[Code of Federal Regulations]
[Title 26, Volume 4]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.338-8]

[Page 127-140]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.338-8  Asset and stock consistency.

    (a) Introduction--(1) Overview. This section implements the 
consistency rules of sections 338(e) and (f). Under this section, no 
election under section 338 is deemed made or required with respect to 
target or any target affiliate. Instead, the person acquiring an asset 
may have a carryover basis in the asset.
    (2) General application. The consistency rules generally apply if 
the purchasing corporation acquires an asset directly from target during 
the target consistency period and target is a subsidiary in a 
consolidated group. In such a case, gain from the sale of the asset is 
reflected under the investment adjustment provisions of the consolidated 
return regulations in the basis of target stock and may reduce gain from

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the sale of the stock. See Sec. 1.1502-32 (investment adjustment 
provisions). Under the consistency rules, the purchasing corporation 
generally takes a carryover basis in the asset, unless a section 338 
election is made for target. Similar rules apply if the purchasing 
corporation acquires an asset directly from a lower-tier target 
affiliate if gain from the sale is reflected under the investment 
adjustment provisions in the basis of target stock.
    (3) Extensions of the general rules. If an arrangement exists, 
paragraph (f) of this section generally extends the carryover basis rule 
to certain cases in which the purchasing corporation acquires assets 
indirectly from target (or a lower-tier target affiliate). To prevent 
avoidance of the consistency rules, paragraph (j) of this section also 
may extend the consistency period or the 12-month acquisition period and 
may disregard the presence of conduits.
    (4) Application where certain dividends are paid. Paragraph (g) of 
this section extends the carryover basis rule to certain cases in which 
dividends are paid to a corporation that is not a member of the same 
consolidated group as the distributing corporation. Generally, this rule 
applies where a 100 percent dividends received deduction is used in 
conjunction with asset dispositions to achieve an effect similar to that 
available under the investment adjustment provisions of the consolidated 
return regulations.
    (5) Application to foreign target affiliates. Paragraph (h) of this 
section extends the carryover basis rule to certain cases involving 
target affiliates that are controlled foreign corporations.
    (6) Stock consistency. This section limits the application of the 
stock consistency rules to cases in which the rules are necessary to 
prevent avoidance of the asset consistency rules. Following the general 
treatment of a section 338(h)(10) election, a sale of a corporation's 
stock is treated as a sale of the corporation's assets if a section 
338(h)(10) election is made. Because gain from this asset sale may be 
reflected in the basis of the stock of a higher-tier target, the 
carryover basis rule may apply to the assets.
    (b) Consistency for direct acquisitions--(1) General rule. The basis 
rules of paragraph (d) of this section apply to an asset if--
    (i) The asset is disposed of during the target consistency period;
    (ii) The basis of target stock, as of the target acquisition date, 
reflects gain from the disposition of the asset (see paragraph (c) of 
this section); and
    (iii) The asset is owned, immediately after its acquisition and on 
the target acquisition date, by a corporation that acquires stock of 
target in the qualified stock purchase (or by an affiliate of an 
acquiring corporation).
    (2) Section 338(h)(10) elections. For purposes of this section, if a 
section 338(h)(10) election is made for a corporation acquired in a 
qualified stock purchase--
    (i) The acquisition is treated as an acquisition of the 
corporation's assets (see Sec. 1.338(h)(10)-1); and
    (ii) The corporation is not treated as target.
    (c) Gain from disposition reflected in basis of target stock. For 
purposes of this section:
    (1) General rule. Gain from the disposition of an asset is reflected 
in the basis of a corporation's stock if the gain is taken into account 
under Sec. 1.1502-32, directly or indirectly, in determining the basis 
of the stock, after applying section 1503(e) and other provisions of the 
Internal Revenue Code.
    (2) Gain not reflected if section 338 election made for target. Gain 
from the disposition of an asset that is otherwise reflected in the 
basis of target stock as of the target acquisition date is not 
considered reflected in the basis of target stock if a section 338 
election is made for target.
    (3) Gain reflected by reason of distributions. Gain from the 
disposition of an asset is not considered reflected in the basis of 
target stock merely by reason of the receipt of a distribution from a 
target affiliate that is not a member of the same consolidated group as 
the distributee. See paragraph (g) of this section for the treatment of 
dividends eligible for a 100 percent dividends received deduction.
    (4) Controlled foreign corporations. For a limitation applicable to 
gain of a target affiliate that is a controlled foreign

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corporation, see paragraph (h)(2) of this section.
    (5) Gain recognized outside the consolidated group. Gain from the 
disposition of an asset by a person other than target or a target 
affiliate is not reflected in the basis of a corporation's stock unless 
the person is a conduit, as defined in paragraph (j)(4) of this section.
    (d) Basis of acquired assets--(1) Carryover basis rule. If this 
paragraph (d) applies to an asset, the asset's basis immediately after 
its acquisition is, for all purposes of the Internal Revenue Code, its 
adjusted basis immediately before its disposition.
    (2) Exceptions to carryover basis rule for certain assets. The 
carryover basis rule of paragraph (d)(1) of this section does not apply 
to the following assets--
    (i) Any asset disposed of in the ordinary course of a trade or 
business (see section 338(e)(2)(A));
    (ii) Any asset the basis of which is determined wholly by reference 
to the adjusted basis of the asset in the hands of the person that 
disposed of the asset (see section 338(e)(2)(B));
    (iii) Any debt or equity instrument issued by target or a target 
affiliate (see paragraph (h)(3) of this section for an exception 
relating to the stock of a target affiliate that is a controlled foreign 
corporation);
    (iv) Any asset the basis of which immediately after its acquisition 
would otherwise be less than its adjusted basis immediately before its 
disposition; and
    (v) Any asset identified by the Internal Revenue Service in a 
revenue ruling or revenue procedure.
    (3) Exception to carryover basis rule for de minimis assets. The 
carryover basis rules of this section do not apply to an asset if the 
asset is not disposed of as part of the same arrangement as the 
acquisition of target and the aggregate amount realized for all assets 
otherwise subject to the carryover basis rules of this section does not 
exceed $250,000.
    (4) Mitigation rule--(i) General rule. If the carryover basis rules 
of this section apply to an asset and the asset is transferred to a 
domestic corporation in a transaction to which section 351 applies or as 
a contribution to capital and no gain is recognized, the transferor's 
basis in the stock of the transferee (but not the transferee's basis in 
the asset) is determined without taking into account the carryover basis 
rules of this section.
    (ii) Time for transfer. This paragraph (d)(4) applies only if the 
asset is transferred before the due date (including extensions) for the 
transferor's income tax return for the year that includes the last date 
for which a section 338 election may be made for target.
    (e) Examples--(1) In general. For purposes of the examples in this 
section, unless otherwise stated, the basis of each asset is the same 
for determining earnings and profits and taxable income, the exceptions 
to paragraph (d)(1) of this section do not apply, the taxable year of 
all persons is the calendar year, and the following facts apply: S is 
the common parent of a consolidated group that includes T, T1, T2, and 
T3; S owns all of the stock of T and T3; and T owns all of the stock of 
T1, which owns all of the stock of T2. B is unrelated to the S group and 
owns all of the stock of P, which owns all of the stock of P1. Y and Y1 
are partnerships that are unrelated to the S group but may be related to 
the P group. Z is a corporation that is not related to any of the other 
parties.

