Dispositions and Deconsolidations of Subsidiary Stock -- Temporary and Final Regulations on Under Section 337(d)

 [4830-01]

 ACTION: Final regulations; temporary regulations; removal of temporary regulations

 SUMMARY: This document contains final section 1.337(d)-1 and temporary section 1.337(d)-2T. These regulations implement aspects of the repeal of the General Utilities doctrine by limiting losses of consolidated groups with respect to the stock of subsidiaries for certain transitional periods. This document also withdraws temporary section 1.1502-20T. New proposed section 1.1502-20 appears in the Proposed Rules section of this issue of the Federal Register.

 DATES: These regulations are effective (date 30 days after publication [which we anticipate to be November 21]) except section 1.337(d)-1 which is effective November 19, 1990. Section 1.337(d)-1 generally applies to dispositions after January 6, 1987, and before the effective date of section 1.337(d)-2T, of stock of a subsidiary that became a member of an affiliated group after January 6, 1987. Section 1.337(d)-2T generally applies to dispositions and deconsolidations of stock of a subsidiary occurring after November 18, 1990, and before the effective date of section 1.1502-20.

 FOR FURTHER INFORMATION CONTACT: Mark S. Jennings, 202-566-2455 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

A. PAPERWORK REDUCTION ACT

The collection of information contained in final section 1.337(d)-1 has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1980 (44 U.S.C. 3504(h)) under the previous control number 1545-1160. The estimated annual burden per respondent to comply with section 1.337(d)-1 is 2 hours.

 This estimate is an approximation of the average time expected to be necessary for a collection of information. It is based on such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time, depending on their particular circumstances.

 Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, D.C. 20224, and to the Office of Management and Budget, Attention: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, D.C. 20503.

 Temporary section 1.337(d)-2T is being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collections of information contained in these regulations have been submitted to the Office of Management and Budget (OMB) pursuant to the Paperwork Reduction Act of 1980 (44 U.S.C. 3507). Notice of OMB action will be published in a subsequent issue of the Federal Register.

 The estimated average annual burden per respondent is 2 hours. This estimate is an approximation of the average time expected to be necessary for a collection of information. It is based on such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time, depending on their particular circumstances.

 For further information concerning these collections of information, and, where to submit comments on these collections of information and the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross- referenced notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.

B. INTRODUCTION

 T.D. 8294, filed with the Federal Register on March 9, 1990 and published in the Federal Register on March 14, 1990, added temporary sections 1.1502-20T and 1.337(d)-1T to Part 1 of Title 26 of the Code of Federal Regulations.

 Section 1.1502-20T added to the consolidated return regulations a general rule that disallowed all consolidated group losses on the disposition of a subsidiary's stock (the "loss disallowance rule"). The regulations also provided a number of related rules, including a basis reduction rule applicable on deconsolidation of a subsidiary's stock and an anti-stuffing rule applicable to transfers of property between members in connection with the disposition or deconsolidation of a subsidiary's stock. Also provided was a rule that permitted reattribution of a subsidiary's losses to the common parent to the extent loss would otherwise be disallowed to the consolidated group on the disposition of a subsidiary's stock. The rules added by section 1.1502-20T generally applied to any disposition or deconsolidation of a subsidiary's stock on or after March 9, 1990.

 Section 1.337(d)-1T added a transitional rule that generally limited loss on the disposition of a subsidiary's stock after January 6, 1987, if the subsidiary became a member of the group after that date (a "transitional subsidiary") and the disposition was not subject to section 1.1502-20T. Unlike section 1.1502-20T, these regulations permitted the loss to the extent the group established that the loss was not attributable to the recognition of "built-in gain" on the disposition of assets owned by the subsidiary (or any lower tier subsidiary). Moreover, although section 1.1502-20T reduced the basis of subsidiary stock on its deconsolidation, section 1.337(d)-1T continued to treat the stock as subject to loss disallowance on later disposition.

 Sections 1.1502-20T and 1.337(d)-1T implemented Notice 87-14, 1987-1 C.B. 445, in which the Internal Revenue Service announced its intention to publish regulations that would prevent utilization of sections 1.1502-32 and 1.1502-33(c) (the "investment adjustment rules") to circumvent the repeal of the General Utilities doctrine by the Tax Reform Act of 1986. The loss disallowance rule of section 1.1502-20T addressed another problem relating to the investment adjustment rules by preventing a subsidiary's losses from being duplicated as investment losses of the parent when the parent disposes of the subsidiary's stock.

 Also filed with the Federal Register on March 9, 1990 and published on March 14, 1990, was a notice of proposed rulemaking (CO-78-87) that incorporated by cross reference the text of sections 1.1502-20T and 1.337(d)-1T. Many written comments were received, and a public hearing was held on June 26, 1990.

 After full consideration of the written comments and the testimony at the public hearing, the following actions are being taken:

1. Proposed section 1.337(d)-1 is amended and promulgated as a final regulation by this document as section 1.337(d)-1, replacing temporary section 1.337(d)-1T.

 2. New section 1.337(d)-2T is promulgated by this document as a temporary regulation. Commentators characterized section 1.1502-20T as far broader than required by Notice 87-14 and requested that taxpayers retain the ability to dispose of subsidiary stock under the more limited approach of section 1.337(d)-1T until the rules of section 1.1502-20T are revised. Section 1.337(d)-2T continues the principles of section 1.337(d)-1 by adding another transitional rule applicable to all subsidiary stock (not just stock of transitional subsidiaries and transitional parents). The new rule allows groups to establish that loss is not attributable to the recognition of built- in gain, but only if the group's entire equity interest in the subsidiary is disposed of in one or more transactions to unrelated persons before the effective date of new section 1.1502-20. Section 1.337(d)-2T also provides basis reduction rules for subsidiary stock that is deconsolidated and anti-stuffing rules. The text of section 1.337(d)-2T set forth in this document also serves as the text of proposed section 1.337(d)-2, cross-referenced in a notice of proposed rulemaking (CO-93-90), published in the Proposed Rules section of this issue of the Federal Register.

 3. Section 1.1502-20T is withdrawn by this document.

 4. The notice of proposed rulemaking (CO-93-90) published in the Proposed Rules section of this issue of the Federal Register withdraws proposed section 1.1502-20 as added by (CO-78-87) and adds new proposed section 1.1502-20. For a discussion of new proposed section 1.1502-20, see the preamble in the notice of proposed rulemaking.

 5. A Revenue Procedure will be issued as a consequence of these rules setting forth procedures under which the Internal Revenue Service will grant permission for all of the members of a group to discontinue filing consolidated returns. Conditions will be included to restrict reconsolidation of any member (or successor) for at least 5 years.

C. AMENDMENTS TO PROPOSED SECTION 1.337(d)-1

 Proposed section 1.337(d)-1 is amended and adopted as a final regulation. For a description of the original provisions of proposed section 1.337(d)-1, see T.D. 8294, published on March 14, 1990. Following is a description of the principal amendments.

1. COORDINATION WITH LOSS DEFERRAL RULES

 Sections 1.337(d)-1(a)(3) and 1.337(d)-1(b)(3) provide that, if a loss is deferred, any disallowance of the loss is also deferred until the loss is taken into account under the consolidated return regulations. The loss disallowance rule takes precedence over other loss disallowance and deferral rules of the Code and regulations, however, and these other rules apply only to the extent that loss is not disallowed under section 1.337(d)-1.

2. STACKING RULES

 Section 1.337(d)-1(a)(1) disallows loss recognized by a member of a consolidated group on the disposition of stock of a transitional subsidiary. However, section 1.337(d)-1(a)(2) provides an exception under which loss is not disallowed to the extent the taxpayer establishes that the loss is not attributable to the recognition of built-in gain on the disposition of an asset after January 6, 1987. The burden is on taxpayers to establish that loss is not attributable to built-in gain.

