[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: 26CFR1.897-6T]

[Page 580-588]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.897-6T  Nonrecognition exchanges applicable to corporations, 

their shareholders, and other taxpayers, and certain transfers of 
property in corporate reorganizations (temporary).

    (a) Nonrecognition exchanges--(1) In general. Except as otherwise 
provided in this section and in Sec. 1.897-5T, for purposes of section 
897(e) any nonrecognition provision shall apply to a transfer by a 
foreign person of a U.S. real property interest on which gain is 
realized only to the extent that the transferred U.S. real property 
interest is exchanged for a U.S. real property interest which, 
immediately following the exchange, would be subject to U.S. taxation 
upon its disposition, and the transferor complies with the filing 
requirements of paragraph (d)(1)(iii) of Sec. 1.897-5T. No loss shall 
be recognized pursuant to section 897(e) or the rules of this section 
unless such loss is otherwise permitted to be recognized. In the case of 
an exchange of a U.S. real property interest for stock in a domestic 
corporation (that is otherwise treated as a U.S. real property 
interest), such stock shall not be considered a U.S. real property 
interest unless the domestic corporation is a U.S. real property holding 
corporation immediately after the exchange. Whether an interest would be 
subject to U.S. taxation in the hands of the transferor upon its 
disposition shall be determined in accordance with the rules of Sec. 
1.897-5T(d)(1).
    (2) Definition of ``nonrecognition'' provision. A ``nonrecognition 
provision'' is any provision of the Code which provides that gain or 
loss shall not be recognized if the requirements of that provision are 
met. Nonrecognition provisions relevant to this section include, but are 
not limited to, sections 332, 351,

[[Page 581]]

354, 355, 361, 721, 731, 1031, 1033, and 1036. For purposes of section 
897(e), sections 121 and 453 are not nonrecognition provisions.
    (3) Consequence of nonapplication of nonrecognition provisions. If a 
nonrecognition provision does not apply to a transaction, then the U.S. 
real property interest transferred shall be considered exchanged 
pursuant to a transaction that is subject to U.S. taxation by reason of 
the operation of section 897. See, however, Sec. 1.897-5T (d)(2) with 
respect to the treaty exceptions to the imposition of tax. If a U.S. 
real property interest is exchanged for an interest the disposition of 
which is only partially subject to taxation under chapter 1 of the Code 
(as modified by the provisions of any applicable U.S. income tax 
treaty), then any nonrecognition provision shall apply only to the 
extent that the interest received in the exchange would be subject to 
taxation under chapter 1 of the Code, as modified. For example, the 
exchange of a U.S. real property interest for an interest in a 
partnership will receive nonrecognition treatment pursuant to section 
721 only to the extent that a disposition of the partnership interest 
will be subject to U.S. taxation by reason of the operation of section 
897(g).
    (4) Section 355 distributions treated as exchanges. If a domestic 
corporation, stock in which is treated as a U.S. real property interest, 
distributes stock in a foreign corporation or stock in a domestic 
corporation that is not a U.S. real property holding corporation to a 
foreign person under section 355(a), then the foreign person shall be 
considered as having exchanged a proportionate part of the stock in the 
domestic corporation that is treated as a U.S. real property interest 
for stock that is not treated as a U.S. real property interest.
    (5) [Reserved]
    (6) Determination of basis. If a nonrecognition provision applies to 
the transfer of a U.S. real property interest pursuant to the provisions 
of this section, then the basis of the property received in the exchange 
shall be determined in accordance with the rules generally applicable 
with respect to such nonrecognition provision. Similarly, the basis of 
the exchanged property in the hands of the transferee shall be 
determined in accordance with the rules that generally apply to such 
transfer.
    (7) Examples. The rules of paragraphs (a) (1) through (6) of this 
section may be illustrated by the following examples. In each instance, 
the filing requirements of paragraph (d)(1)(iii) of Sec. 1.897-5T have 
been satisfied.

