paragraph (b)(2)(ii)(B) of this section applies to reallocate and apply the $10 of positive investment adjustments removed from the transferred loss shares to increase M's bases in its S common shares in a manner that reduces the disparity in its bases in all S common shares to the greatest extent possible. Accordingly, of the $10 of positive investment adjustments to be reallocated, $6 is reallocated and applied to the basis of the transferred Block 2 share (increasing it from $10 to $16) and $4 is reallocated and applied equally to the basis of each of the four retained Block 2 shares (increasing the basis of each from $15 to $16). After giving effect to the reallocations under this paragraph (b), M's basis in each retained Block 1 share is $25, M's basis in the transferred Block 1 share is $20, and M's basis in each Block 2 share is $16.
(iii) Application of paragraph (c) of this section. After the application of this paragraph (b), M's sale of the Block 1 and Block 2 shares is still a transfer of loss shares and, accordingly, subject to paragraph (c) of this section. No adjustment is required to the basis of the transferred Block 1 share under paragraph (c) of this section because, after its basis is redetermined under this paragraph (b), the net positive adjustment to the basis of the share is $0. See paragraph (c)(3) of this section. However, under paragraph (c) of this section M's basis in the transferred Block 2 share is reduced by $6 (the lesser of its net positive adjustment, $6, and its disconformity amount, $6), from $16 to $10, its value. See paragraph (c)(2) of this section.
(iv) Application of paragraph (d) of this section. After the application of paragraph (c) of this section, M's sale of the Block 1 share is still a transfer of a loss share and, accordingly, subject to paragraph (d) of this section. No adjustment is required under paragraph (d) of this section because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section. Because M's sale of the Block 2 share is no longer a transfer of a loss share after the application of paragraph (c) of this section, paragraph (d) of this section does not apply to the transfer of the Block 2 share.
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Example 3.
Tiered subsidiaries. (i) Transfer of all shares of common stock. (A) Facts. P owns the sole outstanding share of S stock with a basis of $100, and the sole outstanding share of M stock with a basis of $300. M has $200 and owns an asset with a basis of $0. S owns one asset, Asset 1, with a basis of $100. At a time when Asset 1 has a value of $200, S issues a second share of common stock to M in exchange for $200. Later S sells Asset 1 for $200, recognizing a $100 gain. After taking into account the effects of all applicable rules of law, P's basis in its S stock is $150 (P's original $100 basis increased under § 1.1502-32
by $50, the share's allocable portion of the $100 gain recognized on the sale of Asset 1), M's basis in its S stock is $250 (M's original $200 basis increased under § 1.1502-32
by $50, the share's allocable portion of the $100 gain recognized on the sale of Asset 1), and P's basis in its M stock is $350 (P's original $300 basis increased under § 1.1502-32
by $50, the tier-up of M's increase in its basis in its S stock). P then sells its M share and its S share to X for $300 and $200, respectively. M and S are not members of the same consolidated group immediately after the sale. Therefore, the M share and both of the S shares are transferred in the transaction. Regarding P's sale of its share of S stock and its share of M stock, see paragraph (f)(10)(i)(A) of this section (ceasing to own a share in a taxable transaction) and paragraph (f)(10)(i)(C) of this section (nonmember acquires share); regarding M's share of S stock, see paragraph (f)(10)(i)(B) of this section (ceasing to be members of the same group). The application of this section begins with respect to the stock of S, the subsidiary at the lowest tier in which there is a transfer of subsidiary stock. See paragraph (a)(3)(ii) of this section. Although both P and M transfer their S shares, only M's S share is a loss share. Thus, only M's transfer is a transfer of a loss share of S stock and only M's transfer is subject to this section.
(B) Application of section to transferred S shares. Although only M's transfer is subject to this section, all members' bases in their shares of S stock are subject to redetermination under this paragraph (b). First, paragraph (b)(2)(i)(A) of this section applies to reduce M's basis in its transferred S share, but not below value, by removing the positive investment adjustment applied to that share. Accordingly, the basis of M's S share is reduced by $50, from $250 to $200 (under § 1.1502-32
, that redetermination adjustment tiers up to reduce P's basis in its M stock by $50, from $350 to $300). Because there are no negative adjustments to reallocate under paragraph (b)(2)(i)(B) of this section, paragraph (b)(2)(ii)(B) of this section then applies to reallocate and apply the $50 positive investment adjustment removed from the transferred loss S share to increase P's basis in its S share in a manner that reduces disparity among members' bases in all S common shares to the greatest extent possible. Accordingly, all $50 of the positive investment adjustment is reallocated and applied to P's basis in its S share (increasing the basis from $150 to $200). Because M's transfer of its S share is not a transfer of a loss share after the application of this paragraph (b), neither paragraph (c) of this section nor paragraph (d) of this section applies to that transfer.
