[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1374-2]

[Page 762-763]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1374-2  Net recognized built-in gain.

    (a) In general. An S corporation's net recognized built-in gain for 
any taxable year is the least of--
    (1) Its taxable income determined by using all rules applying to C 
corporations and considering only its recognized built-in gain, 
recognized built-in loss, and recognized built-in gain carryover (pre-
limitation amount);
    (2) Its taxable income determined by using all rules applying to C 
corporations as modified by section 1375(b)(1)(B) (taxable income 
limitation); and
    (3) The amount by which its net unrealized built-in gain exceeds its 
net recognized built-in gain for all prior taxable years (net unrealized 
built-in gain limitation).
    (b) Allocation rule. If an S corporation's pre-limitation amount for 
any taxable year exceeds its net recognized built-in gain for that year, 
the S corporation's net recognized built-in gain consists of a ratable 
portion of each item of income, gain, loss, and deduction included in 
the pre-limitation amount.
    (c) Recognized built-in gain carryover. If an S corporation's net 
recognized built-in gain for any taxable year is equal to its taxable 
income limitation, the amount by which its pre-limitation amount exceeds 
its taxable income limitation is a recognized built-in gain carryover 
included in its pre-limitation amount for the succeeding taxable year. 
The recognized built-in gain carryover consists of that portion of each 
item of income, gain, loss, and deduction not included in the S 
corporation's net recognized built-in gain for the year the carryover 
arose, as determined under paragraph (b) of this section.

[[Page 763]]

    (d) Accounting methods. In determining its taxable income for pre-
limitation amount and taxable income limitation purposes, a corporation 
must use the accounting method(s) it uses for tax purposes as an S 
corporation.
    (e) Example. The rules of this section are illustrated by the 
following example.

    Example: Net recognized built-in gain. X is a calendar year C 
corporation that elects to become an S corporation on January 1, 1996. X 
has a net unrealized built-in gain of $50,000 and no net operating loss 
or capital loss carryforwards. In 1996, X has a pre-limitation amount of 
$20,000, consisting of ordinary income of $15,000 and capital gain of 
$5,000, a taxable income limitation of $9,600, and a net unrealized 
built-in gain limitation of $50,000. Therefore, X's net recognized 
built-in gain for 1996 is $9,600, because that is the least of the three 
amounts described in paragraph (a) of this section. Under paragraph (b) 
of this section, X's net recognized built-in gain consists of recognized 
built-in ordinary income of $7,200 [$15,000x($9,600/$20,000)=$7,200] and 
recognized built-in capital gain of $2,400 [$5,000x($9,600/
$20,000)=$2,400]. Under paragraph (c) of this section, X has a 
recognized built-in gain carryover to 1997 of $10,400 ($20,000-
$9,600=$10,400), consisting of $7,800 ($15,000-$7,200=$7,800) of 
recognized built-in ordinary income and $2,600 ($5,000-$2,400=$2,600) of 
recognized built-in capital gain.

[T.D. 8579, 59 FR 66463, Dec. 27, 1994]