[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: 26CFR1.1374-3]

[Page 763]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1374-3  Net unrealized built-in gain.

    (a) In general. An S corporation's net unrealized built-in gain is 
the total of the following--
    (1) The amount that would be the amount realized if, at the 
beginning of the first day of the recognition period, the corporation 
had remained a C corporation and had sold all its assets at fair market 
value to an unrelated party that assumed all its liabilities; decreased 
by
    (2) Any liability of the corporation that would be included in the 
amount realized on the sale referred to in paragraph (a)(1) of this 
section, but only if the corporation would be allowed a deduction on 
payment of the liability; decreased by
    (3) The aggregate adjusted bases of the corporation's assets at the 
time of the sale referred to in paragraph (a)(1) of this section; 
increased or decreased by
    (4) The corporation's section 481 adjustments that would be taken 
into account on the sale referred to in paragraph (a)(1) of this 
section; and increased by
    (5) Any recognized built-in loss that would not be allowed as a 
deduction under section 382, 383, or 384 on the sale referred to in 
paragraph (a)(1) of this section.
    (b) Example. The rules of this section are illustrated by the 
following example.

    Example: Net unrealized built-in gain. (i) (a) X, a calendar year C 
corporation using the cash method, elects to become an S corporation on 
January 1, 1996. On December 31, 1995, X has assets and liabilities as 
follows:

------------------------------------------------------------------------
                    Assets                          FMV         Basis
------------------------------------------------------------------------
Factory.......................................     $500,000     $900,000
Accounts Receivable...........................      300,000            0
Goodwill......................................      250,000            0
                                               --------------
      Total...................................    1,050,000      900,000
                  Liabilities                      Amount
Mortgage......................................     $200,000  ...........
Accounts Payable..............................      100,000
                                               -------------
      Total...................................      300,000
------------------------------------------------------------------------

    (b) Further, X must include a total of $60,000 in taxable income in 
1996, 1997, and 1998 under section 481(a).
    (ii) If, on December 31, 1995, X sold all its assets to a third 
party that assumed all its liabilities, X's amount realized would be 
$1,050,000 ($750,000 cash received+$300,000 liabilities 
assumed=$1,050,000). Thus, X's net unrealized built-in gain is 
determined as follows:

Amount realized -.......................................     $1,050,000
Deduction allowed-......................................       (100,000)
Basis of X's assets--...................................       (900,000)
Section 481 adjustments.................................         60,000
                                                         ---------------
      Net unrealized built-in gain-.....................        110,000



[T.D. 8579, 59 FR 66464, Dec. 27, 1994]