[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.897-5T]

[Page 569-580]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.897-5T  Corporate distributions (temporary).

    (a) Purpose and scope. This section provides rules concerning the 
recognition of gain or loss and adjustments to basis required with 
respect to certain corporate distributions that are subject to section 
897. Paragraph (b) of this section provides rules concerning such 
distributions by domestic corporations, including distributions under 
section 301, distributions in redemption of stock, and distributions in 
liquidation. Paragraph (c) sets forth rules concerning distributions by 
foreign corporations, including distributions under sections 301 and 
355, distributions in redemption of stock, and distributions in 
liquidation. Finally, various rules generally applicable to 
distributions subject to this section, as well as to transfers subject 
to Sec. 1.897-6T, are set forth in paragraph (d). The rules contained 
in this section are also subject to the tax avoidance rules of Sec. 
1.897-6T(c).
    (b) Distributions by domestic corporations--(1) Limitation of basis 
upon dividend distribution of U.S. real property interest. Under section 
897(f), if any domestic corporation (distributing corporation) 
distributes a U.S. real property interest to a shareholder that is a 
foreign person (distributee) in a distribution to which section 301 
applies, then the basis of the distributed U.S. real property interest 
in the hands of the foreign distributee shall be determined in 
accordance with the provisions of section 301(d), and shall not exceed--
    (i) The adjusted basis of the property before the distribution in 
the hands of the distributing corporation, increased by
    (ii) The sum of--
    (A) Any gain recognized by the distributing corporation on the 
distribution, and

[[Page 570]]

    (B) Any U.S. tax paid by or on behalf of the distributee with 
respect to the distribution.
    (2) Distributions by U.S. real property holding corporations which 
are taxable exchanges of stock under generally applicable rules. If a 
domestic corporation, stock in which is treated as a U.S. real property 
interest, distributes property with respect to such stock to a foreign 
shareholder, the distributee shall be treated as having disposed of a 
U.S. real property interest, and shall recognize gain or loss on the 
stock of such domestic corporation to the extent that, with respect to 
the distributees--
    (i) Part of all of the distribution is treated pursuant to section 
301(c)(3)(A) as a sale or exchange of stock;
    (ii) Part or all of the distribution is treated pursuant to section 
302(a) as made in part or full payment in exchange for stock; or
    (iii) Part or all of the distribution is treated pursuant to section 
331(a) as made in full payment in exchange for stock.

Stock in a domestic corporation shall not be considered a U.S. real 
property interest pursuant to the provisions of Sec. 1.897-2(f)(2) if 
the corporation does not hold any U.S. real property interests and has 
disposed of all of its U.S. real property interests owned within the 
previous five years in transactions in which the full amount of gain was 
recognized under the rules of Sec. 1.897-2(f)(2). If gain is recognized 
at the corporate level on either a distribution of a U.S. real property 
interest or a sale of a U.S. real property interest in a liquidation, 
such distribution or sale shall be considered a disposition for purposes 
of Sec. 1.897-2(f)(2). With regard to the consequences of a 
distribution from a U.S. real property holding corporation under section 
355(a), see Sec. 1.897-6T(a) (1) and (4).
    (3) Section 332 liquidations of U.S. real property holding 
corporations--(i) General rules. Exchanges that are subject to section 
897(e) are normally covered by Sec. 1.897-6T(a) (1), (2) and (3). This 
paragraph (b)(3) provides rules concerning the application of section 
897(e) and the general principles of Sec. 1.897-6T(a) (1), (2) and (3) 
to section 332 liquidations of U.S real property holding corporations.
    (ii) Distribution to a foreign corporation under section 332 after 
June 18, 1980, and before the repeal of the General Utilities doctrine. 
Except for distributions under paragraph (b)(3)(iii) of this section 
(relating to section 332 and former section 334(b)(2)), the rules of 
this paragraph (b)(3)(ii) shall apply to section 332 distributions after 
June 18, 1980, and before January 1, 1990, pursuant to section 336(a) as 
in effect prior to the effective dates of the amendments made by section 
631 of the Tax Reform Act of 1986. A foreign corporation that meets the 
stock ownership requirements of section 332(b) with respect to stock in 
a domestic corporation that is a U.S. real property interest shall not, 
after December 31, 1984, be subject to taxation by reason of section 
367(a). The foreign corporation shall recognize gain pursuant to section 
897(e)(1) on such stock upon the receipt of property in a section 332(a) 
liquidation from such domestic corporation, but only to the extent that 
the property received constitutes property other than a U.S. real 
property interest. The gain on the stock in the domestic corporation to 
be recognized by the foreign corporation pursuant to section 897(e)(1) 
shall be determined by multiplying the gain realized on the distribution 
by a fraction. The numerator of the fraction shall be the fair market 
value of the property other than U.S. real property interests received 
by the foreign corporation on the distribution, and the denominator 
shall be the fair market value of all property received by the foreign 
corporation on the distribution. The bases of the distributed U.S. real 
property interests in the hands of the foreign corporation shall be the 
same as the bases in the hands of the domestic corporation. The bases of 
the property other than U.S. real property interests in the hands of the 
foreign corporation shall be the same as the bases in the hands of the 
domestic corporation, plus any gain recognized by the foreign 
corporation on the distribution allocated among such assets in 
proportion to the potential gain inherent in each such asset at the time 
of distribution. However, the basis of each asset is limited to its fair 
market value. Property, other than a U.S. real property interest