 Example (3) in proposed section 1.337(d)-1(a)(5) treated any loss on the sale of stock as first attributable to recognized built- in gain. Example (3) is clarified and a new Example (4) is added to clarify that, for purposes of determining whether stock loss is attributable to built-in gain, recognized built-in gain may be offset by recognized built-in loss. If built-in gains and losses are both reflected in the basis of purchased subsidiary stock (or, in the case of subsidiary stock acquired in a carryover basis transaction, neither is reflected in the basis of subsidiary stock), the netting is appropriate. The built-in gain does not create or enhance stock loss when offset by built-in loss.

3. STATEMENTS

 The requirement that a separate statement be filed with respect to deduction of loss on the disposition of stock of transitional subsidiaries is extended to the deduction of loss on the disposition of stock of transitional parents.

4. OTHER CLARIFYING CHANGES

Section 1.337(d)-1 is revised to clarify several provisions. The revisions include -- (a) simplifying the definition of built-in gain, (b) correcting technical defects in the definition of transitional parent and in the successor rule, and (c) additional examples to illustrate such rules as the application of the section to subsidiary stock no longer held by a member and to post-acquisition appreciation. In addition, because section 1.1502-20T has been replaced by a proposed regulation, several rules and examples previously incorporated by cross reference have been restated in full.

D. TRANSITIONAL ISSUES

 Proposed section 1.337(d)-1 applied to all the stock of a subsidiary that became a member of a group after January 6, 1987, regardless of whether the stock of the subsidiary was acquired by purchase. Commentators have argued that section 1.337(d)-1 should apply only to subsidiary stock that was acquired by purchase after January 6, 1987. They contend that Notice 87-14 did not provide adequate notice that section 1.337(d)-1 would reach all cases in which stock losses with respect to transitional subsidiaries are attributable to the recognition of built-in gain. Commentators also contend that, although a particular target within a group may be subject to section 1.337(d)-1, no notice was given that section 1.337(d)-1 would continue to apply if the target is transferred by merger or otherwise to other members who were members before January 7, 1987.

 Notice 87-14 states that "in cases where a target's stock is sold, the regulations will prevent recognition of losses that are attributable to the subsidiary's recognition of built-in gains. The regulations will be effective with respect to stock in a target that was acquired after January 6, 1987." The notice did not define the terms "target" or "acquired," or make clear whether it was the stock or the target that had to be acquired after January 6, 1987.

 Notice 87-14 provides a general statement of the policy concerns of the Service by stating simply that regulations would "affect the adjustment to stock basis in certain cases where one or more members have acquired stock of a target with a built-in gain asset. . . . In general, the adjustment to stock basis [would] not reflect built-in gains that are recognized by target on sales of, or by reason of distributions of, its assets." Because the notice stated simply that these concerns would be addressed with respect to acquisitions after January 6, 1987, taxpayers should reasonably have expected that the policies expressed in the Notice would be implemented so as to treat taxpayers presenting similar policy concerns similarly, despite different forms of acquisition or location within a group. Section 1.337(d)-1 prohibits the deduction of loss only in limited circumstances. A taxpayer must have acquired a subsidiary's stock after January 6, 1987, and thereafter disposed of a built-in gain asset. Applying this rule to a target acquired after January 6, 1987, regardless of whether its stock was acquired by purchase, is consistent with both the language and the policy of Notice 87-14.

E. EXPLANATION OF NEW TEMPORARY SECTION 1.337(d)-2T

 In response to comments that a transitional period should have been provided before section 1.1502-20T became effective, the effective date of new section 1.1502-20 has been deferred. New section 1.337(d)-2T provides a transitional rule, carrying forward the rules of section 1.337(d)-1, that allows loss to the extent the group establishes that the loss is not attributable to the recognition of built-in gain. For this purpose, gain recognized by a consolidated group (or a prior consolidated group) on the disposition of an asset is built-in gain to the extent the asset has an excess of value over basis attributable to a separate return year (as defined in section 1.1502-1(e)) with respect to the consolidated group (or prior consolidated group).

 Unlike section 1.337(d)-1, section 1.337(d)-2T is a prospective rule which taxpayers may take into account when planning transactions. Accordingly, section 1.337(d)-2T contains a deconsolidation rule and an anti-stuffing rule similar to those contained in new section 1.1502-20, in order to limit circumvention of the basic loss limitation rule. The deconsolidation and anti- stuffing rules are explained in the preamble to new section 1.1502-20, published in the Proposed Rules section of this issue of the Federal Register.

 Section 1.337(d)-2T generally applies with respect to dispositions and deconsolidations after November 18, 1990. The rule permitting a group to establish that loss is not attributable to recognition of built-in gain applies, however, only if the group's entire equity interest in a subsidiary is disposed of in one or more transactions to unrelated persons before the application of new section 1.1502-20. Thus, it does not apply (and the loss disallowance rule of section 1.337(d)-2T(a) does apply) if only a portion of the stock held by the group is disposed of, or if the stock is sold to a related party. (See new section 1.1502-20(h), set forth in the Proposed Rules section of this issue of the Federal Register, which permits taxpayers to elect to apply the rules of new section 1.1502-20 instead of section 1.337(d)-2T.) The ability to establish that loss is not attributable to built-in gain is limited under section 1.337(d)-2T in order to avoid the need for continued application of these rules to deconsolidated subsidiaries for a substantial period. Like new section 1.1502-20, section 1.337(d)-2T applies to all subsidiary stock, whether or not the subsidiary is a transitional subsidiary or transitional parent, and even if the disposition of the built-in gain asset occurred before January 7, 1987.

F. SECTION 1.1502-20T

Section 1.1502-20T is removed by this document and a new proposed section 1.1502-20 appears in the Proposed Rules section of this issue of the Federal Register. An explanation of the withdrawal of section 1.1502-20T and of the new provisions is set forth in the preamble to new proposed section 1.1502-20.

SPECIAL ANALYSIS

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required.

 It is hereby certified that these rules do not have a significant impact on a substantial number of small entities. The rules will primarily affect affiliated groups of corporations filing (or required to file) consolidated returns, which tend to be larger businesses. It will not significantly alter the reporting or recordkeeping duties of small entities. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. Chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The project attorney is Mark S. Jennings of the Office of Assistant Chief Counsel (Corporate), Internal Revenue Service. Various other personnel of the Internal Revenue Service and the Treasury Department also participated in the development of these regulations.

LIST OF SUBJECTS

26 CFR 1301-1 THROUGH 1.383-3

Corporate adjustments, Corporate distributions, Corporations, Income taxes, Reorganizations.

26 CFR 1.1501-1 THROUGH 1.1564-1

Income taxes, Controlled group of corporations, Consolidated returns.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR Chapter I is amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1986

Paragraph 1. The authority citation for Part 1 is amended by adding the following citations:

Authority: 26 U.S.C. 7805; * * * section 1.337(d)-1 also issued under 26 U.S.C. 337(d); * * * section 1.337(d)-2T also issued under 26 U.S.C. 337(d); * * * section 1.1502-1 also issued under 26 U.S.C. 1502.

Par. 2. The authority citation for Part 1 continues to include the following citation:

Authority: 26 U.S.C. 7805; * * * section 1.469-IT also issued under 26 U.S.C. 469(l).

Par. 3. The authority citation for Part 1 is further amended by removing the citations for sections 1.337(d)-1T, and 1.1502-20T.

Par. 3A. Section 1.337(d)-1 is added to read as follows:

SECTION 1.337(d)-1 TRANSITIONAL LOSS LIMITATION RULE.

(a) LOSS LIMITATION RULE FOR TRANSITIONAL SUBSIDIARY -- (1) GENERAL RULE. No deduction is allowed for any loss recognized by a member of a consolidated group with respect to the disposition of stock of a transitional subsidiary.

(2) ALLOWABLE LOSS -- (i) IN GENERAL. Paragraph (a)(1) of this section does not apply to the extent the taxpayer establishes that the loss is not attributable to the recognition of built-in gain by any transitional subsidiary on the disposition of an asset (including stock and securities) after January 6, 1987.

