Final anti-loss importation regulations issued
Final rules address tax basis reductions on transfers of built-in loss property
TAX ALERT |
Anti-loss importation rules require tax basis reduction
The Treasury Department and the IRS have issued regulations under the ‘anti-loss importation’ rules of sections 362(e)(1) and 334(b)(1)(B) of the Internal Revenue Code. (T.D. 9759 (Mar. 28, 2016)). These rules may apply where an entity that is not subject to U.S. income tax transfers built-in loss property to a corporation that is.
If the transfer occurs in a tax-free capitalization, reorganization or liquidation transaction, the acquiring corporation must reduce the property’s tax basis to its fair market value (FMV). This basis adjustment prevents ‘importation’ of the built-in loss into the United States.
Framework of new regulations
Basis reduction is required only if the property has a built-in loss, which occurs if the aggregate tax basis of the importation property transferred exceeds its aggregate value. The regulations provide the framework for determining whether the basis reduction is required by defining importation property.
Property is importation property if the property’s transferor would not be subject to U.S. income tax on a hypothetical sale of the property, but the transferee would. For this purpose, the hypothetical sale would be subject to U.S. income tax if gain or loss would be taken into account in determining U.S. tax liability.
A U.S. corporation, for example, is subject to U.S. income tax. A foreign corporation generally is not subject to U.S. income tax unless it has income effectively connected with a U.S. trade or business. A U.S. tax-exempt entity is not considered subject to U.S. tax, except to the extent the property in question is debt-financed property that would be subject to unrelated business income tax if sold by the exempt entity.
Special rules apply to pass-through entities. Partnerships, grantor trusts and S corporations are subject to a look-through rule. They are considered subject to U.S. income tax if their gain or loss, passed through to their partners, grantors or shareholders, would be subject to U.S. income tax. For domestic trusts other than grantor trusts, estates, regulated investment companies, real estate investment trusts and cooperatives, the look-through rule only applies if the transfer was part of a plan to avoid the anti-loss importation provisions.
Tax basis, FMV and partnerships
If the aggregate tax basis of the importation property transferred to the acquiring corporation exceeds its aggregate FMV, the transaction is a loss importation transaction and the corporation receiving the property in the tax-free capitalization, reorganization or liquidation must reduce the property’s tax basis to its FMV. To do this, the acquiring corporation must adjust the tax basis of each item of importation property so that it will equal the FMV. The basis of some items of property will be decreased, and the basis of others may be increased. Overall, the result will be a decrease in basis equal to the aggregate built-in loss. When determining the FMV of a partnership interest, special valuation rules apply under these regulations.
Partnership transfers may raise a number of complex issues in a loss importation context. Treasury and the IRS intend to address some that result from interaction of the loss importation rules and the basis adjustment rules applicable to partnership built-in loss property under section 704(c)(1)(C) in regulations they plan to issue in the future.
These regulations generally apply to transactions occurring on or after March 28, 2016 (the effective date), except for transactions completed pursuant to a binding agreement in effect before the effective date. They also apply to transactions occurring before the effective date in instances where an entity classification election is filed after March 28, 2016. In addition, taxpayers may choose to apply these regulations to any transaction occurring after Oct. 22, 2004 (the effective date of sections 362(e) and 334(b)(1)(B)).