[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]