(ii) STATEMENT OF ALLOWABLE LOSS. Paragraph (a)(2)(i) of this section applies only if a separate statement entitled "ALLOWABLE LOSS UNDER SECTION 1.337(d)-1(a)" is filed with the taxpayer's return for the year of the stock disposition. If the separate statement is required to be filed with a return the due date (including extensions) of which is before January 16, 1991, or with a return due (including extensions) after January 15, 1991 but filed before that date, the statement may be filed with an amended return for the year of the disposition or with the taxpayer's first subsequent return the due date (including extensions) of which is after January 15, 1991.

(iii) CONTENTS OF STATEMENT. The statement required under paragraph (a)(2)(ii) of this section must contain --

(A) The name and employer identification number (E.I.N.) of the transitional subsidiary.

(B) The basis of the stock of the transitional subsidiary immediately before the disposition.

(C) The amount realized on the disposition.

(D) The amount of the deduction not disallowed under paragraph (a)(1) of this section by reason of this paragraph (a)(2).

(E) The amount of loss disallowed under paragraph (a)(1) of this section.

(3) COORDINATION WITH LOSS DEFERRAL RULES -- (i) SINGLE ENTITY TREATMENT OF DEFERRED INTERCOMPANY LOSS. If loss with respect to the disposition of a transitional subsidiary's stock is deferred, paragraph (a)(1) of this section does not apply until the loss is taken into account. For this purpose, the amount of the loss deferred and when the loss is taken into account are determined under sections 1.1502-13, 1.1502-13T, 1.1502-14, and 1.1502-14T, without the application of any other provision of the Code or regulations, such as section 267(f), that provides for disallowance or deferral of the loss.

(ii) OTHER LOSS DEFERRAL RULES. If paragraph (a)(1) of this section applies to a loss subject to deferral or disallowance under any other provision of the Code or the regulations, the other provision applies to the loss only to the extent it is not disallowed under paragraph (a)(1).

(4) DEFINITIONS. For purposes of this section --

(i) The definitions in section 1.1502-1 apply.

(ii) "Transitional subsidiary" means any corporation that became a subsidiary of the group (whether or not the group was a consolidated group) after January 6, 1987. Notwithstanding the preceding sentence, a subsidiary is not a transitional subsidiary if the subsidiary (and each predecessor) was a member of the group at all times after the subsidiary's (and each predecessor's) organization.

(iii) "Built-in gain" of a transitional subsidiary means gain attributable, directly or indirectly, in whole or in part, to any excess of value over basis, determined immediately before the transitional subsidiary became a subsidiary, with respect to any asset owned directly or indirectly by the transitional subsidiary at that time.

(iv) "Disposition" means any event in which gain or loss is recognized, in whole or in part.

(v) "Value" means far market value.

(5) EXAMPLES. For purposes of the examples in this section, unless otherwise stated, the group files consolidated returns on a calendar year basis, the facts set forth the only corporate activity, and all sales and purchases are with unrelated buyers or sellers. The basis of each asset is the same for determining earnings and profits adjustments and taxable income. Tax liability and its effect on basis, value, and earnings and profits are disregarded. "Investment adjustment system" means the rules of sections 1.1502-32 and 1.1502-33(c). The principles of this paragraph (a) are illustrated by the following examples:

EXAMPLE (1). LOSS ATTRIBUTABLE TO RECOGNIZED BUILT-IN GAIN. (i) P buys all the stock of T for $100 on February 1, 1987, and T becomes a member of the P group. T has an asset with a value of $100 and basis of $0. T sells the asset in 1989 and recognizes $100 of built-in gain on the sale (i.e., the asset's value exceeded its basis by $100 at the time T became a member of the P group). Under the investment adjustment system, P's basis in the T stock increases to $200. P sells all the stock of T on December 31, 1989, and recognizes a loss of $100. Under paragraph (a)(1) of this section, no deduction is allowed to P for the $100 loss.

(ii) Assume that, after T sells its asset but before P sells the T stock, T issues additional stock to unrelated persons and ceases to be a member of the P group. P then sells all its stock of T in 1997. Although T ceases to be a subsidiary within the meaning of section 1.1502-1, T continues to be a transitional subsidiary within the meaning of this section. Consequently, under paragraph (a)(1) of this section, no deduction is allowed to P for its $100 loss.

EXAMPLE (2). LOSS ATTRIBUTABLE TO POST-ACQUISITION LOSS. P buys all the stock of T for $100 on February 1, 1987, and T becomes a member of the P group. T has $50 cash and an asset with $50 of built-in gain. During 1988, T retains the asset but loses $40 of the cash. The P group is unable to use the loss, and the loss becomes a net operating loss carryover attributable to T. Under the investment adjustment system, P's basis in the stock of T remains $100. P sells all the stock of T on December 31, 1988, for $60 and recognizes a $40 loss. Under paragraph (a)(2)(i) of this section, P establishes that it did not dispose of the built-in gain asset. None of P's loss is disallowed under paragraph (a)(1) if P satisfies the requirements of paragraph (a)(2)(ii) of this section.

EXAMPLE (3). STACKING RULES -- POSTACQUISITION LOSS OFFSETS POSTACQUISITION GAIN. (i) P buys all the stock of T for $100 on February 1, 1987, and T becomes a member of the P group. T has 2 assets. Asset 1 has a basis and value of $50, and asset 2 has a basis of $0 and a value of $50. During 1989, asset 1 declines in value to $0, and T sells asset 2 for $50, and reinvests the proceeds in asset 3. The value of asset 3 appreciates to $90. Under the investment adjustment system, P's basis in the stock of T increases from $100 to $150 as a result of the gain recognized on the sale of asset 2 but is unaffected by the unrealized post-acquisition decline in the value of asset 1. On December 31, 1989, P sells all the stock of T for $90 and recognizes a $60 loss.

(ii) Although T incurred a $50 post-acquisition loss of built-in gain because of the decline in the value of asset 1, T also recognized $50 of built-in gain. Under paragraph (a)(2) of this section, any loss on the sale of stock is treated first as attributable to recognized built-in gain. Thus, for purposes of determining under paragraph (a)(2) of this section whether P's $60 loss on the disposition of the T stock is attributable to the recognition of built-in gain on the disposition of an asset, T's unrealized post-acquisition gain of $40 offsets $40 of the $50 of unrealized post-acquisition loss. Therefore, $50 of the $60 loss is attributable to the recognition of built-in gain on the disposition of an asset and is disallowed under paragraph (a)(1) of this section.

EXAMPLE (4). STACKING RULES -- BUILT-IN LOSS OFFSETS BUILT- IN GAIN. (i) P buys all the stock of T for $50 on February 1, 1987, and T becomes a member of the P group. T has 2 assets. Asset 1 has a basis of $50 and a value of $0, and asset 2 has a basis of $0 and a value of $50. During 1989, T sells asset 1 for $0 and asset 2 for $50, and reinvests the $50 proceeds in asset 3. The value of asset 3 declines to $40. Under the investment adjustment system, P's basis in the stock of T remains $50 as a result of the offsetting gain and loss recognized on the sale of assets 1 and 2 and is unaffected by the unrealized post- acquisition decline in the value of asset 3. On December 31, 1989, P sells all the stock of T for $40 and recognizes a $10 loss.

(ii) Although T recognized a $50 built-in gain on the sale of asset 2, T also recognized a $50 built-in loss on the sale of asset 1. For purposes of determining under paragraph (a)(2) of this section whether P's $10 loss on the disposition of the T stock is attributable to the recognition of built-in gain on the disposition of an asset, T's recognized built-in gain is offset by its recognized built-in loss. Thus none of P's $10 loss is attributable to the recognition of built-in gain on the disposition of an asset.

(iii) The result would be the same if, instead of a $50 built-in loss in asset 2, T has a $50 net operating loss carryover when P buys the T stock, and the net operating loss carryover is used to offset the built-in gain.

EXAMPLE (5). OUTSIDE BASIS PARTIALLY CORRESPONDS TO INSIDE BASIS. (i) Individual A owns all the stock of T, for which A has a basis of $60. On February 1, 1987, T owns 1 asset with a basis of $0 and a value of $100, P acquires all the stock of T from A in an exchange to which section 351 (a) applies, and T becomes a member of the P group. P has a carryover basis of $60 in the T stock. During 1988, T sells the asset and recognizes $100 of gain. Under the investment adjustment system, P's basis in the T stock increases from $60 to $160. T reinvests the $100 proceeds in another asset, which declines in value to $90. On January 1, 1989, P sells all the stock of T for $90 and recognizes a loss of $70.