    Example 1. (i) A is a citizen and resident of Country F with which 
the U.S. does not have an income tax treaty. A owns Parcel P, a U.S. 
real property interest, with a fair market value of $500,000 and an 
adjusted basis of $300,000. A transfers Parcel P to DC, a newly formed 
U.S. real property holding corporation wholly owned by A, in exchange 
for DC stock.
    (ii) Under paragraph (a)(1) of this section, A has exchanged a U.S. 
real property interest (Parcel P) for another U.S. real property 
interest (DC stock) which is subject to U.S. taxation upon its 
disposition. The nonrecognition provisions of section 351(a) apply to 
A's transfer of Parcel P.
    (iii) Under paragraph (a)(6) of this section, the basis of the DC 
stock received by A is determined in accordance with the rules generally 
applicable to the transfer. A takes a $300,000 adjusted basis in the DC 
stock under the rules of section 358(a)(1).
    Examples 2-3. [Reserved]
    Example 4. (i) B is a citizen and resident of Country F with which 
the U.S. does not have an income tax treaty. B owns stock in DC1, a U.S. 
real property holding corporation. In a reorganization qualifying for 
nonrecognition under section 368(a)(1)(B), B exchanges the DC1 stock 
under section 354(a) for stock in DC2, a U.S. real property holding 
corporation.
    (ii) A does not recognize any gain under paragraph (a)(1) of this 
section on the exchange of the DC1 stock for DC2 stock because there is 
an exchange of a U.S. real property interest (the DC1 stock) for another 
U.S. real property interest (the DC2 stock) which is subject to U.S. 
taxation upon its disposition.
    Example 5. (i) C is a citizen and resident of Country F with which 
the U.S. does not have an income tax treaty. C owns all of the stock of 
DC, a U.S. real property holding corporation. The fair market value of 
the DC stock is 500x, and C has a basis of 100x in the DC stock.
    (ii) In a transaction qualifying as a distribution of stock of a 
controlled corporation under section 355(a), DC distributes to C all of 
the stock of FC, a foreign corporation that has not made a section 
897(i) election. C does not surrender any of the DC stock. The FC stock 
has a fair market value of 200x. After

[[Page 582]]

