section 362(e)(2) analysis

 The American Jobs Creation Act altered Section 362 of the IRC by adding subsection (e), which provides a limitation on built-in losses. Section 362(e)(2) specifically address the limitation on the transfer of built-in losses in Section 351 transactions. It states that a transferee's total basis in properties received from a transferor in a Section 351 transaction (that is not subject to the importation rule of Section 362(e)(1), i.e. US to US and US to foreign) cannot exceed the total fair market value of the properties immediately after the transfer. If Section 362(e)(2) applies, only the loss assets are subject to a step down adjustment. Section 362(e)(2)(B) allocates the total reduction of basis among the properties received in proportion to their respective built-in loss immediately before the transaction. No adjustment is made to built-in gain assets.
Instead of reducing asset basis, the transferor and transferee may elect to reduce the basis in the stock of the transferee corporation transferred to the transferor corporation in the Section 351 exchange. The election to reduce stock basis is: 1) irrevocable, 2) must be jointly made by both the transferor and the transferee, and 3) must be included with the transferor and transferee's tax returns for the taxable year in which the transfer is made. This permits the transferee to retain a carryover basis in the transferred property at a cost of having the transferor's total basis in the transferee stock received capped at the fair market value of the properties.
 
Example:
Assume that P, a domestic corporation, engages in a Section 351 transfer to S, another domestic corporation, of the following assets:
 

BasisFMVGain/Loss
Accounts Receivable$500$300(200)
Inventory$200$300100
Land$700$400(300)
Equipment$600$500(100)
Leaseholds$300$500200
Total$2,300$2,000(300)

 
In this case, Section 362(e)(2) would apply since the transferred property had an aggregate net built-in loss of $300. However, only the basis in the loss assets would be subject to adjustment. Here, the loss properties had a built-in loss of $600, but an aggregate net built-in loss of only $300. Thus, under Section 362(e)(2)(B), the basis in each built-in loss asset would be reduced by $1 for every $2 of built-in loss.
 
Therefore, applying Section 362(e)(2) to this example:
 


Original Basis
Built-in Loss
§362(e)(2)(B) Adjustment
New Basis
Account Receivable$500$200$100$400
Land$700$300$150$550
Equipment$600$100$50$550

 
Alternatively, P and S could jointly elect under Section 362(e)(2)(C) for P to take a $2,000 basis in its S stock received in the Section 351 transaction, thereby allowing S to retain P's carryover basis in the accounts receivables, land and equipment transferred to it by P.

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