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[GRAPHIC] [TIFF OMITTED] TC17OC91.000

    (2) Direct acquisitions. Paragraphs (b), (c), and (d) of this 
section may be illustrated by the following examples:

    Example 1. Asset acquired from target by purchasing corporation. (a) 
On February 1 of Year 1, T sells an asset to P1 and recognizes gain. T's 
gain from the disposition of the asset is taken into account under Sec. 
1.1502-32 in determining S's basis in the T stock. On January 1 of Year 
2, P1 makes a qualified stock purchase of T from S. No section 338 
election is made for T.
    (b) T disposed of the asset during its consistency period, gain from 
the asset disposition is reflected in the basis of the T stock as of T's 
acquisition date (January 1 of Year 2), and the asset is owned both 
immediately after the asset disposition (February 1 of Year 1) and on 
T's acquisition date by P1, the corporation that acquired T stock in the 
qualified stock purchase. Consequently, under paragraph (b) of this 
section, paragraph (d)(1) of this section applies to the asset and P1's 
basis in the asset is T's adjusted basis in the asset immediately before 
the sale to P1.
    Example 2.  Gain from section 338(h)(10) election reflected in stock 
basis. (a) On February 1 of Year 1, P1 makes a qualified stock purchase 
of T2 from T1. A section 338(h)(10) election is made for T2 and T2 
recognizes gain on each of its assets. T2's gain is taken into account 
under Sec. 1.1502-32 in determining S's basis in the T stock. On 
January 1 of Year 2, P1 makes a qualified stock purchase of T from S. No 
section 338 election is made for T.
    (b) Under paragraph (b)(2) of this section, the acquisition of the 
T2 stock is treated as an acquisition of T2's assets on February 1 of 
Year 1, because a section 338(h)(10) election is made for T2. The gain 
recognized by T2 under section 338(h)(10) is reflected in S's basis in 
the T stock as of T's acquisition date. Because the other requirements 
of paragraph (b) of this section are satisfied, paragraph (d)(1) of this 
section applies to the assets and new T2's basis in its assets is old 
T2's adjusted basis in the assets immediately before the disposition.
    Example 3. Corporation owning asset ceases affiliation with 
corporation purchasing target before target acquisition date. (a) On 
February 1 of Year 1, T sells an asset to P1 and recognizes gain. On 
December 1 of Year 1, P disposes of all of the P1 stock while P1 still 
owns the asset. On January 1 of Year 2, P makes a qualified stock 
purchase of T from S. No section 338 election is made for T.
    (b) Immediately after T's disposition of the asset, the asset is 
owned by P1 which is affiliated on that date with P, the corporation 
that acquired T stock in the qualified stock purchase. However, the 
asset is owned by a corporation (P1) that is no longer affiliated with P 
on T's acquisition date. Although the other requirements of paragraph 
(b) of this section are satisfied, the requirements of paragraph 
(b)(1)(iii) of this section are not satisfied. Consequently, the basis 
rules of paragraph (d) of this section do not apply to the asset by 
reason of P1's acquisition.
    (c) If P acquires all of the Z stock and P1 transfers the asset to Z 
on or before T's acquisition date (January 1 of Year 2), the

[[Page 131]]

asset is owned by an affiliate of P both on February 1 of Year 1 (P1) 
and on January 1 of Year 2 (Z). Consequently, all of the requirements of 
paragraph (b) of this section are satisfied and paragraph (d)(1) of this 
section applies to the asset and P1's basis in the asset is T's adjusted 
basis in the asset immediately before the sale to P1.
    Example 4. Gain reflected in stock basis notwithstanding offsetting 
loss or distribution. (a) On April 1 of Year 1, T sells an asset to P1 
and recognizes gain. In Year 1, T distributes an amount equal to the 
gain. On March 1 of Year 2, P makes a qualified stock purchase of T from 
S. No section 338 election is made for T.
    (b) Although, as a result of the distribution, there is no 
adjustment with respect to the T stock under Sec. 1.1502-32 for Year 1, 
T's gain from the disposition of the asset is considered reflected in 
S's basis in the T stock. The gain is considered to have been taken into 
account under Sec. 1.1502-32 in determining the adjustments to S's 
basis in the T stock because S's basis in the T stock is different from 
what it would have been had there been no gain.
    (c) If T distributes an amount equal to the gain on February 1 of 
Year 2, rather than in Year 1, the results would be the same because S's 
basis in the T stock is different from what it would have been had there 
been no gain. If the distribution in Year 2 is by reason of an election 
under Sec. 1.1502-32(f)(2), the results would be the same.
    (d) If, in Year 1, T does not make a distribution and the S group 
does not file a consolidated return, but, in Year 2, the S group does 
file a consolidated return and makes an election under Sec. 1.1502-
32(f)(2) for T, the results would be the same. S's basis in the T stock 
is different from what it would have been had there been no gain. 
Paragraph (c)(3) of this section (gain not considered reflected by 
reason of distributions) does not apply to the deemed distribution under 
the election because S and T are members of the same consolidated group. 
If T distributes an amount equal to the gain in Year 2 and no election 
is made under Sec. 1.1502-32(f)(2), the results would be the same.
    (e) If, in Year 1, T incurs an unrelated loss in an amount equal to 
the gain, rather than distributing an amount equal to the gain, the 
results would be the same because the gain is taken into account under 
Sec. 1.1502-32 in determining S's basis in the T stock.
    Example 5. Gain of a target affiliate reflected in stock basis after 
corporate reorganization. (a) On February 1 of Year 1, T3 sells an asset 
to P1 and recognizes gain. On March 1 of Year 1, S contributes the T3 
stock to T in a transaction qualifying under section 351. On January 15 
of Year 2, P1 makes a qualified stock purchase of T from S. No section 
338 election is made for T.
    (b) T3's gain from the asset sale is taken into account under Sec. 
1.1502-32 in determining S's basis in the T3 stock. Under section 358, 
the gain that is taken into account under Sec. 1.1502-32 in determining 
S's basis in the T3 stock is also taken into account in determining S's 
basis in the T stock following S's contribution of the T3 stock to T. 
Consequently, under paragraph (b) of this section, paragraph (d)(1) of 
this section applies to the asset and P1's basis in the asset is T3's 
adjusted basis in the asset immediately before the sale to P1.
    (c) If on March 1 of Year 1, rather than S contributing the T3 stock 
to T, S causes T3 to merge into T in a transaction qualifying under 
section 368(a)(1)(D), the results would be the same.
    Example 6. Gain not reflected if election under section 338 made. 
(a) On February 1 of Year 1, T1 sells an asset to P1 and recognizes 
gain. On January 1 of Year 2, P1 makes a qualified stock purchase of T1 
from T. A section 338 election (but not a section 338(h)(10) election) 
is made for T1.
    (b) Under paragraph (c)(2) of this section, because a section 338 
election is made for T1, T's basis in the T1 stock is considered not to 
reflect gain from the disposition. Consequently, the requirement of 
paragraph (b)(1)(ii) of this section is not satisfied. Thus, P1's basis 
in the asset is not determined under paragraph (d) of this section. 
Although the section 338 election for T1 results in a qualified stock 
purchase of T2, the requirement of paragraph (b)(1)(ii) of this section 
is not satisfied with respect to T2, whether or not a section 338 
election is made for T2.
    (c) If, on January 1 of Year 2, P1 makes a qualified stock purchase 
of T from S and a section 338 election for T, rather than T1, S's basis 
in the T stock is considered not to reflect gain from T1's disposition 
of the asset. However, the section 338 election for T results in a 
qualified stock purchase of T1. Because the gain is reflected in T's 
basis in the T1 stock, the requirements of paragraph (b) of this section 
are satisfied. Consequently, P1's basis in the asset is determined under 
paragraph (d)(1) of this section unless a section 338 election is also 
made for T1.

