Purchase Price Allocations in Deemed &
Actual Asset Acquisitions

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [TD 8858] RIN 1545-
AZ58

TITLE: Purchase Price Allocations in Deemed and Actual Asset
Acquisitions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations relating to
the allocation of purchase price in deemed and actual asset
acquisitions. The temporary regulations determine the amount
realized and the amount of basis allocated to each asset transferred
in a deemed or actual asset acquisition and affect transactions
reported on either Form 8023 or Form 8594. The intended effect of
the temporary regulations is to remove and replace many of the
current temporary and final regulations sections under sections 338
and 1060 and renumber others.

DATES: Effective Date.... These regulations are effective January 6,
2000.

Applicability Dates.... For dates of applicability of these
regulations, see �1.338(i)-1T and �1.1060-1T(a)(2).

FOR FURTHER INFORMATION CONTACT: Richard Starke of the Office of
Assistant Chief Counsel (Corporate), (202) 622-7790 (not a toll-free
number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these temporary
regulations have been reviewed and approved by the Office of
Management and Budget in accordance with the Paperwork Reduction Act
of 1995 (44 U.S.C. 3507(d)) under the control number 1545-1658.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
valid control number assigned by the Office of Management and
Budget.

The collections of information in these temporary regulations are in
��1.338-2T(d), 1.338-2T(e)(4), 1.338-5T(d)(3), 1.338-10T(a)(4),
1.338(h)(10)-1T( d)(2), and 1.1060-1T(e)(ii)(A) and (B). The
collections of information are necessary to make an election to
treat a sale of stock as a sale of assets, to calculate and collect
the appropriate amount of tax in a deemed or actual asset
acquisition, and to determine the bases of assets acquired in a
deemed or actual asset acquisition.

These collections of information are required to obtain a benefit.
The likely respondents and/or recordkeepers are small businesses or
organizations, businesses, or other for-profit institutions, and
farms.

The regulation provides that a section 338 election is made by
filing Form 8023. The burden for this requirement is reflected in
the burden of Form 8023.

The regulation also provides that both a seller and a purchaser must
each file an asset acquisition statement on Form 8594. The burden
for this requirement is reflected in the burden of Form 8594.

The burden for the collection of information in �1.338-2T(e)(4) is
as follows:

Estimated total annual reporting/recordkeeping burden: 25 hours

Estimated average annual burden per respondent/recordkeeper: 0.56
hours

Estimated number of respondents/recordkeepers: 45

Estimated annual frequency of responses: On occasion

Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Reven e Service , Attn: IRS Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office of Management and B dget ,
Attn: Desk Officer for the Department of the Treasury, Office of
Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Background

On August 10, 1999, the IRS and Treasury published in the Federal
Register (REG-107069-97, 64 FR 43461 (1999-36 I.R.B. 346)) a notice
of proposed rulemaking. The notice contained proposed regulations
under sections 338 and 1060 of the Internal Revenue Code of 1986.
The temporary and final regulations promulgated in this Treasury
decision are substantively the same as the proposed regulations
published on August 10, 1999. The Service and Treasury believe that
the comments received on the proposed regulations warrant further
consideration. For instance, the Service and the Treasury received
several comments requesting reconsideration of (1) the provision in
�1.338-3(b)(2)(ii) of the proposed regulations stating that a
purchase of target stock occurs only so long as more than a nominal
amount is paid for such share, and (2) the example in �1.338-1(a)(2)
of the proposed regulations stating that if target is an insurance
company for which a section 338 election is made, then the deemed
asset sale will be characterized and taxed as an assumption-
reinsurance transaction. The temporary regulations reserve the
purchase issue addressed in �1.338-3(b)(2)(ii) of the proposed
regulations pending further consideration of the comments. The
temporary regulations retain the assumption-reinsurance example
because the example properly illustrates the principles of the
proposed and temporary regulations. The Service and Treasury will
give further consideration to the interaction of section 338 and the
assumption-reinsurance rules and the need for additional guidance on
how the assumption-reinsurance rules should work in the context of a
deemed asset sale.

Notwithstanding such comments, the proposed regulations generally
were favorably received, and the Service and Treasury are convinced
that, in general, the proposed regulations provide clearer guidance
and better rules than the current final and temporary regulations
under sections 338 and 1060.

Accordingly, pending further review of the comments received on the
proposed regulations, the Service and Treasury are replacing
existing temporary and final regulations with the proposed rules
published on August 10, 1999.

As soon as feasible, final regulations will be promulgated,
replacing these new temporary regulations. All comments received in
response to the requests for comments contained in the notice of
August 10, 1999, will be considered in the course of preparing the
final regulations.

Special Analyses

It has been determined that these temporary regulations are not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has been
determined that a final regulatory flexibility analysis is required
for the collection of information in this Treasury decision under 5
U.S.C. 604. This analysis is set forth below under the heading
"Final Regulatory Flexibility Act Analysis." Pursuant to section
7805(f) of the Internal Revenue Code, these temporary regulations
will be submitted to the Chief Counsel for Advocacy of the Small
Business Administration for comment on their impact on small
business.

Final Reg latory Flexibility Act Analysis

This analysis is required under the Regulatory Flexibility Act (5
U.S.C.

chapter 6). This regulatory action is intended to simplify and
clarify the current rules relating to both deemed and actual asset
acquisitions. The current rules were developed over a long period of
time and have been repeatedly amended.

The IRS and Treasury believe these temporary regulations will
significantly improve the clarity of the rules relating to both
deemed and actual asset acquisitions.

