[Federal Register Volume 61, Number 198 (Thursday, October 10, 1996)]
[Rules and Regulations]
[Pages 53062-53066]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-25945]
[[Page 53062]]
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DEPARTMENT OF THE TREASURY
26 CFR Parts 1 and 602
[TD 8684]
RIN 1545-AM98
Treatment of Gain From the Disposition of Interest in Certain
Natural Resource Recapture Property by S Corporations and Their
Shareholders
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the tax
treatment by S corporations and their shareholders of gain from the
disposition by an S corporation (and a corporation that was formerly an
S corporation) of certain natural resource recapture property (section
1254 property after enactment of the Tax Reform Act of 1986 and oil,
gas, or geothermal property before enactment of the Tax Reform Act of
1986), and also rules relating to the disposition of stock in an S
corporation that holds certain natural resource recapture property.
Changes to the applicable tax law were made by the Tax Reform Act of
1986, and the Subchapter S Revision Act of 1982. The regulations
provide the public with guidance in complying with the changed tax
laws.
EFFECTIVE DATE: October 10, 1996.
FOR FURTHER INFORMATION CONTACT: James A. Quinn, 202-622-3060 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1493. This information is required by the IRS to
establish that a portion of the gain recognized upon a sale or exchange
of S corporation stock is not attributable to a shareholder's section
1254 costs so as to qualify for the exception contained in Sec. 1.1254-
4(c)(2)(i)(A).
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated annual burden per respondent varies from .5 hour to
1.5 hours, depending on individual circumstances, with an estimated
average of 1 hour.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,
DC 20224, and to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
Books or records relating to this collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
On December 21, 1995, the IRS published in the Federal Register a
notice of proposed rulemaking (60 FR 66238) providing rules for
applying the provisions of section 1254 to the disposition of natural
resource recapture property by an S corporation (and a corporation that
was formerly an S corporation) and the disposition of S corporation
stock. No written comments responding to this notice were received. No
public hearing was held because no hearing was requested. The proposed
regulations are adopted without any substantive change by this Treasury
decision. However, in the course of preparing the final regulations for
publication, the IRS and Treasury Department have determined that
Secs. 1.1254-2 and 1.1254-3 are in need of minor technical
clarifications. Accordingly, Secs. 1.1254-2 and 1.1254-3 are clarified
as discussed below.
Clarification of Secs. 1.1254-2 and 1.1254-3
Section 1.1254-2(d)(1) is amended to state that Sec. 1.1254-2(d)(1)
is applied without regard to Sec. 1.1254-1(b)(2)(vii). This amendment
clarifies that section 1254 costs must be recaptured in a like-kind
exchange or involuntary conversion that involves the acquisition of
property that is not natural resource recapture property. The amendment
makes clear that the treatment of like- kind exchanges and involuntary
conversions involving natural resource recapture property is similar to
the treatment of these transactions involving section 1245 property.
See Secs. 1.1245-3(a)(3), 1.1245-4(d)(1), 1.1245-4(d)(2), Example 2,
and 1.1245-5(a)(2), Example.
Section 1.1254-3(b)(1) provides that if natural resource recapture
property is transferred in certain transactions the amount of section
1254 costs with respect to the property in the hands of the transferee
equals the amount of section 1254 costs with respect to the property in
the hands of the transferor minus the amount of any gain taken into
account as ordinary income under section 1254(a)(1) by the transferor
upon the disposition. The intent of this rule is that in these
transactions the section 1254 costs with respect to the property are to
be transferred to the transferee but reduced by any gain taken into
account as ordinary income. However, in the case of an S corporation or
partnership transferor, the section 1254 costs have generally been
allocated among the shareholders or partners. Consequently,
Sec. 1.1254-3(b)(1) is clarified to provide that in the case of an S
corporation transferor the section 1254 costs include the section 1254
costs of the shareholders minus any gain taken into account by the
shareholders as ordinary income. A similar clarification is added for
partnership transferors.
