Loss Importation Rules Limit Built-In Losses

By Sally P. Schreiber, J.D.

The IRS issued final rules on Friday that prevent taxpayers from transferring losses to corporations by implementing a framework for determining basis when property with a built-in loss is transferred to a corporation (T.D. 9759). The regulations finalize proposed regulations issued in 2013 (REG-161948-05) with a few clarifications, most pertaining to partnerships.

Under Sec. 362(e)(1), if property is transferred to a corporation with a built-in loss (meaning its adjusted basis in the corporation’s hands is greater than its fair market value (FMV)), the property’s basis in the corporation’s hands is its FMV. This is called the loss importation rule, and the regulations provide rules for determining what is loss importation property.

Loss importation property exists if (1) a transferor’s gain or loss on a sale of an individual property immediately before the transfer would not be subject to federal income tax, and (2) the acquiring corporation’s gain or loss on a sale of the transferred property immediately after the transfer would be subject to federal income tax.

Under the regulations, this determination is made by treating the transferor as a hypothetical seller of the transferred or acquired property to determine whether the hypothetical seller would take the gain or loss into account in determining its federal income tax liability, under all the relevant facts and circumstances.

A lookthrough rule applies when the transferor is a grantor trust, a partnership, or an S corporation. In these cases, determining whether gain or loss from a hypothetical sale is subject to federal income tax is done by looking at the tax treatment of the gain or loss in the hands of the grantors, the partners, or the S corporation shareholders. If an organizing instrument allocates gain or loss in different amounts, including under a partnership agreement, determining whether gain or loss from a hypothetical sale is subject to federal income tax is done by reference to the person to whom, under the terms of the instrument, the gain or loss on the entity’s hypothetical sale would actually be allocated, taking into account the entity’s net gain or loss actually recognized in the tax period in which the transaction occurred.

Finally, the regulations include an anti-avoidance rule for domestic trusts, estates, regulated investment companies (RICs), real estate investment trusts (REITs), and cooperatives that directly or indirectly transferred property (including through other similar entities) in a Sec. 362(a) or (b) transaction (property acquired by issuance of stock in the corporation or in a corporate reorganization).

If the property had been directly or indirectly transferred to or acquired by the entity as part of a plan to avoid the anti-loss importation provisions, a lookthrough rule applies. Then, the entity is presumed to distribute the proceeds of its hypothetical sale, and the tax treatment of the gain or loss in the hands of the distributees determines whether gain or loss was taken into account in determining federal income tax liability. If the distributee is also one of those entities, the rule looks to the ultimate owners of the entity’s interests. The determination of whether the property is importation property is then made by reference to the deemed distributees or, in the case of tiered entities, to the ultimate deemed distributees.

The final regulations generally apply to transactions occurring on or after March 28, 2016, unless completed pursuant to a binding agreement that was in effect prior to that date and all times afterward. They also apply to transactions occurring before March 28, 2016, resulting from entity classification elections made under Regs. Sec. 301.7701-3 that are filed on or after that date. In addition, the final regulations provide that taxpayers may apply these rules to any transaction occurring after Oct. 22, 2004.

Sally P. Schreiber (sschreiber@aicpa.org) is a Tax Adviser senior editor.

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