(ii) Although P's basis in the T stock was increased by $100 as a result of the recognition of built-in gain on the disposition of T's asset, only $60 of the $70 loss on the sale of the stock is attributable under paragraph (a)(2) of this section to the recognition of built-in gain from the disposition of the asset. (Had T's asset not declined in value to $90, the T stock would have been sold for $100, and a $60 loss would have been attributable to the recognition of the built-in gain.) Therefore, $60 of the $70 loss is disallowed under paragraph (a)(2), and $10 is not disallowed if P satisfies the requirements of paragraph (a)(2). If P had sold the stock of T for $95 because T's other assets had unrealized appreciation of $5, $60 of the $65 loss would still be attributable to T's recognition of built-in gain on the disposition of assets.

EXAMPLE (6). CREEPING ACQUISITION. P owns 60 percent of the stock of S on January 6, 1987. On February 1, 1987, P buys an additional 20 percent of the stock of S, and S becomes a member of the P group. P sells all the S stock on March 1, 1989 and recognizes a loss of $100. All 80 percent of the stock of S owned by P is subject to the rules of this section and, under paragraph (a)(1) and (2) of this section, P is not allowed to deduct the $100 loss, except to the extent P establishes the loss is not attributable to the recognition by S of built-in gain on the disposition of assets.

EXAMPLE (7). EFFECT OF POST-ACQUISITION APPRECIATION. P buys all the stock of T for $100, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100. Under the investment adjustment system, P's basis in the T stock increases to $200. T reinvests the proceeds of the sale in an asset that appreciates in value to $180. Five years after the sale, P sells all the stock of T for $180 and recognizes a $20 loss. Under paragraph (a)(1) of this section, no deduction is allowed to P for the $20 loss.

EXAMPLE (8). DEFERRED LOSS AND RECOGNIZED GAIN. (i) P, the common parent of a group, owns 50 shares of the stock of T with an aggregate basis of $10, and S, a wholly owned subsidiary of P, recently purchased the remaining 50 shares of T stock in which it has an aggregate basis of $50. T has an asset with a basis of $40 and a value of $100. T sells the asset for $100. Under the investment adjustment system, P's basis in the T stock increases from $10 to $40, and S's basis in the T stock increases from $50 to $80. S sells its block of T stock to P for $50 in a deferred intercompany transaction, and S liquidates 2 years later. P subsequently sells all the stock of T for $100 to X, a member of the same controlled group (as defined in section 267(f)) as P but not a member of the P consolidated group.

(ii) Under paragraph (a)(3)(i) of this section, the application of paragraph (a)(1) of this section to S's $30 loss is deferred, because S's loss is deferred under section 1.1502-13(c) (determined without the application of any other provision of the Code or regulations that provides for disallowance or deferral of the loss).

(iii) S's deferred $30 loss is inherited by P under section 1.1502-13(c)(6) following the liquidation of S. When the T stock is sold to X (a member of the same controlled group but not a member of the P consolidated group), the inherited deferred $30 loss is taken into account under section 1.1502-13(f) and paragraph (a)(3) of this section. Under paragraph (a)(1) of this section, no deduction is allowed to P for the $30 loss.

(b) INDIRECT DISPOSITION OF TRANSITIONAL SUBSIDIARY -- (1) LOSS LIMITATION RULE FOR TRANSITIONAL PARENT. No deduction is allowed for any loss recognized by a member of a consolidated group with respect to the disposition of stock of a transitional parent.

(2) ALLOWABLE LOSS -- (i) IN GENERAL. Paragraph (b)(1) of this section does not apply to the extent the taxpayer establishes that the loss exceeds the amount that would be disallowed under paragraph (a) of this section if each highest tier transitional subsidiary's stock in which the transitional parent has a direct or indirect interest had been sold immediately before the disposition of the transitional parent's stock. In applying the preceding sentence, appropriate adjustments shall be made to take into account circumstances where less than all the stock of a transitional parent owned by members of a consolidated group is disposed of in the same transaction, or the stock of a transitional subsidiary or a transitional parent is directly owned by more than 1 member.

(ii) STATEMENT OF ALLOWABLE LOSS. Paragraph (b)(2)(i) of this section applies only if a separate statement entitled "ALLOWABLE LOSS UNDER SECTION 1.337(d)-1(b)" is filed with the taxpayer's return for the year of the stock disposition. If the separate statement is required to be filed with a return the due date (including extensions) of which is before January 16, 1991, or with a return due (including extensions) after January 15, 1991 but filed before that date, the statement may be filed with an amended return for the year of the disposition or with the taxpayer's first subsequent return the due date (including extensions) of which is after January 15, 1991.

(iii) CONTENTS OF STATEMENT. The statement required under paragraph (b)(2)(ii) of this section must contain --

(A) The name and employer identification number (E.I.N.) of the transitional parent.

(B) The basis of the stock of the transitional parent immediately before the disposition.

(C) The amount realized on the disposition.

(D) The amount of the deduction not disallowed under paragraph (b)(1) of this section by reason of this paragraph (b)(2).

(E) The amount of loss disallowed under paragraph (b)(1) of this section.

(3) COORDINATION WITH LOSS DEFERRAL RULES -- (i) SINGLE ENTITY TREATMENT OF DEFERRED INTERCOMPANY LOSS. If loss with respect to the disposition of a transitional parent's stock is deferred, paragraph (b)(1) of this section does not apply until the loss is taken into account. For this purpose, the amount of the loss deferred and when the loss is taken into account are determined under sections 1.1502-13, 1.1502-13T, 1.1502-14, and 1.1502-14T, without the application of any other provision of the Code or regulations such as section 267(f), that provides for disallowance or deferral of the loss.

(ii) OTHER LOSS DEFERRAL RULES. If paragraph (b)(1) of this section applies to a loss subject to deferral or disallowance under any other provision of the Code or the regulations, the other provision applies to the loss only to the extent it is not disallowed under paragraph (b)(1).

(4) DEFINITIONS. For purposes of this section --

(i) "Transitional parent" means any subsidiary, other than a transitional subsidiary, that owned at any time after January 6, 1987, a direct or indirect interest in the stock of a corporation that is a transitional subsidiary.

(ii) "Highest tier transitional subsidiary" means the transitional subsidiary (or subsidiaries) in which the transitional parent has a direct or indirect interest and that is the highest transitional subsidiary (or subsidiaries) in a chain of members.

(5) EXAMPLES. The principles of this paragraph (b) are illustrated by the following examples:

EXAMPLE (1). OWNERSHIP OF CHAIN OF TRANSITIONAL SUBSIDIARIES. (i) P forms S with $200 on January 1, 1985, and S becomes a member of the P group. On February 1, 1987, S buys all the stock of T, and T buys all the stock of T1, and both T and T1 become members of the P group. On January 1, 1989, P sells all the stock of S and recognizes a $90 loss on the sale.

(ii) Under paragraph (a)(4)(ii) of this section, both T and T1 are transitional subsidiaries, because they became members of the P group after January 6, 1987. Under paragraph (b)(4)(i) of this section, S is a transitional parent, because it owns a direct interest in stock of transitional subsidiaries and is not itself a transitional subsidiary.

(iii) Under paragraph (b)(1) and (2) of this section, because S is a transitional parent, no deduction is allowed to P for its $90 loss except to the extent the loss exceeds the amount of S's loss that would have been disallowed if S had sold all the stock of T, S's highest tier transitional subsidiary, immediately before P's sale of all the S stock. Assume all the T stock would have been sold for a $90 loss and that all the loss would be attributable to the recognition of built-in gain from the disposition of assets. Because in that case $90 of loss would be disallowed, all of P's loss on the sale of the S stock is disallowed under paragraph (b).