[[Page 571]]

that is distributed by the domestic corporation, shall not be considered 
to be distributed by the domestic corporation pursuant to a section 332 
liquidation (that is, the foreign corporation shall not be considered to 
be a corporation for purposes of section 332) if the requirements of 
section 367(a) are not satisfied. See, for example, sections 1245(b)(3) 
and 1250(d)(3) regarding the consequences to the distributing domestic 
corporation if the requirements of section 367(a) are not satisfied.
    (iii) Distribution to a foreign corporation under section 332 and 
former section 334(b)(2) after June 18, 1980. The rules of this 
paragraph (b)(2)(iii) shall apply to section 332 distributions after 
June 18, 1980 where the basis of the distributed property in the hands 
of the foreign corporation is determined under section 334(b)(2) as in 
effect prior to the Tax Equity and Fiscal Responsibility Act of 1982. A 
foreign corporation that meets the stock ownership requirements of 
section 332(b) with respect to stock in a domestic corporation that is a 
U.S. real property interest shall recognize gain on the reciept of 
property in a section 332(a) liquidation where section 334(b)(2) applies 
to the extent that the fair market value of the distributed assets that 
are not U.S real property interests exceeds the basis of such assets 
determined under section 334(b)(2) (for example, if the liquidation does 
not occur immediately upon the purchase of stock in the domestic 
corporation). The gain recognized shall not exceed the excess of the 
fair market value of the stock of the domestic corporation in the hands 
of the foreign corporation at the time of the distribution over the 
shareholder's adjusted basis in such stock. The basis of the distributed 
U.S. real property interests in the hands of the foreign corporation 
shall be determined under section 334(b)(2), by reference to the 
adjusted basis of the stock with respect to which the distribution was 
made. The basis of such property other than U.S. real property interests 
shall be tentatively determined under section 334(b)(2), and then 
increased by any gain recognized by the foreign corporation on the 
distribution allocated among such assets in proportion to the potential 
gain inherent in each such asset at the time of distribution (computed 
using the tentative basis as determined under section 334(b)(2)). The 
basis of each asset is limited, however, to its fair market value.
    (iv) Distribution to a foreign corporation under section 332 after 
July 31, 1986 and after the repeal of the General Utilities doctrine. 
The rules of this subdivision (iv) shall apply to section 332 
distributions after July 31, 1986, pursuant to section 337(a) as in 
effect after the effectivie dates of the amendments of section 631 of 
the Tax Reform Act of 1986.
    (A) Liquidation of domestic corporation. A foreign corporation that 
meets the stock ownership requirements of section 332(b) with respect to 
stock in a domestic corporation that is a U.S. real property interest 
(except a foreign corporation that has made an effective election under 
section 897(i) and the stock of which is treated as a U.S. real property 
interest) shall not recognize any gain under sections 367(a) or 
897(e)(1) on the receipt of property in a section 332(a) liquidation. 
The domestic corporation shall not recognize gain under section 
367(e)(2) on the distribution of U.S. real property interests (other 
than stock in a former U.S. real property holding corporation which is 
treated as a U.S. real property interest) to the foreign corporation. 
The domestic corporation shall recognize gain under section 367(e)(2) on 
the distribution of stock in a former U.S. real property holding 
corporation which is treated as a U.S. real property interest. With 
respect to the recognition of gain or loss by the domestic corporation 
under section 367(e)(2) on the distribution of property other than U.S. 
real property interests, see the regulations under section 367(e)(2). 
The basis of the distributed U.S. real property interests (other than 
stock in a former U.S. real property holding corporation) in the hands 
of the foreign corporation shall be the same as it was in the hands of 
the domestic corporation. The basis of any property (other than U.S. 
real property interests) and stock in a former U.S. real property 
holding corporation that is a U.S. real property interest in the hands 
of the foreign corporation shall be the same as it was in the hands of 
the domestic corporation

[[Page 572]]

increased by any gain recognized by the distributing corporation on the 
distribution that was subject to U.S. taxation.
    (B) Liquidation of certain foreign corporations making a section 
897(i) election. A foreign corporation that meets the stock ownership 
requirements of section 332(b) with respect to stock in another foreign 
corporation, that has made an effective election under section 897(i) 
and the stock of which is treated as a U.S. real property interest, 
shall recognize gain pursuant to section 897(e)(1) on such stock upon 
the receipt from the distributing foreign corporation of property that 
is not a U.S. real property interest, and that is not used by the 
distributee foreign corporation in the conduct of a trade or business 
within the United States (if the distributee foreign corporation is not 
a resident of a country with which the United States maintains an income 
tax treaty) or in a permanent establishment within the United States (if 
the distributee foreign corporation is a resident of a country with 
which the United States maintains an income tax treaty). The gain on the 
stock in the foreign corporation (making an effective election under 
section 897(i)) to be recognized by the distributee foreign corporation 
pursuant to section 897(e)(1) shall be determined by multiplying the 
gain realized on the distribution by a fraction. The numerator of the 
fraction shall be the fair market value of the property received by the 
distributee foreign corporation upon which it must recognize gain, and 
the denominator of the fraction shall be the fair market value of all 
property received by the distributee foreign corporation on the 
distribution. The distributing foreign corporation shall not recognize 
gain under section 367(e)(2) on the distribution of U.S. real property 
interests to the distributee foreign corporation. With respect to the 
recognition of gain or loss under section 367(e)(2) on the distribution 
of property other than U.S. real property interests, see the regulations 
under section 367(e)(2). The basis of the distributed U.S. real property 
interests in the hands of the distributee foreign corporation shall be 
the same as it was in the hands of the distributing foreign corporation. 
The basis of the property upon which the distributee foreign corporation 
recognized gain in the hands of the distributee foreign corporation 
shall be the same as the basis in the hands of the distributing foreign 
corporation, plus any gain recognized by the distributee foreign 
corporation on the receipt of such property allocated among such 
property in proportion to the potential gain inherent in each such 
property at the time of the distribution. In regard to the basis of any 
other property received by the distributee foreign corporation in the 
liquidation, see the regulations under section 367(e)(2). However, the 
basis of each asset is limited to its fair market value.
    (v) Transfer of foreign corporation stock followed by a section 332 
liquidation treated as a reorganization. If a nonresident alien or 
foreign corporation transfers the stock of a foreign-corporation that 
owns a U.S. real property interest to a domestic corporation in exchange 
for stock of the domestic corporation (or its domestic or foreign parent 
corporation) in a reorganization under section 368(a)(1)(B) or in an 
exchange under section 351(a), and if the foreign corporation then 
distributes the U.S. real property interest to the domestic corporation 
in a liquidation described in section 332(a) within five years of the 
transfer of the stock of the foreign corporation to the domestic 
corporation, then the transfer of the foreign corporation stock and the 
liquidation shall be treated as a reorganization described in section 
368(a)(1) (C) or (D). The rules of Sec. 1.897-6T(a)(1) shall apply to 
the transfer of the U.S. real property interest to the domestic 
corporation in exchange for domestic corporation stock, and the rules of 
Sec. 1.897-5T(c)(4) shall apply to the distribution of domestic 
corporation stock by the foreign corporation. However, the rules of this 
paragraph (b)(3)(v) shall not apply if the transfer of the foreign 
corporation stock and the liquidation under section 332(a) are separate 
and independent transactions justified by substantial and verifiable 
business purposes.
    (4) Section 897(i) companies. Except as otherwise provided herein 
for purposes of this section and Sec. 1.897-6T, a foreign

