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Some common tax-free reorganizations may require a special election to prevent an otherwise mandatory reduction in the tax basis of certain assets. This article explains how certain rules designed to limit the duplication of built-in losses may apply to reduce basis in several common domestic and foreign transactions- including some situations that are not readily apparent- and how an election might protect taxpayers from those consequences.
Background
In general, the basis of property received by a corporation in certain tax-free transactions (e.g., Section 368 reorganizations, Section 351 exchanges, Section 332 liquidations) is identical to the basis the property had in the hands of the transferor. This basis- which is technically described as transferred basis, but which is colloquially known as carryover basis- preserves the inherent gain or loss in the transferred property so that the transferee corporation will recognize gain or loss upon a subsequent disposition of the transferred property. If the property transferred is net built-in loss property, however, this concept of carryover basis may not always apply.1
In 2004, the American Jobs Creation Act created Sections 362(e) and 334(b)(1) to limit a corporate taxpayers ability to obtain a carryover basis in certain built-in loss property that is received in tax-free transactions. One aspect of this rule targets cross-border transactions in which property not previously subject to U.S. federal income tax ("U.S. tax") is transferred to a U.S. corporation in certain tax-free transactions including formations, reorganizations, and liquidations. However, Section 362(e) must also be considered in both purely domestic and foreign-to-foreign Section 351 exchanges- if the transferee corporation receives aggregate built-in loss property.2 How Section 362(e) applies to Section 351 exchanges may surprise some practitioners.
This article is divided into four parts. The first part reviews the general rule of Section 362(e) and explains the operation of this provisions anti-loss importation and anti-loss duplication language. The second part discusses rules preventing the importation of built-in loss property into the U.S. tax jurisdiction. The third part discusses Section 362(e)(2), which prevents the duplication of a built-in loss when built-in loss property is transferred in non-importation Section 351 transactions. The last part illustrates how Section 362(e)(2) may apply in some ordinary and not so ordinary transactions.
General rule
When a corporation acquires property through certain...