The major objective of these temporary regulations is to modify the
rules for allocating purchase price in both deemed and actual asset
acquisitions. In addition, these temporary regulations replace the
general rules for electing to treat a stock sale as an asset sale.

These collections of information may affect small businesses if the
stock of a corporation which is a small entity is acquired in a
qualified stock purchase or if a trade or business which is also a
small business is transferred in a taxable transaction. Form 8023
(on which an election to treat a stock sale as an asset sale is
filed) has been submitted to and approved by the Office of
Management and Budget. With respect to Form 8023, the IRS estimated
that 201 forms would be filed each year and that each taxpayer would
require 12.98 hours to comply.

Form 8594 (on which a sale or acquisition of assets constituting a
trade or business is reported) has also been submitted to and
approved by the Office of Management and Budget. With respect to
Form 8594, the IRS estimated that 20,000 forms would be filed each
year and that each taxpayer would require 12.25 hours to comply.
These estimates have been made available for public comment and no
public comments have been received. The regulations do not impose
new requirements on small businesses and, in fact, should lessen any
difficulties associated with the existing reporting requirements by
clarifying the rules associated with deemed and actual asset
acquisitions.

The collections of information require taxpayers to file an election
in order to treat a stock sale as an asset sale. In addition,
taxpayers must file a statement regarding the amount of
consideration allocated to each class of assets under the residual
method. The professional skills that would be necessary to make the
election or allocate the consideration would be the same as those
required to prepare a return for the small business.

Consideration was given to limiting the reporting requirements under
section 1060 to trades or businesses meeting a threshold level of
business activity. However, any threshold derived without further
information would be arbitrary. Instead, these regulations authorize
the Commissioner to exclude certain transactions from the reporting
requirements.

Drafting Information

The principal author of these regulations is Richard Starke, Office
of the Assistant Chief Counsel (Corporate). However, other personnel
from the IRS and Treasury Department participated extensively in
their development.

List of S bjects

26 CFR Part 1 Income taxes, Reporting and recordkeeping
requirements.

26 CFR Part 602 Reporting and recordkeeping requirements. Adoption
of Amendments to the Regulations Accordingly, 26 CFR parts 1 and 602
are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by
removing the entries for 1.338(b)-1, 1.338(b)-3T, and 1.1060-1T and
by adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.338-6T also issued under 26 U.S.C. 337(d), 338, and 1502.

Section 1.338-7T also issued under 26 U.S.C. 337(d), 338, and 1502.

Section 1.338-8 also issued under 26 U.S.C. 337(d), 338, and 1502.

Section 1.338-9 also issued under 26 U.S.C. 337(d), 338, and 1502.

Section 1.338-10T also issued under 26 U.S.C. 337(d), 338, and
1502.* * *

Section 1.1060-1T also issued under 26 U.S.C. 1060.* * *

Par. 2. In the list below, for each section indicated in the left
column, remove the language in the middle column and add the
language in the right column:

Section Remove Add

1.56(g)-1(k)(1) of �1.338(b)-2T(b), if of �1.338-6T(b), if otherwise
otherwise

1.56(g)-1(k)(1) of ��1.338(b)-2T(c)(1) of �1.338-6T(c)(1) and and
(2) also (2) also

1.368-1(a) (k) and 1.338-2(c)(3). (k) and 1.338-3T(c)(3).

1.368-1(e)(6), Example see �1.338-2(c)(3) see �1.338-3T(c)(3) 4,
paragraph (ii) (which (which 1.597-2(d)(5)(iii)(B) (see
�1.338(b)-3T) (see �1.338-7T) 1.597-5(c)(3)(i) under
��1.338(b)-2T(b), under �1.338-6T(b), (c)(1) and (2). (c)(1) and
(2).

1.597-5(d)(2)(i) under ��1.338(b)-2T(b), under �1.338-6T(b), (c)(1)
and (2). (c)(1) and (2).

1.921-1T(b)(1), A-1 and �1.338-1(d). and �1.338-2T(d).

1.1031(d)-1T see �1.1060-1T(b), (d), see �1.1060-1T(b), (c), and (g)
Example (3). and (d) Example 1.

1.1031(j)-1(b)(2)(iii) in �1.1060-1T(d). in �1.338-6T(b), to which
reference is made by �1.1060-1T(c)(2).

1.1502-75(k) See �1.338(h)(10)- See �1.338(h)(10)-1( e)(6) for 1T(d)
(7) for 1.1502-76(b)(1)(ii)(A)(1) See �1.338-1(e)(5) See
�1.338-10T(a)(5) (deemed (deemed �1.338-0 thro gh 1.338-3 [Removed ]
Par. 3. Sections 1.338-0 through 1.338-3 are removed.

Par. 4. Sections 1.338-0T through 1.338-3T are added to read as
follows: �1.338-0T Outline of topics (temporary). This section lists
the captions contained in the regulations under section 338 as
follows: �1.338-1T General principles; status of old target and new
target (temporary).

(a) In general.

(1) Deemed transaction.

(2) Application of other rules of law.

(3) Overview.

(b) Treatment of target under other provisions of the Internal
Revenue Code.

(1) General rule for subtitle A.

(2) Exceptions for subtitle A.

(3) General rule for other provisions of the Internal Revenue Code.

(c) Anti-abuse rule.

(1) In general.

(2) Examples.

�1.338-2T Nomenclature and definitions; mechanics of the section 338
election (temporary).

(a) Scope.

(b) Nomenclature.