[[Page 573]]

corporation that has made a valid election under section 897(i) shall be 
treated as a domestic corporation and not as a foreign corporation in 
determining the application of section 897. For rules concerning the 
making of a section 897(i) election, see Sec. Sec. 1.897-3 and 1.897-
8T. In regard to section 367(e)(2) and foreign corporations that have 
made an effective election under section 897(i), see paragraph 
(b)(3)(iv) of this section.
    (5) Examples. The following examples illustrate the rules of this 
paragraph (b). In each example there is no applicable income tax treaty 
to which the United States is a party.

    Example 1. (i) A is a nonresident alien who owns 100 percent of the 
stock of DC, a U.S. real property holding corporation. DC's only asset 
is Parcel P, a U.S. real property interest, with a fair market value of 
$500,000 and an adjusted basis of $300,000. DC completely liquidates in 
1987 and distributes Parcel P to A in exchange for the DC stock held by 
A.
    (ii) Under section 336(a), DC must recognize gain to the extent of 
the excess of the fair market value ($500,000) over the adjusted basis 
($300,000), or $200,000.
    (iii) A does not recognize any gain under section 897(a) because the 
DC stock in the hands of A is no longer a U.S. real property interest 
under paragraph (b)(2) of this section and paragraph 2(f) of Sec. 
1.897-2. A does recognize gain (if any) under section 331(a); however, 
the gain is not subject to taxation under section 871(a). A's adjusted 
basis in Parcel P is $500,000.
    (iv) If DC did not recognize all of the gain on the disposition 
under a transitional rule to section 631 of the Tax Reform Act of 1986, 
then paragraph (b)(2) of this section and paragraph 2(f) of Sec. 1.897-
2 would not apply to A. A would recognize gain (if any) under paragraph 
(b)(2) because the distribution is treated as in full payment in 
exchange for the DC stock under section 897(a).
    Example 2. (i) FC, a Country F corporation, owns 100 percent of the 
stock of DC, a U.S. real property holding corporation. FC's basis in the 
stock of DC is $400,000, and the fair market value of the DC stock is 
$800,000. DC owns a U.S. real property interest with an adjusted basis 
of $350,000 and a fair market value of $600,000. DC also owns other 
assets that are not U.S. real property interests that have an adjusted 
basis of $125,000 and a fair market value of $200,000. DC completely 
liquidates in 1985 and distributes all of its property to FC in exchange 
for the DC stock held by FC.
    (ii) Under paragraph (b)(3)(ii) of this section, FC recognizes 
$100,000 of gain under section 897(a) on the disposition of the DC 
stock. This is determined by multiplying FC's gain realized ($400,000) 
by a fraction. The numerator of the fraction is the fair market value of 
the property other than U.S. real property interests ($200,000), and the 
denominator of the fraction is the fair market value of all property 
received ($800,000). FC takes a carryover adjusted basis in the U.S. 
real property interest ($350,000). FC's adjusted basis in the assets 
that are not U.S. real property interests ($200,000) is the basis of 
those assets in the hands of DC ($125,000) plus the gain recognized by 
FC on the distribution ($100,000) not to exceed the fair market value 
($200,000).
    Example 3. (i) FC, a Country F corporation, owns 100 percent of the 
stock of DC, a U.S. real property holding corporation. FC's basis in the 
stock of DC is $300,000, and the fair market value of the DC stock is 
$500,000. DC owns Parcel P, a U.S. real property interest, with an 
adjusted basis of $250,000 and a fair market value of $400,000. DC also 
owns all of the stock of DX, a former U.S. real property holding 
corporation whose stock is a U.S. real property interest, with an 
adjusted basis of $50,000 and a fair market value of $100,000. DC 
completely liquidates in 1987 and distributes all of its property to FC 
in exchange for the DC stock held by FC.
    (ii) Under paragraph (b)(3)(iv)(A) of this section, DC recognizes 
$50,000 of gain on the distribution to FC of the DX stock. DC does not 
recognize any gain for purposes of section 367(e)(2) on the distribution 
to FC of Parcel P.
    (iii) Under paragraph (b)(3)(iv)(A) of this section, FC's 
disposition of its DC stock is not treated as a disposition of a U.S. 
real property interest. Under section 334(b)(1), FC takes a carryover 
adjusted basis of $250,000 in Parcel P. FC takes an increased basis of 
$100,000 in the DX stock which is equal to DC's basis ($50,000) 
increased by the gain recognized by DC ($50,000).
    (iv) The result would be the same if FC had made an effective 
election under section 897(i).

