[Code of Federal Regulations]
[Title 26, Volume 12]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1502-35T]

[Page 408-423]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1502-35T  Transfers of subsidiary member stock and deconsolidations 
of subsidiary members (temporary).

    (a) Purpose. The purpose of this section is to prevent a group from 
obtaining more than one tax benefit from a single economic loss. The 
provisions of this section shall be construed in a manner consistent 
with that purpose and in a manner that reasonably carries out that 
purpose.
    (b) Redetermination of basis on certain nondeconsolidating transfers 
of subsidiary member stock and on certain deconsolidations of subsidiary 
members--(1) Redetermination of basis on certain nondeconsolidating 
transfers of subsidiary member stock. Except as provided in paragraph 
(b)(3)(i) of this section, if, immediately after a transfer of stock of 
a subsidiary member that has a basis that exceeds its value, the 
subsidiary member remains a member of the group, then the basis in each 
share of subsidiary member stock owned by each member of the group shall 
be redetermined in accordance with the provisions of this paragraph 
(b)(1) immediately before such transfer. All of the members' bases in 
the shares of subsidiary member stock immediately before such transfer 
shall be aggregated. Such aggregated basis shall be allocated first to 
the shares of the subsidiary member's preferred stock that are owned by 
the members of the group immediately before such transfer, in proportion 
to, but not in excess of, the value of those shares at such time. After 
allocation of the aggregated basis to all shares of the preferred stock 
of the subsidiary member pursuant to the preceding sentence, any 
remaining

[[Page 409]]

basis shall be allocated among all common shares of subsidiary member 
stock held by members of the group immediately before the transfer, in 
proportion to the value of such shares at such time.
    (2) Redetermination of basis on certain deconsolidations of 
subsidiary members--(i) Allocation of reallocable basis amount. Except 
as provided in paragraph (b)(3)(ii) of this section, if, immediately 
before a deconsolidation of a subsidiary member, any share of stock of 
such subsidiary owned by a member of the group has a basis that exceeds 
its value, then the basis in each share of the subsidiary member's stock 
owned by each member of the group shall be redetermined in accordance 
with the provisions of this paragraph (b)(2) immediately before such 
deconsolidation. The basis in each share of the subsidiary member's 
stock held by members of the group immediately before the 
deconsolidation that has a basis in excess of value at such time shall 
be reduced, but not below such share's value, in a manner that, to the 
greatest extent possible, causes the ratio of the basis to the value of 
each such share to be the same; provided, however, that the aggregate 
amount of such reduction shall not exceed the reallocable basis amount 
(as computed pursuant to paragraph (b)(2)(ii) of this section). Then, to 
the extent of the reallocable basis amount, the basis of each share of 
the preferred stock of the subsidiary member that are held by members of 
the group immediately before the deconsolidation shall be increased, but 
not above such share's value, in a manner that, to the greatest extent 
possible, causes the ratio of the basis to the value of each such share 
to be the same. Then, to the extent that the reallocable basis amount 
does not increase the basis of shares of preferred stock of the 
subsidiary member pursuant to the third sentence of this paragraph 
(b)(2)(i), such amount shall increase the basis of all common shares of 
the subsidiary member's stock held by members of the group immediately 
before the deconsolidation in a manner that, to the greatest extent 
possible, causes the ratio of the basis to the value of each such share 
to be the same.
    (ii) Calculation of reallocable basis amount. The reallocable basis 
amount shall equal the lesser of--
    (A) The aggregate of all amounts by which, immediately before the 
deconsolidation, the basis exceeds the value of a share of subsidiary 
member stock owned by any member of the group at such time; and
    (B) The total of the subsidiary member's (and any predecessor's) 
items of deduction and loss, and the subsidiary member's (and any 
predecessor's) allocable share of items of deduction and loss of all 
lower-tier subsidiary members, that were taken into account in computing 
the adjustment under Sec. 1.1502-32 to the bases of shares of stock of 
the subsidiary member (and any predecessor) held by members of the group 
immediately before the deconsolidation, other than shares that have 
bases in excess of value immediately before the deconsolidation.
    (3) Exceptions to application of redetermination rules. (i) 
Paragraph (b)(1) of this section shall not apply to a transfer of 
subsidiary member stock if--
    (A) During the taxable year of such transfer, in one or more fully 
taxable transactions, the members of the group dispose of all of the 
shares of the subsidiary member stock that they own immediately before 
the transfer, other than the shares the transfer of which would 
otherwise trigger the application of paragraph (b)(1) of this section, 
to a person or persons that are not members of the group;
    (B) During the taxable year of such transfer, the members of the 
group are allowed a worthless stock loss under section 165(g) (taking 
into account the provisions of Sec. 1.1502-80(c)) with respect to all 
of the shares of subsidiary member stock that they own immediately 
before the transfer, other than the shares the transfer of which would 
otherwise trigger the application of paragraph (b)(1) of this section; 
or
    (C) Such transfer is to a member of the group and section 332 
(provided the stock is transferred to an 80-percent distributee), 
section 351, section 354, or section 361 applies to such transfer.
    (ii) Paragraph (b)(2) of this section shall not apply to a 
deconsolidation of a subsidiary member if--

[[Page 410]]

    (A) During the taxable year of such deconsolidation, in one or more 
fully taxable transactions, the members of the group dispose of all of 
the shares of the subsidiary member stock that they own immediately 
before the deconsolidation to a person or persons that are not members 
of the group;
    (B) Such deconsolidation results from a fully taxable disposition, 
to a person or persons that are not members of the group, of some of the 
shares of the subsidiary member, and, during the taxable year of such 
deconsolidation, the members of the group are allowed a worthless stock 
loss under section 165(g) with respect to all of the shares of the 
subsidiary member stock that they own immediately after the 
deconsolidation;
    (C) The members of the group are allowed a worthless stock loss 
under section 165(g) with respect to all of the shares of the subsidiary 
member stock that they own immediately before the deconsolidation;
    (D) The deconsolidation of the subsidiary member results from the 
deconsolidation of a higher-tier subsidiary member and, immediately 
after the deconsolidation of the subsidiary member, none of the stock of 
the subsidiary member is owned by a group member; or
    (E) The deconsolidation of the subsidiary member results from a 
termination of the group.
    (4) Special rule for lower-tier subsidiaries. If, immediately after 
a transfer of subsidiary member stock or a deconsolidation of a 
subsidiary member, a lower-tier subsidiary member some of the stock of 
which is owned by the subsidiary member is a member of the group, then, 
for purposes of applying paragraph (b) of this section, the subsidiary 
member shall be treated as having transferred its stock of the lower-
tier subsidiary member. This principle shall apply to stock of 
subsidiary members that are owned by such lower-tier subsidiary member.
    (5) Stock basis adjustments for higher-tier stock. The basis 
adjustments required under this paragraph (b) result in basis 
adjustments to higher-tier member stock. The adjustments are applied in 
the order of the tiers, from the lowest to highest. For example, if a 
common parent owns stock of a subsidiary member that owns stock of a 
lower-tier subsidiary member and the subsidiary member recognizes a loss 
on the disposition of a portion of its shares of the lower-tier 
subsidiary member stock, the common parent must adjust its basis in its 
subsidiary member stock under the principles of Sec. 1.1502-32 to 
reflect the adjustments that the subsidiary member must make to its 
basis in its stock of the lower-tier subsidiary member.
    (6) Ordering rules. (i) The rules of this paragraph (b) apply after 
the rules of Sec. 1.1502-32 are applied.
    (ii) The rules of this paragraph (b) apply before the rules of Sec. 
1.337(d)-2T and paragraphs (c) and (f) of this section are applied.
    (iii) Paragraph (b) of this section (and any resulting basis 
adjustments to higher-tier member stock made pursuant to paragraph 
(b)(5) of this section) applies to redetermine the basis of stock of a 
lower-tier subsidiary member before paragraph (b) of this section 
applies to a higher-tier member of such lower-tier subsidiary member.
    (c) Loss suspension--(1) General rule. Any loss recognized by a 
member of a consolidated group with respect to the disposition of a 
share of subsidiary member stock shall be suspended to the extent of the 
duplicated loss with respect to such share of stock if, immediately 
after the disposition, the subsidiary is a member of the consolidated 
group of which it was a member immediately prior to the disposition (or 
any successor group).
    (2) Special rule for lower-tier subsidiaries. This paragraph (c)(2) 
applies if neither paragraph (c)(1) nor (f) of this section applies to a 
member's disposition of a share of stock of a subsidiary member (the 
departing member), a loss is recognized on the disposition of such 
share, and the departing member owns stock of one or more other 
subsidiary members (a remaining member) that is a member of such group 
immediately after the disposition. In that case, such loss shall be 
suspended to the extent the duplicated loss with respect to the 
departing member stock disposed of is attributable to the remaining 
member or members.