(c) Definitions.

(1) Acquisition date.

(2) Acquisition date assets.

(3) Affiliated group.

(4) Common parent.

(5) Consistency period.

(6) Deemed asset sale.

(7) Deemed sale gain.

(8) Deemed sale return.

(9) Domestic corporation.

(10) Old target's final return.

(11) Purchasing corporation.

(12) Qualified stock purchase.

(13) Related persons.

(14) Section 338 election.

(15) Section 338(h)(10) election.

(16) Selling group.

(17) Target; old target; new target.

(18) Target affiliate.

(19) 12-month acquisition period.

(d) Time and manner of making election.

(e) Special rules for foreign corporations or DISCs.

(1) Elections by certain foreign purchasing corporations.

(i) General rule.

(ii) Qualifying foreign purchasing corporation.

(iii) Qualifying foreign target.

(iv) Triggering event.

(v) Subject to United States tax.

(2) Acquisition period.

(3) Statement of section 338 may be filed by United States
shareholders in certain cases.

(4) Notice requirement for U.S. persons holding stock in foreign
market.

(i) General rule.

(ii) Limitation.

(iii) Form of notice.

(iv) Timing of notice.

(v) Consequence of failure to comply.

(vi) Good faith effort to comply. �1.338-3T Qualification for the
section 338 election (temporary).

(a) Scope.

(b) Rules relating to qualified stock purchases.

(1) Purchasing corporation requirement.

(2) Purchase.

(i) Definition.

(ii) Purchase of target. [Reserved]

(iii) Purchase of target affiliate.

(3) Acquisitions of stock from related corporations.

(i) In general.

(ii) Time for testing relationship.

(iii) Cases where section 338(h)(3)(C) applies--acquisitions treated
as purchases.

(iv) Examples.

(4) Acquisition date for tiered targets.

(i) Stock sold in deemed asset sale.

(ii) Examples.

(5) Effect of redemptions.

(i) General rule.

(ii) Redemptions from persons unrelated to the purchasing
corporation.

(iii) Redemptions from the purchasing corporation or related persons
during 12- month acquisition period.

(A) General rule.

(B) Exception for certain redemptions from related corporations.

(iv) Examples.

(c) Effect of post-acquisition events on eligibility for section 338
election.

(1) Post-acquisition elimination of target.

(2) Post-acquisition elimination of the purchasing corporation.

(3) Consequences of post-acquisition elimination of target.

(i) Scope.

(ii) Continuity of interest.

(iii) Control requirement.

(iv) Example.

�1.338-4T Aggregate deemed sale price; various aspects of taxation
of the deemed asset sale (temporary).

(a) Scope.

(b) Determination of ADSP.

(1) General rule.

(2) Time and amount of ADSP.

(i) Original determination.

(ii) Redetermination of ADSP.

(iii) Example.

(c) Grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased
target stock.

(1) Determination of amount.

(2) Example.

(d) Liabilities of old target.

(1) In general.

(2) Time and amount of liabilities.

(3) Interaction with deemed sale gain.

(e) Calculation of deemed sale gain.

(f) Other rules apply in determining ADSP.

(g) Examples.

(h) Deemed sale of target affiliate stock.

(1) Scope.

(2) In general.

(3) Deemed sale of foreign target affiliate by a domestic target.

(4) Deemed sale producing effectively connected income.

(5) Deemed sale of insurance company target affiliate electing under
section 953(d).

(6) Deemed sale of DISC target affiliate.

(7) Anti-stuffing rule.

(8) Examples. �1.338-5T Adjusted grossed-up basis (temporary).

(a) Scope.

(b) Determination of AGUB.

(1) General rule.

(2) Time and amount of AGUB.

(i) Original determination.

(ii) Redetermination of AGUB.

(iii) Examples.

(c) Grossed-up basis of recently purchased stock.

(d) Basis of nonrecently purchased stock; gain recognition election.

(1) No gain recognition election.

(2) Procedure for making gain recognition election.

(3) Effect of gain recognition election.

(i) In general.

(ii) Basis amount.

(iii) Losses not recognized.

(iv) Stock subject to election.

(e) Liabilities of new target.

(1) In general.

(2) Time and amount of liabilities.

(3) Interaction with deemed sale gain.

(f) Adjustments by the Internal Revenue Service.

(g) Examples.

�1.338-6T Allocation of ADSP and AGUB among target assets
(temporary).

(a) Scope.

(1) In general.

(2) Fair market value.

(i) In general.

(ii) Transaction costs.

(iii) Internal Revenue Service authority.

(b) General rule for allocating ADSP and AGUB.

(1) Reduction in the amount of consideration for Class I assets.

(2) Other assets.

(i) In general.

(ii) Class II assets.

(iii) Class III assets.

(iv) Class IV assets.

(v) Class V assets.

(vi) Class VI assets.

(vii) Class VII assets.

(3) Other items designated by the Internal Revenue Service.

(c) Certain limitations and other rules for allocation to an asset.

(1) Allocation not to exceed fair market value.

(2) Allocation subject to other rules.

(3) Special rule for allocating AGUB when purchasing corporation has
nonrecently purchased stock.

(i) Scope.

(ii) Determination of hypothetical purchase price.

(iii) Allocation of AGUB.

(4) Liabilities taken into account in determining amount realized on
subsequent disposition.

(d) Examples.

�1.338-7T Allocation of redetermined ADSP and AGUB among target
assets (temporary).

(a) Scope.