(C) Application of section to transfers at next higher tier. After the adjustments to M's share of S stock are given effect, P's transfer of its share of M stock is not a transfer of a loss share and so this section does not apply to that transfer.
(D) Result of application of section. After the application of this section, P recognizes no gain or loss on its sale of either the S share or the M share. In addition, the unrecognized (noneconomic) loss in M's basis in its S share is eliminated. The results would be the same if, in addition to the facts in paragraph (i)(A) of this Example 3, M transferred its S share to X in a fully taxable transaction and, as permitted under paragraph (b)(1)(ii)(B) of this section, P elected to redetermine basis under this paragraph (b).
(ii) Transfer of less than all lower-tier shares of stock. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 1, except that M and S are members of the same consolidated group immediately after the sale. Therefore, in this case, M's S share is not transferred and so this section has no application with respect to M's S share. P's transfer of its S share is not a transfer of a loss share and so is also not subject to this section. However, P's sale of its share of M stock is a transfer of a loss share and is subject to this section.
(B) Basis redetermination under this paragraph (b). Although P's transfer of its share of M stock is subject to this section, this paragraph (b) does not apply to the transfer because there is only one share of M stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). Accordingly, after the application of this paragraph (b), P's sale of its M share is still a transfer of a loss share and therefore subject to paragraph (c) of this section.
(C) Application of paragraphs (c) and (d) of this section. Under paragraph (c) of this section, P must reduce its basis in its M share by $50, the lesser of its net positive adjustment ($50, see paragraph (c)(3) of this section) and its disconformity amount ($150, see paragraphs (c)(4), (c)(5), and (c)(6) of this section). As a result, the share is no longer a loss share and the transfer is not subject to paragraph (d) of this section.
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(D) Result of application of section. After the application of this section, P recognizes a $50 gain on its sale of the S share and no loss on its sale of the M share. Although there is unrecognized loss preserved in M's basis in its S share, if M later transfers the share when it is a loss share, that transfer will be subject to this section.
Code of Federal Regulations
Example 4.
Application to outstanding common and preferred shares. (i) Facts. P owns all the stock of M and all eight outstanding shares of S common stock. S also has two shares of nonvoting preferred stock outstanding; the preferred shares each have a $100 annual, cumulative preference as to dividends. M owns one of the preferred shares (PS1) and P owns the other (PS2). On January 1, year 1, the bases and values of the outstanding S shares are:
| Basis |
1250 |
990 |
1025 |
710 |
550 |
400 |
375 |
250 |
215 |
100 |
| Value |
1000 |
1000 |
375 |
375 |
375 |
375 |
375 |
375 |
375 |
375 |
(A) As of January 1, year 1, there are no arrearages on the preferred stock. In year 1, S has a $1100 capital loss and $100 of ordinary income. The group absorbs the loss and the negative remaining adjustment of $1000 is allocable entirely to the common stock, equally to each common share ($125 per share). See § 1.1502-32(c)(1)(iii) and (c)(2)
.