    (6) Section 333 elections--(i) General rule. A foreign shareholder 
that elects section 333 as in effect prior to its repeal by the Tax 
Reform Act of 1986 upon the distribution of property in a liquidation by 
a domestic corporation whose stock is treated as a U.S. real property 
interest shall recognize gain on such stock to the extent that--
    (A) The property received by the foreign shareholder constitutes 
property other than U.S. real property interests subject to U.S. 
taxation upon its disposition as specified by paragraph (a)(1) of this 
section, or
    (B) The basis of a U.S. real property interest subject to U.S. 
taxation upon

[[Page 574]]

its disposition in the hands of the recipient foreign shareholder 
exceeds the basis of the U.S. real property interest in the hands of the 
liquidating domestic corporation.

In determining the amount of gain recognized by the foreign shareholder, 
the foreign shareholder shall be considered to have exchanged the 
domestic corporation stock for all the property distributed on a 
proportionate fair market value basis. The gain recognized on a 
respective portion of domestic corporation stock shall not exceed the 
gain realized on that portion. Property other than U.S. real property 
interests subject to U.S. taxation upon disposition shall have a fair 
market value basis in the hands of the foreign shareholder. The basis of 
U.S. real property interests subject to U.S. taxation upon disposition 
shall be the basis of the proportionate part of the domestic corporation 
stock cancelled or redeemed in the liquidation, increased in the amount 
of gain recognized (other than gain recognized under this section) by 
the shareholder in respect to that proportionate part of the domestic 
corporation stock.
    (ii) Example. The rules of paragraph (b)(6)(i) of this section may 
be illustrated by the following example.

    Example. (i) A is a citizen and resident of Country F with which the 
U.S. does not have an income tax treaty. A owns all of the stock of DC, 
a U.S. real property holding corporation. The DC stock has a fair market 
value of $1,000,000. A acquired the DC stock in two purchases. The basis 
of one lot of the DC stock is $150,000, and the basis of the other lot 
is $650,000.
    (ii) DC owns Parcel P, a U.S. real property interest, with a fair 
market value of $750,000 and an adjusted basis of $400,000. DC's only 
other property is equipment with a fair market value of $250,000 and an 
adjusted basis of $100,000. DC does not have any earnings and profits.
    (iii) DC completely liquidates in 1985 in accordance with section 
333 by distributing Parcel P and the equipment to A. A elects section 
333 treatment.
    (iv) A is considered as having exchanged 75 percent (fair market 
value of Parcel P/fair market value of all property distributed) of the 
DC stock for Parcel P. A realized gain of $150,000 on that portion of 
the DC stock ($750,000-$600,000). All of the gain of $150,000 is 
recognized under section 897 (a) because A's basis in Parcel P under 
section 334 (c) ($600,000) would exceed DC's basis in Parcel P 
($400,000) by at least the amount of realized gain. A takes a basis of 
$750,000 in Parcel P.
    (v) A is considered as having exchanged 25 percent (fair market 
value of equipment/fair market value of all property distributed) of the 
DC stock for the equipment. A realized gain of $50,000 on that portion 
of the DC stock ($250,000-$200,000). All of the gain of $50,000 is 
recognized under section 897 (a). A takes a basis of $250,000 in the 
equipment.

    (c) Distributions of U.S. real property interests by foreign 
corporations--(1) Recognition of gain required. If a foreign corporation 
makes a distribution (including a distribution in liquidation or 
redemption) of a U.S. real property interest to a shareholder (whether 
foreign or domestic), then, except as provided in paragraph (c) (2), 
(3), or (4) of this section, the distributing corporation shall 
recognize gain (but not loss) on the distribution under section 897 (d) 
(1). The gain recognized shall be equal to the excess of the fair market 
value of the U.S. real property interest (as of the time of the 
distribution) over its adjusted basis. Except as otherwise provided, the 
distributee's basis in the distributed U.S. real property interest shall 
be determined under the otherwise applicable sections of the Code. The 
distributee (whether domestic or foreign) of a foreign corporation in a 
liquidation under section 332 shall take the foreign corporation's basis 
in the distributed U.S. real property interest increased by any gain 
recognized (and subject to U.S. income taxation) by the foreign 
corporation on the distribution of such U.S. real property interest.
    (2) Recognition of gain not required--(i) Statutory exception rule. 
Under section 897(d)(2)(A), gain shall not be recognized by a 
distributing foreign corporation if--
    (A) At the time of the receipt of the distributed U.S. real property 
interest, the distributee would be subject to U.S. income taxation on a 
subsequent disposition of the U.S. real property interest, determined in 
accordance with the rules of paragraph (d)(1) of this section;
    (B) The basis of the distributed U.S. real property interest in the 
hands of the distributee is no greater than the adjusted basis of such 
property before the distribution, increased by the amount of gain (if 
any) recognized by the distributing corporation upon the distribution 
and added to the adjusted

[[Page 575]]