    (f) Extension of consistency to indirect acquisitions--(1) 
Introduction. If an arrangement exists (see paragraph (j)(5) of this 
section), this paragraph (f) generally extends the consistency rules to 
indirect acquisitions that have the same effect as direct acquisitions. 
For example, this paragraph (f) applies if, pursuant to an arrangement, 
target sells an asset to an unrelated person who then sells the asset to 
the purchasing corporation.

[[Page 132]]

    (2) General rule. This paragraph (f) applies to an asset if, 
pursuant to an arrangement--
    (i) The asset is disposed of during the target consistency period;
    (ii) The basis of target stock as of, or at any time before, the 
target acquisition date reflects gain from the disposition of the asset; 
and
    (iii) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied, but the asset is owned, at any time 
during the portion of the target consistency period following the target 
acquisition date, by--
    (A) A corporation--
    (1) The basis of whose stock, as of, or at any time before, the 
target acquisition date, reflects gain from the disposition of the 
asset; and
    (2) That is affiliated, at any time during the target consistency 
period, with a corporation that acquires stock of target in the 
qualified stock purchase; or
    (B) A corporation that at the time it owns the asset is affiliated 
with a corporation described in paragraph (f)(2)(iii)(A) of this 
section.
    (3) Basis of acquired assets. If this paragraph (f) applies to an 
asset, the principles of the basis rules of paragraph (d) of this 
section apply to the asset as of the date, following the disposition 
with respect to which gain is reflected in the basis of target's stock, 
that the asset is first owned by a corporation described in paragraph 
(f)(2)(iii) of this section. If the principles of the carryover basis 
rule of paragraph (d)(1) of this section apply to an asset, the asset's 
basis also is reduced (but not below zero) by the amount of any 
reduction in its basis occurring after the disposition with respect to 
which gain is reflected in the basis of target's stock.
    (4) Examples. This paragraph (f) may be illustrated by the following 
examples:

    Example 1. Acquisition of asset from unrelated party by purchasing 
corporation. (a) On February 1 of Year 1, T sells an asset to Z and 
recognizes gain. On February 15 of Year 1, P1 makes a qualified stock 
purchase of T from S. No section 338 election is made for T. P1 buys the 
asset from Z on March 1 of Year 1, before Z has reduced the basis of the 
asset through depreciation or otherwise.
    (b) Paragraph (b) of this section does not apply to the asset 
because the asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied. However, the asset ownership 
requirements of paragraph (f)(2)(iii) of this section are satisfied 
because, during the portion of T's consistency period following T's 
acquisition date, the asset is owned by P1 while it is affiliated with 
T. Consequently, paragraph (f) of this section applies to the asset if 
there is an arrangement for T to dispose of the asset during T's 
consistency period, for the gain to be reflected in S's basis in the T 
stock as of T's acquisition date, and for P1 to own the asset during the 
portion of T's consistency period following T's acquisition date. If the 
arrangement exists, under paragraph (f)(3) of this section, P1's basis 
in the asset is determined as of March 1 of Year 1, under the principles 
of paragraph (d) of this section. Consequently, P1's basis in the asset 
is T's adjusted basis in the asset immediately before the sale to Z.
    (c) If P1 acquires the asset from Z on January 15 of Year 2 (rather 
than on March 1 of Year 1), and Z's basis in the asset has been reduced 
through depreciation at the time of the acquisition, P1's basis in the 
asset as of January 15 of Year 2 would be T's adjusted basis in the 
asset immediately before the sale to Z, reduced (but not below zero) by 
the amount of the depreciation. Z's basis and depreciation are 
determined without taking into account the basis rules of paragraph (d) 
of this section.
    (d) If P, rather than P1, acquires the asset from Z, the results 
would be the same.
    (e) If, on March 1 of Year 1, P1 acquires the Z stock, rather than 
acquiring the asset from Z, paragraph (f) of this section would apply to 
the asset if an arrangement exists. However, under paragraph (f)(3) of 
this section, Z's basis in the asset would be determined as of February 
1 of Year 1, the date the asset is first owned by a corporation (Z) 
described in paragraph (f)(2)(iii) of this section. Consequently, Z's 
basis in the asset as of February 1 of Year 1, determined under the 
principles of paragraph (d) of this section, would be T's adjusted basis 
in the asset immediately before the sale to Z.
    Example 2. Acquisition of asset from target by target affiliate. (a) 
On February 1 of Year 1, T contributes an asset to T1 in a transaction 
qualifying under section 351 and in which T recognizes gain under 
section 351(b) that is deferred under Sec. 1.1502-13. On March 1 of 
Year 1, P1 makes a qualified stock purchase of T from S and, pursuant to 
Sec. 1.1502-13, the deferred gain is taken into account by T 
immediately before T ceases to be a member of the S group. No section 
338 election is made for T.