EXAMPLE (2). OWNERSHIP OF BROTHER-SISTER TRANSITIONAL SUBSIDIARIES. (i) P forms S with $200 on January 1, 1985, and S becomes a member of the p group. On February 1, 1987, S buys all the stock of both T and T1, and T and T1 become members of the P group. On January 1, 1988, P sells all the stock of S and recognizes a $90 loss on the sale.

(ii) Under paragraph (b)(1) and (2) of this section, no deduction is allowed to P for its $90 loss except to the extent P establishes that the loss exceeds the amount of S's stock losses that would be disallowed if S sold all the stock of T and T1, S's highest tier transitional subsidiaries, immediately before P's sale of all the S stock. Assume that all the T stock would have been sold for a $50 loss, all the T1 stock for a $40 loss, and that the entire amount of each loss would be attributable to the recognition of built-in gain on the disposition of assets. Because $90 of loss would be disallowed with respect to the sale of S's T and T1 stock, P's $90 loss on the sale of all the S stock is disallowed under paragraph (b).

(c) SUCCESSORS -- (1) GENERAL RULE. This section applies, to the extent necessary to effectuate the purposes of this section, to --

(i) Any property owned by a member or former member, the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis in a subsidiary's stock, and

(ii) Any property owned by any other person whose basis in the property is determined, directly or indirectly, in whole or in part, by reference to a member's (or former member's) basis in a subsidiary's stock.

(2) EXAMPLES. The principles of this paragraph (c) are illustrated by the following examples:

EXAMPLE (1). Merger into grandfathered subsidiary. P, the common parent of a group, owns all the stock of T, a transitional subsidiary. On January 1, 1989, T merges into S, a wholly owned subsidiary of P that is not a transitional subsidiary. Under paragraph (c)(1) of this section, all the stock of S is treated as stock of a transitional subsidiary. As a result, no deduction is allowed for any loss recognized by P on the disposition of any S stock, except to the extent the P group establishes under paragraph (a)(2) that the loss is not attributable to the recognition of built-in gain on the disposition of assets of T.

EXAMPLE (2). Nonrecognition exchange of transitional stock. (i) P, the common parent of a group, owns all the stock of T, a transitional subsidiary. On January 1, 1989, P transfers the stock of T to X, a corporation that is not a member of the P group, in exchange for 20 percent of its stock in a transaction to which section 351 (a) applies. T and X file separate returns.

(ii) Under paragraph (c)(1) of this section, all the stock of X owned by P is treated as stock of a transitional subsidiary because P's basis for the X stock is determined by reference to its basis for the T stock. As a result, no deduction is allowed to P for any loss recognized on the disposition of the X stock, except to the extent permitted under paragraph (a) of this section.

(iii) Under paragraph (c)(1), X is treated as a member subject to paragraph (a) of this section with respect to the T stock because X's basis for the stock is determined by reference to P's basis for the stock. Moreover, all of the T stock owned by X continues to be stock of a transitional subsidiary. As a result, no deduction is allowed to X for any loss recognized on the disposition of any T stock, except to the extent permitted under paragraph (a) of this section.

(d) INVESTMENT ADJUSTMENTS AND EARNINGS AND PROFITS -- (1) IN GENERAL. For purposes of determining investment adjustments under section 1.1502-32 and earnings and profits under section 1.1502-33(c) with respect to a member of a consolidated group that owns stock in a subsidiary, any deduction that is disallowed under this section is treated as a loss absorbed by the member in the tax year in which the disallowance occurs.

(2) EXAMPLE. (i) In 1986, P forms S with a contribution of $100, and S becomes a member of the P group. On February 1, 1987, S buys all the stock of T for $100. T has an asset with a basis of $0 and a value of $100. In 1988, T sells the asset for $100. Under the investment adjustment system, S's basis in the T stock increases to $200, P's basis in the S stock increases to $200, and P's earnings and profits and S's earnings and profits increase by $100. In 1989, S sells all of the T stock for $100, and S's recognized loss of $100 is disallowed under paragraph (a)(1) of this section.

(ii) Under paragraph (d)(1) of this section, S's earnings and profits for 1989 are reduced by $100, the amount of the loss disallowed under paragraph (a)(1). As a result, P's basis in the S stock is reduced from $200 to $100 under the investment adjustment system. P's earnings and profits for 1989 are correspondingly reduced by $100.

(e) EFFECTIVE DATES -- (1) GENERAL RULE. This section is effective November 19, 1990, and applies with respect to dispositions after January 6, 1987. After November 18, 1990, however, this section applies only if the stock was deconsolidated (as that term is defined in section 1.337(d)-2T(b)(2)) before November 19, 1990, and only to the extent the disposition is not subject to section 1.337(d)-2T.

(2) BINDING CONTRACT RULE. For purposes of this paragraph (e), if a corporation became a subsidiary pursuant to a binding written contract entered into before January 6, 1987, and in continuous effect until the corporation became a subsidiary, or a disposition was pursuant to a binding written contract entered into before March 9, 1990, and in continuous effect until the disposition, the date the contract became binding shall be treated as the date the corporation became a subsidiary or as the date of disposition.

Par. 5. New section 1.337(d)-2T is added to read as follows:

SECTION 1.337(d)-2T LOSS LIMITATION WINDOW PERIOD (TEMPORARY).

(a) LOSS DISALLOWANCE -- (1) GENERAL RULE. No deduction is allowed for any loss recognized by a member of a consolidated group with respect to the disposition of stock of a subsidiary.

(2) DEFINITIONS. For purposes of this section --(i) The definitions in section 1.1502-1 apply.

(ii) "Disposition" means any event in which gain or loss is recognized, in whole or in part.

(3) COORDINATION WITH LOSS DEFERRAL RULES -- (i) SINGLE ENTITY TREATMENT OF DEFERRED INTERCOMPANY LOSS. If loss with respect to the disposition of a subsidiary's stock is deferred, paragraph (a)(1) of this section does not apply until the loss is taken into account. For this purpose, the amount of the loss deferred and when the loss is taken into account are determined under sections 1.1502-13, 1.1502-13T, 1.1502-14 and 1.1502-14T, without the application of any other provision of the Code or regulations, such as section 267 (f), that provides for disallowance or deferral of the loss.

(ii) OTHER LOSS DEFERRAL RULES. If paragraph (a)(1) of this section applies to a loss subject to deferral or disallowance under any other provision of the Code or the regulations, the other provision applies to the loss only to the extent it is not disallowed under paragraph (a)(1).

(b) BASIS REDUCTION ON DECONSOLIDATION -- (1) GENERAL RULE. If the basis of a member of a consolidated group in a share of stock of a subsidiary exceeds its value immediately before a deconsolidation of the share, the basis of the share is reduced at that time to an amount equal to its value. If both a disposition and a deconsolidation occur with respect to a share in the same transaction, paragraph (a) of this section applies and, to the extent necessary to effectuate the purposes of this section, this paragraph (b) applies following the application of paragraph (a).

(2) DECONSOLIDATION. "Deconsolidation" means any event that causes a share of stock of a subsidiary that remains outstanding to be no longer owned by a member of any consolidated group of which the subsidiary is also a member.

(3) VALUE. "Value" means fair market value.

(4) LOSS WITHIN 2 YEARS AFTER BASIS REDUCTION -- (i) IN GENERAL. If the basis of a share of stock is reduced under this paragraph (b) and a direct or indirect disposition of the stock occurs within 2 years after the date of the basis reduction, a separate statement entitled "STATEMENT PURSUANT TO SECTION 1.337(d)-2T(b)(4)" must be filed with the taxpayer's return for the year of disposition. If the taxpayer fails to file the statement as required, no deduction is allowed for any loss recognized on the disposition. If the separate statement is required to be filed with a return the due date (including extensions) of which is before January 16, 1991, or with a return due (including extensions) after January 15, 1991 but filed before that date, the statement may be filed with an amended return for the year of the disposition or with the taxpayer's first subsequent return the due date (including extensions) of which is after January 15, 1991. A disposition after the 2-year period described in this paragraph (b)(4) that is pursuant to an agreement, option, or other arrangement entered into within the 2-year period is treated as a disposition within the 2-year period for purposes of this section.