Similarly, Sec. 1.1254-3(d) is clarified for like-kind exchanges
and involuntary conversions to provide that in the case of an S
corporation the section 1254 costs include the section 1254 costs of
the shareholders minus any gain taken into account by the shareholders
as ordinary income. A similar clarification is added for a partnership.
Effective Date
Section 1.1254-4 applies to dispositions of natural resource
recapture property by an S corporation (and a corporation that was
formerly an S corporation) and dispositions of S corporation stock
occurring on or after October 10, 1996. The clarifications to
Secs. 1.1254-2 and 1.1254-3 are effective for dispositions of property
occurring on or after October 10, 1996.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking preceding the regulations was issued prior to March 29,
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Small
Business Administration for comment on its impact on small business.
Drafting Information
The principal author of these regulations is James A. Quinn of the
[[Page 53063]]
Office of Assistant Chief Counsel (Passthroughs and Special
Industries), IRS. However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * * Section 1.1254-4 also issued
under 26 U.S.C. 1254(b). * * *
Par. 2. Section 1.1254-0 is amended by revising the entry for
Sec. 1.1254-4 to read as follows:
Sec. 1.1254-0 Table of contents for section 1254 recapture rules.
* * * * *
Sec. 1.1254-4 Special rules for S corporations and their
shareholders.
(a) In general.
(b) Determination of gain treated as ordinary income under
section 1254 upon a disposition of natural resource recapture
property by an S corporation.
(1) General rule.
(2) Examples.
(c) Character of gain recognized by a shareholder upon a sale or
exchange of S corporation stock.
(1) General rule.
(2) Exceptions.
(3) Examples.
(d) Section 1254 costs of a shareholder.
(e) Section 1254 costs of an acquiring shareholder after certain
acquisitions.
(1) Basis determined under section 1012.
(2) Basis determined under section 1014(a).
(3) Basis determined under section 1014(b)(9).
(4) Gifts and section 1041 transfers.
(f) Special rules for a corporation that was formerly an S
corporation or formerly a C corporation.
(1) Section 1254 costs of an S corporation that was formerly a C
corporation.
(2) Examples.
(3) Section 1254 costs of a C corporation that was formerly an S
corporation.
(g) Determination of a shareholder's section 1254 costs upon
certain stock transactions
(1) Issuance of stock.
(2) Natural resource recapture property acquired in exchange for
stock.
(3) Treatment of nonvested stock.
(4) Exception.
(5) Aggregate of S corporation shareholders' section 1254 costs
with respect to natural resource recapture property held by the S
corporation
(6) Examples.
* * * * *
Par. 3. Section 1.1254-2 is amended by revising paragraph
(d)(1)(ii) to read as follows:
Sec. 1.1254-2 Exceptions and limitations.
* * * * *
(d) * * * (1) * * *
(ii) The fair market value of property acquired that is not natural
resource recapture property (determined without regard to Sec. 1.1254-
1(b)(2)(vii)) and is not taken into account under paragraph (d)(1)(i)
of this section (that is, qualifying property under section 1031 or
1033 that is not natural resource recapture property).
* * * * *
Par. 4. Section 1.1254-3 is amended by revising paragraphs
(b)(1)(i), (b)(1)(ii), (d)(1)(i) and (d)(1)(ii) to read as follows:
Sec. 1.1254-3 Section 1254 costs immediately after certain
acquisitions.
* * * * *
(b) * * * (1) * * *
(i) The amount of section 1254 costs with respect to the natural
resource recapture property in the hands of the transferor immediately
before the disposition (and in the case of an S corporation or
partnership transferor, the section 1254 costs of the shareholders or
partners with respect to the natural resource recapture property);
minus
(ii) The amount of any gain taken into account as ordinary income
under section 1254(a)(1) by the transferor upon the disposition (and in
the case of an S corporation or partnership transferor, any such gain
taken into account as ordinary income by the shareholders or partners).