the distribution, the DC stock has a fair market value of 300x.
    (iii) Under the rules of paragraph (a)(4) of this section, C is 
considered to have exchanged DC stock with a fair market value of 200x 
and an adjusted basis of 40x for FC stock with a fair market value of 
200x. Because the FC stock is not a U.S. real property interest, C must 
recognize gain of 160x under section 897(a) on the distribution. C takes 
a basis of 200x in the FC stock. C's basis in the DC stock is reduced to 
60x pursuant to section 358(c).
    Example. (i) A is an individual citizen and resident of Country F. F 
has an income tax treaty with the United States that exempts gain from 
the sale of stock, but not real property, by a resident of F from U.S. 
taxation. In 1981, A transferred Parcel P, an appreciated U.S. real 
property interest, to DC, a U.S. real property holding corporation, in 
exchange for DC stock. A owned all of the stock of DC.
    (ii) Under the rules of paragraph (a)(1) of this section, A must 
recognize gain on the transfer of Parcel P. Even though there is an 
exchange of a U.S. real property interest for another U.S. real property 
interest, there is gain recognition because the U.S. real property 
interest received (the DC stock) would not have been subject to U.S. 
taxation upon a disposition immediately following the exchange. A may 
not convert a U.S. real property interest that was subject to taxation 
under section 897 into a U.S. real property interest that could be sold 
without taxation under section 897 due to a treaty exemption.
    Example 7. (i) A, a nonresident alien, organized FC1, a Country W 
corporation in September 1980 to invest in U.S. real property. FC1'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 $200,000. The FCI stock has a 
fair market value of $500,000 and A's basis in the FC1 stock is 
$100,000. The United States does not have a treaty with Country W.
    (ii) A, organized FC2, a Country W corporation in July 1987. FC2 
organized DC in August 1987. Pursuant to a plan of reorganization under 
section 368 (a)(1)(C), FC1 transfers Parcel P to DC in exchange for FC2 
voting stock. As a result of the transfer, DC is a U.S. real property 
holding corporation wholly owned by FC2. The FC2 stock used by DC in the 
acquisition had been transferred by FC2 to DC as part of the plan of 
reorganization. FC1 distributes the FC2 stock to A in exchange for A's 
FC1 stock.
    (iii) FC1's exchange of Parcel P for the FC2 stock under section 
361(a) is a disposition of a U.S. real property interest. FC1 must 
recognize gain of $300,000 under section 897(e) and paragraph (a)(1) of 
this section on the exchange because the FC2 stock received in exchange 
for Parcel P is not a U.S. real property interest.
    (iv) Under section 362(b), DC takes a basis of $500,000 in Parcel P. 
FC2 takes a basis of $500,000 in the DC stock. A takes a basis of 
$100,000 in the FC2 stock under section 358(a)(1). Section 897(d) and 
paragraph (c)(1) of Sec. 1.897-5T do not apply to FC1's distribution of 
the FC2 stock because the FC2 stock is not a U.S. real property 
interest.
    Example 8. (i) The facts are the same as in Example 7, except that 
the United States has a treaty with Country W that entitles FC1 and FC2 
to nondiscriminatory treatment as described in Sec. 1.897-3(b)(2). FC1, 
but not FC2, makes a valid section 897(i) election prior to the 
transaction.
    (ii) FC1's transfer of Parcel P to DC in exchange for FC2 stock is 
not subject to section 897(e) and paragraph (a)(1) of this section 
because FC1 made an election under section 897(i). DC takes a basis of 
$200,000 in Parcel P under section 362(b).
    (iii) FC1's distribution of the FC2 stock to A in exchange for the 
FC1 stock is not subject to the section 897(d) and paragraph (c)(1) of 
Sec. 1.897-5T because FC1 made an election under section 897(i).
    (iv) A must recognize gain on the exchange under section 354(a) of 
the FC1 stock for the FC2 stock. A exchanged a U.S. real property 
interest (the FC1 stock) for an interest which is not a U.S. real 
property interest (the FC2 stock). A recognizes gain of $400,000. Under 
section 1012, A takes a $500,000 basis in the FC2 stock.
    Example 9. (i) The facts are the same as in Example 7 except that 
the United States has a treaty with Country W that entitles FC1 and FC2 
to nondiscriminatory treatment as described in Sec. 1.897-3(b)(2). FC2, 
but not FC1, makes a valid section 897(i) election prior to the 
transaction.
    (ii) FC1's exchange of Parcel P for the FC2 stock under section 
361(a) is a disposition of a U.S. real property interest. FC1 does not 
recognize any gain under section 897(e) and paragraph (a)(1) of this 
section because there is an exchange of a U.S. real property interest 
(Parcel P) for another U.S. real property interest (the FC2 stock). DC 
takes a basis of $200,000 in Parcel P under section 362(b). FC2 takes a 
basis of $200,000 in the DC stock.
    (iii) FC1's distribution of the FC2 stock to A in exchange for the 
FC1 stock is subject to section 897(d) and paragraph (c)(1) of Sec. 
1.897-5T. Because A takes a basis of $100,000 in the FC2 stock under 
section 358(a) (which is less than the $200,000 basis of the FC2 stock 
in the hands of FC1), and A would be subject to U.S. taxation under 
section 897(a) on a subsequent disposition of the FC2 stock, FC1 does 
not recognize any gain under paragraph (c)(1) of Sec. 1.897-5T due to 
the statutory exception of paragraph (c)(2)(i) of that section, provided 
that FC1 complies with the filing requirements of paragraph (d)(1)(C) of 
Sec. 1.897-5T.
    (iv) Since, the FC1 stock was not a U.S. real property interest, its 
disposition by A in

[[Page 583]]

the section 354(a) exchange for FC2 stock is not subject to section 
897(e) and paragraph (a)(1) of this section.
    Example 10. (i) The facts are the same as in Example 7, except that 
the United States has a treaty with Country W that entitles FC1 and FC2 
to nondiscriminatory treatment as described in Sec. 1.897-3(b)(2). FC1 
and FC2 made valid section 897(i) elections prior to the transactions.
    (ii) FC1's transfer of Parcel P to DC in exchange for FC2 stock is 
not subject to section 897(e) and paragraph (a)(1) of this section 
because FC1 made an election under section 897(i). DC takes a basis of 
$200,000 in Parcel P under section 362(a). FC2 takes a basis of $200,000 
in the DC stock.
    (iii) FC1's distribution of the FC2 stock to A in exchange for the 
FC1 stock is not subject to section 897(d) and paragraph (c)(1) of Sec. 
1.897-5T because FC1 made an election under section 897(i).
    (iv) A does not recognize any gain on the exchange of the FC1 stock 
for the FC2 stock under section 354(a). Under paragraph (a)(1) of this 
section, there is an exchange of a U.S. real property interest (FC1 
stock) for another U.S. real property interest (FC2 stock). A takes a 
basis of $100,000 in the FC2 stock under section 358(a).