[[Page 411]]

    (3) Treatment of suspended loss. For purposes of the rules of Sec. 
1.1502-32, any loss suspended pursuant to paragraph (c)(1) or (c)(2) of 
this section is treated as a noncapital, nondeductible expense of the 
member that disposes of subsidiary member stock, incurred during the 
taxable year that includes the date of the disposition of stock to which 
paragraph (c)(1) or (c)(2) of this section applies. See Sec. 1.1502-
32T(b)(3)(iii)(C). Consequently, the basis of a higher-tier member's 
stock of the member that disposes of subsidiary member stock is reduced 
by the suspended loss in the year it is suspended.
    (4) Reduction of suspended loss--(i) General rule. The amount of any 
loss suspended pursuant to paragraphs (c)(1) and (c)(2) of this section 
shall be reduced, but not below zero, by the subsidiary member's (and 
any successor's) items of deduction and loss, and the subsidiary 
member's (and any successor's) allocable share of items of deduction and 
loss of all lower-tier subsidiary members, that are allocable to the 
period beginning on the date of the disposition that gave rise to the 
suspended loss and ending on the day before the first date on which the 
subsidiary member (or any successor) is not a member of the group of 
which it was a member immediately prior to the disposition (or any 
successor group), and that are taken into account in determining 
consolidated taxable income (or loss) of such group for any taxable year 
that includes any date on or after the date of the disposition and 
before the first date on which the subsidiary member (or any successor) 
is not a member of such group; provided, however, that such reduction 
shall not exceed the excess of the amount of such items over the amount 
of such items that are taken into account in determining the basis 
adjustments made under Sec. 1.1502-32 to stock of the subsidiary member 
(or any successor) owned by members of the group. The preceding sentence 
shall not apply to items of deduction and loss to the extent that the 
group can establish that all or a portion of such items was not 
reflected in the computation of the duplicated loss with respect to the 
subsidiary member on the date of the disposition of stock that gave rise 
to the suspended loss.
    (ii) Operating rules--(A) Year in which deduction or loss is taken 
into account. For purposes of paragraph (c)(4)(i) of this section, a 
subsidiary member's (or any successor's) deductions and losses are 
treated as taken into account when and to the extent they are absorbed 
by the subsidiary member (or any successor) or any other member. To the 
extent that the subsidiary member's (or any successor's) deduction or 
loss is absorbed in the year it arises or is carried forward and 
absorbed in a subsequent year (e.g., under section 172, 465, or 1212), 
the deduction is treated as taken into account in the year in which it 
is absorbed. To the extent that a subsidiary member's (or any 
successor's) deduction or loss is carried back and absorbed in a prior 
year (whether consolidated or separate), the deduction or loss is 
treated as taken into account in the year in which it arises and not in 
the year in which it is absorbed.
    (B) Determination of items that are allocable to the post-
disposition, pre-deconsolidation period. For purposes of paragraph 
(c)(4)(i) of this section, the determination of whether a subsidiary 
member's (or any successor's) items of deduction and loss and allocable 
share of items of deduction and loss of all lower-tier subsidiary 
members are allocable to the period beginning on the date of the 
disposition of subsidiary stock that gave rise to the suspended loss and 
ending on the day before the first date on which the subsidiary member 
(or any successor) is not a member of the consolidated group of which it 
was a member immediately prior to the disposition (or any successor 
group) is determined pursuant to the rules of Sec. 1.1502-76(b)(2), 
without regard to Sec. 1.1502-76(b)(2)(ii)(D), as if the subsidiary 
member ceased to be a member of the group at the end of the day before 
the disposition and filed separate returns for the period beginning on 
the date of the disposition and ending on the day before the first date 
on which it is not a member of such group.
    (5) Allowable loss--(i) General rule. To the extent not reduced 
under paragraph (c)(4) of this section, any loss

[[Page 412]]

suspended pursuant to paragraph (c)(1) or (c)(2) of this section shall 
be allowed, to the extent otherwise allowable under applicable 
provisions of the Internal Revenue Code and regulations thereunder, on a 
return filed by the group of which the subsidiary was a member on the 
date of the disposition of subsidiary stock that gave rise to the 
suspended loss (or any successor group) for the taxable year that 
includes the day before the first date on which the subsidiary (and any 
successor) is not a member of such group or the date the group is 
allowed a worthless stock loss under section 165(g) (taking into account 
the provisions of Sec. 1.1502-80(c)) with respect to all of the 
subsidiary member stock owned by members.
    (ii) No tiering up of certain adjustments. No adjustments shall be 
made to a member's basis of stock of a subsidiary member (or any 
successor) for a suspended loss that is taken into account under 
paragraph (c)(5)(i) of this section. See Sec. 1.1502-32T(a)(2).
    (iii) Statement of allowed loss. Paragraph (c)(5)(i) of this section 
applies only if the separate statement required under this paragraph 
(c)(5)(iii) is filed with, or as part of, the taxpayer's return for the 
year in which the loss is allowable. The statement must be entitled 
``ALLOWED LOSS UNDER Sec. 1.1502-35T(c)(5)'' and must contain the name 
and employer identification number of the subsidiary the stock of which 
gave rise to the loss.
    (6) Special rule for dispositions of certain carryover basis assets. 
If--
    (i) A member of a group recognizes a loss on the disposition of an 
asset other than stock of a subsidiary member;
    (ii) Such member's basis in the asset disposed of was determined, 
directly or indirectly, in whole or in part, by reference to the basis 
of stock of a subsidiary member and, at the time of the determination of 
the member's basis in the asset disposed of, there was a duplicated loss 
with respect to such stock of the subsidiary member; and
    (iii) Immediately after the disposition, the subsidiary member is a 
member of such group, then such loss shall be suspended pursuant to the 
principles of paragraphs (c)(1) and (c)(2) of this section to the extent 
of the duplicated loss with respect to such stock at the time of the 
determination of basis of the asset disposed of. Principles similar to 
those set forth in paragraphs (c)(3), (c)(4), and (c)(5) of this section 
shall apply to a loss suspended pursuant to this paragraph (c)(6).
    (7) Coordination with loss deferral, loss disallowance, and other 
rules--(i) In general. Loss recognized on the disposition of subsidiary 
member stock or another asset is subject to redetermination, deferral, 
or disallowance under other applicable provisions of the Internal 
Revenue Code and regulations thereunder, including sections 267(f) and 
482. Paragraphs (c)(1), (c)(2), and (c)(6) of this section do not apply 
to a loss that is disallowed under any other provision. If loss is 
deferred under any other provision, paragraphs (c)(1), (c)(2), and 
(c)(6) of this section apply when the loss would otherwise be taken into 
account under such other provision. However, if an overriding event 
described in paragraph (c)(7)(ii) of this section occurs before the 
deferred loss is taken into account, paragraphs (c)(1), (c)(2), and 
(c)(6) of this section apply to the loss immediately before the event 
occurs, even though the loss may not be taken into account until a later 
time.
    (ii) Overriding events. For purposes of paragraph (c)(7)(i) of this 
section, the following are overriding events--
    (A) The stock ceases to be owned by a member of the consolidated 
group;
    (B) The stock is canceled or redeemed (regardless of whether it is 
retired or held as treasury stock); or
    (C) The stock is treated as disposed of under Sec. 1.1502-
19(c)(1)(ii)(B) or (c)(1)(iii).
    (8) Application. This paragraph (c) shall not be applied in a manner 
that permanently disallows a deduction for an economic loss, provided 
that such deduction is otherwise allowable. If the application of any 
provision of this paragraph (c) results in such a disallowance, proper 
adjustment may be made to prevent such a disallowance. Whether a 
provision of this paragraph (c) has resulted in such a disallowance is 
determined on the date on which the subsidiary (or any successor) the 
disposition of the stock of which gave rise to a suspended stock loss is 
not a member of the group or the date the group