(b) Allocation of redetermined ADSP and AGUB.

(c) Special rules for ADSP.

(1) Increases or decreases in deemed sale gain taxable
notwithstanding old target ceases to exist.

(2) Procedure for transactions in which section 338(h)(10) is not
elected.

(i) Deemed sale gain included in new target's return.

(ii) Carryovers and carrybacks.

(A) Loss carryovers to new target taxable years.

(B) Loss carrybacks to taxable years of old target.

(C) Credit carryovers and carrybacks.

(3) Procedure for transactions in which section 338(h)(10) is
elected.

(d) Special rules for AGUB.

(1) Effect of disposition or depreciation of acquisition date
assets.

(2) Section 38 property.

(e) Examples.

�1.338-8 Asset and stock consistency.

(a) Introduction.

(1) Overview.

(2) General application.

(3) Extension of the general rules.

(4) Application where certain dividends are paid.

(5) Application to foreign target affiliates.

(6) Stock consistency.

(b) Consistency for direct acquisitions.

(1) General rule.

(2) Section 338(h)(10) elections.

(c) Gain from disposition reflected in basis of target stock.

(1) General rule.

(2) Gain not reflected if section 338 election made for target.

(3) Gain reflected by reason of distributions.

(4) Controlled foreign corporations.

(5) Gain recognized outside the consolidated group.

(d) Basis of acquired assets.

(1) Carryover basis rule.

(2) Exceptions to carryover basis rule for certain assets.

(3) Exception to carryover basis rule for de minimis assets.

(4) Mitigation rule.

(i) General rule.

(ii) Time for transfer.

(e) Examples.

(1) In general.

(2) Direct acquisitions.

(f) Extension of consistency to indirect acquisitions.

(1) Introduction.

(2) General rule.

(3) Basis of acquired assets.

(4) Examples.

(g) Extension of consistency if dividends qualifying for 100 percent
dividends received deduction are paid.

(1) General rule for direct acquisitions from target.

(2) Other direct acquisitions having same effect.

(3) Indirect acquisitions.

(4) Examples.

(h) Consistency for target affiliates that are controlled foreign
corporations.

(1) In general.

(2) Income or gain resulting from asset dispositions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Operating rule.

(iv) Increase in asset or stock basis.

(3) Stock issued by target affiliate that is a controlled foreign
corporation.

(4) Certain distributions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Increase in asset or stock basis.

(5) Examples.

(i) [Reserved]

(j) Anti-avoidance rules.

(1) Extension of consistency rules.

(2) Qualified stock purchase and 12-month acquisition period.

(3) Acquisitions by conduits.

(i) Asset ownership.

(A) General rule.

(B) Application of carryover basis rule.

(ii) Stock acquisitions.

(A) Purchase by conduit.

(B) Purchase of conduit by corporation.

(C) Purchase of conduit by conduit.

(4) Conduit.

(5) Existence of arrangement.

(6) Predecessor and successor.

(i) Persons.

(ii) Assets.

(7) Examples.

�1.338-9 International aspects of section 338.

(a) Scope.

(b) Application of section 338 to foreign targets.

(1) In general.

(2) Ownership of FT stock on the acquisition date.

(3) Carryover FT stock.

(i) Definition.

(ii) Carryover of earnings and profits.

(iii) Cap on carryover of earnings and profits.

(iv) Post-acquisition date distribution of old FT earnings and
profits.

(v) Old FT earnings and profits unaffected by post-acquisition date
deficits.

(vi) Character of FT stock as carryover FT stock eliminated upon
disposition.

(4) Passive foreign investment company stock.

(c) Dividend treatment under section 1248(e).

(d) Allocation of foreign taxes.

(e) Operation of section 338(h)(16). [Reserved]

(f) Examples.

�1.338-10T Filing of returns (temporary).

(a) Returns including tax liability from deemed asset sale.

(1) In general.

(2) Old target's final taxable year otherwise included in
consolidated return of selling group.

(i) General rule.

(ii) Separate taxable year.

(iii) Carryover and carryback of tax attributes.

(iv) Old target is a component member of purchasing corporation's
controlled group.

(3) Old target is an S corporation.

(4) Combined deemed sale return.

(i) General rule.

(ii) Gain and loss offsets.

(iii) Procedure for filing a combined return.

(iv) Consequences of filing a combined return.

(5) Deemed sale excluded from purchasing corporation's consolidated
return.

(6) Due date for old target's final return.

(i) General rule.

(ii) Application of �1.1502-76(c).

(A) In general.

(B) Deemed extension.

(C) Erroneous filing of deemed sale return.

(D) Erroneous filing of return for regular tax year.

(E) Last date for payment of tax.

(7) Examples.

(b) Waiver.

(1) Certain additions to tax.

(2) Notification.

(3) Elections or other actions required to be specified on a timely
filed return.

(i) In general.

(ii) New target in purchasing corporation's consolidated return.

(4) Examples.

�1.338(h)(10)-1T Deemed asset sale and liquidation (temporary).

(a) Scope.

(b) Definitions.

(1) Consolidated target.

(2) Selling consolidated group.

(3) Selling affiliate; affiliated target.

(4) S corporation target

(5) S corporation shareholders.

(6) Liquidation.

(c) Section 338(h)(10) election.

(1) In general.

(2) Simultaneous joint election requirement.

(3) Irrevocability.

(4) Effect of invalid election.

(d) Certain consequences of section 338(h)(10) election.

(1) P.

(2) New T.

(3) Old T--deemed sale.

(i) In general.