basis under the otherwise applicable provisions; and
    (C) The distributing corporation complies with the filing 
requirements of paragraph (d)(1)(iii) of this section.
    (ii) Section 332 liquidations--(A) In general. A distributing 
foreign corporation that meets the requirements of paragraph (c)(2)(i) 
in a section 332(a) liquidation shall not recognize gain on the 
distribution of U.S. real property interests to a foreign corporation 
meeting the stock ownership requirements of section 332(b) if the 
distributing corporation complies with the procedural requirements of 
paragraph (d)(1)(iii). Whether a foreign corporation recognizes gain on 
the distribution of U.S. real property interests to a U.S. corporation 
meeting the stock ownership requirements of section 332(b) depends upon 
whether the U.S. corporation satisfies the subject to tax requirement 
provided in paragraph (d)(1)(i) (in addition to the procedural 
requirements of paragraph (d)(1)(iii)). With respect to section 332 
distributions by a foreign corporation occurring after July 31, 1986, 
section 367(e)(2) shall not affect the application of section 337(a) (as 
in effect after the Tax Reform Act of 1986) and paragraph (c)(2)(i) of 
this section to the distribution of a U.S. real property interest.
    (B) Recognition of gain required in certain section 332 
liquidations. Notwithstanding the other rules of this paragraph (c), a 
foreign corporation shall, pursuant to the authority conferred by 
section 897(e)(2), recognize gain on its distribution after May 5, 1988 
of a U.S. real property interest to a domestic corporation meeting the 
stock ownership requirements of section 332(b) if--
    (1) The foreign corporation has not made an election under section 
897(i), and any gain on the stock in the foreign corporation would be 
subject to U.S. taxation if an election were made on the date of the 
liquidation; and
    (2) The distribution of the U.S. real property interest by the 
foreign corporation to the domestic corporation pursuant to section 
332(a) occurs less than five years after the date of the last gain from 
the disposition of stock of the foreign corporation that would be 
subject to payment of tax under Sec. 1.897-3(d)(2)(i) if an election 
under section 897(i) were made by the foreign corporation on the date of 
its liquidation.

With regard to the treatment of certain foreign corporations as domestic 
corporations under section 897(i), however, see Sec. Sec. 1.897-3 and 
1.897-8T.
    (iii) Examples. The rules of this paragraph (c)(2) may be 
illustrated by the following examples.

    Example 1. (i) DC, a domestic corporation, owns 100 percent of the 
stock of FC, a Country F corporation, FC's only asset is Parcel P, a 
U.S. real property interest, with a fair market value of $500x and an 
adjusted basis of $100x. In September 1987, FC liquidates under section 
332(a) and transfers Parcel P to DC. The transitional rules contained in 
section 633 of the Tax Reform Act of 1986 concerning the repeal of the 
General Utilities doctrine would not be applicable to a subsequent 
distribution or disposition of assets by DC.
    (ii) Assume that FC complies with the filing requirements of 
paragraph (d)(1)(iii). DC will be subject to U.S. income taxation on a 
subsequent disposition of Parcel P under the rules of paragraph (d)(1). 
The basis of Parcel P in the hands of DC will be $100x under section 
334(b)(1), and thus no greater than the basis of Parcel P in the hands 
of FC. FC does not recognize any gain under the rules of paragraph 
(c)(1) of this section on the distribution because the exception of 
paragraph (d)(2)(i) applies.
    Example 2. If in Example (1) the distribution by FC to DC occurred 
in September 1985, and DC sold or exchanged Parcel P under scctions 
336(a) or 337(a) as in effect prior to the Tax Reform Act of 1986, then 
FC must recognize gain of $400x on the distribution of Parcel P. The 
gain must be recognized because Parcel P in the hands of DC is not 
considered subject to U.S. income taxation on a subsequent disposition 
under the rules of paragraph (d)(1) of this section.

    (3) Limitation of gain recognized under paragraph (c)(1) of this 
section for certain section 355 distributions--(i) In general. Under 
paragraph (c)(1) of this section, a foreign corporation that distributes 
stock in a domestic corporation that constitutes a U.S. real property 
interest in a distribution to which section 355 applies shall recognize 
gain on the distribution to the extent that the fair market value of the 
distributed stock exceeds its adjusted basis in the hands of the 
distributing foreign corporation. The gain recognized shall be limited 
under this paragraph (c)(3), however, to the amount by which the 
aggregate basis of the distributed stock in the

[[Page 576]]

hands of the distributees exceeds the aggregate adjusted basis of the 
distributed stock in the hands of the distributing corporation. The 
distributees' basis in the distributed U.S. real property interest shall 
be determined under the otherwise applicable provisions of section 358. 
(Thus, the distributees' basis in the distributed U.S. real property 
interest shall be determined without any increase for any gain 
recognized by the foreign corporation).
    (ii) Example. The rules of paragraph (c)(3)(i) of this section may 
be illustrated by the following example.

    Example. (i) C is a citizen and resident of Country F. C owns all of 
the stock of FC, a Country F corporation. The fair market value of the 
FC stock is 1000x, and C has a basis of 600x in the FC stock. Country F 
does not have an income tax treaty with the United States.
    (ii) In a transaction qualifying as a distribution of stock of a 
controlled corporation under section 355(a), FC distributes to C all of 
the stock of DC, a U.S. real property holding corporation. C does not 
surrender any of the FC stock. The DC stock has a fair market value of 
600x, and FC has an adjusted basis of 200x in the DC stock. After the 
distribution, the FC stock has a fair market value of 400x.
    (iii) Under paragraph (c)(3)(i) of this section, FC must recognize 
gain on the distribution of the DC stock to C equal to the difference 
between the fair market value of the DC stock (600x) and FC's adjusted 
basis in the DC stock (200x). This results in a potential gain of 400x. 
Under section 358, C takes a 360x adjusted basis in the DC stock. 
Provided that FC complies with the filing requirements of paragraph 
(d)(1)(iii) of this section, the gain recognized by FC is limited under 
paragraph (c)(3)(i) to 160x because (A) this is the amount by which the 
basis of the DC stock in the hands of C (360x) exceeds the adjusted 
basis of the DC stock in the hands of FC (200x), and (B) at the time of 
receipt of the DC stock, C would be subject to U.S. taxation on a 
subsequent disposition of the stock.
    (iv) C's adjusted basis in the DC stock is not increased by the 160x 
recognized by FC.