[[Page 413]]

is allowed a worthless stock loss under section 165(g) (taking into 
account the provisions of Sec. 1.1502-80(c)) with respect to all of 
such subsidiary member stock owned by members. Proper adjustment in such 
cases shall be made by restoring the suspended stock loss immediately 
before the subsidiary ceases to be a member of the group or the group is 
allowed a worthless stock loss under section 165(g) (taking into account 
the provisions of Sec. 1.1502-80(c)) with respect to all of such 
subsidiary member stock owned by members, to the extent that its 
reduction pursuant to paragraph (c)(4) of this section had the result of 
permanently disallowing a deduction for an economic loss.
    (9) Ordering rule. The rules of this paragraph (c) apply after the 
rules of paragraph (b) of this section and Sec. 1.337(d)-2T are 
applied.
    (d) Definitions--(1) Disposition. Disposition means any event in 
which gain or loss is recognized, in whole or in part.
    (2) Deconsolidation. Deconsolidation means any event that causes a 
subsidiary member to no longer be a member of the consolidated group.
    (3) Value. Value means fair market value.
    (4) Duplicated loss--(i) In general. Duplicated loss is determined 
immediately after a disposition and equals the excess, if any, of--
    (A) The sum of--
    (1) The aggregate adjusted basis of the subsidiary member's assets 
other than any stock that subsidiary member owns in another subsidiary 
member; and
    (2) Any losses attributable to the subsidiary member and carried to 
the subsidiary member's first taxable year following the disposition; 
and
    (3) Any deductions of the subsidiary member that have been 
recognized but are deferred under a provision of the Internal Revenue 
Code (such as deductions deferred under section 469); over
    (B) The sum of--
    (1) The value of the subsidiary member's stock; and
    (2) Any liabilities of the subsidiary member that have been taken 
account for tax purposes.
    (ii) Special rules. (A) The amounts determined under paragraph 
(d)(4)(i) (other than amounts described in paragraph (d)(4)(i)(B)(1)) of 
this section with respect to a subsidiary member include its allocable 
share of corresponding amounts with respect to all lower-tier subsidiary 
members. If 80 percent or more in value of the stock of a subsidiary 
member is acquired by purchase in a single transaction (or in a series 
of related transactions during any 12-month period), the value of the 
subsidiary member's stock may not exceed the purchase price of the stock 
divided by the percentage of the stock (by value) so purchased. For this 
purpose, stock is acquired by purchase if the transferee is not related 
to the transferor within the meaning of sections 267(b) and 707(b)(1), 
using the language ``'10 percent''' instead of ``'50 percent''' each 
place that it appears, and the transferee's basis in the stock is 
determined wholly by reference to the consideration paid for such stock.
    (B) The amounts determined under paragraph (d)(4)(i) of this section 
are not applied more than once to suspend a loss under this section.
    (5) Predecessor and Successor. A predecessor is a transferor of 
assets to a transferee (the successor) in a transaction--
    (i) To which section 381(a) applies;
    (ii) In which substantially all of the assets of the transferor are 
transferred to members in a complete liquidation;
    (iii) In which the successor's basis in assets is determined 
(directly or indirectly, in whole or in part) by reference to the 
transferor's basis in such assets, but the transferee is a successor 
only with respect to the assets the basis of which is so determined; or
    (iv) Which is an intercompany transaction, but only with respect to 
assets that are being accounted for by the transferor in a prior 
intercompany transaction.
    (6) Successor group. A surviving group is treated as a successor 
group of a consolidated group (the terminating group) that ceases to 
exist as a result of--
    (i) The acquisition by a member of another consolidated group of 
either the assets of the common parent of the terminating group in a 
reorganization described in section 381(a)(2), or the stock of the 
common parent of the terminating group; or

[[Page 414]]

    (ii) The application of the principles of Sec. 1.1502-75(d)(2) or 
(3).
    (7) Preferred stock, common stock. Preferred stock and common stock 
shall have the meanings set forth in Sec. 1.1502-32(d)(2) and (3), 
respectively.
    (8) Higher-tier. A subsidiary member is higher-tier with respect to 
a member if or to the extent investment basis adjustments under Sec. 
1.1502-32 with respect to the stock of the latter member would affect 
investment basis adjustments with respect to the stock of the former 
member.
    (9) Lower-tier. A subsidiary member is lower-tier with respect to a 
member if or to the extent investment basis adjustments under Sec. 
1.1502-32 with respect to the stock of the former member would affect 
investment basis adjustments with respect to the stock of the latter 
member.
    (e) Examples. For purposes of the examples in this section, unless 
otherwise stated, all groups file consolidated returns on a calendar-
year basis, the facts set forth the only corporate activity, all 
transactions are between unrelated persons, and tax liabilities are 
disregarded. The principles of paragraphs (a) through (d) of this 
section are illustrated by the following examples:

    Example 1. Nondeconsolidating sale of preferred stock of lower-tier 
subsidiary member. (i) Facts. P owns 100 percent of the common stock of 
each of S1 and S2. S1 and S2 each have only one class of stock 
outstanding. P's basis in the stock of S1 is $100 and the value of such 
stock is $130. P's basis in the stock of S2 is $120 and the value of 
such stock is $90. P, S1, and S2 are all members of the P group. S1 and 
S2 form S3. In Year 1, in transfers to which section 351 applies, S1 
contributes $100 to S3 in exchange for all of the common stock of S3 and 
S2 contributes an asset with a basis of $50 and a value of $20 to S3 in 
exchange for all of the preferred stock of S3. S3 becomes a member of 
the P group. In Year 3, in a transaction that is not part of the plan 
that includes the contributions to S3, S2 sells the preferred stock of 
S3 for $20. Immediately after the sale, S3 is a member of the P group.
    (ii) Application of basis redetermination rule. Because S2's basis 
in the preferred stock of S3 exceeds its value immediately prior to the 
sale and S3 is a member of the P group immediately after the sale, all 
of the P group members' bases in the stock of S3 is redetermined 
pursuant to paragraph (b)(1) of this section. Of the group members' 
total basis of $150 in the S3 stock, $20 is allocated to the preferred 
stock, the fair market value of the preferred stock on the date of the 
sale, and $130 is allocated to the common stock. S2's sale of the 
preferred stock results in the recognition of $0 of gain/loss. Pursuant 
to paragraph (b)(5) of this section, the redetermination of S1's and 
S2's bases in the stock of S3 results in adjustments to P's basis in the 
stock of S1 and S2. In particular, P's basis in the stock of S1 is 
increased by $30 to $130 and its basis in the stock of S2 is decreased 
by $30 to $90.