(ii) Tiered targets.

(4) Old T and selling consolidated group, selling affiliate, or S
corporation shareholders--deemed liquidation; tax characterization.

(i) In general.

(ii) Tiered targets.

(5) Selling consolidated group, selling affiliate, or S corporation
shareholders.

(i) In general.

(ii) Basis and holding period of T stock not acquired.

(iii) T stock sale.

(6) Nonselling minority shareholders other than nonselling S
corporation shareholders.

(i) In general.

(ii) T stock sale.

(iii) T stock not acquired.

(7) Consolidated return of selling consolidated group.

(8) Availability of the section 453 installment method.

(i) In deemed asset sale.

(ii) In deemed liquidation.

(9) Treatment consistent with an actual asset sale.

(e) Examples.

(f) Inapplicability of provisions.

(g) Required information.

�1.338(i)-1T Effective dates (temporary).

�1.338-1T General principles; status of old target and new target
(temporary).

(a) In general--(1) Deemed transaction. Elections are available
under section 338 when a purchasing corporation acquires the stock
of another corporation (the target) in a qualified stock purchase.
One type of election, under section 338(g), is available to the
purchasing corporation. Another type of election, under section
338(h)(10), is, in more limited circumstances, available jointly to
the purchasing corporation and the sellers of the stock. (Rules
concerning eligibility for these elections are contained in ��
1.338-2T, 1.338-3T, and 1.338(h)(10)-1T.) Although target is a
single corporation under corporate law, if a section 338 election is
made, then two separate corporations, old target and new target,
generally are considered to exist for purposes of subtitle A of the
Internal Revenue Code. Old target is treated as transferring all of
its assets to an unrelated person in exchange for consideration that
includes the assumption of, or taking subject to, liabilities, and
new target is treated as acquiring all of its assets from an
unrelated person in exchange for consideration that includes the
assumption of or taking subject to liabilities. (Such transaction
is, without regard to its characterization for Federal income tax
purposes, referred to as the deemed asset sale and the income tax
consequences thereof as the deemed sale gain.) If a section 338(h)
(10) election is made, old target is also deemed to liquidate
following the deemed asset sale.

(2) Application of other rules of law. Other rules of law apply to
determine the tax consequences to the parties as if they had
actually engaged in the transactions deemed to occur under section
338 and ��1.338-0T through 1.338- 7T, 1.338-8, 1.338-9, 1.338-10T,
1.338(h)(10)-1T, and 1.338(i)-1T except to the extent otherwise
provided in ��1.338-0T through 1.338-7T, 1.338-8, 1.338-9,
1.338-10T, 1.338(h)(10)-1T, and 1.338(i)-1T. See also �1.338-6T(c)
(2). Other rules of law may characterize the transaction as
something other than or in addition to a sale and purchase of
assets; however, it must be a taxable transaction. For example, if
target is an insurance company for which a section 338 election is
made, the deemed asset sale would be characterized and taxed as an
assumption-reinsurance transaction under applicable Federal income
tax law. See �1.817-4(d).

(3) Overview. Definitions and special nomenclature and rules for
making the section 338 election are provided in �1.338-2T.
Qualification for the section 338 election is addressed in
�1.338-3T. The amount for which old target is treated as selling all
of its assets (the aggregate deemed sale price, or ADSP) is
addressed in �1.338-4T. The amount for which new target is deemed to
have purchased all its assets (the adjusted grossed-up basis, or
AGUB) is addressed in �1.338-5T. Section 1.338-6T addresses
allocation both of ADSP among the assets old target is deemed to
have sold and of AGUB among the assets new target is deemed to have
purchased. Section 1.338-7T addresses allocation of ADSP or AGUB
when those amounts change after the close of new target's first
taxable year. Asset and stock consistency are addressed in �1.338-8.

International aspects of section 338 are covered in �1.338-9. Rules
for the filing of returns are provided in �1.338-10T. Eligibility
for and treatment of section 338(h)(10) elections is addressed in
�1.338(h)(10)-1T.

(b) Treatment of target under other provisions of the Internal
Revenue Code--(1) General rule for subtitle A. Except as provided in
this section, new target is treated as a new corporation that is
unrelated to old target for purposes of subtitle A of the Internal
Revenue Code. Thus-- (i) New target is not considered related to old
target for purposes of section 168 and may make new elections under
section 168 without taking into account the elections made by old
target; and (ii) New target may adopt, without obtaining prior
approval from the Commissioner, any taxable year that meets the
requirements of section 441 and any method of accounting that meets
the requirements of section 446.

Notwithstanding �1.441-1T(b)(2), a new target may adopt a taxable
year on or before the last day for making the election under section
338 by filing its first return for the desired taxable year on or
before that date.

(2) Exceptions for subtitle A. New target and old target are treated
as the same corporation for purposes of-- (i) The rules applicable
to employee benefit plans (including those plans described in
sections 79, 104, 105, 106, 125, 127, 129, 132, 137, and 220),
qualified pension, profit-sharing, stock bonus and annuity plans
(sections 401(a) and 403(a)), simplified employee pensions (section
408(k)), tax qualified stock option plans (sections 422 and 423),
welfare benefit funds (sections 419, 419A, 512(a)(3), and 4976),
voluntary employee benefit associations (section 501(c)(9) and the
regulations thereunder); (ii) Sections 1311 through 1314 (relating
to the mitigation of the effect of limitations) if a section 338(h)
(10) election is not made for target; (iii) Section 108(e)(5)
(relating to the reduction of purchase money debt); (iv) Section 45A
(relating to the Indian Employment Credit), section 51 (relating to
the Work Opportunity Credit), section 51A (relating to the Welfare
to Work Credit), and section 1396 (relating to the Empowerment Zone
Act); (v) Sections 401(h) and 420 (relating to medical benefits for
retirees); (vi) Section 414 (relating to definitions and special
rules); and (vii) Any other provision designated in the Internal
Revenue Bulletin by the Internal Revenue Service. See �601.601(d)(2)
(ii) of this chapter (relating to the Internal Revenue Bulletin).
See �1.1001-3(e)(4)(F) providing that an election under section 338
does not result in the substitution of a new obligor on target's
debt.