    (8) Treatment of nonqualifying property--(i) In general. If, under 
paragraph (a)(1) of this section, a nonrecognition provision would apply 
to an exchange but for the fact that nonqualifying property (cash or 
property other than U.S. real property interests) is received in 
addition to property (U.S. real property interests) that is permitted to 
be received under paragraph (a)(1) of this section, then the transferor 
shall recognize gain under this section equal to the lesser of--
    (A) The sum of the cash received plus the fair market value of the 
nonqualifying property received, or
    (B) The gain realized with respect to the U.S. real property 
interest transferred. However, no loss shall be recognized pursuant to 
this paragraph (a)(8) unless such loss is otherwise permitted to be 
recognized.
    (ii) Treatment of mixed exchanges. In a mixed exchange where both a 
U.S. real property interest and other property (including cash) is 
transferred in exchange both for property the receipt of which would 
qualify for nonrecognition treatment pursuant to paragraph (a)(1) of 
this section and for other property (including cash) which would not so 
qualify, the transferor will recognize gain in accordance with the rules 
set forth in subdivisions (A) through (C) of this paragraph (a)(8)(ii).
    (A) Allocation of nonqualifying property. The amount of 
nonqualifying property (including cash) considered to be received in 
exchange for U.S. real property interests shall be determined by 
multiplying the fair market value of the nonqualifying property received 
by a fraction (``real property fraction''). The numerator of the 
fraction is the fair market value of the U.S. real property interest 
transferred in the exchange. The denominator of the fraction is the fair 
market value of all property transferred in the exchange.
    (B) Recognition of gain. The amount of gain that must be recognized, 
and that shall be subject to U.S. taxation by reason of the operation of 
section 897, shall be equal to the lesser of:
    (1) The amount determined under subdivision (A) of this paragraph 
(a)(8)(ii), or
    (2) The gain or loss realized with respect to the U.S. real property 
interest exchanged.
    (C) Treatment of other amounts. The treatment of other amounts 
received in a mixed exchange shall be determined as follows:
    (1) The amount of nonqualifying property (including cash) considered 
to be received in exchange for property (including cash) other than U.S. 
real property interests shall be treated in the manner provided in the 
relevant nonrecognition provision. Such amounts shall be determined by 
subtracting the amount determined under subdivision (A) of this 
paragraph (a)(8)(ii) from the total amount of nonqualifying property 
received in the exchange.
    (2) The amount of qualifying property considered to be received in 
exchange for U.S. real property interests shall be treated in the manner 
provided in paragraph (a)(1) of this section. Such amount shall be 
determined by multiplying the total fair market value of qualifying 
property received in the exchange by the real property fraction 
described in subdivision (A) of this paragraph (a)(8)(ii).
    (3) The amount of qualifying property considered to be received in 
exchange for property other than U.S.

[[Page 584]]

real property interests shall be treated in the manner provided in the 
relevant nonrecognition provision. Such amount shall be determined by 
subtracting the amount determined under subdivision (2) of this 
paragraph (a)(8)(ii)(C) from the total fair market value of qualifying 
property received in the exchange.
    (iii) Example. The rules of paragraph (a)(8)(ii) of this section may 
be illustrated by the following example.