* * * * *
(d) * * *
(1) * * *
(i) The amount of section 1254 costs with respect to the natural
resource recapture property disposed of (including the section 1254
costs of the shareholders of an S corporation or of the partners of a
partnership with respect to the natural resource recapture property);
minus
(ii) The amount of any gain taken into account as ordinary income
under section 1254(a)(1) by the transferor upon the disposition (and in
the case of an S corporation or partnership transferor, any such gain
taken into account as ordinary income by the shareholders or partners).
* * * * *
Par. 5. Section 1.1254-4 is amended by adding text to read as
follows:
Sec. 1.1254-4 Special rules for S corporations and their shareholders.
(a) In general. This section provides rules for applying the
provisions of section 1254 to S corporations and their shareholders
upon the disposition by an S corporation (and a corporation that was
formerly an S corporation) of natural resource recapture property and
upon the disposition by a shareholder of stock of an S corporation that
holds natural resource recapture property.
(b) Determination of gain treated as ordinary income under section
1254 upon a disposition of natural resource recapture property by an S
corporation--(1) General rule. Upon a disposition of natural resource
recapture property by an S corporation, the amount of gain treated as
ordinary income under section 1254 is determined at the shareholder
level. Each shareholder must recognize as ordinary income under section
1254 the lesser of--
(i) The shareholder's section 1254 costs with respect to the
property disposed of; or
(ii) The shareholder's share of the amount, if any, by which the
amount realized on the sale, exchange, or involuntary conversion, or
the fair market value of the property upon any other disposition
(including a distribution), exceeds the adjusted basis of the property.
(2) Examples. The following examples illustrate the provisions of
paragraph (b)(1) of this section:
Example 1. Disposition of natural resource recapture property
other than oil and gas property. A and B are equal shareholders in
X, an S corporation. On January 1, 1997, X acquires for $90,000 an
undeveloped mineral property, its sole property. During 1997, X
expends and deducts $100,000 in developing the property. On January
15, 1998, X sells the property for $250,000 when X's basis in the
property is $90,000. Thus, X recognizes gain of $160,000 on the
sale. A and B's share of the $160,000 gain recognized is $80,000
each. Each shareholder has $50,000 of section 1254 costs with
respect to the property. Under these circumstances, A and B each are
required to recognize $50,000 of the $80,000 of gain on the sale of
the property as ordinary income under section 1254.
Example 2. Disposition of oil and gas property the adjusted
basis of which is allocated to the shareholders under section
613A(c)(11). C and D are equal shareholders in Y, an S corporation.
On January 1, 1997, Y acquires for $150,000 an undeveloped oil and
gas property, its sole property. During 1997, Y expends in
developing the property
[[Page 53064]]
$40,000 in intangible drilling costs which it elects to expense
under section 263(c). On January 15, 1998, Y sells the property for
$200,000. C and D's share of the $200,000 amount realized on the
sale is $100,000 each. C and D each have a basis of $75,000 in the
property and $20,000 of section 1254 costs with respect to the
property. Under these circumstances, C and D each are required to
recognize $20,000 of the $25,000 gain on the sale of the property as
ordinary income under section 1254.
(c) Character of gain recognized by a shareholder upon a sale or
exchange of S corporation stock--(1) General rule. Except as provided
in paragraph (c)(2) of this section, if an S corporation shareholder
recognizes gain upon a sale or exchange of stock in the S corporation
(determined without regard to section 1254), the gain is treated as
ordinary income under section 1254 to the extent of the shareholder's
section 1254 costs (with respect to the shares sold or exchanged).