(3) General rule for other provisions of the Internal Revenue Code.

Except as provided in the regulations under section 338 or in the
Internal Revenue Bulletin by the Internal Revenue Service (see
�601.601(d)(2)(ii) of this chapter), new target is treated as a
continuation of old target for purposes other than subtitle A of the
Internal Revenue Code. For example-- (i) New target is liable for
old target's Federal income tax liabilities, including the tax
liability for the deemed sale gain and those tax liabilities of the
other members of any consolidated group that included old target
that are attributable to taxable years in which those corporations
and old target joined in the same consolidated return (see
�1.1502-6(a)); (ii) Wages earned by the employees of old target are
considered wages earned by such employees from new target for
purposes of sections 3101 and 3111 (Federal Insurance Contributions
Act) and section 3301 (Federal Unemployment Tax Act); and (iii) Old
target and new target must use the same employer identification
number.

(c) Anti-abuse rule--(1) In general. For purposes of applying the
residual method of ��1.338-0T through 1.338-7T, 1.338-8, 1.338-9,
1.338-10T, 1.338(h)(10)-1T, and 1.338(i)-1T, the Commissioner is
authorized to treat any property (including cash) transferred by old
target in connection with the transactions resulting in the
application of the residual method as, nonetheless, property of
target at the close of the acquisition date if the property so
transferred, within 24 months after the deemed asset sale, is owned
by new target, or is owned, directly or indirectly, by a member of
the affiliated group of which new target is a member and continues
after the election to be held or used to more than an insignificant
extent in connection with one or more of the activities of new
target. The Commissioner is authorized to treat any property
(including cash) transferred to old target in connection with the
transactions resulting in the application of the residual method as,
nonetheless, not being property of target at the close of the
acquisition date if the property so transferred by the transferor
is, within 24 months after the deemed asset sale, not owned by new
target but owned, directly or indirectly, by a member of the
affiliated group of which new target is a member or owned by new
target but held or used to more than an insignificant extent in
connection with an activity conducted, directly or indirectly, by
another member of the affiliated group of which new target is a
member in combination with other property acquired, directly or
indirectly, from the transferor of the property (or a member of the
same affiliated group) to old target. For purposes of this paragraph
(c)(1), an interest in an entity is considered held or used in
connection with an activity if property of the entity is so held or
used. The authority under this paragraph (c)(1) includes the making
of any necessary correlative adjustments.

(2) Examples. The following examples illustrate this paragraph (c):
Example 1. Prior to a qualified stock purchase under section 338,
target transfers one of its assets to a related party. The
purchasing corporation then purchases the target stock and also
purchases the transferred asset from the related party. After its
purchase of target, the purchasing corporation and target are
members of the same affiliated group. A section 338 election is
made.

Under an arrangement with the purchaser, target continues to use the
separately transferred asset to more than an insignificant extent in
connection with its own activities. Applying the anti-abuse rule of
this paragraph (c), the Commissioner may consider target to own the
transferred asset for purposes of applying section 338 and its
allocation rules.

Example 2. Target (T) owns all the stock of T1. T1 leases
intellectual property to T, which T uses in connection with its own
activities. P, a purchasing corporation, wishes to buy the T-T1
chain of corporations. P, in connection with its planned purchase of
the T stock, contracts to consummate a purchase of all the stock of
T1 on March 1 and of all the stock of T on March 2. Section 338
elections are thereafter made for both T and T1. Immediately after
the purchases, P, T and T1 are members of the same affiliated group.
T continues to lease the intellectual property from T1 and to use
the property to more than an insignificant extent in connection with
its own activities. Thus, an asset of T, the T1 stock, was removed
from T 's own assets prior to the qualified stock purchase of the T
stock, T1's own assets are used after the deemed asset sale in
connection with T's own activities, and the T1 stock is after the
deemed asset sale owned by P, a member of the same affiliated group
of which T is a member.

Applying the anti-abuse rule of this paragraph (c), the Commissioner
may, for purposes of application of section 338 both to T and to T1,
consider P to have bought only the stock of T, with T at the time of
the qualified stock purchases of both T and T1 (the qualified stock
purchase of T1 being triggered by the deemed sale under section 338
of T's assets) owning T1. The Commissioner would accordingly apply
section 338 first at the T level and then at the T1 level.

�1.338-2T Nomenclature and definitions; mechanics of the section 338
election (temporary).

(a) Scope. This section prescribes rules relating to elections under
section 338.

(b) Nomenclature. For purposes of the regulations under section 338
(except as otherwise provided): (1) T is a domestic target
corporation that has only one class of stock outstanding. Old T
refers to T for periods ending on or before the close of T's
acquisition date; new T refers to T for subsequent periods.

(2) P is the purchasing corporation.

(3) The P group is an affiliated group of which P is a member.

