SERVICE PROVIDES TEMPORARY GUIDANCE WITH RESPECT TO RICs AND REITs TO AVOID BUILT-IN GAINS TAX OF GENERAL UTILITIES REPEAL.

Notice 88-19

The Internal Revenue Service intends to promulgate regulations under the authority of section 337(d) of the Internal Revenue Code to prevent the avoidance of corporate-level taxation with respect to the net built-in gain of C corporation assets in connection with transactions or events that result in the ownership of such assets by a regulated investment company (a "RIC") or a real estate investment trust (a "REIT") with a basis determined by reference to the C corporation's basis (a "carryover basis").

BACKGROUND

Section 337(d)(1) of the Code provides, in part, that the Secretary shall prescribe regulations to prevent circumvention of the purposes of the repeal of the General Utilities doctrine through the use of any provision of law or regulations, specifically including the consolidated return regulations and the tax-free reorganization provisions of the Code (part III of subchapter C). The grant of authority includes the authority to issue, or to amend, regulations to ensure that the purposes of the provisions implementing the repeal of the General Utilities doctrine (including section 1374, relating to tax imposed on certain built-in gains of S corporations) are not avoided through the use of entities that are not fully subject to corporate taxation, such as RICs and REITs.

DESCRIPTION OF REGULATIONS

The regulations will 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 in a carryover basis transaction. In cases to which the regulations apply, unless the election described below is made, the C corporation will be treated, for all purposes, as if it had sold all of its assets at their respective fair market values on the relevant date described below and immediately liquidated. Generally, if a corporation is subject to corporate-level taxation under these provisions, the basis of the assets in the hands of the RIC or REIT will be adjusted to their respective fair market values.

In the case of a C corporation that qualifies to be taxed as a RIC or REIT, the regulations will require the C corporation to recognize any net built-in gain (the excess of aggregate gains (including items of income) over aggregate losses) that would have been realized if the corporation had liquidated at the end of its last taxable year before the taxable year in which it qualifies to be taxed as a RIC or REIT. In the case of a C corporation that transfers property to a RIC or REIT in a carryover basis transaction, the regulations will require the transferor C corporation to recognize any net built-in gain that would have been realized if the corporation had liquidated on the day before the date of the transfer. In either case, the regulations will not apply to permit the C corporation to recognize a net built-in loss.

The regulations will permit the transferee RIC or REIT to elect, in lieu of the treatment described above, to be subject to rules similar to the rules of section 1374 of the Code. Section 1374 is currently the subject of proposed technical corrections. The regulations will take into account amendments to section 1374, as appropriate, but will not necessarily include similar effective date provisions. Generally, section 1374 subjects an S corporation to corporate-level taxation on built-in gains recognized within a ten- year period on assets formerly held by a C corporation. The built-in gains of electing RICs and REITs, and the corporate-level tax imposed on such gains, will be subject to rules similar to the rules relating to net income from foreclosure property of REITs. See sections 857(a)(1)(A)(ii) and 857(b)(2)(B), (D), and (E).

TRANSITIONAL RELIEF

The regulations will take into account the provisions of section 633(d) of the Tax Reform Act of 1986, which provide transitional rules for certain small corporations with respect to the repeal of the General Utilities doctrine. The regulations will also provide for appropriate basis adjustments, and other modifications as necessary, if the result of taking such transitional rules into account is the partial recognition of gain.

SCOPE OF REGULATIONS

Except to the extent described in this Notice, the regulations will 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 receive RIC shares in a transaction that qualifies as a reorganization under section 368(a)(1)(C) of the Code will not recognize gain or loss solely because under the regulations the C corporation is subject to corporate-level taxation.

EFFECTIVE DATES

In the case of carryover basis transactions involving the transfer of property of a C corporation to a RIC or REIT, the regulations will apply to transactions occurring on or after June 10, 1987. In the case of a C corporation that qualifies to be taxed as a RIC or REIT, the regulations will apply to such qualifications that are effective for taxable years beginning on or after June 10, 1987, unless the provisions of subchapter M (relating to RICs or REITs as the case may be) apply to such corporation for the taxable year including June 9, 1987.

These effective dates correspond to the introduction in Congress of legislation to effect technical corrections to the Tax Reform Act of 1986. The Technical Corrections Act of 1987 (introduced June 10, 1987 as H.R. 2636 and S. 1350) would amend section 337(d) of the Code to clarify that the authority of the Secretary to promulgate regulations to prevent the circumvention of the purposes of the provisions of the Tax Reform Act of 1986 that implement the repeal of the General Utilities doctrine includes the authority to prevent avoidance of such purposes through the use of RICs or REITs.

ADMINISTRATIVE PRONOUNCEMENT

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or revenue procedure.

FOR FURTHER INFORMATION

For further information contact Robert M. Casey of the Legislation and Regulations Division of the Office of Chief Counsel, Internal Revenue Service, on 202-566-3458 (not a toll-free number).