    Example. (i) A is an individual citizen and resident of country F. 
Country F does not have an income tax treaty with the United States. A 
is the sole proprietor of a business located in the United States, the 
assets of which consist of a U.S. real property interest with a fair 
market value of $1,000,000 and an adjusted basis of $700,000, and 
equipment used in the business with a fair market value of $500,000 and 
an adjusted basis of $250,000. A decides to incorporate the business, 
and on January 1, 1987, A transfers his assets to domestic corporation 
DC in exchange for 100 percent of the stock of DC, with a fair market 
value of $900,000. In addition, A receives a long term note 
(constituting a security) from DC for $600,000, bearing arm's length 
interest and repayment terms. DC has no assets other than those received 
in the exchange with A. Pursuant to section 897(c)(2) and Sec. 1.897-2, 
DC is a U.S. real property holding corporation. Therefore, the stock of 
DC is a U.S. real property interest. Assume that the note from DC 
constitutes an interest in the corporation solely as a creditor as 
provided by Sec. 1.897-1(d)(4) of the regulation. A complies with the 
filing requirements of paragraph (d)(1)(iii) of Sec. 1.897-5T.
    (ii) Because the note from DC would not be subject to U.S. taxation 
upon its disposition, it is nonqualifing property for purposes of 
determining whether A is entitled to receive nonrecognition treatment 
pursuant to section 351 with respect to his exchange of the U.S. real 
property interest. Thus, A must recognize gain in the manner provided in 
paragraph (a)(8)(ii) of this section. Pursuant to paragraph 
(a)(8)(ii)(A), the amount of nonqualifying property received in exchange 
for the real property interests is determined by multiplying the fair 
market value of such property ($600,000) by the real property fraction. 
The numerator of the fraction is $1,000,000, the fair market value of 
the real property transferred by A. The demoninator is $1,500,000, the 
fair market value of all property transferred by A. Thus, A is 
considered to have received $400,000 of the note in exchange for the 
real property ($600,000 X $1,000,000/$1,500,000). Pursuant to paragraph 
(a)(8)(ii)(B), A must recognize the lesser of the amount initially 
determined or the gain realized with respect to the U.S. real property 
interest. Therefore, A must recognize the $300,000 gain realized with 
respect to the real property.
    (iii) Pursuant to paragraph (a)(8)(ii)(C) of this section, A is 
considered to have received $200,000 of the note in exchange for 
equipment ($600,000 [total value of note received] minus $400,000 
[portion of note received in exchange for real property]), $600,000 of 
the stock in exchange for real property ($900,000 [total value of stock 
received] times $1,000,000/1,500,000) [proportion of property exchanged 
consisting of real property]), and $300,000 of the stock in exchange for 
equipment ($900,000 [total value of stock received] minus $600,000 
[portion of stock received in exchange for real property]). All three 
amounts are entitled to nonrecognition treatment pursuant to section 
351.
    (iv) Pursuant to paragraph (a)(2) of this section, A's basis in the 
stock and note received and DC's basis in the U.S. real property 
interest and equipment will be determined in accordance with the 
generally applicable rules. The $400,000 portion of the note received in 
exchange for the real property interest is other property. Pursuant to 
section 358(a)(2), A takes a fair market value ($400,000) basis for that 
portion of the note. Pursuant to section 358(a)(1), A's basis in the 
property received without the recognition of gain (the DC stock and the 
other portion of the note) will be equal to the basis of the property 
transferred ($950,000 [$700,000 basis of U.S. real property interest 
plus $250,000 basis of equipment]), decreased by the fair market value 
of the other property received ($400,000 portion of the note), and 
increased by the amount of gain recognized to A on the transaction 
($300,000). Thus, A's basis in the stock and the nonrecognition portion 
of the note is $850,000 ($950,000-$400,000+$300,000). Under Sec. 1.358-
2(b)(2) of the regulations, the $850,000 is allocated between the stock 
and the nonrecognition portion of the note in proportion to their fair 
market values. A takes a basis of $697,000 in the DC stock 
($850,000x900,000/1,100,000). A takes a basis of $153,000 in the 
nonrecognition portion of the note ($850,000x200,000/1,100,000). A's 
basis in the note is $553,000 ($400,000+$153,000). DC's basis in the 
property received from A will be determined under section 362(a). DC 
takes a basis of $1,000,000 in the real property interest (A's basis of 
$700,000 increased by the $300,000 of gain recognized by A on it). DC 
takes a basis of $250,000 in the equipment (A's basis of $250,000).