    (4) Distribution by a foreign corporation in certain 
reorganizations--(i) In general. Under paragraph (c)(1) of this section, 
a foreign corporation that transfers property to another corporation in 
an exchange under section 361(a) for stock of a domestic corporation 
which is a United States real property holding corporation immediately 
after the transfer in a reorganization under section 368(a)(1) (C), (D), 
or (F) shall recognize gain under section 897(d)(1) on the distribution 
(whether actual or deemed) of the stock of the domestic corporation 
received by the foreign corporation to its shareholders (whether 
domestic or foreign). See Sec. 1.897-6T(a) of the regulations for the 
consequences to the foreign corporation of the exchange of its property 
for the domestic corporation stock.
    (ii) Statutory exception. Pursuant to the exception provided in 
section 897(d)(2)(A), no gain shall be recognized by the foreign 
corporation on its distribution of the domestic corporation stock if--
    (A) At the time of the distribution, the distributee (i.e., the 
exchanging shareholder in the section 354 exchange) would be subject to 
U.S. taxation on a subsequent disposition of the stock of the domestic 
corporation, determined in accordance with the rules of paragraph (d)(1) 
of this section;
    (B) The distributee's adjusted basis in the stock of the foreign 
corporation immediately before the distribution was no greater than the 
foreign corporation's basis in the stock of the domestic corporation 
determined under section 358; and
    (C) The distributing corporation complies with the filing 
requirements of paragraph (d)(1)(iii) of this section.
    (iii) Regulatory limitation on gain recognized. If the requirements 
of subdivisions (A) and (C) of paragraph (c)(4)(ii) are met, the amount 
of any gain recognized by the foreign corporation shall not exceed the 
excess of the distributee's adjusted basis in the stock of the foreign 
corporation immediately before the distribution over the foreign 
corporation's basis in the stock of the domestic corporation immediately 
before the distribution as determined under section 358.
    (iv) Examples. The rules of paragraph (c)(4) of this section may be 
illustrated by the following examples.

    Example 1. (i) A, a nonresident alien, organized FC, a Country W 
corporation, in September 1980 to invest in U.S. real estate. In 1986, 
FC's only asset is Parcel P, a U.S. real property interest with a fair 
market value of $600,000 and an adjusted basis to FC of $200,000. Parcel 
P is subject to a mortgage with an outstanding balance of $100,000. The

[[Page 577]]

fair market value of the FC stock is $500,000, and A's adjusted basis in 
the stock is $100,000. FC does not have liabilities in excess of the 
adjusted basis in Parcel P. The United States does not have a treaty 
with Country W that entitles FC to nondiscriminatory treatment as 
described in section 1.897-3(b)(2) of the regulations.
    (ii) Pursuant to a plan of reorganization under section 
368(a)(1)(D), FC transfers Parcel P to DC, a newly formed domestic 
corporation, in exchange for DC stock. FC distributes the DC stock to A 
in exchange for A's FC stock.
    (iii) FC's exchange of Parcel P for the DC stock is a disposition of 
a U.S. real property interest. Under Sec. 1.897-6T(a)(1), there is an 
exchange of a U.S. real property interest (Parcel P) for another U.S. 
real property interest (DC stock) so that no gain is recognized on the 
exchange under section 897(e). DC takes FC's basis of $200,000 in Parcel 
P under section 362(b). Under section 358(a)(1), FC takes a $100,000 
basis in the DC stock because FC's substituted basis of $200,000 in the 
DC stock is reduced by the $100,000 of liabilities to which Parcel P is 
subject.
    (iv) Under section 897(d)(1) and paragraph (c)(4)(i) of this 
section, FC generally must recognize gain on the distribution of the DC 
stock received in exchange for FC's assets equal to the difference 
between the fair market value of the DC stock ($500,000) and FC's 
adjusted basis in the DC stock prior to the distribution ($100,000). 
This results in a potential gain of $400,000. Under section 358(a)(1), A 
takes a basis in the DC stock equal to its basis in the FC stock of 
$100,000. Provided that FC complies with the filing requirements of 
paragraph (d)(1)(iii) of this section, no gain is recognized by FC on 
the distribution of the DC stock under the statutory exception to the 
general rule of section 897(d)(1) provided in section 897(d)(2)(A) and 
paragraph (c)(4)(ii) of this section because (1) A's basis in the DC 
stock ($100,000) does not exceed FC's adjusted basis in the DC stock 
($100,000) immediately prior to the distribution and (2) A, at the time 
of receipt of the DC stock, would be subject to U.S. taxation on a 
subsequent disposition of the stock.
    (v) The FC stock in the hands of A is not a U.S. real property 
interest because FC is a foreign corporation that has not elected to be 
treated as a domestic corporation under section 897(i). Accordingly, the 
exchange of the FC stock by A for DC stock is not a disposition of a 
U.S. real property interest under section 897(a).
    Example 2. The facts are the same as in Example 1, except that A 
purchased the FC stock in September 1983 for $100,000 from S, a 
nonresident alien, and that S had a basis of $40,000 in the FC stock at 
the time of the sale to A. The results are the same as in Example 1.
    Example 3. (i) The facts are the same as in Example 1, except that 
A's adjusted basis in the FC stock prior to the reorganization is 
$300,000. Following the distribution, A takes its basis of $300,000 in 
the FC stock as its basis in the DC stock pursuant to section 358(a)(1).
    (ii) FC does not qualify under the statutory exception of paragraph 
(c)(4)(ii) to the general recognition rule of section 897(d)(1) and 
paragraph (c)(4)(i) of this section because A's basis in the DC stock 
($300,000) exceeds FC's adjusted basis in the DC stock ($100,000) 
immediately prior to the distribution. However, provided that FC 
complies with the filing requirements of paragraph (d)(1)(iii) of this 
section, the gain recognized by FC is limited to $200,000 under the 
regulatory limitation of gain provided by paragraph (c)(4)(iii). This is 
the excess of A's basis in the FC stock immediately before the 
distribution ($300,000) over A's adjusted basis in the DC stock 
immediately before the distribution ($100,000).
    (iii) A takes a basis of $300,000 in the DC stock under section 
358(a)(1). A's basis in the DC stock is not increased by the gain 
recognized by FC. DC takes a basis of $200,000 in Parcel P under section 
362(b).
    Example 4. (i) The facts are the same as in Example 3, except that 
the United States has an income tax treaty with Country W entitling FC 
to nondiscriminatory treatment under section 1.897-3(b)(2) of the 
regulations. A valid election under section 897(i) is made to treat FC 
as a U.S. corporation.
    (ii) FC is treated as a domestic corporation for purposes of section 
897 and is not required to recognize gain under section 897(d)(1) and 
paragraph (c)(4)(i) of this section on the distribution of the DC stock 
as described in Example 3. (If a valid section 897(i) election were not 
made, the result would be same as in Example 3.)
    (iii) The FC stock in the hands of A is a U.S. real property 
interest because an election was made under section 897(i) to treat FC 
as a U.S. corporation. The exchange of the FC stock for DC stock by A is 
a disposition of a U.S. real property interest. Under section 897(e)(1) 
and paragraph (a) of Sec. 1.897-6T, A does not recognize gain on the 
exchange because there is an exchange of a U.S. real property interest 
(the FC stock) for another U.S. real property interest (the DC stock). 
Under section 358(a)(1), A takes as its basis in the DC stock A's basis 
in the FC stock ($300,000).