(2) Exceptions--(i) Gain not attributable to section 1254 costs--
(A) General rule. Paragraph (c)(1) of this section does not apply to
any portion of the gain recognized on the sale or exchange of the stock
that the taxpayer establishes is not attributable to section 1254
costs. The portion of the gain recognized that is not attributable to
section 1254 costs is that portion of the gain recognized that exceeds
the amount of ordinary income that the shareholder would have
recognized under section 1254 (with respect to the shares sold or
exchanged) if, immediately prior to the sale or exchange of the stock,
the corporation had sold at fair market value all of the corporation's
property the disposition of which would result in the recognition by
the shareholder of ordinary income under section 1254.
(B) Substantiation. To establish that a portion of the gain
recognized is not attributable to a shareholder's section 1254 costs so
as to qualify for the exception contained in paragraph (c)(2)(i)(A) of
this section, the shareholder must attach to the shareholder's tax
return a statement detailing the shareholder's share of the fair market
value and basis, and the shareholder's section 1254 costs, for each of
the S corporation's natural resource recapture properties held
immediately before the sale or exchange of stock.
(ii) Transactions entered into as part of a plan to avoid
recognition of ordinary income under section 1254. In the case of a
contribution of property prior to a sale or exchange of stock pursuant
to a plan a principal purpose of which is to avoid recognition of
ordinary income under section 1254, paragraph (c)(1) of this section
does not apply. Instead, the amount recognized as ordinary income under
section 1254 is the amount of ordinary income the selling or exchanging
shareholder would have recognized under section 1254 (with respect to
the shares sold or exchanged) had the S corporation sold its natural
resource recapture property the disposition of which would have
resulted in the recognition of ordinary income under section 1254. The
amount recognized as ordinary income under the preceding sentence
reduces the amount realized on the sale or exchange of the stock.
This reduced amount realized is used in determining any gain or
loss on the sale or exchange.
(3) Examples. The following examples illustrate the provisions of
this paragraph (c):
Example 1. Application of general rule upon a sale of S
corporation stock. C and D are equal shareholders in Y, an S
corporation. As of January 1, 1997, Y holds two mining properties:
Blackacre, with an adjusted basis of $5,000 and a fair market value
of $35,000, and Whiteacre, with an adjusted basis of $20,000 and a
fair market value of $15,000. Y also holds securities with a basis
of $5,000 and a fair market value of $10,000. On January 1, 1997, D
sells 50 percent of D's Y stock to E for $15,000. As of the date of
the sale, D's adjusted basis in the Y stock sold is $7,500, and D
has $18,000 of section 1254 costs with respect to Blackacre and
$12,000 of section 1254 costs with respect to Whiteacre. Under this
paragraph (c), the gain recognized by D upon the sale of Y stock is
treated as ordinary income to the extent of D's section 1254 costs
with respect to the stock sold, unless D establishes that a portion
of such excess is not attributable to D's section 1254 costs.
However, because D would recognize $7,500 in ordinary income under
section 1254 with respect to the stock sold if Y sold Blackacre (the
only asset the disposition of which would result in ordinary income
to D under section 1254), the $7,500 of gain recognized by D upon
the sale of D's Y stock is attributable to D's section 1254 costs.
Therefore, upon the sale of stock to E, D recognizes $7,500 of
ordinary income under this paragraph (c).
Example 2. Sale of S corporation stock where gain is not
entirely attributable to section 1254 costs. Assume the same facts
as in Example 1, except that Blackacre has a fair market value of
$25,000, and the securities have a fair market value of $20,000.
Immediately prior to the sale of stock to E, if Y had sold Blackacre
(its only asset the disposition of which would result in the
recognition of ordinary income to D under section 1254), D would
recognize $5,000 in ordinary income with respect to the stock sold
under section 1254. D attaches a statement to D's tax return for
1997 detailing D's share of the fair market values and bases, and
D's section 1254 costs with respect to Blackacre and Whiteacre.
Therefore, upon the sale of stock to E, of the $7,500 gain
recognized by D, $5,000 is ordinary income under this paragraph (c).