    (9) Treaty exception to imposition of tax. If gain that would be 
currently recognized pursuant to the provisions of this section is 
subject to an exemption from, or reduction of, U.S. tax pursuant to a 
U.S. income tax treaty, then

[[Page 585]]

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 XII (9) and XXX (5) of the United States-Canada 
Income Tax Convention or other income tax treaty entered into after June 
6, 1988. In regard to Article XXX (5) the Income Tax Treaty with Canada, 
see, Rev. Rul. 85-76, 1985-1 C.B. 409.
    (b) Certain foreign to foreign exchanges--(1) Exceptions to the 
general rule. Notwithstanding the provisions of paragraph (a)(1) of this 
section and pursuant to authority conferred by section 897(e)(2), a 
foreign person shall not recognize gain, in the instances described in 
paragraph (b)(2) of this section, on the transfer of a U.S. real 
property interest to a foreign corporation in exchange for stock in a 
foreign corporation, but only if the transferee's subsequent disposition 
of the transferred U.S. real property interest would be subject to U.S. 
taxation, as determined in accordance with the provisions of Sec. 
1.897-5T(d)(1), if the filing requirements of paragraph (d)(1)(iii) of 
Sec. 1.897-5T have been satisfied, if one of the five conditions set 
forth in paragraph (b)(2) exists, and if one of the following three 
forms of exchange takes place.
    (i) The exchange is made by a foreign corporation pursuant to 
section 361(a) in a reorganization described in section 368(a)(1) (D) or 
(F) and there is an exchange of the transferor corporation stock for the 
transferee corporation stock under section 354(a); or
    (ii) The exchange is made by a foreign corporation pursuant to 
section 361(a) in a reorganization described in section 368(a)(1)(C); 
there is an exchange of the transferor corporation stock for the 
transferee corporation stock (or stock of the transferee corporation's 
parent in the case of a parenthetical C reorganization) under section 
354(a); and the transferor corporation's shareholders own more than 
fifty percent of the voting stock of the transferee corporation (or 
stock of the transferee corporation's parent in the case of a 
parenthetical C reorganization) immediately after the reorganization; or
    (iii) The U.S. real property interest exchanged is stock in a U.S. 
real property holding corporation; the exchange qualifies under section 
351(a) of section 354(a) in a reorganization described in section 
368(a)(1)(B); and immediately after the exchange, all of the outstanding 
stock of the transferee corporation (or stock of the transferee 
corporation's parent in the case of a parenthetical B reorganization) is 
owned in the same proportions by the same nonresident alien individuals 
and foreign corporations that, immediately before the exchange, owned 
the stock of the U.S. real property holding corporation.

If, however, a nonresident alien individual or foreign corporation which 
received stock in an exchange described in subdivision (iii) of this 
paragraph (b)(1) (or the transferee corporation's parent) disposes of 
any of such foreign stock within three years from the date of its 
receipt, then that individual or corporation shall recognize that 
portion of the gain realized with respect to the stock in the U.S. real 
property holding corporation for which foreign stock disposed of was 
received.
    (2) Applicability of exception. The exception to the provisions of 
paragraph (a)(1) provided by paragraph (b)(1) shall apply only if one of 
the following five conditions exists.
    (i) Each of the interests exchanged or received in a transferor 
corporation or transferee corporation would not be a U.S. real property 
interest as defined in Sec. 1.897-1(c)(1) if such corporations were 
domestic corporations; or
    (ii) The transferee corporation (and the transferee corporation's 
parent in the case of a parenthetical B or C reorganization) is 
incorporated in a foreign country that maintains an income tax treaty 
with the United States that contains an information exchange provision; 
the transfer occurs after May 5, 1988; and the transferee corporation 
(and the transferee corporation's parent in the case of a parenthetical 
B or C reorganization) submit a binding waiver of all benefits of the 
respective income tax treaty (including the opportunity to make an 
election under section 897 (i)), which must be attached to

[[Page 586]]

each of the transferor and transferee corporation's income tax returns 
for the year of the transfer; or
    (iii) The transferee foreign corporation (and the transferee 
corporation's parent in the case of a parenthetical B or C 
reorganization) is a qualified resident as defined in section 884(e) and 
any regulations thereunder of the foreign country in which it is 
incorporated; or
    (iv) The transferee foreign corporation (and the transferee 
corporation's parent in the case of a parenthetical B or C 
reorganization) is incorporated in the same foreign country as the 
transferor foreign corporation; and there is an income tax treaty in 
force between that foreign country and the United States at the time of 
the transfer that contains an exchange of information provision; or
    (v) The transferee foreign corporation is incorporated in the same 
foreign country as the transferor foreign corporation; and the transfer 
is incident to a mere change in identity, form, or place of organization 
of one corporation under section 368(a)(1)(F).