(4) P1, P2, etc., are domestic corporations that are members of the
P group.

(5) T1, T2, etc., are domestic corporations that are target
affiliates of T.

These corporations (T1, T2, etc.) have only one class of stock
outstanding and may also be targets.

(6) S is a domestic corporation (unrelated to P and B) that owns T
prior to the purchase of T by P. (S is referred to in cases in which
it is appropriate to consider the effects of having all of the
outstanding stock of T owned by a domestic corporation.)

(7) A, a U.S. citizen or resident, is an individual (unrelated to P
and B) who owns T prior to the purchase of T by P. (A is referred to
in cases in which it is appropriate to consider the effects of
having all of the outstanding stock of T owned by an individual who
is a U.S. citizen or resident. Ownership of T by A and ownership of
T by S are mutually exclusive circumstances.)

(8) B, a U.S. citizen or resident, is an individual (unrelated to T,
S, and A) who owns the stock of P.

(9) F, used as a prefix with the other terms in this paragraph (b),
connotes foreign, rather than domestic, status. For example, FT is a
foreign corporation (as defined in section 7701(a)(5)) and FA is an
individual other than a U.S.

citizen or resident.

(10) CFC, used as a prefix with the other terms in this paragraph
(b) referring to a corporation, connotes a controlled foreign
corporation (as defined in section 957, taking into account section
953(c)). A corporation identified with the prefix F may be a
controlled foreign corporation. The prefix CFC is used when the
corporation's status as a controlled foreign corporation is
significant.

(c) Definitions. For purposes of the regulations under section 338
(except as otherwise provided): (1) Acquisition date. The term
acquisition date has the same meaning as in section 338(h)(2).

(2) Acquisition date assets. Acquisition date assets are the assets
of the target held at the beginning of the day after the acquisition
date (other than assets that were not assets of old target).

(3) Affiliated group. The term affiliated group has the same meaning
as in section 338(h)(5). Corporations are affiliated on any day they
are members of the same affiliated group. (4) Common parent. The
term common parent has the same meaning as in section 1504.

(5) Consistency period. The consistency period is the period
described in section 338(h)(4)(A) unless extended pursuant to
�1.338-8(j)(1).

(6) Deemed asset sale. The deemed asset sale is the transaction
described in �1.338-1T(a)(1) that is deemed to occur for purposes of
subtitle A of the Internal Revenue Code if a section 338 election is
made.

(7) Deemed sale gain. Deemed sale gain refers to, in the aggregate,
the Federal income tax consequences (generally, the income, gain,
deduction, and loss) of the deemed asset sale. Deemed sale gain also
refers to the Federal income tax consequences of the transfer of a
particular asset in the deemed asset sale.

(8) Deemed sale return. The deemed sale return is the return on
which target's deemed sale gain is reported that does not include
any other items of target. Target files a deemed sale return when a
section 338 election (but not a section 338(h)(10) election) is
filed for target and target is a member of a selling group (defined
in paragraph (c)(16) of this section) that files a consolidated
return for the period that includes the acquisition date or is an S
corporation.

See �1.338-10T.

(9) Domestic corporation. A domestic corporation is a corporation--
(i) That is domestic within the meaning of section 7701(a)(4) or
that is treated as domestic for purposes of subtitle A of the
Internal Revenue Code (e.g., to which an election under section
953(d) or 1504(d) applies); and (ii) That is not a DISC, a
corporation described in section 1248(e), or a corporation to which
an election under section 936 applies.

(10) Old target's final return. Old target's final return is the
income tax return of old target for the taxable year ending at the
close of the acquisition date that includes the deemed sale gain. If
the disaffiliation rule of �1.338- 10T(a)(2)(i) applies or if target
is an S corporation, target's deemed sale return is considered old
target's final return.

(11) Purchasing corporation. The term purchasing corporation has the
same meaning as in section 338(d)(1). The purchasing corporation may
also be referred to as purchaser. Unless otherwise provided, any
reference to the purchasing corporation is a reference to all
members of the affiliated group of which the purchasing corporation
is a member. See sections 338(h)(5) and (8).

Also, unless otherwise provided, any reference to the purchasing
corporation is, with respect to a deemed purchase of stock under
section 338(a)(2), a reference to new target with respect to its own
deemed purchase of stock in another target.

(12) Qualified stock purchase. The term qualified stock purchase has
the same meaning as in section 338(d)(3).

(13) Related persons. Two persons are related if stock in a
corporation owned by one of the persons would be attributed under
section 318(a) (other than section 318(a)(4)) to the other.

(14) Section 338 election. A section 338 election is an election to
apply section 338(a) to target. A section 338 election is made by
filing a statement of section 338 election pursuant to paragraph (d)
of this section. The form on which this statement is filed is
referred to in the regulations under section 338 as the Form 8023
Elections Under Section 338 for Corporations Making Qualified Stock
Purchases.

(15) Section 338(h)(10) election. A section 338(h)(10) election is
an election to apply section 338(h)(10) to target. A section 338(h)
(10) election is made by making a joint election for target under
�1.338(h)(10)-1T.

(16) Selling group. The selling group is the affiliated group (as
defined in section 1504) eligible to file a consolidated return that
includes target for the taxable period in which the acquisition date
occurs. However, a selling group is not an affiliated group of which
target is the common parent on the acquisition date.

(17) Target; old target; new target. Target is the target
corporation as defined in section 338(d)(2). Old target refers to
target for periods ending on or before the close of target's
acquisition date. New target refers to target for subsequent
periods.