    Example 2. Deconsolidating sale of common stock. (i) Facts. In Year 
1, in a transfer to which section 351 applies, P contributes Asset A 
with a basis of $900 and a value of $200 to S in exchange for one share 
of S common stock (CS1). In Years 2 and 3, in successive but unrelated 
transfers to which section 351 applies, P transfers $200 to S in 
exchange for one share of S common stock (CS2), Asset B with a basis of 
$300 and a value of $200 in exchange for one share of S common stock 
(CS3), and Asset C with a basis of $1000 and a value of $200 in exchange 
for one share of S common stock (CS4). In Year 4, S sells Asset A for 
$200, recognizing $700 of loss that is used to offset income of P 
recognized during Year 4. As a result of the sale of Asset A, the basis 
of each of P's four shares of S common stock is reduced by $175. 
Therefore, the basis of CS1 is $725. The basis of CS2 is $25. The basis 
of CS3 is $125, and the basis of CS4 is $825. In Year 5 in a transaction 
that is not part of a plan that includes the Year 1 contribution, P 
sells CS4 for $200. Immediately after the sale of CS4, S is not a member 
of the P group.
    (ii) Application of basis redetermination rule. Because P's basis in 
each of CS1 and CS4 exceeds its value immediately prior to the 
deconsolidation of S, P's basis in its shares of S common stock is 
redetermined pursuant to paragraph (b)(2) of this section. Pursuant to 
paragraph (b)(2)(ii) of this section, the reallocable basis amount is 
$350 (the lesser of $1150, the gross loss inherent in the stock of S 
owned by P immediately before the sale, and $350, the aggregate amount 
of S's items of deduction and loss that were previously taken into 
account in the computation of the adjustment to the basis of the stock 
of S that P did not hold at a loss immediately before the 
deconsolidation). Pursuant to paragraph (b)(2)(i) of this section, 
first, P's basis in CS1 is reduced from $725 to $600 and P's basis in 
CS4 is reduced from $825 to $600. Then, the reallocable basis amount 
increases P's basis in CS2 from $25 to $250 and P's basis in CS3 from 
$125 to $250. P recognizes $400 of loss on the sale of CS4. The loss 
suspension rule does not apply because S is no longer a member of the P 
group. Thus, the loss is allowable at that time.

[[Page 415]]

    Example 3. Nondeconsolidating sale of common stock. (i) Facts. In 
Year 1, P forms S with a contribution of $80 in exchange for 80 shares 
of the common stock of S, which at that time represents all of the 
outstanding stock of S. S becomes a member of the P group. In Year 2, P 
contributes Asset A with a basis of $50 and a value of $20 in exchange 
for 20 shares of the common stock of S in a transfer to which section 
351 applies. In Year 3, in a transaction that is not part of the plan 
that includes the Year 2 contribution, P sells the 20 shares of the 
common stock of S that it acquired in Year 2 for $20. Immediately after 
the Year 3 stock sale, S is a member of the P group. At the time of the 
Year 3 stock sale, S has $80 and Asset A. In Year 4, S sells Asset A , 
the basis and value of which have not changed since its contribution to 
S. On the sale of Asset A for $20, S recognizes a $30 loss. The P group 
cannot establish that all or a portion of the $30 loss was not reflected 
in the calculation of the duplicated loss of S on the date of the Year 3 
stock sale. The $30 loss is used on the P group return to offset income 
of P. In Year 5, P sells its remaining S common stock for $80.
    (ii) Application of basis redetermination and loss suspension rules. 
Because P's basis in the common stock sold exceeds its value immediately 
prior to the sale and S is a member of the P group immediately after the 
sale, P's basis in all of the stock of S is redetermined pursuant to 
paragraph (b)(1) of this section. Of P's total basis of $130 in the S 
common stock, a proportionate amount is allocated to each of the 100 
shares of S common stock. Accordingly, $26 is allocated to the common 
stock of S that is sold and $104 is allocated to the common stock of S 
that is retained. On P's sale of the 20 shares of the common stock of S 
for $20, P recognizes a loss of $6. Because the sale of the 20 shares of 
common stock of S does not result in the deconsolidation of S, under 
paragraph (c)(1) of this section, that loss is suspended to the extent 
of the duplicated loss with respect to the shares sold. The duplicated 
loss with respect to the shares sold is $6. Therefore, the entire $6 
loss is suspended.
    (iii) Effect of subsequent asset sale on stock basis. Of the $30 
loss recognized on the sale of Asset A, $24 is taken into account in 
determining the basis adjustments made under Sec. 1.1502-32 to the 
stock of S owned by P. Accordingly, P's basis in its S stock is reduced 
by $24 from $104 to $80.
    (iv) Effect of subsequent asset sale on suspended loss. Because P 
cannot establish that all or a portion of the loss recognized on the 
sale of Asset A was not reflected in the calculation of the duplicated 
loss of S on the date of the Year 3 stock sale and such loss is 
allocable to the period beginning on the date of the Year 3 disposition 
of the S stock and ending on the day before the first date on which S is 
not a member of the P group and is taken into account in determining 
consolidated taxable income (or loss) of the P group for a taxable year 
that includes a date on or after the date of the Year 3 disposition and 
before the first date on which S is not a member of the P group, such 
asset loss reduces the suspended loss pursuant to paragraph (c)(4) of 
this section. The amount of such reduction, however, cannot exceed $6, 
the excess of the amount of such loss, $30, over the amount of such loss 
that is taken into account in determining the basis adjustment made to 
the stock of S owned by P, $24. Therefore, the suspended loss is reduced 
to zero.
    (v) Effect of subsequent stock sale. P recognizes $0 gain/loss on 
the Year 5 sale of its remaining S common stock. No amount of suspended 
loss remains to be allowed under paragraph (c)(5) of this section.
    Example 4. Nondeconsolidating sale of common stock of lower-tier 
subsidiary. (i) Facts. In Year 1, P forms S1 with a contribution of $200 
in exchange for all of the common stock of S1, which represents all of 
the outstanding stock of S1. In the same year, S1 forms S2 with a 
contribution of $80 in exchange for 80 shares of the common stock of S2, 
which at that time represents all of the outstanding stock of S2. S1 and 
S2 become members of the P group. In the same year, S2 purchases Asset A 
for $80. In Year 2, S1 contributes Asset B with a basis of $50 and a 
value of $20 in exchange for 20 shares of the common stock of S2 in a 
transfer to which section 351 applies. In Year 3, S1 sells the 20 shares 
of the common stock of S2 that it acquired in Year 2 for $20. 
Immediately after the Year 3 stock sale, S2 is a member of the P group. 
At the time of the Year 3 stock sale, the bases and values of Asset A 
and Asset B are unchanged. In Year 4, S2 sells Asset B for $45, 
recognizing a $5 loss. The P group cannot establish that all or a 
portion of the $5 loss was not reflected in the calculation of the 
duplicated loss of S2 on the date of the Year 3 stock sale. The $5 loss 
is used on the P group return to offset income of P. In Year 5, S1 sells 
its remaining S2 common stock for $100.
    (ii) Application of basis redetermination and loss suspension rules. 
Because S1's basis in the S2 common stock sold exceeds its value 
immediately prior to the sale and S2 is a member of the P group 
immediately after the sale, S1's basis in all of the stock of S2 is 
redetermined pursuant to paragraph (b)(1) of this section. Of S1's total 
basis of $130 in the S2 common stock, a proportionate amount is 
allocated to each of the 100 shares of S2 common stock. Accordingly, a 
total of $26 is allocated to the common stock of S2 that is sold and 
$104 is allocated to the common stock of S2 that is retained. On S1's 
sale of the 20 shares of the common stock of S2 for $20, S1 recognizes a 
loss of $6. Because the sale of the 20 shares of common stock of S2 does 
not

[[Page 416]]