(ii) CONTENTS OF STATEMENT. The statement required under paragraph (b)(4)(i) of this section must contain --

(A) The name and employer identification number (E.I.N.) of the subsidiary.

(B) The amount of prior basis reduction with respect to the stock of the subsidiary under paragraph (b)(1) of this section.

(C) The basis of the stock of the subsidiary immediately before the disposition.

(D) The amount realized on the disposition.

(E) The amount of the deduction not disallowed under paragraph (b)(4)(i) of this section.

(F) The amount of loss disallowed under paragraph (b)(4)(i) of this section.

(c) ALLOWABLE LOSS -- (1) APPLICATION. This paragraph (c) applies with respect to stock of a subsidiary only if --

(i) The consolidated group disposes (in one or more transactions), before the effective date of section 1.1502-20, of its entire equity interest in the subsidiary to persons not related to any member of the consolidated group within the meaning of sections 267(b) and 707(b)(1) (substituting "10 percent" for "50 percent" each place that it appears), and

(ii) A separate statement entitled "ALLOWED LOSS UNDER SECTION 1.337(d)-2T(c)" is filed in accordance with paragraph (c)(3) of this section.

(2) GENERAL RULE. Loss is not disallowed under paragraph (a)(1) of this section and basis is not reduced under paragraph (b)(1) of this section to the extent the taxpayer establishes that the loss or basis is not attributable to the recognition of built-in gain on the disposition of an asset (including stock and securities). Loss or basis may be attributable to the recognition of built-in gain on the disposition of an asset by a prior consolidated group. For purposes of this section, gain recognized by the consolidated group (or prior consolidated group) on the disposition of an asset is built-in gain to the extent attributable, directly or indirectly, in whole or in part, to any excess of value over basis attributable to a separate return year (as defined in section 1.1502-1(e)) with respect to the consolidated group (or prior consolidated group).

(3) CONTENTS OF STATEMENT AND TIME OF FILING. The statement required under paragraph (c)(1)(ii) of this section must be filed with the taxpayer's return for the year of the disposition or deconsolidation, and must contain --

(i) The name and employer identification number (E.I.N.) of the subsidiary.

(ii) The basis of the stock of the subsidiary immediately before the disposition or deconsolidation.

(iii) The amount realized on the disposition and the amount of fair market value on the deconsolidation.

(iv) The amount of the deduction not disallowed under paragraph (a)(1) of this section by reason of this paragraph (c) and the amount of basis not reduced under paragraph (b)(1) of this section by reason of this paragraph (c).

(v) The amount of loss disallowed under paragraph (a)(1) of this section and the amount of basis reduced under paragraph (b)(1) of this section. If the separate statement is required to be filed with a return the due date (including extensions) of which is before January 16, 1991, or with a return due (including extensions) after January 15, 1991 but filed before that date, the statement may be filed with an amended return for the year of the disposition or deconsolidation or with the taxpayer's first subsequent return the due date (including extensions) of which is after January 15, 1991.

(4) EXAMPLES. For purposes of the examples in this section, unless otherwise stated, the group files consolidated returns on a calendar year basis, the facts set forth the only corporate activity, and all sales and purchases are with unrelated buyers or sellers. The basis of each asset is the same for determining earnings and profits adjustments and taxable income. Tax liability and its effect on basis, value, and earnings and profits are disregarded. "Investment adjustment system" means the rules of sections 1.1502-32 and 1.1502-33(c). The principles of paragraphs (a), (b), and (c) of this section, such as the attribution of recognized gain to built-in gain, are illustrated by the examples in section 1.337(d)-1(a)(5) and by the examples in this paragraph (c)(4). For an example that treats a disposition after the 2-year period as being within the period, see paragraph (e)(3) of this section.

EXAMPLE (1). SIMULTANEOUS APPLICATION OF LOSS DISALLOWANCE RULE AND BASIS REDUCTION RULE TO STOCK OF THE SAME SUBSIDIARY. (i) P buys all the stock of T for $100 in 1985, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100 and recognizes built- in gain (i.e., gain that is attributable to a separate return year with respect to the group recognizing the gain). Under the investment adjustment system, P's basis in the T stock increases to $200. Five years later, P sells 60 shares of T stock for $60 and recognizes a $60 loss on the sale.

(ii) P's $60 loss on the sale of T stock is disallowed under paragraph (a)(1) of this section.

(iii) P's sale of 60 shares of T stock causes a deconsolidation of the remaining 40 shares held by P. Under paragraph (b)(1) of this section, P must reduce the basis of the 40 shares of T stock it continues to own from $80 to $40, the value of the shares immediately before the deconsolidation. Although P's disposition of the 60 shares also causes a deconsolidation of these shares, paragraph (b)(1) of this section provides that, if both paragraph (a) and paragraph (b) of this section apply to a share in the same transaction, paragraph (a) applies first and paragraph (b) applies only to the extent necessary to effectuate the purposes of this section. Under paragraph (a)(1), P's $60 loss on the sale of the 60 shares is disallowed. Under the facts of this example, it is not necessary to also apply paragraph (b) of this section to the 60 shares in order to effectuate the purposes of this section.

EXAMPLE (2). DECONSOLIDATION OF SUBSIDIARY STOCK ON CONTRIBUTION TO A PARTNERSHIP. (i) P buys all the stock of T for $100, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100. Under the investment adjustment system, P's basis in the T stock increases to $200. Five years later, P transfers all the stock of T to partnership M in exchange for a partnership interest in M, in a transaction to which section 721 applies.

(ii) At the time of the exchange, P's basis in the T stock is $200 and the T stock's value is $100. Under paragraph (b)(1) of this section, the transfer to M causes a deconsolidation of the T stock, and P must reduce its basis in the T stock, immediately before the transfer to M, from $200 to the stock's $100 value at that time. As a result, P has a basis of $100 in its interest in M, and M has a basis of $100 in the stock of T.

EXAMPLE (3). Simultaneous application of loss disallowance rule and basis reduction rule to stock of different subsidiaries. (i) P owns all the stock of S, which in turn owns all the stock of S1, and S and S1 are members of the P group. P's basis in the S stock is $100 and S's basis in the S1 stock is $100. S1 buys all the stock of T for $100, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100. Under the investment adjustment system, S1's basis in the T stock, S's basis in the S1 stock, and P's basis in the S stock each increase from $100 to $200. S then sells all the S1 stock for $100 and recognizes a loss of $100.

(ii) Under paragraph (a)(1) of this section, S's $100 loss on the sale of the S1 stock is disallowed.

(iii) If S1 and T are not members of a consolidated group immediately after the sale of the stock of S1, the T stock is deconsolidated, and under paragraph (b)(1) of this section, S1 must reduce the basis of the T stock to $100, its value immediately before the sale.

(iv) If S1 and T are members of a consolidated group immediately after the sale of the S1 stock, the T stock is not deconsolidated, and no reduction is required under paragraph (b)(1). However, if the new group sells the T stock and recognizes a $100 loss, the loss is disallowed, because under paragraph (c)(2) of this section the loss is attributable to T's recognition of built-in gain (i.e., gain attributable to a separate return year with respect to the group recognizing the gain).

EXAMPLE (4). LOSS OFFSETTING BUILT-IN GAIN IN A PRIOR GROUP. (i) P buys all the stock of T for $50 in Year 1, and T becomes a member of the P group. T has 2 assets. Asset 1 has a basis of $50 and a value of $0, and asset 2 has a basis of $0 and a value of $50. T sells asset 2 during Year 3 for $50, and recognizes a $50 gain. Under the investment adjustment system, P's basis in the T stock increases to $100 as a result of the recognition of gain. In year 5, all of the stock of P is acquired by the P1 group, and the former members of the P group become members of the P1 group. T then sells asset 1 for $0, and recognizes a $50 loss. Under the investment adjustment system, P's basis in the T stock decreases to $50 as a result of the loss. T's assets decline in value from $50 to $40. P then sells all the stock of T for $40 and recognizes a $10 loss.