[[Page 133]]

    (b) Paragraph (b) of this section does not apply to the asset 
because the asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied.
    (c) T1 is not described in paragraph (f)(2)(iii)(A) of this section 
because the basis of the T1 stock does not reflect gain from the 
disposition of the asset. Although, under section 358(a)(1)(B)(ii), T's 
basis in the T1 stock is increased by the amount of the gain, the gain 
is not taken into account directly or indirectly under Sec. 1.1502-32 
in determining T's basis in the T1 stock.
    (d) T1 is described in paragraph (f)(2)(iii)(B) of this section 
because, during the portion of T's consistency period following T's 
acquisition date, T1 owns the asset while it is affiliated with T, a 
corporation described in paragraph (f)(2)(iii)(A) of this section. 
Consequently, paragraph (f) of this section applies to the asset if 
there is an arrangement. Under paragraph (j)(5) of this section, the 
fact that, at the time T1 acquires the asset from T, T1 is related 
(within the meaning of section 267(b)) to T indicates that an 
arrangement exists.
    Example 3. Acquisition of asset from target and indirect acquisition 
of target stock. (a) On February 1 of Year 1, T sells an asset to P1 and 
recognizes gain. On March 1 of Year 1, Z makes a qualified stock 
purchase of T from S. No section 338 election is made for T. On January 
1 of Year 2, P1 acquires the T stock from Z other than in a qualified 
stock purchase.
    (b) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied because the asset was never owned by Z, 
the corporation that acquired T stock in the qualified stock purchase 
(or by a corporation that was affiliated with Z at the time it owned the 
asset). However, because the asset is owned by P1 while it is affiliated 
with T during the portion of T's consistency period following T's 
acquisition date, paragraph (f) of this section applies to the asset if 
there is an arrangement. If there is an arrangement, the principles of 
the carryover basis rule of paragraph (d)(1) of this section apply to 
determine P1's basis in the asset unless Z makes a section 338 election 
for T. See paragraph (c)(2) of this section.
    (c) If P1 also makes a qualified stock purchase of T from Z, the 
results would be the same. If there is an arrangement, the principles of 
the carryover basis rule of paragraph (d)(1) of this section apply to 
determine P1's basis in the asset unless Z makes a section 338 election 
for T. However, these principles apply to determine P1's basis in the 
asset if P1, but not Z, makes a section 338 election for T. The basis of 
the T stock no longer reflects, as of T's acquisition date by P1, the 
gain from the disposition of the asset.
    (d) Assume Z purchases the T stock other than in a qualified stock 
purchase and P1 makes a qualified stock purchase of T from Z. Paragraph 
(b) of this section does not apply to the asset because gain from the 
disposition of the asset is not reflected in the basis of T's stock as 
of T's acquisition date (January 1 of Year 2). However, because the gain 
is reflected in S's basis in the T stock before T's acquisition date and 
the asset is owned by P1 while it is affiliated with T during the 
portion of T's consistency period following T's acquisition date, 
paragraph (f) of this section applies to the asset if there is an 
arrangement. If there is an arrangement, the principles of the carryover 
basis rule of paragraph (d)(1) of this section apply to determine P1's 
basis in the asset even if P1 makes a section 338 election for T. The 
basis of the T stock no longer reflects, as of T's acquisition date, the 
gain from the disposition of the asset.
    Example 4. Asset acquired from target affiliate by corporation that 
becomes its affiliate. (a) On February 1 of Year 1, T1 sells an asset to 
P1 and recognizes gain. On February 15 of Year 1, Z makes a qualified 
stock purchase of T from S. No section 338 election is made for T. On 
June 1 of Year 1, P1 acquires the T1 stock from T, other than in a 
qualified stock purchase.
    (b) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are not satisfied because the asset was never owned by Z, 
the corporation that acquired T stock in the qualified stock purchase 
(or by a corporation that was affiliated with Z at the time it owned the 
asset).
    (c) P1 is not described in paragraph (f)(2)(iii)(A) of this section 
because gain from the disposition of the asset is not reflected in the 
basis of the P1 stock.
    (d) P1 is described in paragraph (f)(2)(iii)(B) of this section 
because the asset is owned by P1 while P1 is affiliated with T1 during 
the portion of T's consistency period following T's acquisition date. T1 
becomes affiliated with Z, the corporation that acquired T stock in the 
qualified stock purchase, during T's consistency period, and, as of T's 
acquisition date, the basis of T1's stock reflects gain from the 
disposition of the asset. Consequently, paragraph (f) of this section 
applies to the asset if there is an arrangement.
    Example 5. De minimis rules. (a) On February 1 of Year 1, T sells an 
asset to P and recognizes gain. On February 15 of Year 1, T1 sells an 
asset to Z and recognizes gain. The aggregate amount realized by T and 
T1 on their respective sales of assets is not more than $250,000. On 
March 1 of Year 1, T3 sells an asset to P and recognizes gain. On April 
1 of Year 1, P makes a qualified stock purchase of T from S. No section 
338 election is made for T. On June 1 of Year 1, P1 buys from Z the 
asset sold by T1.
    (b) Under paragraph (b) of this section, the basis rules of 
paragraph (d) of this section

[[Page 134]]

apply to the asset sold by T. Under paragraph (f) of this section, the 
principles of the basis rules of paragraph (d) of this section apply to 
the asset sold by T1 if there is an arrangement. Because T3's gain is 
not reflected in the basis of the T stock, the basis rules of this 
section do not apply to the asset sold by T3.
    (c) The de minimis rule of paragraph (d)(3) of this section applies 
to an asset if the asset is not disposed of as part of the same 
arrangement as the acquisition of T and the aggregate amount realized 
for all assets otherwise subject to the carryover basis rules does not 
exceed $250,000. The aggregate amount realized by T and T1 does not 
exceed $250,000. (The asset sold by T3 is not taken into account for 
purposes of the de minimis rule.) Thus, the de minimis rule applies to 
the asset sold by T if the asset is not disposed of as part of the same 
arrangement as the acquisition of T.
    (d) If, under paragraph (f) of this section, the principles of the 
carryover basis rules of paragraph (d)(1) of this section otherwise 
apply to the asset sold by T1 because of an arrangement, the de minimis 
rules of this section do not apply to the asset because of the 
arrangement.
    (e) Assume on June 1 of Year 1, Z acquires the T1 stock from T, 
other than in a qualified stock purchase, rather than P1 buying the T1 
asset, and paragraph (f) of this section applies because there is an 
arrangement. Because the asset was disposed of and the T1 stock was 
acquired as part of the arrangement, the de minimis rules of this 
section do not apply to the asset.

    (g) Extension of consistency if dividends qualifying for 100 percent 
dividends received deduction are paid--(1) General rule for direct 
acquisitions from target. Unless a section 338 election is made for 
target, the basis rules of paragraph (d) of this section apply to an 
asset if--
    (i) Target recognizes gain (whether or not deferred) on disposition 
of the asset during the portion of the target consistency period that 
ends on the target acquisition date;
    (ii) The asset is owned, immediately after the asset disposition and 
on the target acquisition date, by a corporation that acquires stock of 
target in the qualified stock purchase (or by an affiliate of an 
acquiring corporation); and
    (iii) During the portion of the target consistency period that ends 
on the target acquisition date, the aggregate amount of dividends paid 
by target, to which section 243(a)(3) applies, exceeds the greater of--
    (A) $250,000; or
    (B) 125 percent of the yearly average amount of dividends paid by 
target, to which section 243(a)(3) applies, during the three calendar 
years immediately preceding the year in which the target consistency 
period begins (or, if shorter, the period target was in existence).
    (2) Other direct acquisitions having same effect. The basis rules of 
paragraph (d) of this section also apply to an asset if the effect of a 
transaction described in paragraph (g)(1) of this section is achieved 
through any combination of disposition of assets and payment of 
dividends to which section 243(a)(3) applies (or any other dividends 
eligible for a 100 percent dividends received deduction). See paragraph 
(h)(4) of this section for additional rules relating to target 
affiliates that are controlled foreign corporations.
    (3) Indirect acquisitions. The principles of paragraph (f) of this 
section also apply for purposes of this paragraph (g).
    (4) Examples. This paragraph (g) may be illustrated by the following 
examples:

    Example 1. Asset acquired from target paying dividends to which 
section 243(a)(3) applies. (a) The S group does not file a consolidated 
return. In Year 1, Year 2, and Year 3, T pays dividends to S to which 
section 243(a)(3) applies of $200,000, $250,000, and $300,000, 
respectively. On February 1 of Year 4, T sells an asset to P and 
recognizes gain. On January 1 of Year 5, P makes a qualified stock 
purchase of T from S. No section 338 election is made for T. During the 
portion of T's consistency period that ends on T's acquisition date, T 
pays S dividends to which section 243(a)(3) applies of $1,000,000.
    (b) Under paragraph (g)(1) of this section, paragraph (d) of this 
section applies to the asset. T recognizes gain on disposition of the 
asset during the portion of T's consistency period that ends on T's 
acquisition date, the asset is owned by P immediately after the 
disposition and on T's acquisition date, and T pays dividends described 
in paragraph (g)(1)(iii) of this section. Consequently, under paragraph 
(d)(1) of this section, P's basis in the asset is T's adjusted basis in 
the asset immediately before the sale to P.
    (c) If T is a controlled foreign corporation, the results would be 
the same if T pays dividends in the amount described in paragraph 
(g)(1)(iii) of this section that qualify for a 100 percent dividends 
received deduction. See sections 243(e) and 245.
    (d) If S and T3 file a consolidated return in which T, T1, and T2 do 
not join, the results

[[Page 135]]

would be the same because the dividends paid by T are still described in 
paragraph (g)(1)(iii) of this section.
    (e) If T, T1, and T2 file a consolidated return in which S and T3 do 
not join, the results would be the same because the dividends paid by T 
are still described in paragraph (g)(1)(iii) of this section.
    Example 2. Asset disposition by target affiliate achieving same 
effect. (a) The S group does not file a consolidated return. On February 
1 of Year 1, T2 sells an asset to P and recognizes gain. T pays 
dividends to S described in paragraph (g)(1)(iii) of this section. On 
January 1 of Year 2, P makes a qualified stock purchase of T from S. No 
section 338 election is made for T.
    (b) Paragraph (g)(1) of this section does not apply to the asset 
because T did not recognize gain on the disposition of the asset. 
However, under paragraph (g)(2) of this section, because the asset 
disposition by T2 and the dividends paid by T achieve the effect of a 
transaction described in paragraph (g)(1) of this section, the carryover 
basis rule of paragraph (d)(1) of this section applies to the asset. The 
effect was achieved because T2 is a lower-tier affiliate of T and the 
dividends paid by T to S reduce the value to S of T and its lower-tier 
affiliates.
    (c) If T2 is a controlled foreign corporation, the results would be 
the same because T2 is a lower-tier affiliate of T and the dividends 
paid by T to S reduce the value to S of T and its lower-tier affiliates.
    (d) If P buys an asset from T3, rather than T2, the asset 
disposition and the dividends do not achieve the effect of a transaction 
described in paragraph (g)(1) of this section because T3 is not a lower-
tier affiliate of T. Thus, the basis rules of paragraph (d) of this 
section do not apply to the asset. The results would be the same whether 
or not P also acquires the T3 stock (whether or not in a qualified stock 
purchase).
    Example 3. Dividends by target affiliate achieving same effect. (a) 
The S group does not file a consolidated return. On February 1 of Year 
1, T1 sells an asset to P and recognizes gain. On January 1 of Year 2, P 
makes a qualified stock purchase of T from S. No section 338 election is 
made for T. T does not pay dividends to S described in paragraph 
(g)(1)(iii) of this section. However, T1 pays dividends to T that would 
be described in paragraph (g)(1)(iii) of this section if T1 were a 
target.
    (b) Paragraph (g)(1) of this section does not apply to the asset 
because T did not recognize gain on the disposition of the asset and did 
not pay dividends described in paragraph (g)(1)(iii) of this section. 
Further, paragraph (g)(2) of this section does not apply because the 
dividends paid by T1 to T do not reduce the value to S of T and its 
lower-tier affiliates.
    (c) If both S and T own T1 stock and T1 pays dividends to S that 
would be described in paragraph (g)(1)(iii) of this section if T1 were a 
target, paragraph (g)(2) of this section would apply because the 
dividends paid by T1 to S reduce the value to S of T and its lower-tier 
affiliates. If T, rather than T1, sold the asset to P, the results would 
be the same. Further, if T and T1 pay dividends to S that, only when 
aggregated, would be described in paragraph (g)(1)(iii) of this section 
(if they were all paid by T), the results would be the same.
    Example 4. Gain reflected by reason of dividends. (a) S and T file a 
consolidated return in which T1 and T2 do not join. On February 1 of 
Year 1, T1 sells an asset to P and recognizes gain. On January 1 of Year 
2, P makes a qualified stock purchase of T from S. No section 338 
election is made for T. T1 pays dividends to T that would be described 
in paragraph (g)(1)(iii) of this section if T1 were a target.
    (b) The requirements of paragraph (b) of this section are not 
satisfied because, under paragraph (c)(3) of this section, gain from 
T1's sale is not reflected in S's basis in the T stock by reason of the 
dividends paid by T1 to T.
    (c) Although the dividends paid by T1 to T do not reduce the value 
to S of T and its lower-tier affiliates, paragraph (g)(2) of this 
section applies because the dividends paid by T1 to T are taken into 
account under Sec. 1.1502-32 in determining S's basis in the T stock. 
Consequently, the carryover basis rule of paragraph (d)(1) of this 
section applies to the asset.