    (5) Sales of U.S. real property interests by foreign corporations 
under section 337. Section 337 as in effect prior to the Tax Reform Act 
of 1986 shall not apply to any sale or exchange (including a deemed 
section 337 sale pursuant to an election under section 338(a) to treat a

[[Page 578]]

stock purchase as an asset acquisition) of a U.S. real property interest 
by a foreign corporation.
    (6) Section 897(l) credit. If a foreign corporation adopts a plan of 
complete liquidation and if, solely by reason of section 897(d) and this 
section, section 337(a) (as in effect before the Tax Reform Act of 1986) 
does not apply to sales or exchanges of, or section 336 (as in effect 
before the Tax Reform Act of 1986) does not apply to distributions of, 
United States real property interests by the liquidating corporation, 
then--
    (i) The amount realized by the shareholder on the distribution shall 
be increased by its proportionate share of the amount by which the tax 
imposed by chapter 1 of the Code, as modified by the provisions of any 
applicable U.S. income tax treaty, on the liquidating corporation would 
have been reduced if section 897(d) and this section had not been 
applicable, and
    (ii) For purposes of the Code, the shareholder shall be deemed to 
have paid, on the last day prescribed by law for the payment of the tax 
imposed by subtitle A of the Code on the shareholder for the taxable 
year, an amount of tax equal to the amount of increase in the amount 
realized described in subdivison (i) of this paragraph (c).

The special rule provided by this paragraph (c)(5) applies only to 
shareholders who are United States citizens or residents, and who have 
held stock in the liquidating corporation continuously since June 18, 
1980. This special rule also only applies for the first taxable year of 
any such shareholder in which the shareholder receives a distribution in 
complete liquidation from the foreign corporation.
    (7) Other applicable rules. For rules concerning exemption of gain 
pursuant to a U.S. income tax treaty, withholding of tax from 
distributions, and other applicable rules, see paragraph (d) of this 
section. For the treatment of liquidations described in section 
334(b)(2)(A) of certain foreign corporations acquired before November 6, 
1980, see Sec. 1.897-4.
    (d) Rules of general application--(1) Interests subject to taxation 
upon later disposition--(i) In general. Pursuant to the otherwise 
applicable rules of this section and Sec. 1.897-6T, nonrecognition of 
gain or loss may apply with respect to certain distribution or exchanges 
of U.S. real property interests if any gain from a subsequent 
disposition of the interests that are distributed or received by the 
transferor in the exchange would be included in the gross income of the 
distributee or transferor and be subject to U.S. taxation. Gain is 
considered subject to U.S. taxation if the gain is included on the 
income tax return of a U.S. tax paying entity even if there is no U.S. 
tax liability (for example, because of net operating losses or an 
investment tax credit). Gain is not considered subject to U.S. taxation 
if the gain is derived by a tax exempt entity. A real estate investment 
trust is considered to be a pass-through entity for purposes of the rule 
of taxability of this paragraph (d)(1)(i). Thus, for example, a tax 
exempt entity holding an interest in a real estate investment trust is 
not subject to tax. A domestic corporation (including a foreign 
corporation that makes an effective section 897(i) election after 
receipt of the U.S. real property interest) shall not be considered 
subject to U.S. taxation on a subsequent disposition of a U.S. real 
property interest if it received the U.S. real property interest prior 
to the effective date of the repeal of section 336(a) or 337(a) as in 
effect prior to the Tax Reform Act of 1986, unless the U.S. real 
property interest has not been sold or exchanged by the domestic 
corporation prior to such effective date in a transaction to which 
either section 336(a) or section 337(a) (as in effect prior to such 
effective date) applied. In addition, an interest shall be considered to 
be subject to U.S. taxation upon its subsequent disposition only if the 
requirements set forth in subdivision (iii) of this paragraph (d)(1) are 
met.
    (ii) Effects of income tax treaties--(A) Effect of treaty exemption 
from tax. Except as otherwise provided in subdivision (C) of this 
paragraph (d)(1)(ii), a U.S. real property interest shall not be 
considered to be subject to U.S. taxation upon a subsequent disposition 
if, at the time of its distribution or exchange, the recipient is 
entitled pursuant to the provisions of a U.S. income tax treaty to an 
exemption from U.S.