(ii) P's cost basis on acquisition of the T stock reflects both T's unrecognized gain and unrecognized loss. The gain T recognizes on the disposition of asset 2 is attributable to the recognition of built-in gain with respect to both the P and the P1 groups for purposes of paragraph (c)(2) of this section. As with the recognized built-in gain, the built-in loss that was recognized in the P1 group before P's disposition of the T stock was attributable to a separate return year with respect to the P and P1 groups. T's recognition of the built-in loss while a member of the P1 group offset the effect of the recognition of the built-in gain on T's stock basis, even though the gain was recognized in the P group. Thus, under paragraph (c)(2), P's $10 loss on the sale of the T stock is not attributable to the recognition of built-in gain, and the loss is therefore not disallowed under paragraph (c)(2).

(iii) The result would be the same if when P buys the T stock, T has a $50 net operating loss carryover instead of a $50 built-in loss in asset 2, and the net operating loss carryover is used to offset the built-in gain.

(d) SUCCESSORS -- (1) GENERAL RULE. This section applies, to the extent necessary to effectuate the purposes of this section, to any property the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis of a subsidiary's stock.

(2) EXAMPLE. The principles of this paragraph (d) are illustrated by Example 1 in section 1.337(d)-1(c).

(e) ANTI-STUFFING RULE -- (1) APPLICATION. This paragraph (e) applies if --

(i) A transfer of any asset (including stock and securities) after March 8, 1990 is followed within 2 years by a direct or indirect disposition or a deconsolidation of stock, and

(ii) The transfer is with a view to avoiding, directly or indirectly, in whole or in part --

(A) The disallowance of loss on the disposition or the basis reduction on the deconsolidation of stock of a subsidiary, or

(B) The recognition of the unrealized gain on the transferred asset.

A disposition after the 2-year period described in this paragraph (e)(1) that is pursuant to an agreement, option, or other arrangement entered into within the 2-year period is treated as a disposition within the 2-year period for purposes of this section.

(2) BASIS REDUCTION. If this paragraph (e) applies, the basis of the stock is reduced, immediately before the disposition or deconsolidation, to cause recognition of gain in an amount equal to the loss disallowance or basis reduction, or the gain recognition, otherwise avoided by reason of the transfer.

(3) EXAMPLES. The principles of this paragraph (e) are illustrated by the following examples:

EXAMPLE (1). BASIC STUFFING CASE. (i) In Year 1, P buys all the stock of T for $100, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100. Under the investment adjustment system, P's basis in the T stock increases from $100 to $200. In Year 5, p transfers to T an asset with a basis of $0 and a value of $100 in a transaction to which section 351 applies, with the view described in paragraph (e)(1) of this section. In Year 6, P sells all the stock of T for $200.

(ii) Under paragraph (e)(2) of this section, P must reduce the basis in its T stock by $100 immediately before the sale. This basis reduction causes a $100 gain to be recognized on the sale.

(iii) The $100 basis reduction also would be required if the T stock is deconsolidated in Year 6 instead of being sold. P must reduce the basis in its T stock by $100 immediately before the deconsolidation.

(iv) The $100 basis reduction also would be required if the P stock were acquired at the beginning of Year 6 by the M group, even though the asset transfer took place outside the M group. Paragraph (e)(1) requires only that the transferor have the view at the time of the transfer.

EXAMPLE (2). STACKING RULES. (i) In Year 1, P buys all the stock of T for $100, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100. Under the investment adjustment system, P's basis in the T stock increases from $100 to $200. In Year 5, when the value of the T stock remains $100, P transfers to T an asset with a basis of $0 and a value of $100 in a transaction to which section 351 applies, with the view described in paragraph (e)(1) of this section. Thereafter, the value of the contributed asset declines to $10. In Year 6, P sells all the T stock for $110.

(ii) Because the transferred asset declined in value by $90, the transfer enabled P to avoid the disallowance of loss on the sale of T only to the extent of $10. Under paragraph (e)(2) of this section, P must reduce the basis in its T stock immediately before the sale to cause recognition of gain in an amount equal to the loss disallowance otherwise avoided by reason of the transfer. The amount of this basis reduction is $100, causing a $10 gain to be recognized on the sale.

(iii) Assume, instead, that the transferred asset does not decline in value and that T reinvests the $100 in proceeds from the asset sale in another asset that appreciates in value to $190. In Year 6, P sells T for $290. Because the new asset appreciated in value by $90, the transfer enabled P to avoid the disallowance of loss on the sale of T only to the extent of $10. Under paragraph (e)(2) of this section, P must reduce the basis in its T stock immediately before the sale to cause recognition of gain in an amount equal to the loss disallowance otherwise avoided by reason of the transfer. The amount of this basis reduction is $10, causing a $100 gain to be recognized on the sale.

EXAMPLE (3). CONTRIBUTION OF BUILT-IN LOSS ASSET. (i) In Year 1, P forms S with a contribution of $100 in exchange for all of S's stock, and S becomes a member of the P group. S buys an asset for $100, and the asset appreciates in value to $200. P then buys all the stock of T for $100, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100, and under the investment adjustment system P's basis in the T stock increases from $100 to $200. In Year 5, when the value of the T stock remains $100, P transfers the T stock to S in a transaction to which section 351 applies, with the view described in paragraph (e)(1) of this section. The transfer causes P's basis in the S stock to increase from $100 to $300 and the value of S to increase from $200 to $300. In Year 6, P sells the S stock for $300.

(ii) Under paragraph (e)(2) of this section, P must reduce the basis in its S stock immediately before the sale to cause recognition of gain in an amount equal to the gain recognition otherwise avoided by reason of the transfer. The amount of this basis reduction is $100, causing a $100 gain to be recognized on the sale.

EXAMPLE (4). ABSENCE OF VIEW. (i) In Year 1, P buys all the stock of T for $100, and T becomes a member of the P group. T has 2 assets, asset 1 with a basis of $50 and value of $100, and asset 2 with a basis of $50 and value of $0. T sells asset 1 for $100. Under the investment adjustment system, P's basis in the T stock increases from $100 to $150. In Year 5, T transfers asset 2 to P in a transaction to which section 1.1502-14(a) applies, with a view to having the group retain the loss inherent in the asset. This transfer reduces P's basis in the T stock from $150 to $100. In Year 6, P sells all the stock of T for $100.

(ii) The transfer from T to P achieves a result that could have been obtained by other methods that would not have been prevented by this section. The transfer therefore is not with the view described in paragraph (e)(1) of this section, P is not required to reduce the basis of its T stock under paragraph (e)(2) of this section. P is in substantially the same position holding asset 2 as it would be if T sold the asset and the resulting loss was available to the P group through T.

EXAMPLE (5). EXTENDING THE TIME PERIOD FOR DISPOSITIONS. (i) In Year 1, P buys all the stock of T for $100, and T becomes a member of the P group. T has an asset with a basis of $0 and a value of $100. T sells the asset for $100. Under the investment adjustment system, P's basis in the T stock increases from $100 to $200. At the beginning of Year 5, P transfers to T an asset with a basis of $0 and a value of $100 in a transaction to which section 351 applies, with the view described in paragraph (e)(1) of this section. Within 2 years, P agrees to sell all the stock of T for $200 at the end of Year 7.

(ii) Under paragraph (e)(1) of this section, P's disposition of the T stock at the end of Year 7 is treated as occurring within the 2-year period following P's transfer of the asset to T, because the disposition is pursuant to an agreement reached within 2 years after the transfer. Accordingly, under paragraph (e)(2) of this section, P must reduce the basis in its T stock by $100 immediately before the sale. This result is reached whether or not the agreement is in writing. P's disposition would also have been treated as occurring within the 2-year period if the disposition were pursuant to an option issued within the period.

(f) INVESTMENT ADJUSTMENTS AND EARNINGS AND PROFITS -- (1) EFFECT ON INVESTMENT ADJUSTMENTS AND EARNINGS AND PROFITS -- (i) GENERAL RULE. For purposes of determining investment adjustments under section 1.1502-32 and earnings and profits under section 1.1502-33(c) with respect to a member of a consolidated group that owns stock in a subsidiary, any deduction that is disallowed, or any amount by which basis is reduced, under this section is treated as a loss absorbed by the member in the tax year in which the disallowance or basis reduction occurs.