For purposes of any election by a transferee foreign corporation (or the 
transferee corporation's parent in the case of a parenthetical C 
reorganization) to be treated as a domestic corporation under section 
897(i) and Sec. 1.897-3 where the exchange was described in 
subdivisions (i) or (ii) of paragraph (b)(1) of this section, any prior 
dispositions of the transferor foreign corporation stock will be subject 
to the requirements of Sec. 1.897-3(d)(2) upon an election under 
section 897(i) by the transferee foreign corporation (or the transferee 
corporation's parent in the case of a parenthetical C reorganization).
    (3) No exceptions. No exception to recognition of gain under 
paragraph (a)(1) of this section is provided for the transfer of a U.S. 
real property interest by a foreign person to a foreign corporation in 
exchange for stock in a foreign corporation other than as provided in 
this paragraph (b). Thus, no exception is provided where--
    (i) Such exchange is made pursuant to section 351 and the U.S. real 
property interest transferred is not stock in a U.S. real property 
holding corporation; or
    (ii) Such exchange is made pursuant to section 361(a) in a 
reorganization described in section 368(a)(1) that does not qualify for 
nonrecognition of gain under this paragraph (b). With regard to the 
treatment of certain foreign corporations as domestic corporations under 
section 897(i), see Sec. Sec. 1.897-3 and 1.897-8T.
    (4) Examples. The rules of paragraph (b)(1) and (2) of this section 
may be illustrated by the following examples. In each instance, the 
filing requirements of paragraph (d)(1)(iii) of Sec. 1.897-5T have been 
satisfied.

    Example 1. (i) FC is a Country F corporation that has not made a 
section 897 (i) election. FC owns Parcel P, a U.S. real property 
interest, with a fair market value of $450x and an adjusted basis of 
100x.
    (ii) FC transfers Parcel P to FS, its wholly owned Country F 
subsidiary, in exchange for FS stock under section 351 (a). FS has not 
made a section 897(i) election. Under the rules of paragraph (a)(1) of 
this section, FC must recognize gain of 350x under section 897 (a) 
because the FS stock received in the exchange is not a U.S. real 
property interest. No exception to the recognition rule of paragraph 
(a)(1) is provided under this paragraph (b) for a transfer under section 
351 (a) of a U.S. real property interest (that is not stock in a U.S. 
real property holding corporation) by a foreign corporation to another 
foreign corporation in exchange for stock to the transferee corporation.
    Example 2. (i) FC is a Country F corporation that has not made a 
section 897(i) election. FC owns several U.S. real property interests 
that have appreciated in value since FC purchased the interests. FP, a 
Country F corporation, owns all of the outstanding stock of FC. Country 
F maintains an income tax treaty with the United States.
    (ii) For valid business purposes, FC transferred substantially all 
of its assets including all of its U.S. real property interests to FS in 
1989 under section 361(a) in a reorganization in exchange for FS stock. 
FS is a newly formed Country F corporation that is owned by FC. The 
transfer qualifies as a reorganization under section 368(a)(1)(D). FC 
immediately distributes the FS stock to FP in exchange for the FC stock 
and FC dissolves. FP has no gain or loss on the exchange of the FC stock 
for the FS stock under section 354(a).
    (iii) Under the rules of paragraph (b)(1)(i) of this section, FC 
does not recognize any gain on the transfer of the U.S. real property

[[Page 587]]

interests to FS under section 361(a) in the reorganization under section 
368(a)(1)(D) because FS would be subject to U.S. taxation on a 
subsequent disposition of the interests, as required by paragraph (b)(1) 
of this section; there is an exchange of stock under section 354(a), as 
required by paragraph (b)(1)(i); and FC and FS are incorporated in 
Country F which maintains an income tax treaty with the United States, 
as required by paragraph (b)(2)(iv).