result in the deconsolidation of S2, under paragraph (c)(1) of this 
section, that loss is suspended to the extent of the duplicated loss 
with respect to the shares sold. The duplicated loss with respect to the 
shares sold is $6. Therefore, the entire $6 loss is suspended. Pursuant 
to paragraph (c)(3) of this section and Sec. 1.1502-32T(b)(3)(iii)(C), 
the suspended loss is treated as a noncapital, nondeductible expense 
incurred by S1 during the tax year that includes the date of the 
disposition of stock to which paragraph (c)(1) of this section applies. 
Accordingly, P's basis in its S1 stock is reduced from $200 to $194.
    (iii) Effect of subsequent asset sale on stock basis. Of the $5 loss 
recognized on the sale of Asset B, $4 is taken into account in 
determining the basis adjustments made under Sec. 1.1502-32 to the 
stock of S2 owned by S1. Accordingly, S1's basis in its S2 stock is 
reduced by $4 from $104 to $100 and P's basis in its S1 stock is reduced 
by $4 from $194 to $190.
    (iv) Effect of subsequent asset sale on suspended loss. Because P 
cannot establish that all or a portion of the loss recognized on the 
sale of Asset B was not reflected in the calculation of the duplicated 
loss of S2 on the date of the Year 3 stock sale and such loss is 
allocable to the period beginning on the date of the Year 3 disposition 
of the S2 stock and ending on the day before the first date on which S2 
is not a member of the P group and is taken into account in determining 
consolidated taxable income (or loss) of the P group for a taxable year 
that includes a date on or after the date of the Year 3 disposition and 
before the first date on which S2 is not a member of the P group, such 
asset loss reduces the suspended loss pursuant to paragraph (c)(4) of 
this section. The amount of such reduction, however, cannot exceed $1, 
the excess of the amount of such loss, $5, over the amount of such loss 
that is taken into account in determining the basis adjustment made to 
the stock of S2 owned by members of the P group, $4. Therefore, the 
suspended loss is reduced to $5.
    (v) Effect of subsequent stock sale. In Year 5, when S1 sells its 
remaining S2 stock for $100, it recognizes $0 gain/loss. Pursuant to 
paragraph (c)(5) of this section, the remaining $5 of the suspended loss 
is allowed on the P group's return for Year 5 when S1 sells its 
remaining S2 stock.
    Example 5. Deconsolidating sale of subsidiary member owning stock of 
another subsidiary member that remains in group. (i) Facts. In Year 1, P 
forms S1 with a contribution of Asset A with a basis of $50 and a value 
of $20 in exchange for 100 shares of common stock of S1 in a transfer to 
which section 351 applies. Also in Year 1, P and S1 form S2. P 
contributes $80 to S2 in exchange for 80 shares of common stock of S2. 
S1 contributes Asset A to S2 in exchange for 20 shares of common stock 
of S2 in a transfer to which section 351 applies. In Year 3, in a 
transaction that is not part of a plan that includes the Year 1 
contributions, P sells its 100 shares of S1 common stock for $20. 
Immediately after the Year 3 stock sale, S2 is a member of the P group. 
At the time of the Year 3 stock sale, S1 owns 20 shares of common stock 
of S2, and S2 has $80 and Asset A. In Year 4, S2 sells Asset A, the 
basis and value of which have not changed since its contribution to S2. 
On the sale of Asset A for $20, S2 recognizes a $30 loss. That $30 loss 
is used on the P group return to offset income of P. In Year 5, P sells 
its S2 common stock for $80.
    (ii) Application of basis redetermination and loss suspension rules. 
Pursuant to paragraph (b)(4) of this section, because immediately before 
P's transfer of S1 stock S1 owns stock of S2 (another subsidiary member 
of the same group) that has a basis that exceeds its value, paragraph 
(b) of this section applies as if S1 had transferred its stock of S2. 
Because S2 is a member of the group immediately after the transfer of 
the S1 stock, the group member's basis in the S2 stock is redetermined 
pursuant to paragraph (b)(1) of this section immediately prior to the 
sale of the S1 stock. Of the group members' total basis of $130 in the 
S2 stock, $26 is allocated to S1's 20 shares of S2 common stock and $104 
is allocated to P's 80 shares of S2 common stock. Pursuant to paragraph 
(b)(5) of this section, the redetermination of S1's basis in the stock 
of S2 results in an adjustment to P's basis in the stock of S1. In 
particular, P's basis in the stock of S1 is decreased by $24 to $26. On 
P's sale of its 100 shares of S1 common stock for $20, P recognizes a 
loss of $6. Because S1 is not a member of the P group immediately after 
P's sale of the S1 stock, paragraph (c)(1) of this section does not 
apply to suspend such loss. However, because P recognizes a loss with 
respect to the disposition of the S1 stock and S1 owns stock of S2 
(which is a member of the P group immediately after the disposition), 
paragraph (c)(2) of this section does apply to suspend up to $6 of that 
loss, an amount equal to the amount by which the duplicated loss with 
respect to the stock of S1 sold is attributable to S2's adjusted basis 
in its assets, loss carryforwards, and deferred deductions.
    (iii) Effect of subsequent asset sale on stock basis. Of the $30 
loss recognized on the sale of Asset A, $24 is taken into account in 
determining the basis adjustments made under Sec. 1.1502-32 to the 
stock of S2 owned by P. Accordingly, P's basis in its S2 stock is 
reduced by $24 from $104 to $80.
    (iv) Effect of subsequent asset sale on suspended loss. Because P 
cannot establish that all or a portion of the loss recognized on the 
sale of Asset A was not reflected in the calculation of the duplicated 
loss of S2 on the date of the Year 3 stock sale and such loss is 
allocable to the period beginning on the date

[[Page 417]]

of the Year 3 deemed disposition of the S2 stock and ending on the day 
before the first date on which S2 is not a member of the P group and is 
taken into account in determining consolidated taxable income (or loss) 
of the P group for a taxable year that includes a date on or after the 
date of the Year 3 deemed disposition and before the first date on which 
S2 is not a member of the P group, such asset loss reduces the suspended 
loss pursuant to paragraph (c)(4) of this section. The amount of such 
reduction, however, cannot exceed $6, the excess of the amount of such 
loss, $30, over the amount of such loss that is taken into account in 
determining the basis adjustment made to the stock of S2 owned by P, 
$24. Therefore, the suspended loss is reduced to zero.
    (v) Effect of subsequent stock sale. P recognizes $0 gain/loss on 
the Year 5 sale of its remaining S2 common stock. No amount of suspended 
loss remains to be allowed under paragraph (c)(5) of this section.
    Example 6. Loss recognized on asset with basis determined by 
reference to stock basis of subsidiary member. (i) Facts. In Year 1, P 
forms S with a contribution of $80 in exchange for 80 shares of common 
stock of S which at that time represents all of the outstanding stock of 
S. S becomes a member of the P group. In Year 2, P contributes Asset A 
with a basis of $50 and a value of $20 in exchange for 20 shares of 
common stock of S in a transfer to which section 351 applies. In Year 3, 
in a transaction that is not part of a plan that includes the Year 1 and 
Year 2 contributions, P contributes the 20 shares of S common stock it 
acquired in Year 2 to PS, a partnership, in exchange for a 20 percent 
capital and profits interest in a transaction described in section 721. 
Immediately after the contribution to PS, S is a member of the P group. 
In Year 4, P sells its interest in PS for $20, recognizing a $30 loss.
    (ii) Application of basis redetermination rule upon nonrecognition 
transfer. Because P's basis in the S common stock contributed to PS 
exceeds its value immediately prior to the transfer and S is a member of 
the P group immediately after the transfer, P's basis in all of the S 
stock is redetermined pursuant to paragraph (b)(1) of this section. Of 
P's total basis of $130 in the common stock of S, a proportionate amount 
is allocated to each share of S common stock. Accordingly, $26 is 
allocated to the S common stock that is contributed to PS and, under 
section 722, P's basis in its interest in PS is $26.
    (iii) Application of loss suspension rule on disposition of asset 
with basis determined by reference to stock basis of subsidiary member. 
P recognizes a $6 loss on its disposition of its interest in PS. Because 
P's basis in its interest in PS was determined by reference to the basis 
of S stock and at the time of the determination of P's basis in its 
interest in PS such S stock had a duplicated loss of $6, and, 
immediately after the disposition, S is a member of the P group, such 
loss is suspended to the extent of such duplicated loss. Principles 
similar to those of paragraphs (c)(3), (c)(4), and (c)(5) of this 
section shall apply to such suspended loss.