    (h) Consistency for target affiliates that are controlled foreign 
corporations--(1) In general. This paragraph (h) applies only if target 
is a domestic corporation. For additional rules that may apply with 
respect to controlled foreign corporations, see paragraph (g) of this 
section. The definitions and nomenclature of Sec. 1.338-2(b) and (c) 
and paragraph (e) of this section apply for purposes of this section.
    (2) Income or gain resulting from asset dispositions--(i) General 
rule. Income or gain of a target affiliate that is a controlled foreign 
corporation from the disposition of an asset is not reflected in the 
basis of target stock under paragraph (c) of this section unless the 
income or gain results in an inclusion under section 951(a)(1)(A), 
951(a)(1)(C), 1291 or 1293.
    (ii) Basis of controlled foreign corporation stock. If, by reason of 
paragraph (h)(2)(i) of this section, the carryover basis rules of this 
section apply to an

[[Page 136]]

asset, no increase in basis in the stock of a controlled foreign 
corporation under section 961(a) or 1293(d)(1), or under regulations 
issued pursuant to section 1297(b)(5), is allowed to target or a target 
affiliate to the extent the increase is attributable to income or gain 
described in paragraph (h)(2)(i) of this section. A similar rule applies 
to the basis of any property by reason of which the stock of the 
controlled foreign corporation is considered owned under section 
958(a)(2) or 1297(a).
    (iii) Operating rule. For purposes of this paragraph (h)(2)--
    (A) If there is an income inclusion under section 951 (a)(1)(A) or 
(C), the shareholder's income inclusion is first attributed to the 
income or gain of the controlled foreign corporation from the 
disposition of the asset to the extent of the shareholder's pro rata 
share of such income or gain; and
    (B) Any income or gain under section 1293 is first attributed to the 
income or gain from the disposition of the asset to the extent of the 
shareholder's pro rata share of the income or gain.
    (iv) Increase in asset or stock basis--(A) If the carryover basis 
rules under paragraph (h)(2)(i) of this section apply to an asset, and 
the purchasing corporation disposes of the asset to an unrelated party 
in a taxable transaction and recognizes and includes in its U.S. gross 
income or the U.S. gross income of its shareholders the greater of the 
income or gain from the disposition of the asset by the selling 
controlled foreign corporation that was reflected in the basis of the 
target stock under paragraph (c) of this section, or the gain recognized 
on the asset by the purchasing corporation on the disposition of the 
asset, then the purchasing corporation or the target or a target 
affiliate, as appropriate, shall increase the basis of the selling 
controlled foreign corporation stock subject to paragraph (h)(2)(ii) of 
this section, as of the date of the disposition of the asset by the 
purchasing corporation, by the amount of the basis increase that was 
denied under paragraph (h)(2)(ii) of this section. The preceding 
sentence shall apply only to the extent that the controlled foreign 
corporation stock is owned (within the meaning of section 958(a)) by a 
member of the purchasing corporation's affiliated group.
    (B) If the carryover basis rules under paragraph (h)(2)(i) of this 
section apply to an asset, and the purchasing corporation or the target 
or a target affiliate, as appropriate, disposes of the stock of the 
selling controlled foreign corporation to an unrelated party in a 
taxable transaction and recognizes and includes in its U.S. gross income 
or the U.S. gross income of its shareholders the greater of the gain 
equal to the basis increase that was denied under paragraph (h)(2)(ii) 
of this section, or the gain recognized in the stock by the purchasing 
corporation or by the target or a target affiliate, as appropriate, on 
the disposition of the stock, then the purchasing corporation shall 
increase the basis of the asset, as of the date of the disposition of 
the stock of the selling controlled foreign corporation by the 
purchasing corporation or by the target or a target affiliate, as 
appropriate, by the amount of the basis increase that was denied 
pursuant to paragraph (h)(2)(i) of this section. The preceding sentence 
shall apply only to the extent that the asset is owned (within the 
meaning of section 958(a)) by a member of the purchasing corporation's 
affiliated group.
    (3) Stock issued by target affiliate that is a controlled foreign 
corporation. The exception to the carryover basis rules of this section 
provided in paragraph (d)(2)(iii) of this section does not apply to 
stock issued by a target affiliate that is a controlled foreign 
corporation. After applying the carryover basis rules of this section to 
the stock, the basis in the stock is increased by the amount treated as 
a dividend under section 1248 on the disposition of the stock (or that 
would have been so treated but for section 1291), except to the extent 
the basis increase is attributable to the disposition of an asset in 
which a carryover basis is taken under this section.
    (4) Certain distributions--(i) General rule. In the case of a target 
affiliate that is a controlled foreign corporation, paragraph (g) of 
this section applies with respect to the target affiliate by treating 
any reference to a dividend to which section 243(a)(3) applies as a 
reference to any amount taken

[[Page 137]]

into account under Sec. 1.1502-32 in determining the basis of target 
stock that is--
    (A) A dividend;
    (B) An amount treated as a dividend under section 1248 (or that 
would have been so treated but for section 1291); or
    (C) An amount included in income under section 951(a)(1)(B).
    (ii) Basis of controlled foreign corporation stock. If the carryover 
basis rules of this section apply to an asset, the basis in the stock of 
the controlled foreign corporation (or any property by reason of which 
the stock is considered owned under section 958(a)(2)) is reduced (but 
not below zero) by the sum of any amounts that are treated, solely by 
reason of the disposition of the asset, as a dividend, amount treated as 
a dividend under section 1248 (or that would have been so treated but 
for section 1291), or amount included in income under section 
951(a)(1)(B). For this purpose, any dividend, amount treated as a 
dividend under section 1248 (or that would have been so treated but for 
section 1291), or amount included in income under section 951(a)(1)(B) 
is considered attributable first to earnings and profits resulting from 
the disposition of the asset.
    (iii) Increase in asset or stock basis--(A) If the carryover basis 
rules under paragraphs (g) and (h)(4)(i) of this section apply to an 
asset, and the purchasing corporation disposes of the asset to an 
unrelated party in a taxable transaction and recognizes and includes in 
its U.S. gross income or the U.S. gross income of its shareholders the 
greater of the gain equal to the basis increase denied in the asset 
pursuant to paragraphs (g) and (h)(4)(i) of this section, or the gain 
recognized on the asset by the purchasing corporation on the disposition 
of the asset, then the purchasing corporation or the target or a target 
affiliate, as appropriate, shall increase the basis of the selling 
controlled foreign corporation stock subject to paragraph (h)(4)(ii) of 
this section, as of the date of the disposition of the asset by the 
purchasing corporation, by the amount of the basis reduction under 
paragraph (h)(4)(ii) of this section. The preceding sentence shall apply 
only to the extent that the controlled foreign corporation stock is 
owned (within the meaning of section 958(a)) by a member of the 
purchasing corporation's affiliated group.
    (B) If the carryover basis rules under paragraphs (g) and (h)(4)(i) 
of this section apply to an asset, and the purchasing corporation or the 
target or a target affiliate, as appropriate, disposes of the stock of 
the selling controlled foreign corporation to an unrelated party in a 
taxable transaction and recognizes and includes in its U.S. gross income 
or the U.S. gross income of its shareholders the greater of the amount 
of the basis reduction under paragraph (h)(4)(ii) of this section, or 
the gain recognized in the stock by the purchasing corporation or by the 
target or a target affiliate, as appropriate, on the disposition of the 
stock, then the purchasing corporation shall increase the basis of the 
asset, as of the date of the disposition of the stock of the selling 
controlled foreign corporation by the purchasing corporation or by the 
target or a target affiliate, as appropriate, by the amount of the basis 
increase that was denied pursuant to paragraphs (g) and (h)(4)(i) of 
this section. The preceding sentence shall apply only to the extent that 
the asset is owned (within the meaning of section 958(a)) by a member of 
the purchasing corporation's affiliated group.
    (5) Examples. This paragraph (h) may be illustrated by the following 
examples:

    Example 1. Stock of target affiliate that is a CFC. (a) The S group 
files a consolidated return; however, T2 is a controlled foreign 
corporation. On December 1 of Year 1, T1 sells the T2 stock to P and 
recognizes gain. On January 2 of Year 2, P makes a qualified stock 
purchase of T from S. No section 338 election is made for T.
    (b) Under paragraph (b)(1) of this section, paragraph (d) of this 
section applies to the T2 stock. Under paragraph (h)(3) of this section, 
paragraph (d)(2)(iii) of this section does not apply to the T2 stock. 
Consequently, paragraph (d)(1) of this section applies to the T2 stock. 
However, after applying paragraph (d)(1) of this section, P's basis in 
the T2 stock is increased by the amount of T1's gain on the sale of the 
T2 stock that is treated as a dividend under section 1248. Because P has 
a carryover basis in the T2 stock, the T2 stock is not considered 
purchased within the meaning of section 338(h)(3) and no section 338 
election may be made for T2.

[[Page 138]]

    Example 2. Stock of target affiliate CFC; inclusion under subpart F. 
(a) The S group files a consolidated return; however, T2 is a controlled 
foreign corporation. On December 1 of Year 1, T2 sells an asset to P and 
recognizes subpart F income that results in an inclusion in T1's gross 
income under section 951(a)(1)(A). On January 2 of Year 2, P makes a 
qualified stock purchase of T from S. No section 338 election is made 
for T.
    (b) Because gain from the disposition of the asset results in an 
inclusion under section 951(a)(1)(A), the gain is reflected in the basis 
of the T stock as of T's acquisition date. See paragraph (h)(2)(i) of 
this section. Consequently, under paragraph (b)(1) of this section, 
paragraph (d)(1) of this section applies to the asset. In addition, 
under paragraph (h)(2)(ii) of this section, T1's basis in the T2 stock 
is not increased under section 961(a) by the amount of the inclusion 
that is attributable to the sale of the asset.
    (c) If, in addition to making a qualified stock purchase of T, P 
acquires the T2 stock from T1 on January 1 of Year 2, the results are 
the same for the asset sold by T2. In addition, under paragraph 
(h)(2)(ii) of this section, T1's basis in the T2 stock is not increased 
by the amount of the inclusion that is attributable to the gain on the 
sale of the asset. Further, under paragraph (h)(3) of this section, 
paragraph (d)(1) of this section applies to the T2 stock. However, after 
applying paragraph (d)(1) of this section, P's basis in the T2 stock is 
increased by the amount of T1's gain on the sale of the T2 stock that is 
treated as a dividend under section 1248. Finally, because P has a 
carryover basis in the T2 stock, the T2 stock is not considered 
purchased within the meaning of section 338(h)(3) and no section 338 
election may be made for T2.
    (d) If P makes a qualified stock purchase of T2 from T1, rather than 
of T from S, and T1's gain on the sale of T2 is treated as a dividend 
under section 1248, under paragraph (h)(1) of this section, paragraphs 
(h)(2) and (3) of this section do not apply because there is no target 
that is a domestic corporation. Consequently, the carryover basis rules 
of paragraph do not apply to the asset sold by T2 or the T2 stock.
    Example 3. Gain reflected by reason of section 1248 dividend; gain 
from non-subpart F asset. (a) The S group files a consolidated return; 
however, T2 is a controlled foreign corporation. In Years 1 through 4, 
T2 does not pay any dividends to T1 and no amount is included in T1's 
income under section 951(a)(1)(B). On December 1 of Year 4, T2 sells an 
asset with a basis of $400,000 to P for $900,000. T2's gain of $500,000 
is not subpart F income. On December 15 of Year 4, T1 sells T2, in which 
it has a basis of $600,000, to P for $1,600,000. Under section 1248, 
$800,000 of T1's gain of $1,000,000 is treated as a dividend. However, 
in the absence of the sale of the asset by T2 to P, only $300,000 would 
have been treated as a dividend under section 1248. On December 30 of 
Year 4, P makes a qualified stock purchase of T1 from T. No section 338 
election is made for T1.
    (b) Under paragraph (h)(4) of this section, paragraph (g)(2) of this 
section applies by reference to the amount treated as a dividend under 
section 1248 on the disposition of the T2 stock. Because the amount 
treated as a dividend is taken into account in determining T's basis in 
the T1 stock under Sec. 1.1502-32, the sale of the T2 stock and the 
deemed dividend have the effect of a transaction described in paragraph 
(g)(1) of this section. Consequently, paragraph (d)(1) of this section 
applies to the asset sold by T2 to P and P's basis in the asset is 
$400,000 as of December 1 of Year 4.
    (c) Under paragraph (h)(3) of this section, paragraph (d)(1) of this 
section applies to the T2 stock and P's basis in the T2 stock is 
$600,000 as of December 15 of Year 4. Under paragraphs (h)(3) and 
(4)(ii) of this section, however, P's basis in the T2 stock is increased 
by $300,000 (the amount of T1's gain treated as a dividend under section 
1248 ($800,000), other than the amount treated as a dividend solely as a 
result of the sale of the asset by T2 to P ($500,000)) to $900,000.
    (i) [Reserved]
    (j) Anti-avoidance rules. For purposes of this section--
    (1) Extension of consistency period. The target consistency period 
is extended to include any continuous period that ends on, or begins on, 
any day of the consistency period during which a purchasing corporation, 
or any person related, within the meaning of section 267(b) or 
707(b)(1), to a purchasing corporation, has an arrangement--
    (i) To purchase stock of target; or
    (ii) To own an asset to which the carryover basis rules of this 
section apply, taking into account the extension.
    (2) Qualified stock purchase and 12-month acquisition period. The 
12-month acquisition period is extended if, pursuant to an arrangement, 
a corporation acquires by purchase stock of another corporation 
satisfying the requirements of section 1504(a)(2) over a period of more 
than 12 months.
    (3) Acquisitions by conduits--(i) Asset ownership--(A) General rule. 
A corporation is treated as owning any portion of an asset attributed to 
the corporation from a conduit under section 318(a) (treating any asset 
as stock for this purpose), for purposes of--
    (1) The asset ownership requirements of this section; and

[[Page 139]]