Example 3. Contribution of property prior to sale of S
corporation stock as part of a plan to avoid recognition of ordinary
income under section 1254. H owns all of the stock of Z, an S
corporation. As of January 1, 1997, H has $3,000 of section 1254
costs with respect to property P, which is natural resource
recapture property and Z's only asset. Property P has an adjusted
basis of $5,000 and a fair market value of $8,000. H has a basis of
$5,000 in Z stock, which has a fair market value of $8,000. On
January 1, 1997, H contributes securities to Z which have a basis of
$7,000 and a fair market value of $4,000. On April 15, 1997, H sells
all of the Z stock to J for $12,000. On that date, H's adjusted
basis in the Z stock is also $12,000. Based on all the facts and
circumstances, the sale of stock is part of a plan (along with the
contribution by H of the securities to Z) that has a principal
purpose to avoid recognition of ordinary income under section 1254.
Consequently, under paragraph (c)(2)(ii) of this section, H must
recognize $3,000 as ordinary income under section 1254, the amount
of ordinary income that H would recognize as ordinary income under
section 1254 if property P were sold at fair market value. In
addition, H reduces the amount realized on the sale of the stock
($12,000) by $3,000. As a result, H also recognizes a $3,000 capital
loss on the sale of the stock ($9,000 amount realized less $12,000
adjusted basis).
(d) Section 1254 costs of a shareholder. An S corporation
shareholder's section 1254 costs with respect to any natural resource
recapture property held by the corporation include all of the
shareholder's section 1254 costs with respect to the property in the
hands of the S corporation. See Sec. 1.1254-1(b)(1) for the definition
of section 1254 costs.
(e) Section 1254 costs of an acquiring shareholder after certain
acquisitions--(1) Basis determined under section 1012. If stock in an S
corporation that holds natural resource recapture property is acquired
and the acquiring shareholder's basis for the stock is determined
solely by reference to its cost (within the meaning of section 1012),
the amount of section 1254 costs with respect to the property held by
the corporation in the acquiring shareholder's hands is zero on the
acquisition date.
(2) Basis determined under section 1014(a). If stock in an S
corporation that holds natural resource recapture property is acquired
from a decedent and the acquiring shareholder's basis is determined, by
reason of the application of section 1014(a), solely by reference to
the fair market value of the stock on the date of the decedent's death
or on the applicable date provided in section 2032 (relating to
alternate valuation date), the amount of section 1254 costs
[[Page 53065]]
with respect to the property held by the corporation in the acquiring
shareholder's hands is zero on the acquisition date.
(3) Basis determined under section 1014(b)(9). If stock in an S
corporation that holds natural resource recapture property is acquired
before the death of the decedent, the amount of section 1254 costs with
respect to the property held by the corporation in the acquiring
shareholder's hands includes the amount, if any, of the section 1254
costs deducted by the acquiring shareholder before the decedent's
death, to the extent that the basis of the stock (determined under
section 1014(a)) is required to be reduced under section 1014(b)(9)
(relating to adjustments to basis when the property is acquired before
the death of the decedent).
(4) Gifts and section 1041 transfers. If stock is acquired in a
transfer that is a gift, in a transfer that is a part sale or exchange
and part gift, or in a transfer that is described in section 1041(a),
the amount of section 1254 costs with respect to the property held by
the corporation in the acquiring shareholder's hands immediately after
the transfer is an amount equal to--
(i) The amount of section 1254 costs with respect to the property
held by the corporation in the hands of the transferor immediately
before the transfer; minus
(ii) The amount of any gain recognized as ordinary income under
section 1254 by the transferor upon the transfer.
(f) Special rules for a corporation that was formerly an S
corporation or formerly a C corporation--(1) Section 1254 costs of an S
corporation that was formerly a C corporation. In the case of a C
corporation that holds natural resource recapture property and that
elects to be an S corporation, each shareholder's section 1254 costs as
of the beginning of the corporation's first taxable year as an S
corporation include a pro rata share of the section 1254 costs of the
corporation as of the close of the last taxable year that the
corporation was a C corporation.
(2) Examples. The following examples illustrate the application of
the provisions of paragraph (f)(1) of this section:
Example 1. Sale of natural resource recapture property held by
an S corporation that was formerly a C corporation--(i) Y is a C
corporation that elects to be an S corporation effective January 1,
1997. On that date, Y owns Oil Well, which is natural resource
recapture property and a capital asset. Y has section 1254 costs of
$20,000 as of the close of the last taxable year that it was a C
corporation. On January 1, 1997, Oil Well has a value of $200,000
and a basis of $100,000. Thus, under section 1374, Y's net
unrealized built-in gain is $100,000. Also on that date, Y's basis
in Oil Well is allocated to A, Y's sole shareholder, under section
613A(c)(11) and the section 1254 costs are allocated to A under
paragraph (f)(1) of this section. In addition, A has a basis in A's
Y stock of $100,000.
(ii) On November 1, 1997, Y sells Oil Well for $250,000. During
1997, Y has taxable income greater than $100,000, and no other
transactions or items treated as recognized built-in gain or loss.
Under section 1374, Y has net recognized built-in gain of $100,000.
Assuming a tax rate of 35 percent on capital gain, Y has a tax of
$35,000 under section 1374. The tax of $35,000 is treated as a
capital loss under section 1366(f)(2). A has a realized gain on the
sale of $150,000 ($250,000 minus $100,000) of which $20,000 is
recognized as ordinary income under section 1254, and $130,000 is
recognized as capital gain. Consequently, A recognizes ordinary
income of $20,000 and net capital gain of $95,000 ($130,000 minus
$35,000) on the sale.
Example 2. Sale of stock followed by sale of natural resource
recapture property held by an S corporation that was formerly a C
corporation--(i) Assume the same facts as in Example 1(i). On
November 1, 1997, A sells all of A's Y stock to P for $250,000. A
has a realized gain on the sale of $150,000 ($250,000 minus
$100,000) of which $20,000 is recognized as ordinary income under
section 1254, and $130,000 is recognized as capital gain.
(ii) On November 2, 1997, Y sells Oil Well for $250,000. During
1997, Y has taxable income greater than $100,000, and no other
transactions or items treated as recognized built-in gain or loss.
Under section 1374, Y has net recognized built-in gain of $100,000.
Assuming a tax rate of 35 percent on capital gain, Y has a tax of
$35,000 under section 1374. The tax of $35,000 is treated as a
capital loss under section 1366(f)(2). P has a realized gain on the
sale of $150,000 ($250,000 minus $100,000), which is recognized as
capital gain. Consequently, P recognizes net capital gain of
$115,000 ($150,000 minus $35,000) on the sale.
(3) Section 1254 costs of a C corporation that was formerly an S
corporation. In the case of an S corporation that becomes a C
corporation, the C corporation's section 1254 costs with respect to any
natural resource recapture property held by the corporation as of the
beginning of the corporation's first taxable year as a C corporation
include the sum of its shareholders' section 1254 costs with respect to
the property as of the close of the last taxable year that the
corporation was an S corporation. In the case of an S termination year
as defined in section 1362(e)(4), the shareholders' section 1254 costs
are determined as of the close of the S short year as defined in
section 1362(e)(1)(A). See paragraph (g)(5) of this section for rules
on determining the aggregate amount of the shareholders' section 1254
costs.
(g) Determination of a shareholder's section 1254 costs upon
certain stock transactions--(1) Issuance of stock. Upon an issuance of
stock (whether such stock is newly-issued or had been held as treasury
stock) by an S corporation in a reorganization described in section 368
or otherwise--
(i) Each recipient of shares must be allocated a pro rata share
(determined solely with respect to the shares issued in the
transaction) of the aggregate of the S corporation shareholders'
section 1254 costs with respect to natural resource recapture property
held by the S corporation immediately before the issuance (as
determined pursuant to paragraph (g)(5) of this section); and
(ii) Each pre-existing shareholder must reduce his or her section
1254 costs with respect to natural resource recapture property held by
the S corporation immediately before the issuance by an amount equal to
the pre-existing shareholder's section 1254 costs immediately before
the issuance multiplied by the percentage of stock of the corporation
issued in the transaction.
(2) Natural resource recapture property acquired in exchange for
stock. If natural resource recapture property is transferred to an S
corporation in exchange for stock of the S corporation (for example, in
a section 351 transaction, or in a reorganization described in section
368), the S corporation must allocate to its shareholders a pro rata
share of the S corporation's section 1254 costs with respect to the
property immediately after the transaction (as determined under
Sec. 1.1254-3(b)(1)).
(3) Treatment of nonvested stock. Stock issued in connection with
the performance of services that is substantially nonvested (within the
meaning of Sec. 1.83-3(b)) is treated as issued for purposes of this
section at the first time it is treated as outstanding stock of the S
corporation for purposes of section 1361.
(4) Exception. Paragraph (g)(1) of this section does not apply to
stock issued in exchange for stock of the same S corporation (as for
example, in a recapitalization described in section 368(a)(1)(E)).
(5) Aggregate of S corporation shareholders' section 1254 costs
with respect to natural resource recapture property held by the S
corporation--(i) In general. The aggregate of S corporation
shareholders' section 1254 costs is equal to the sum of each
shareholder's section 1254 costs. The S corporation must determine each
[[Page 53066]]
shareholder's section 1254 costs under either paragraph (g)(5)(ii)
(written data) or paragraph (g)(5)(iii) (assumptions) of this section.
The S corporation may determine the section 1254 costs of some
shareholders under paragraph (g)(5)(ii) of this section and of others
under paragraph (g)(5)(iii) of this section.
(ii) Written data. An S corporation may determine a shareholder's
section 1254 costs by using written data provided by a shareholder
showing the shareholder's section 1254 costs with respect to natural
resource recapture property held by the S corporation unless the S
corporation knows or has reason to know that the written data is
inaccurate. If an S corporation does not receive written data upon
which it may rely, the S corporation must use the assumptions provided
in paragraph (g)(5)(iii) of this section in determining a shareholder's
section 1254 costs.
(iii) Assumptions. An S corporation that does not use written data
pursuant to paragraph (g)(5)(ii) of this section to determine a
shareholder's section 1254 costs must use the following assumptions to
determine the shareholder's section 1254 costs--
(A) The shareholder deducted his or her share of the amount of
deductions under sections 263(c), 616, and 617 in the first year in
which the shareholder could claim a deduction for such amounts, unless
in the case of expenditures under sections 263(c) or 616 the S
corporation elected to capitalize such amounts;
(B) The shareholder was not subject to the following limitations
with respect to the shareholder's depletion allowance under section
611, except to the extent a limitation applied at the corporate level:
the taxable income limitation of section 613(a); the depletable
quantity limitations of section 613A(c); or the limitations of sections
613A(d)(2), (3), and (4) (exclusion of retailers and refiners).
(6) Examples. The following examples illustrate the provisions of
this paragraph (g):
Example 1. Transfer of natural resource recapture property to an
S corporation in a section 351 transaction. As of January 1, 1997, A
owns all the stock (20 shares) in X, an S corporation. X holds
property that is not natural resource recapture property that has a
fair market value of $2,000 and an adjusted basis of $2,000. On
January 1, 1997, B transfers natural resource recapture property,
Property P, to X in exchange for 80 shares of X stock in a
transaction that qualifies under section 351. Property P has a fair
market value of $8,000 and an adjusted basis of $5,000. Pursuant to
section 351, B does not recognize gain on the transaction.