    (f) Worthlessness not followed by separate return years--(1) General 
rule. Notwithstanding any other provision in the regulations under 
section 1502, if a member of a group (the claiming group) treats stock 
of a subsidiary as worthless under section 165 (taking into account the 
provisions of Sec. 1.1502-80(c)) and, on the day following the last day 
of the claiming group's taxable year in which the worthless stock 
deduction is claimed, the subsidiary (or its successor, determined 
without regard to paragraphs (d)(5)(iii) and (iv) of this section) is a 
member of a group that includes any corporation that, during that 
taxable year, was a member of the claiming group (other than a lower-
tier subsidiary of the subsidiary) or is a successor (determined without 
regard to paragraphs (d)(5)(iii) and (iv) of this section) of such a 
member, then all losses treated as attributable to the subsidiary under 
the principles of Sec. 1.1502-21T(b)(2)(iv) shall be treated as expired 
as of the day following the last day of the claiming group's taxable 
year in which the worthless stock deduction is claimed. In addition, 
notwithstanding any other provision in the regulations under section 
1502, if a member recognizes a loss with respect to subsidiary stock and 
on the following day the subsidiary is not a member of the group and 
does not have a separate return year, then all losses treated as 
attributable to the subsidiary under the principles of Sec. 1.1502-
21T(b)(2)(iv) shall be treated as expired as of the day following the 
last day of the group's taxable year in which the stock loss is claimed. 
For purposes of this paragraph (f), the determination of the losses 
attributable to the subsidiary shall be made after computing the taxable 
income of the group for the taxable year in which the group treats the 
stock of the subsidiary as worthless or the subsidiary liquidates and 
after computing the taxable income for any taxable year to which such 
losses may be carried back. The loss treated as expired under this 
paragraph (f)

[[Page 418]]

shall not be treated as a noncapital, nondeductible expense under Sec. 
1.1502-32(b)(2)(iii). This paragraph (f) applies to worthlessness 
determinations and liquidations that occur after March 18, 2004 and 
before March 12, 2006. However, the group may apply this paragraph (f) 
to worthlessness determinations and liquidations that occur on or after 
March 7, 2002 and before March 18, 2004; otherwise, paragraph (f) of 
Sec. 1.1502-35T as contained in 26 CFR part 1 edition revised as of 
April 1, 2003, shall apply to such determinations of worthlessness and 
liquidations.
    (2) Election in the case of determinations of worthlessness and 
dispositions not followed by a separate return that occurred prior to 
March 14, 2003. If stock of a subsidiary member is treated as worthless 
under section 165 (taking into account the provisions of Sec. 1.1502-
80(c)) on or after March 7, 2002, and prior to March 14, 2003, or if a 
member of a group disposes of subsidiary member stock on or after March 
7, 2002, and prior to March 14, 2003 and on the following day the 
subsidiary is not a member of the group and does not have a separate 
return year, then, notwithstanding paragraph (f)(1) of this section, the 
common parent may make an irrevocable election to reattribute to itself 
all or any portion of the losses treated as attributable to such 
subsidiary member under the principles of Sec. 1.1502-21(b)(2)(iv). The 
election shall be in the form of a statement filed with or as part of 
the group's return for the taxable year in which the worthlessness is 
established or the disposition occurs. The statement shall be entitled 
``Election under Section 1.1502-35T(f)(2)'' and must state that the 
common parent is making an irrevocable election under this paragraph 
(f)(2) to reattribute to itself the losses of the subsidiary member the 
stock of which is worthless or disposed of. In addition, it must 
identify the subsidiary to which the election relates and the portion of 
losses subject to the election. If the election provided in this 
paragraph is made, the common parent shall be treated as succeeding to 
the reattributed losses as if the losses were succeeded to in a 
transaction described in section 381(a). For purposes of applying the 
provisions of Sec. 1.1502-32, the reattributed losses shall be treated 
as absorbed by the group immediately prior to the allowance of any loss 
or inclusion of any income or gain with respect to the determination of 
worthlessness or the disposition. In the case of an election to 
reattribute less than all of the losses otherwise treated as 
attributable to such subsidiary member under the principles of Sec. 
1.1502-21(b)(2)(iv), paragraph (f)(1) of this section shall apply to 
that portion of the losses for which an election under this paragraph 
(f)(2) is not made.
    (g) Anti-avoidance rules--(1) Transfer of share without a loss in 
avoidance. If a share of subsidiary member stock has a basis that does 
not exceed its value and the share is transferred with a view to 
avoiding application of the rules of paragraph (b) of this section prior 
to the transfer of a share of subsidiary member stock that has a basis 
that does exceed its value or a deconsolidation of a subsidiary member, 
the rules of paragraph (b) of this section shall apply immediately prior 
to the transfer of stock that has a basis that does not exceed its 
value.
    (2) Transfers of loss property in avoidance. If a member of a 
consolidated group contributes an asset with a basis that exceeds its 
value to a partnership in a transaction described in section 721 or a 
corporation that is not a member of such group in a transfer described 
in section 351, such partnership or corporation contributes such asset 
to a subsidiary member in a transfer described in section 351, and such 
contributions are undertaken with a view to avoiding the rules of 
paragraph (b) or (c) of this section, adjustments must be made to carry 
out the purposes of this section.
    (3) Anti-loss reimportation--(i) Application. This paragraph (g)(3) 
applies if--
    (A) A member of a group recognizes and is allowed a loss on the 
disposition of a share of stock of a subsidiary member with respect to 
which there is a duplicated loss; and
    (B) Within the 10-year period beginning on the date the subsidiary 
member (or any successor) ceases to be a member of such group--
    (1) The subsidiary member (or any successor) again becomes a member 
of such group (or any successor group)

[[Page 419]]

when the subsidiary member (or any successor) owns any asset that has a 
basis in excess of value at such time and that was owned by the 
subsidiary member (or any successor) on the date of a disposition of 
stock of such subsidiary member (or any successor) and that had a basis 
in excess of value on such date;
    (2) The subsidiary member (or any successor) again becomes a member 
of such group (or any successor group) when the subsidiary member (or 
any successor) owns any asset that has a basis in excess of value at 
such time and that has a basis that reflects, directly or indirectly, in 
whole or in part, the basis of any asset that was owned by the 
subsidiary member on the date of a disposition of stock of such 
subsidiary member (or any successor) and that had a basis in excess of 
value on such date;
    (3) In a transaction described in section 381 or section 351, any 
member of such group (or any successor group) acquires any asset of the 
subsidiary member (or any successor) that was owned by the subsidiary 
member (or any successor) on the date of a disposition of stock of such 
subsidiary member (or any successor) and that had a basis in excess of 
its value on such date, or any asset that has a basis that reflects, 
directly or indirectly, in whole or in part, the basis of any asset that 
was owned by the subsidiary member (or any successor) on the date of a 
disposition of stock of such subsidiary member (or any successor) and 
that had a basis in excess of its value on such date, and, immediately 
after the acquisition of such asset, such asset has a basis in excess of 
its value;
    (4) The subsidiary member (or any successor) again becomes a member 
of such group (or any successor group) when the subsidiary member (or 
any successor) has a liability (within the meaning of section 358(h)(3)) 
that it had on the date of a disposition of stock of such subsidiary 
member (or any successor) and such liability will give rise to a 
deduction;
    (5) In a transaction described in section 381 or section 351, any 
member of such group (or any successor group) assumes a liability 
(within the meaning of section 358(h)(3)) that was a liability of the 
subsidiary member (or any successor) on the date of a disposition of 
stock of such subsidiary member (or any successor);
    (6) The subsidiary member (or any successor) again becomes a member 
of such group (or any successor group) when the subsidiary member (or 
any successor) has any losses or deferred deductions that were losses or 
deferred deductions of the subsidiary member (or any successor) on the 
date of a disposition of stock of such subsidiary member (or any 
successor);
    (7) The subsidiary member (or any successor) again becomes a member 
of such group (or any successor group) when the subsidiary member (or 
any successor) has any losses or deferred deductions that are 
attributable to any asset that was owned by the subsidiary member (or 
any successor) on the date of a disposition of stock of such subsidiary 
member (or any successor) and that had a basis in excess of value on 
such date;
    (8) The subsidiary member (or any successor) again becomes a member 
of such group (or any successor group) when the subsidiary member (or 
any successor) has any losses or deferred deductions that are 
attributable to any asset that had a basis that reflected, directly or 
indirectly, in whole or in part, the basis of any asset that was owned 
by the subsidiary member (or any successor) on the date of a disposition 
of stock of such subsidiary member (or any successor) and that had a 
basis in excess of value on such date;
    (9) The subsidiary member (or any successor) again becomes a member 
of such group (or any successor group) when the subsidiary member (or 
any successor) has any losses or deferred deductions that are 
attributable to a liability (within the meaning of section 358(h)(3)) 
that it had on the date of a disposition of stock of such subsidiary 
member (or any successor);
    (10) Any member of such group (or any successor group) succeeds to 
any losses or deferred deductions of the subsidiary member (or any 
successor) that were losses or deferred deductions of the subsidiary 
member (or any successor) on the date of a disposition of stock of such 
subsidiary member (or any successor), that are attributable to

[[Page 420]]

any asset that was owned by the subsidiary member (or any successor) on 
the date of a disposition of stock of such subsidiary member (or any 
successor) and that had a basis in excess of value on such date, that 
are attributable to any asset that had a basis that reflected, directly 
or indirectly, in whole or in part, the basis of any asset that was 
owned by the subsidiary member (or any successor) on the date of a 
disposition of stock of such subsidiary member (or any successor) and 
that had a basis in excess of value on such date, or that are 
attributable to a liability (within the meaning of section 358(h)(3)) of 
the subsidiary member (or any successor) on the date of a disposition of 
stock of such subsidiary member (or any successor); or
    (11) Any losses or deferred deductions of the subsidiary member (or 
any successor) that were losses or deferred deductions of the subsidiary 
member (or any successor) on the date of a disposition of stock of such 
subsidiary member (or any successor), that are attributable to any asset 
that was owned by the subsidiary member (or any successor) on the date 
of a disposition of stock of such subsidiary member (or any successor) 
and that had a basis in excess of value on such date, that are 
attributable to any asset that had a basis that reflected, directly or 
indirectly, in whole or in part, the basis of any asset that was owned 
by the subsidiary member (or any successor) on the date of a disposition 
of stock of such subsidiary member (or any successor) and that had a 
basis in excess of value on such date, or that are attributable to a 
liability (within the meaning of section 358(h)(3)) of the subsidiary 
member (or any successor) on the date of a disposition of stock of such 
subsidiary member (or any successor) are carried back to a pre-
disposition taxable year of the subsidiary member.
    (ii) Operating rules. (A) For purposes of paragraph (g)(3)(i)(B) of 
this section, assets shall include stock and securities and the 
subsidiary member (or any successor) shall be treated as having its 
allocable share of losses and deferred deductions of all lower-tier 
subsidiary members and as owning its allocable share of each asset of 
all lower-tier subsidiary members.
    (B) For purposes of paragraphs (g)(3)(i)(B)(6), (7), (8), and (9) of 
this section, unless the group can establish otherwise, if the 
subsidiary member (or any successor) again becomes a member of such 
group (or any successor group) at a time when the subsidiary member (or 
any successor) has any losses or deferred deductions, such losses and 
deferred deductions shall be treated as losses or deferred deductions 
that were losses or deferred deductions of the subsidiary member (or any 
successor) on the date of a disposition of stock of such subsidiary 
member (or any successor), losses or deferred deductions that are 
attributable to assets that were owned by the subsidiary member (or any 
successor) on the date of a disposition of stock of such subsidiary 
member (or any successor) and that had bases in excess of value on such 
date, losses or deferred deductions that are attributable to assets that 
had bases that reflected, directly or indirectly, in whole or in part, 
the bases of assets that were owned by the subsidiary member (or any 
successor) on the date of a disposition of stock of such subsidiary 
member (or any successor) and that had bases in excess of value on such 
date, or losses or deferred deductions attributable to a liability 
(within the meaning of section 358(h)(3)) of the subsidiary member (or 
any successor) on the date of a disposition of stock of such subsidiary 
member (or any successor).
    (C) For purposes of paragraph (g)(3)(i)(B)(10) of this section, 
unless the group can establish otherwise, if a member of such group (or 
any successor group) succeeds to any losses or deferred deductions of 
the subsidiary member (or any successor), such losses and deferred 
deductions shall be treated as losses or deferred deductions that were 
losses or deferred deductions of the subsidiary member (or any 
successor) on the date of a disposition of stock of such subsidiary 
member (or any successor), losses or deferred deductions that are 
attributable to assets that were owned by the subsidiary member (or any 
successor) on the date of a disposition of stock of such subsidiary 
member (or any successor) and

[[Page 421]]

that had bases in excess of value on such date, losses or deferred 
deductions that are attributable to assets that had bases that 
reflected, directly or indirectly, in whole or in part, the bases of 
assets that were owned by the subsidiary member (or any successor) on 
the date of a disposition of stock of such subsidiary member (or any 
successor) and that had bases in excess of value on such date, or losses 
or deferred deductions attributable to a liability (within the meaning 
of section 358(h)(3)) of the subsidiary member (or any successor) on the 
date of a disposition of stock of such subsidiary member (or any 
successor).
    (D) For purposes of paragraph (g)(3)(i)(B)(11) of this section, 
unless the group can establish otherwise, if any losses or deferred 
deductions of the subsidiary member (or any successor) are carried back 
to a pre-disposition taxable year of the subsidiary member, such losses 
and deferred deductions shall be treated as losses or deferred 
deductions that were losses or deferred deductions of the subsidiary 
member (or any successor) on the date of a disposition of stock of such 
subsidiary member (or any successor), losses or deferred deductions that 
are attributable to assets that were owned by the subsidiary member (or 
any successor) on the date of a disposition of stock of such subsidiary 
member (or any successor) and that had a basis in excess of value on 
such date, losses or deferred deductions that are attributable to assets 
that had bases that reflected, directly or indirectly, in whole or in 
part, the bases of assets that were owned by the subsidiary member (or 
any successor) on the date of a disposition of stock of such subsidiary 
member (or any successor) and that had a basis in excess of value on 
such date, or losses or deferred deductions that are attributable to a 
liability (within the meaning of section 358(h)(3)) of the subsidiary 
member (or any successor) on the date of a disposition of stock of such 
subsidiary member (or any successor).
    (iii) Loss disallowance. If this paragraph (g)(3) applies, then, to 
the extent that the aggregate amount of loss recognized by members of 
the group (and any successor group) on dispositions of the subsidiary 
member stock was attributable to a duplicated loss of such subsidiary 
member that was allowed, such group (or any successor group) will be 
denied the use of--
    (A) Any loss recognized that is attributable to, directly or 
indirectly, an asset that was owned by the subsidiary member (or any 
successor) on the date of a disposition of stock of such subsidiary 
member (or any successor) and that had a basis in excess of value on 
such date, to the extent of the lesser of the loss inherent in such 
asset on the date of a disposition of the stock of the subsidiary member 
(or any successor) and the loss inherent in such asset on the date of 
the event described in paragraph (g)(3)(i)(B) of this section that gives 
rise to the application of this paragraph (g)(3);
    (B) Any loss recognized that is attributable to, directly or 
indirectly, an asset that has a basis that reflects, directly or 
indirectly, in whole or in part, the basis of any asset that was owned 
by the subsidiary member (or any successor) on the date of a disposition 
of stock of such subsidiary member (or any successor) and that had a 
basis in excess of its value on such date, to the extent of the lesser 
of the loss inherent in the asset that was owned by the subsidiary 
member (or any successor) on the date of a disposition of stock of such 
subsidiary member (or any successor) the basis of which is reflected, 
directly or indirectly, in whole or in part, in the basis of such asset 
on the date of the disposition and the loss inherent in such asset on 
the date of the event described in paragraph (g)(3)(i)(B) of this 
section that gives rise to the application of this paragraph (g)(3);
    (C) Any loss or deduction that is attributable to a liability 
described in paragraph (g)(3)(i)(B)(4) or (5) of this section; and
    (D) Any loss or deduction described in paragraph (g)(3)(i)(B)(6), 
(7), (8), (9), (10), or (11) of this section, provided that a loss or 
deferred deduction described in paragraph (g)(3)(i)(B)(11) of this 
section shall be allowed to be carried forward to a post-disposition 
taxable year of the subsidiary member.
    (iv) Treatment of disallowed loss. For purposes of Sec. 1.1502-
32(b)(3)(iii), any loss