    (2) Determining whether a controlled foreign corporation is a target 
affiliate for purposes of paragraph (h) of this section.
    (B) Application of carryover basis rule. If the basis rules of this 
section apply to the asset, the basis rules of this section apply to the 
entire asset (not just the portion for which ownership is attributed).
    (ii) Stock acquisitions--(A) Purchase by conduit. A corporation is 
treated as purchasing stock of another corporation attributed to the 
corporation from a conduit under section 318(a) on the day the stock is 
purchased by the conduit. The corporation is not treated as purchasing 
the stock, however, if the conduit purchased the stock more than two 
years before the date the stock is first attributed to the corporation.
    (B) Purchase of conduit by corporation. If a corporation purchases 
an interest in a conduit (treating the interest as stock for this 
purpose), the corporation is treated as purchasing on that date any 
stock owned by a conduit on that date and attributed to the corporation 
under section 318(a) with respect to the interest in the conduit that 
was purchased.
    (C) Purchase of conduit by conduit. If a conduit (the first conduit) 
purchases an interest in a second conduit (treating the interest as 
stock for this purpose), the first conduit is treated as purchasing on 
that date any stock owned by a conduit on that date and attributed to 
the first conduit under section 318(a) with respect to the interest in 
the second conduit that was purchased.
    (4) Conduit. A person (other than a corporation) is a conduit as to 
a corporation if--
    (i) The corporation would be treated under section 318(a)(2)(A) and 
(B) (attribution from partnerships, estates, and trusts) as owning any 
stock owned by the person; and
    (ii) The corporation, together with its affiliates, would be treated 
as owning an aggregate of at least 50 percent of the stock owned by the 
person.
    (5) Existence of arrangement. The existence of an arrangement is 
determined under all the facts and circumstances. For an arrangement to 
exist, there need not be an enforceable, written, or unconditional 
agreement, and all the parties to the transaction need not have 
participated in each step of the transaction. One factor indicating the 
existence of an arrangement is the participation of a related party. For 
this purpose, persons are related if they are related within the meaning 
of section 267(b) or 707(b)(1).
    (6) Predecessor and successor--(i) Persons. A reference to a person 
(including target, target affiliate, and purchasing corporation) 
includes, as the context may require, a reference to a predecessor or 
successor. For this purpose, a predecessor is a transferor or 
distributor of assets to a person (the successor) in a transaction--
    (A) To which section 381(a) applies; or
    (B) In which the successor's basis for the assets is determined, 
directly or indirectly, in whole or in part, by reference to the basis 
of the transferor or distributor.
    (ii) Assets. A reference to an asset (the first asset) includes, as 
the context may require, a reference to any asset the basis of which is 
determined, directly or indirectly, in whole or in part, by reference to 
the first asset.
    (7) Examples. This paragraph (j) may be illustrated by the following 
examples:

    Example 1. Asset owned by conduit treated as owned by purchaser of 
target stock. (a) P owns a 60-percent interest in Y. On March 1 of Year 
1, T sells an asset to Y and recognizes gain. On January 1 of Year 2, P 
makes a qualified stock purchase of T from S. No section 338 election is 
made for T.
    (b) Under paragraph (j)(4) of this section, Y is a conduit with 
respect to P. Consequently, under paragraph (j)(3)(i)(A) of this 
section, P is treated as owning 60% of the asset on March 1 of Year 1 
and January 1 of Year 2. Because P is treated as owning part or all of 
the asset both immediately after the asset disposition and on T's 
acquisition date, paragraph (b) of this section applies to the asset. 
Consequently, paragraph (d)(1) of this section applies to the asset and 
Y's basis in the asset is T's adjusted basis in the asset immediately 
before the sale to Y.
    Example 2. Corporation whose stock is owned by conduit treated as 
affiliate. (a) P owns an 80-percent interest in Y. Y owns all of the 
stock of Z. On March 1 of Year 1, T sells an asset to Z and recognizes 
gain. On January 1 of Year 2, P makes a qualified stock purchase of T 
from S. No section 338 election is made for T.
    (b) Under paragraph (j)(4) of this section, Y is a conduit with 
respect to P. Consequently,

[[Page 140]]

under paragraph (j)(3)(i)(A) of this section, P is treated as owning 80% 
of the Z stock and Z is therefore treated as an affiliate of P for 
purposes of applying the asset ownership requirements of paragraph 
(b)(1)(iii) of this section. Because Z, an affiliate of P, owns the 
asset both immediately after the asset disposition and on T's 
acquisition date, paragraph (b) of this section applies to the asset, 
and the asset's basis is determined under paragraph (d) of this section.
    (c) If, instead of owning an 80-percent interest in Y, P owned a 79-
percent interest in Y, Z would not be treated as an affiliate of P and 
paragraph (b) of this section would not apply to the asset.
    Example 3. Qualified stock purchase by reason of stock purchase by 
conduit. (a) P owns a 90-percent interest in Y. Y owns a 60-percent 
interest in Y1. On February 1 of Year 2, T sells an asset to P and 
recognizes gain. On January 1 of Year 3, P purchases 70% of the T stock 
from S and Y1 purchases the remaining 30% of the T stock from S.
    (b) Under paragraph (j)(3)(ii)(A) of this section, P is treated as 
purchasing on January 1 of Year 3, the 16.2% of the T stock that is 
attributed to P from Y and Y1 under section 318(a). Thus, for purposes 
of this section, P is treated as making a qualified stock purchase of T 
on January 1 of Year 3, paragraph (b) of this section applies to the 
asset, and the asset's basis is determined under paragraph (d) of this 
section. However, because P is not treated as having made a qualified 
stock purchase of T for purposes of making an election under section 
338, no election can be made for T.
    (c) If Y1 purchases 20% of the T stock from S on December 1 of Year 
1, rather than 30% on January 1 of Year 3, P would be treated as 
purchasing 10.8% of the T stock on December 1 of Year 1. Thus, if 
paragraph (j)(2) of this section (relating to extension of the 12-month 
acquisition period) does not apply, P would not be treated as making a 
qualified stock purchase of T, because P is not treated as purchasing T 
stock satisfying the requirements of section 1504(a)(2) within a 12-
month period.
    Example 4. Successor asset. (a) On February 1 of Year 1, T sells 
stock of X to P1 and recognizes gain. On December 1 of Year 1, P1 
exchanges its X stock for stock in new X in a reorganization qualifying 
under section 368(a)(1)(F). On January 1 of Year 2, P1 makes a qualified 
stock purchase of T from S. No section 338 election is made for T.
    (b) The asset ownership requirements of paragraph (b)(1)(iii) of 
this section are satisfied because, under paragraph (j)(6)(ii) of this 
section, P1 is treated as owning the X stock on T's acquisition date. P1 
is treated as owning the X stock on that date because P1 owns the new X 
stock and P1's basis in the new X stock is determined by reference to 
P1's basis in the X stock. Consequently, under paragraph (d)(1) of this 
section, P1's basis in the X stock on February 1 of Year 1 is T's 
adjusted basis in the X stock immediately before the sale to P1.

[T.D. 8515, 59 FR 2972, Jan. 20, 1994, as amended by T.D. 8597, 60 FR 
36679, July 18, 1995; T.D. 8710, 62 FR 3459, Jan. 23, 1997. Redesignated 
by T.D. 8858, 65 FR 1246, Jan. 7, 2000, as amended by T.D. 8940, 66 FR 
9929, Feb. 13, 2001; 66 FR 17466, Mar. 30, 2001]