Immediately prior to the transaction, B's section 1254 costs with
respect to Property P equaled $6,000. Under Sec. 1.1254-2(c)(1), B
does not recognize any gain under section 1254 on the section 351
transaction and, under Sec. 1.1254-3(b)(1), X's section 1254 costs
with respect to Property P immediately after the contribution equal
$6,000. Under paragraph (g)(2) of this section, each shareholder is
allocated a pro rata share of X's section 1254 costs. The pro rata
share of X's section 1254 costs that is allocated to A equals $1,200
(20 percent interest in X multiplied by X's $6,000 of section 1254
costs). The pro rata share of X's section 1254 costs that is
allocated to B equals $4,800 (80 percent interest in X multiplied by
X's $6,000 of section 1254 costs).
Example 2. Contribution of money in exchange for stock of an S
corporation holding natural resource recapture property. As of
January 1, 1997, A and B each own 50 percent of the stock (50 shares
each) in X, an S corporation. X holds natural resource recapture
property, Property P, which has a fair market value of $20,000 and
an adjusted basis of $14,000. A's and B's section 1254 costs with
respect to Property P are $4,000 and $1,500, respectively. On
January 1, 1997, C contributes $20,000 to X in exchange for 100
shares of X's stock. Under paragraph (g)(1)(i) of this section, X
must allocate to C a pro rata share of its shareholders' section
1254 costs. Using the assumptions set forth in paragraph (g)(5)(iii)
of this section, X determines that A's section 1254 costs with
respect to natural resource recapture property held by X equal
$4,500. Using written data provided by B, X determines that B's
section 1254 costs with respect to Property P equal $1,500. Thus,
the aggregate of X's shareholders' section 1254 costs equals $6,000.
C's pro rata share of the $6,000 of section 1254 costs equals $3,000
(C's 50 percent interest in X multiplied by $6,000). Under paragraph
(g)(1)(ii) of this section, A's section 1254 costs are reduced by
$2,000 (A's actual section 1254 costs ($4,000) multiplied by 50
percent). B's section 1254 costs are reduced by $750 (B's actual
section 1254 costs ($1,500) multiplied by 50 percent).
Example 3. Merger involving an S corporation that holds natural
resource recapture property. X, an S corporation with one
shareholder, A, holds as its sole asset natural resource recapture
property that has a fair market value of $120,000 and an adjusted
basis of $40,000. A has section 1254 costs with respect to the
property of $60,000. For valid business reasons, X merges into Y, an
S corporation with one shareholder, B, in a reorganization described
in section 368(a)(1)(A). Y holds property that is not natural
resource recapture property that has a fair market value of $120,000
and basis of $120,000. Under paragraph (c) of this section, A does
not recognize ordinary income under section 1254 upon the exchange
of stock in the merger because A did not otherwise recognize gain on
the merger. Under paragraph (g)(2) of this section, Y must allocate
to A and B a pro rata share of its $60,000 of section 1254 costs.
Thus, A and B are each allocated $30,000 of section 1254 costs (50
percent interest in X, each, multiplied by $60,000).
Par. 6. Section 1.1254-6 is amended by adding two sentences at the
end of this section to read as follows:
Sec. 1.1254-6 Effective date of regulations.
* * * Section 1.1254-4 applies to dispositions of natural resource
recapture property by an S corporation (and a corporation that was
formerly an S corporation) and dispositions of S corporation stock
occurring on or after October 10, 1996. Sections 1.1254-2(d)(1)(ii) and
1.1254-3(b)(1)(i) and (ii) and (d)(1)(i) and (ii) are effective for
dispositions of property occurring on or after October 10, 1996.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 7. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 8. In Sec. 602.101, paragraph (c) is amended by adding an
entry in numerical order to the table to read as follows.
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current
OMB
CFR part of section where identified and described control
No.
------------------------------------------------------------------------
* * * * *
1.1254-4.................................................... 1545-1493
* * * * *
------------------------------------------------------------------------
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
Approved: September 10, 1996.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 96-25945 Filed 10-9-96; 8:45 am]
BILLING CODE 4830-01-U