    (5) Contributions of property. A foreign person that contributes a 
U.S. real property interest to a foreign corporation as paid in surplus 
or as a contribution to capital (including a contribution provided in 
section 304(a)) shall be treated, for purposes of section 897(j) and 
this section, as exchanging the U.S. real property interest for stock in 
the foreign corporation.
    (c) Denial of nonrecognition with respect to certain tax avoidance 
transfers--(1) In general. The provisions of Sec. 1.897-5T and 
paragraphs (a) and (b) of this section are subject to the rules of this 
paragraph (c).
    (2) Certain transfers to domestic corporations--
    (i) General rule. If a foreign person transfers property, that is 
not a U.S. real property interest, to a domestic corporation in a 
nonrecognition exchange, where--
    (A) The adjusted basis of such property transferred exceeded its 
fair market value on the date of the transfer to the domestic 
corporation;
    (B) The property transferred will not immediately be used in, or 
held by the domestic corporation for use in, the conduct of a trade or 
business as defined in Sec. 1.897-1(f); and
    (C) Within two years of the transfer to the domestic corporation, 
the property transferred is sold at a loss;

then, it will be presumed, absent clear and convincing evidence to the 
contrary, that the purpose for transferring the loss property was the 
avoidance of taxation on the disposition of U.S. real property interests 
by the domestic corporation. Any loss recognized by the domestic 
corporation on the sale or exchange of such property shall not be used 
by the domestic corporation, either by direct offset or as part of a net 
operating loss or capital loss carryback or carryover to offset any gain 
recognized from the sale or exchange of a U.S. real property interest by 
the domestic corporation.
    (ii) Example. The rules of paragraph (c)(2)(i) of this section may 
be illustrated by the following example.

    Example. A is an individual citizen and resident of country F, which 
does not have an income tax treaty with the U.S. On January 1, 1987, A 
transfers a U.S. real property interest with a basis of $100,000 and a 
fair market value of $600,000 to domestic corporation DC in exchange for 
all of the stock of DC. On October 20, 1987, A transfers stock of a 
publicly traded domestic corporation with a basis in his hands of 
$900,000 and a fair market value of $500,000, in exchange for additional 
stock of DC. The stock of the publicly traded domestic corporation does 
not constitute an asset used or held for use in DC's trade or business. 
If DC sells the stock of the publicly traded domestic corporation before 
October 20, 1989 and recognizes a loss, the loss may not be used to 
offset any gain recognized on the sale of the U.S. real property 
interests by DC.

    (3) Basis adjustment for certain related person transactions. In the 
case of any disposition after December 31, 1979, of a U.S. real property 
interest to a related person (within the meaning of section 453(f)(1)), 
the basis of the interest in the hands of the person acquiring such 
interest shall be reduced by the amount of any gain which is not subject 
to taxation under section 871(b)(1) or 882(a)(1) because the disposition 
occurred before June 19, 1980 or because of any treaty obligation of the 
United States. If a foreign corporation makes an election under section 
897(i), and the stock of such corporation was transferred between 
related persons after December 31, 1979 and before June 19, 1980, then 
such stock shall be treated as a U.S. real property interest solely for 
purposes of this paragraph (c)(3).
    (4) Rearrangement of ownership to gain treaty benefit. A foreign 
person who directly or indirectly owns a U.S. real property interest may 
not directly or indirectly rearrange the incidents of ownership of the 
U.S. real property interest through the use of nonrecognition provisions 
in order to gain the benefit of a treaty exemption from taxation. Such 
nonrecognition will not apply to the foreign transferor. The transferor 
will recognize gain but not loss on the transfer under section 897(a).

[[Page 588]]

    (d) Effective date. Except as specifically provided otherwise in the 
text of the regulations, paragraphs (a) through (c) shall be effective 
for transfers, exchanges and other dispositions occurring after June 18, 
1980. Paragraph (a)(5)(ii) of this section shall be effective for 
exchanges and elections occurring after June 6, 1988.

[T.D. 8198, 53 FR 16224, May 5, 1988; 53 FR 18022, May 19, 1988; T.D. 
9082, 68 FR 46084, Aug. 5, 2003]