(B) In year 2, S has $700 of ordinary income and a $100 ordinary loss. Also, on October 1, year 2, S declares and makes a $200 dividend distribution with respect to the preferred stock ($100 per share). Under § 1.1502-32(c)(1)(i)
, a negative adjustment of $100 is first allocated to each of the preferred shares to reflect the declaration of the dividend. The $600 positive remaining adjustment determined under § 1.1502-32(c)(1)(iii)
(reflecting S's net income reduced by the distribution) is then allocated to each of the preferred shares to the extent of its entitlement to dividends accruing in year 1 and year 2 ($200 per share). See § 1.1502-32(c)(1)(iii) and (c)(3)
. The $200 of the positive remaining adjustment not allocated to the preferred shares is then allocated to the common stock, equally to each common share ($25 per share). See § 1.1502-32(c)(1)(iii) and (c)(2)
. After taking into account the effects of all applicable rules of law, the adjusted bases and the values of the shares as of January 1, year 3, are:
| Basis |
1250 |
990 |
1025 |
710 |
550 |
400 |
375 |
250 |
215 |
100 |
| Year 1§ 1.1502-32
adjustments |
N/A |
N/A |
−125 |
−125 |
−125 |
−125 |
−125 |
−125 |
−125 |
−125 |
| Year 2§ 1.1502-32
adjustments |
−100 |
−100 |
25 |
25 |
25 |
25 |
25 |
25 |
25 |
25 |
|
200 |
200 |
|
|
|
|
|
|
|
|
|
100 |
100 |
|
|
|
|
|
|
|
|
| Adjusted basis |
1350 |
1090 |
925 |
610 |
450 |
300 |
275 |
150 |
115 |
0 |
| Value |
1100 |
1100 |
275 |
275 |
275 |
275 |
275 |
275 |
275 |
275 |
| Unrecognized gain/(loss) |
(250) |
10 |
(650) |
(335) |
(175) |
(25) |
0 |
125 |
160 |
275 |
(C) On January 1, year 3, M sells PS1 for $1100 and P sells CS2 for $275. The sales of PS1 and CS2 are transfers of loss shares and therefore subject to this section.
(ii) Basis redetermination under this paragraph (b). Under this paragraph (b), all members' bases in shares of S stock are subject to redetermination in accordance with the following:
(A) Removing positive investment adjustments from transferred loss common shares. First, paragraph (b)(2)(i)(A) of this section applies to reduce P's basis in CS2, but not below value, by removing the positive investment adjustment applied to the basis of the share. Accordingly, P's basis in CS2 is reduced by $25, from $610 to $585.
(B) Reallocating negative investment adjustments from common shares that are not transferred loss shares. Because the transferred shares remain loss shares after the removal of positive investment adjustments, their bases are further reduced under paragraph (b)(2)(i)(B) of this section, but not below value, by reallocating negative investment adjustments applied to common shares that are not transferred loss shares. Reallocations are made first to preferred shares and then to the common shares, in a manner that reduces disparity among members' bases in transferred loss preferred shares, and reduces disparity among members' bases in all common shares, to the greatest extent possible. The loss on PS1 is $250, the remaining loss on CS2 is $310, and the total amount of negative investment adjustments applied to shares that are not transferred loss shares is $875 (the sum of the negative adjustments applied to all common shares other than CS2). Thus, $250 of negative investment adjustments are reallocated and applied to the basis of PS1, reducing it to the share's value, $1100. The negative investment adjustments are reallocated from the common shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all common shares to the greatest extent possible. The negative investment adjustments may be reallocated to PS1 from the common shares that are not transferred loss shares as follows: $125 from each of CS7 and CS8. Such reallocations increase the basis of CS7 by $125, from $115 to $240, and increase the basis of CS8 by $125, from $0 to $125. Negative investment adjustments are then reallocated to CS2 from the common shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all common shares to the greatest extent possible. The negative investment adjustments may be reallocated to CS2 from the other common shares as follows: $80 from CS4, $105 from CS5, and $125 from CS6. Such reallocations reduce the basis of CS2 by $310, from $585 to $275, increase the basis of CS4 by $80, from $300 to $380, increase the basis of CS5 by $105, from $275 to $380, and increase the basis of CS6 by $125, from $150 to $275. However, there may be other reasonable reallocations.
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(C) Increasing basis by reallocated positive investment adjustments. Under paragraph (b)(2)(ii)(A) of this section, the $25 positive investment adjustment removed from CS2 (the transferred loss common share) is then reallocated and applied to increase the basis of preferred shares, but not above value. Accordingly, $10 of that amount is reallocated to PS2, increasing its basis from $1090 to $1100, its value. Under paragraph (b)(2)(ii)(B) of this section, the remaining $15 is reallocated and applied to the common shares in a manner that reduces disparity among members' bases in all common shares to the greatest extent possible. The $15 positive investment adjustment that is reallocated to common shares may be reallocated entirely to CS8, increasing its basis from $125 to $140. However, there may be other reasonable reallocations.
(D) Summary of the reallocation of adjustments. The adjustments made under this paragraph (b) are: