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The IRS has issued proposed regulations (REG-139991-08) that
deal with various rules for transfers of property to RICs and
REITs.
The current regulations under Treas. Reg. Sec 1.337(d)-7 were
published in 2003 (TD 9047) and generally provide that if C
corporation property becomes the property of a RIC or a REIT
because the C corporation becomes a RIC or a REIT or transfers the
assets to a RIC or REIT (a "conversion transaction"), the
RIC or REIT will be subject to tax on the net built-in gain in the
converted property under the rules of Section 1374. This treatment,
however, does not apply if the C corporation transferor elects to
recognize gain and loss as if it had sold the converted property to
an unrelated party at fair market value (deemed sale
treatment).
The proposed regulations provide an exception from this general
rule for a transfer of property by a C corporation to a RIC or a
REIT to the extent that the transfer qualifies for nonrecognition
treatment under either Section 1031 or Section 1033. In such a
transaction, a C corporation derives its basis in the property it
receives from the basis in the property it transfers and thus
reflects the built-in gain. At the same time, the basis of the
transferee RIC or REIT in the converted property has no relation to
the C corporation transferor's basis therein.
The proposed regulations would also change the rules in cases
when a C corporation had both taxable and tax exempt entities as
partners. The current regulations apply to property transferred by
a C corporation directly to a RIC or a REIT, or indirectly through
a partnership to the extent of any C corporation partner's
proportionate share of the transferred property. The current
regulations state that if the partnership elects deemed sale
treatment related to such transfer, any net gain recognized by the
partnership on the deemed sale must be allocated to the C
corporation partner.
This general rule had unintended effects when the partnership
had multiple C corporation partners including both taxable and
tax-exempt entities. To illustrate, if such a partnership
transferred built-in gain property to a RIC or a REIT in a
conversion transaction without making a deemed sale election (i.e.,
Section 1374 treatment), and if the transferee RIC or REIT sold the
converted property during the recognition period, the RIC or the
REIT would be subject to a corporate-level tax on the net built-in
gain — including the portion of the net built-in gain
that would have been allocated to tax-exempt C corporation partners
if a deemed sale election had been made. This is because the net
recognized built-in gain is determined with reference to the amount
of gain that would have been allocated to all C corporation
partners, regardless of their taxable or tax-exempt status. In
contrast, if the transferring partnership made a deemed sale
election, the taxable C corporation partners would recognize gain
that could have been deferred if Section 1374 treatment had
applied.
To address this, the proposed regulations would amend the 2003
final regulations to provide that the definition of a C corporation
excludes tax-exempt entities within the meaning of Treas. Reg. Sec.
1.337(d)-4(c)(2). As a result, transfers of property by a
tax-exempt entity to a RIC or a REIT (or by a partnership to a RIC
or a REIT to the extent of a tax-exempt partner's distributive
share of the gain in the transferred property) generally will not
be subject to Section 1374 treatment. For this purpose, however, an
entity will not be considered to be tax-exempt to the extent it
would be subject to tax (such as under Section 511) related to gain
(if any) resulting from a deemed sale election if such an election
was made under Treas. Reg. Sec. 1.337(d)-7(c)(5) regarding the
transfer.
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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