[[Page 422]]

or deduction the use of which is disallowed pursuant to paragraph 
(g)(3)(iii) of this section (other than a loss or deduction described in 
paragraph (g)(3)(i)(B)(11) of this section), and with respect to which 
no waiver described in Sec. 1.1502-32(b)(4) is filed, is treated as a 
noncapital, nondeductible expense incurred during the taxable year that 
such loss would otherwise be absorbed.
    (4) Avoidance of recognition of gain. (i) If a transaction is 
structured with a view to, and has the effect of, deferring or avoiding 
the recognition of gain on a disposition of stock by invoking the 
application of paragraph (b)(1) of this section to redetermine the basis 
of stock of a subsidiary member, and the stock loss that gives rise to 
the application of paragraph (b)(1) of this section is not significant, 
paragraphs (b) and (c) of this section shall not apply.
    (ii) If a transaction is structured with a view to, and has the 
effect of, deferring or avoiding the recognition of gain on a 
disposition of stock by invoking the application of paragraph (b)(2) of 
this section to redetermine the basis of stock of a subsidiary member, 
and the duplicated loss of the subsidiary member that is reflected in 
stock of the subsidiary member owned by members of the group immediately 
before the deconsolidation is not significant, paragraphs (b) and (c) of 
this section shall not apply.
    (5) Examples. The principles of this paragraph (g) are illustrated 
by the following examples:

    Example 1. Transfers of property in avoidance of basis 
redetermination rule. (i) Facts. In Year 1, P forms S with a 
contribution of $100 in exchange for 100 shares of common stock of S 
which at that time represents all of the outstanding stock of S. S 
becomes a member of the P group. In Year 2, P contributes 20 shares of 
common stock of S to PS, a partnership, in exchange for a 20 percent 
capital and profits interest in a transaction described in section 721. 
In Year 3, P contributes Asset A with a basis of $50 and a value of $20 
to PS in exchange for an additional capital and profits interest in PS 
in a transaction described in section 721. Also in Year 3, PS 
contributes Asset A to S and P contributes an additional $80 to S in 
transfers to which section 351 applies. In Year 4, S sells Asset A for 
$20, recognizing a loss of $30. The P group uses that loss to offset 
income of P. Also in Year 4, P sells its entire interest in PS for $40, 
recognizing a loss of $30.
    (ii) Analysis. Pursuant to paragraph (g)(2) of this section, if P's 
contributions of S stock and Asset A to PS were undertaken with a view 
to avoiding the application of the basis redetermination or the loss 
suspension rule, adjustments must be made such that the group does not 
obtain more than one tax benefit from the $30 loss inherent in Asset A.
    Example 2. Transfers effecting a reimportation of loss. (i) Facts. 
In Year 1, P forms S with a contribution of Asset A with a value of $100 
and a basis of $120, Asset B with a value of $50 and a basis of $70, 
Asset C with a value of $90 and a basis of $100 in exchange for all of 
the common stock of S and S becomes a member of the P group. In Year 2, 
in a transaction that is not part of a plan that includes the 
contribution, P sells the stock of S for $240, recognizing a loss of 
$50. At such time, the bases and values of Assets A, B, and C have not 
changed since their contribution to S. In Year 3, S sells Asset A, 
recognizing a $20 loss. In Year 3, S merges into M in a reorganization 
described in section 368(a)(1)(A). In Year 8, P purchases all of the 
stock of M for $300. At that time, M has a $10 net operating loss. In 
addition, M owns Asset D, which was acquired in an exchange described in 
section 1031 in connection with the surrender of Asset B. Asset C has a 
value of $80 and a basis of $100. Asset D has a value of $60 and a basis 
of $70. In Year 9, P has operating income of $100 and M recognizes $20 
of loss on the sale of Asset C. In Year 10, P has operating income of 
$50 and M recognizes $50 of loss on the sale of Asset D.
    (ii) Analysis. P's $50 loss on the sale of S stock is entirely 
attributable to duplicated loss. Therefore, pursuant to paragraph (g)(3) 
of this section, assuming the P group cannot establish otherwise, M's 
$10 net operating loss is treated as attributable to assets that were 
owned by S on the date of the disposition and that had bases in excess 
of value on such date. Without regard to any other limitations on the 
group's use of M's net operating loss, the P group cannot use M's $10 
net operating loss pursuant to paragraph (g)(3)(iii)(D) of this section. 
Pursuant to paragraph (g)(3)(iv) of this section and Sec. 1.1502-
32T(b)(3)(iii)(D), such loss is treated as a noncapital, nondeductible 
expense of M incurred during the taxable year that includes the day 
after the reorganization. In addition, the P group is denied the use of 
$10 of the loss recognized on the sale of Asset C. Finally, the P group 
is denied the use of $10 of the loss recognized on the sale of Asset D. 
Pursuant to paragraph (g)(3)(iv) of this section and Sec. 1.1502-
32T(b)(3)(iii)(D), each such disallowed loss is treated as a noncapital, 
nondeductible expense of M incurred during the taxable year that 
includes the date of

[[Page 423]]

the disposition of the asset with respect to which such loss was 
recognized.
    Example 3. Transfers to avoid recognition of gain. (i) Facts. P owns 
all of the stock of S1 and S2. The S2 stock has a basis of $400 and a 
value of $500. S1 owns 50% of the stock of the S3 common stock with a 
basis of $150. S2 owns the remaining 50% of the S3 common stock with a 
basis of $100 and a value of $200 and one share of S3 preferred stock 
with a basis of $10 and a value of $9. P intends to sell all of its S2 
stock to an unrelated buyer. P, therefore, engages in the following 
steps to dispose of S2 without recognizing a substantial portion of the 
built-in gain in S2. First, P causes a recapitalization of S3 in which 
S2's S3 common stock is exchanged for new S3 preferred shares. P then 
sells all of its S2 stock. Immediately after the sale of the S2 stock, 
S3 is a member of the P group.
    (ii) Analysis. Pursuant to paragraph (b)(4) of this section, because 
S2 owns stock of S3 (another subsidiary member of the same group) and, 
immediately after the sale of the S2 stock, S3 is a member of the group, 
then for purposes of applying paragraph (b) of this section, S2 is 
deemed to have transferred its S3 stock. Because S3 is a member of the 
group immediately after the transfer of the S2 stock and the S3 stock 
deemed transferred has a basis in excess of value, the group member's 
basis in the S3 stock is redetermined pursuant to paragraph (b)(1) of 
this section immediately prior to the sale of the S2 stock. Pursuant to 
paragraph (b)(1) of this section, the total basis of S3 stock held by 
members of the P group is allocated first to the S3 preferred shares, up 
to their value of $209, and then to the remaining shares of S3 common 
held by S1. S2's aggregate basis in the S3 preferred stock is increased 
from $110 to $209. This increase tiers up and increases P's basis in the 
S2 stock from $400 to $499. Accordingly, P will recognize only $1 of 
gain on the sale of its S2 stock. However, because the recapitalization 
of S3 was structured with a view to, and has the effect of, avoiding the 
recognition of gain on a disposition of stock by invoking the 
application of paragraph (b) of this section, paragraph (g)(4)(i) of 
this section applies. Accordingly, paragraph (b) of this section does 
not apply upon P's disposition of the S2 stock and P recognizes $100 of 
gain on the disposition of the S2 stock.

    (h) Application of other anti-abuse rules. The rules of this section 
do not preclude the application of anti-abuse rules under other 
provisions of the Internal Revenue Code and regulations thereunder.
    (i) [Reserved]
    (j) Effective date. This section, except for paragraph (g)(3) of 
this section, applies with respect to stock transfers, deconsolidations 
of subsidiary members, determinations of worthlessness, and stock 
dispositions on or after March 7, 2002, and no later than March 11, 
2006, but only if such events occur during a taxable year the original 
return for which is due (without regard to extensions) after March 14, 
2003. Paragraph (g)(3) of this section applies to events described in 
paragraph (g)(3)(iii) of this section occurring on or after October 18, 
2002, and no later than March 11, 2006, but only if such events occur 
during a taxable year the original return for which is due (without 
regard to extensions) after March 14, 2003.

[T.D. 9048, 68 FR 12292, Mar. 14, 2003; 68 FR 16431, Apr. 4, 2003; 68 FR 
33382, June 4, 2003; 69 FR 1918, Jan. 13, 2004, as amended by T.D. 9118, 
69 FR 12801, Mar. 18, 2004]

                       Special Taxes and Taxpayers