(ii) EXAMPLE. (A) In Year 1, P forms S with a contribution of $100, and S becomes a member of the P group. S buys all the stock of T for $100. T has an asset with a basis of $0 and a value of $100. In Year 2, T sells the asset for $100. Under the investment adjustment system, S's basis in the T stock increases to $200, and P's basis in the S stock increases to $200. In Year 6, S sells all the stock of T for $100, and S's recognized loss of $100 is disallowed under paragraph (a)(1) of this section.

(B) Under paragraph (f)(1) of this section, the earnings and profits of S for Year 6 are reduced by $100, the amount of the loss disallowed under paragraph (a)(1). P's basis in the S stock is reduced from $200 to $100 under the investment adjustment system. Correspondingly, P's earnings and profits for Year 6 are reduced by $100, the amount of the loss disallowed under paragraph (a)(1) of this section.

(2) COORDINATION RULES -- (i) ORDER OF ADJUSTMENTS. Deconsolidation of a share is treated as a disposition of the share for purposes of determining when investment adjustments are made to the share.

(ii) NO TIERING UP OF CERTAIN ADJUSTMENTS. If the basis of stock of a subsidiary owned by a member (the "owning member") is reduced under this section on the deconsolidation of the stock, no corresponding adjustment is made under section 1.1502-32 to the basis of the stock of the owning member (or any higher tier member) if a disposition or deconsolidation occurs in the same transaction with respect to all the stock of the owning member. In the case of a disposition or deconsolidation in the same transaction of less than all the stock of the owning member, appropriate adjustments shall be made under section 1.1502-32 with respect to the stock of the owning member (or any higher tier member).

(iii) EXAMPLE. (A) P, the common parent of a group, owns all the stock of S, S owns all the stock of Sl, and Sl owns all the stock of S2. P's basis in the S stock is $100, S's basis in the Sl stock is $100, and S1 basis in the S2 stock is $100. In Year 1, S2 buys T for $100. T has an asset with a basis of $0 and a value of $100. In Year 2, T sells the asset for $100. Under the investment adjustment system, the basis of each subsidiary's stock increases from $100 to $200. In Year 6, S sells all the stock of Sl for $100 to A, an individual, and recognizes a loss of $100. Sl, S2, and T are not members of a consolidated group immediately after the sale because the new Sl group does not file a consolidated return for its first taxable year.

(B) Under paragraph (a)(1) of this section, no deduction is allowed to S for its loss on the sale of the Sl stock. Under paragraph (f)(1) of this section, S's earnings and profits for Year 6 are reduced by the $100 loss that is disallowed. Correspondingly, under the investment adjustment system, S's reduction in earnings and profits causes a reduction in P's basis in the S stock, and a reduction in P's earnings and profits for Year 6.

(C) Under paragraph (b)(1) of this section, because the stock of T and S2 is deconsolidated, S2 must reduce the basis of the T stock from $200 to $100 (its value immediately before the deconsolidation), and Sl must reduce the basis of the S2 stock from $200 to $100 (its value immediately before the deconsolidation). Under paragraph (f)(1), S2's earnings and profits for Year 6 are reduced by the $100 reduction to the basis of the T stock, and S1's earnings and profits are reduced by the $100 reduction to the basis of the S2 stock. Under paragraph (f)(2)(ii) of this section, because the stock of S2 is deconsolidated in the same transaction, the basis reduction to the T stock does not cause any corresponding investment adjustment to the stock of S2, or to the stock of any higher tier subsidiary. Similarly, because the stock of S1 is disposed of in the same transaction, the reduction to the basis of the S2 stock does not cause an investment adjustment to the stock of S1, or the stock of any higher tier subsidiary.

(iv) BASIS REDUCTION TREATED AS INVESTMENT ADJUSTMENT. For purposes of the consolidated return regulations, the amount of any basis reduction to stock under this section is generally treated as a net negative adjustment under section 1.1502-32(e) (in addition to the adjustment otherwise required under section 1.1502-32(e)) with respect to the stock. The amount of the basis reduction is not treated as a net negative adjustment for purposes of section 1.1502-32T(a), however.

(g) EFFECTIVE DATES -- (1) GENERAL RULE. This section is effective (Insert date that is 30 days after date of publication in the Federal Register [we anticipate it to be November 21, 1990]). Except as otherwise provided in this paragraph (g), this section applies with respect to dispositions and deconsolidations after November 18, 1990, but only to the extent the disposition or deconsolidation is not subject to section 1.1502-20. For this purpose, dispositions deferred under sections 1.1502-13, 1.1502-13T, 1.1502-14, and 1.1502-14T are deemed to occur at the time the deferred gain or loss is taken into account unless the stock was deconsolidated before November 19, 1990. If stock of a subsidiary became worthless during a taxable year including November 19, 1990, the disposition with respect to the stock is treated as occurring on the date the stock became worthless.

(2) BINDING CONTRACT RULE. For purposes of this paragraph (g), if a disposition or deconsolidation is pursuant to a binding written contract entered into before March 9, 1990, and in continuous effect until the disposition or deconsolidation, the date the contract became binding is treated as the date of the disposition or deconsolidation.

Par. 6. New temporary section 1.267(f)-3T is added to read as follows:

SECTION 1.267(f)-3T DISPOSITION OR DECONSOLIDATION OF SUBSIDIARY STOCK (TEMPORARY).

For purposes of applying section 267(f)(2) to the sale or exchange of the stock of one member of a consolidated group by another member, see sections 1.337(d)-1(a) and 1.337(d)-2T(a). For purposes of this section, the definitions in section 1.1502-1 apply.

Par. 7. Paragraph (h)(2) of section 1.469-1T is revised to read as follows:

SECTION 1.469-1T GENERAL RULES (TEMPORARY).

* * * * *

(h) * * *

(2) DEFINITIONS. For purposes of this paragraph (h) --

(i) The terms "group," "consolidated group," "member," "subsidiary," and "consolidated return year" have the meanings set forth in section 1.1502-1; and

(ii) The term "consolidated taxable income" has the meaning set forth in section 1.1502-11.

* * * * *

Par. 8. The text of section 1.1502-1T is redesignated as section 1.1502-1(h) and the section heading is removed.

Par. 9. Paragraph (r) of section 1.1502-12 is revised to read as follows:

SECTION 1.1502-12 SEPARATE TAXABLE INCOME.

* * * * *

(r) For rules relating to loss disallowance or basis reduction on the disposition or deconsolidation of stock of a subsidiary, see sections 1.337(d)-1 and 1.337(d)-2T.

* * * * *

Par. 9A. Section 1.1502-20T is removed.

Par. 10. The last sentence of section 1.1502-32(a) is revised to read as follows:

SECTION 1.1502-32 INVESTMENT ADJUSTMENT.

* * * * *

(a) * * * For rules relating to loss disallowance or basis reduction on the disposition or deconsolidation of stock of a subsidiary, see sections 1.337(d)-1 and 1.337(d)-2T.

* * * * *

Par. 11. The last sentence of section 1.1502-33(c)(6) is revised to read as follows:

SECTION 1.1502-33 EARNINGS AND PROFITS.

* * * * *

(c) * * *

(6) * * * For rules relating to the effect on earnings and profits of loss disallowance or basis reduction on the disposition or deconsolidation of stock of a subsidiary, see sections 1.337(d)-1 and 1.337(d)-2T.

* * * * *

PART 602 -- [AMENDED]

Par. 13. The authority for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

SECTION 602.101 [Amended]

Par. 14. Section 602.101(c) is amended by inserting in the appropriate place in the table "Section 1.337(d)-1 * * * 1545-1160".

Par. 12. Section 1.1502-79 is amended by removing paragraph (a)(1)(iii).

* * * * *

NEED FOR TEMPORARY REGULATIONS

Because of the need to prevent circumvention of the repeal of the General Utilities doctrine, it is impracticable and contrary to the public interest to issue temporary regulation section 1.337(d)-2T with notice and public procedure under section 553(b) of title 5 of the United States Code, or subject to the effective date limitation of section 553(d) of title 5.