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Final Regs. Eliminate Hot Stock Rule for Certain Reorganizations

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On October 19, the IRS issued final regulations that generally hold that the so-called hot stock rule is inapplicable in reorganizations where a subsidiary is a member of the distributing corporation’s separate affiliated group (DSAG) (T.D. 9548). The regulations finalize without change rules that were issued as temporary and proposed regulations in 2008 (T.D. 9435, REG-150670-07).

The regulations are designed to harmonize the hot stock rule of Sec. 355(a)(3)(B) with the affiliated group rules for determining satisfaction of the active trade or business requirement under Sec. 355(b)(3).

Before the issuance of the 2008 temporary regulations, controlled corporation stock acquired within five years of the distribution of such stock in a transaction in which gain or loss was recognized would be treated as boot under the hot stock rule. However, this treatment could conflict with the Sec. 355(b)(3)(A) rule that members of a corporation’s separate affiliated group (SAG) will be treated as one corporation for purposes of determining whether a corporation meets the active trade or business requirements of Sec. 355(b)(2)(A).

The final regulations generally provide that controlled stock acquired by the DSAG within the predistribution period in a taxable transaction will not constitute hot stock (that is, will not be treated as “other property” or boot), if the controlled corporation is a DSAG member at any time after the acquisition (but prior to the distribution of controlled).

The regulations also address distributions among members of a DSAG. Under Regs. Sec. 1.355-2(g), “[t]ransfers of controlled corporation stock that is owned by the DSAG immediately before and immediately after the transfer are disregarded and are not acquisitions for purposes of” the hot stock rule.

The regulations exempt from the hot stock rule transactions in which a distributing corporation acquires controlled stock from a member of its own affiliated group.

The IRS said it is continuing to study the interrelationship between Sec. 355(a)(3)(B) and the active business requirements in Sec. 355(b).

The final regulations are effective upon their publication in the Federal Register.