[[Page 579]]

taxation upon a disposition of the interest.
    (B) Effect of treaty reduction of tax. If, at the time of a 
distribution or exchange, a distributee of a U.S. real property interest 
in a distribution or a transferor who receives a U.S. real property 
interest in an exchange would be entitled pursuant to the provisions of 
a U.S. income tax treaty to reduced U.S. taxation upon the disposition 
of the interest, then a portion of the interest received shall be 
treated as an interest subject to U.S. taxation upon its disposition, 
and, therefore, that portion shall be entitled to nonrecognition 
treatment under the rules of this section or Sec. 1.897-6T. The portion 
of the interest that is treated as subject to U.S. taxation is 
determined by multiplying the fair market value of the interest by a 
fraction. The numerator of the fraction is the amount of tax that would 
be due pursuant to the provisions of the applicable U.S. income tax 
treaty upon the recipient's disposition of the interest, determined as 
of the date of the distribution or transfer. The denominator of the 
fraction is the amount of tax that would be due upon such disposition 
but for the provisions of the treaty. However, nonrecognition treatment 
may be preserved in accordance with the provisions of subdivision (C) of 
this paragraph (d)(1)(ii). With regard to the provisions of this 
paragraph, see Article XIII (9) of the United States-Canada Income Tax 
Convention.
    (C) Waiver of treaty benefits to preserve nonrecognition. 
Notwithstanding the provisions of subdivisions (A) and (B) of this 
paragraph (d)(1)(ii), an interest shall be considered to be subject to 
U.S. taxation upon its subsequent disposition if, in accordance with 
paragraph (d)(1)(iii)(F) of this section, the recipient waives the 
benefits of a U.S. income tax treaty that would otherwise entitle the 
recipient to an exemption from (or reduction of) U.S. tax upon a 
disposition of the interest.
    (iii) Procedural requirements. If a U.S. real property interest is 
distributed or transferred after December 31, 1987, the transferor or 
distributor (that is a nonresident alien individual or a foreign 
corporation) shall file an income tax return for the taxable year of the 
distribution or transfer. Also, if a U.S. real property interest is 
distributed or transferred in a transaction before January 1, 1988, with 
respect to which nonrecognition treatment would not have been available 
under the express provisions of section 897 (d) or (e) of the Code but 
is available under the provisions of this section or Sec. 1.897-6T, 
then the person that would otherwise be subject to tax by reason of the 
operation of section 897 must file an income tax return for the taxable 
year of the distribution or transfer. This requirement is satisfied by 
filing a tax return or an amended tax return for the year of the 
distribution or transfer by May 5, 1989, or by the date that the filing 
of the return is otherwise required. The person filing the return must 
attach thereto a document setting forth the following:
    (A) A statement that the distribution or transfer is one to which 
section 897 applies;
    (B) A description of the U.S. real property interest distributed or 
transferred, including its location, its adjusted basis in the hands of 
the distributor or tranferor immediately before the distribution or 
transfer, and the date of the distribution or transfer;
    (C) A description of the U.S. real property interest received in an 
exchange;
    (D) A declaration signed by an officer of the corporation that the 
distributing foreign corporation has substantiated the adjusted basis of 
the shareholder in its stock if the distributing corporation has 
nonrecognition or recognition limitation under paragraph (c) (3) or (4) 
of this section;
    (E) The amount of any gain recognized and tax withheld by any person 
with respect to the distribution or transfer;
    (F) [Reserved]. For further guidance, see Sec. 1.897-
5(d)(1)(iii)(F).
    (G) The treaty and article (if any) under which the distributee or 
transferor would be exempt from U.S. taxation on a sale of the 
distributed U.S. real property interest or the U.S. real property 
interest received in the transfer; and
    (H) A declaration, signed by the distributee or transferor or its 
authorized legal representative, that the distributee or transferor 
shall treat any

[[Page 580]]

subsequent sale, exchange, or other disposition of the U.S. real 
property interest as a disposition that is subject to U.S. taxation, 
notwithstanding the provisions of any U.S. income tax treaty or 
intervening change in circumstances.

A person who has provided or filed a notice described in Sec. 1.1445-
2(d)(2)(iii) or Sec. 1.1445-5(b)(2)(ii) in connection with a 
transaction may satisfy the requirement of this paragraph (d)(1)(iii) by 
attaching to his return a copy of that notice together with any 
information or declaration required by this subdivision not contained in 
that notice.
    (2) Treaty exception to imposition of tax. If gain that would be 
currently recognized pursuant to the provisions of this section or Sec. 
1.897-6T is subject to an exemption from (or reduction of) U.S. tax 
pursuant to a U.S. income tax treaty, then gain shall be recognized only 
as provided by that treaty, for dispositions occurring before January 1, 
1985. For dispositions occurring after December 31, 1984, all gain shall 
be recognized as provided in section 897 and the regulations thereunder, 
except as provided by Articles XIII (9) and XXX (5) of the United 
States-Canada Income Tax Convention or other income tax treaty entered 
into force after June 6, 1988.
    With regard to Article XXX (5) of the Income Tax Treaty with Canada, 
see, Rev. Rul. 85-76, 1985-1 C.B. 409. With regard to basis adjustments 
for certain related person transactions, see, Sec. 1.897-6T(c)(3).
    (3) Withholding. Under sections 1441 and 1442, as modified by the 
provisions of any applicable U.S. income tax treaty, a corporation must 
withhold tax from a dividend distribution to which section 301 applies 
to a shareholder that is a foreign person, if the dividend is considered 
to be from sources inside the United States. For a description of 
dividends that are considered to be from sources inside the United 
States, see section 861(a)(2). Under section 1445, withholding is 
required with respect to certain dispositions and distributions of U.S. 
real property interests.
    (4) Effect on earnings and profits. With respect to adjustments to 
earnings and profits for gain recognized to a distributing corporation 
on a distribution, see section 312 and the regulations thereunder.
    (e) Effective date. Except as otherwise specifically provided in the 
text of these regulations, this section shall be effective for 
transfers, exchanges, distributions and other dispositions occurring 
after June 18, 1980.

[T.D. 8198, 53 FR 16217, May 5, 1988; 53 FR 18022, May 19, 1988; T.D. 
9082, 68 FR 46084, Aug. 5, 2003]