(18) Target affiliate. The term target affiliate has the same
meaning as in section 338(h)(6) (applied without section 338(h)(6)
(B)(i)). Thus, a corporation described in section 338(h)(6)(B)(i) is
considered a target affiliate for all purposes of section 338. If a
target affiliate is acquired in a qualified stock purchase, it is
also a target. (19) 12-Month acquisition period. The 12-month
acquisition period is the period described in section 338(h)(1),
unless extended pursuant to �1.338- 8(j)(2).

(d) Time and manner of making election. The purchasing corporation
makes a section 338 election for target by filing a statement of
section 338 election on Form 8023 in accordance with the
instructions to the form. The section 338 election must be made not
later than the 15th day of the 9th month beginning after the month
in which the acquisition date occurs. A section 338 election is
irrevocable. See �1.338(h)(10)-1T(c)(2) for section 338(h)(10)
elections.

(e) Special rules for foreign corporations or DISCs--(1) Elections
by certain foreign purchasing corporations--(i) General rule. A
qualifying foreign purchasing corporation is not required to file a
statement of section 338 election for a qualifying foreign target
before the earlier of 3 years after the acquisition date and the
180th day after the close of the purchasing corporation's taxable
year within which a triggering event occurs.

(ii) Qualifying foreign purchasing corporation. A purchasing
corporation is a qualifying foreign purchasing corporation only if,
during the acquisition period of a qualifying foreign target, all
the corporations in the purchasing corporation's affiliated group
are foreign corporations that are not subject to United States tax.

(iii) Qualifying foreign target. A target is a qualifying foreign
target only if target and its target affiliates are foreign
corporations that, during target's acquisition period, are not
subject to United States tax (and will not become subject to United
States tax during such period because of a section 338 election). A
target affiliate is taken into account for purposes of the preceding
sentence only if, during target's 12-month acquisition period, it is
or becomes a member of the affiliated group that includes the
purchasing corporation.

(iv) Triggering event. A triggering event occurs in the taxable year
of the qualifying foreign purchasing corporation in which either
that corporation or any corporation in its affiliated group becomes
subject to United States tax.

(v) Subject to United States tax. For purposes of this paragraph (e)
(1), a foreign corporation is considered subject to United States
tax--

(A) For the taxable year for which that corporation is required
under �1.6012-2(g) (other than �1.6012-2(g)(2)(i)(B)(2)) to file a
United States income tax return; or

(B) For the period during which that corporation is a controlled
foreign corporation, a passive foreign investment company for which
an election under section 1295 is in effect, a foreign investment
company, or a foreign corporation the stock ownership of which is
described in section 552(a)(2).

(2) Acquisition period. For purposes of this paragraph (e), the term
acquisition period means the period beginning on the first day of
the 12-month acquisition period and ending on the acquisition date.

(3) Statement of section 338 election may be filed by United States
shareholders in certain cases. The United States shareholders (as
defined in section 951(b)) of a foreign purchasing corporation that
is a controlled foreign corporation (as defined in section 957
(taking into account section 953(c))) may file a statement of
section 338 election on behalf of the purchasing corporation if the
purchasing corporation is not required under �1.6012-2(g) (other
than �1.6012-2(g)(2)(i)(B)(2)) to file a United States income tax
return for its taxable year that includes the acquisition date. Form
8023 must be filed as described in the form and its instructions and
also must be attached to the Form 5471 (information return with
respect to a foreign corporation) filed with respect to the
purchasing corporation by each United States shareholder for the
purchasing corporation's taxable year that includes the acquisition
date (or, if paragraph (e)(1)(i) of this section applies to the
election, for the purchasing corporation's taxable year within which
it becomes a controlled foreign corporation). The provisions of
�1.964-1(c) (including �1.964-1(c)(7)) do not apply to an election
made by the United States shareholders.

(4) Notice requirement for U.S. persons holding stock in foreign
market--

(i) General rule. If a target subject to a section 338 election was
a controlled foreign corporation, a passive foreign investment
company, or a foreign personal holding company at any time during
the portion of its taxable year that ends on its acquisition date,
the purchasing corporation must deliver written notice of the
election (and a copy of Form 8023, its attachments and instructions)
to--

(A) Each U.S. person (other than a member of the affiliated group of
which the purchasing corporation is a member (the purchasing group
member)) that, on the acquisition date of the foreign target, holds
stock in the foreign target; and

(B) Each U.S. person (other than a purchasing group member) that
sells stock in the foreign target to a purchasing group member
during the foreign target's 12-month acquisition period.

(ii) Limitation. The notice requirement of this paragraph (e)(4)
applies only where the section 338 election for the foreign target
affects income, gain, loss, deduction, or credit of the U.S. person
described in paragraph (e)(4)(i) of this section under section 551,
951, 1248, or 1293.

(iii) Form of notice. The notice to U.S. persons must be identified
prominently as a notice of section 338 election and must--

(A) Contain the name, address, and employer identification number
(if any) of, and the country (and, if relevant, the lesser political
subdivision) under the laws of which is organized, the purchasing
corporation and the relevant target (i.e., target the stock of which
the particular U.S. person held or sold under the circumstances
described in paragraph (e)(4)(i) of this section);

(B) Identify those corporations as the purchasing corporation and
the foreign target, respectively; and

(C) Contain the following declaration (or a substantially similar
declaration): THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION UNDER
SECTION 338 FOR THE ABOVE CITED FOREIGN TARGET THE STOCK OF WHICH
YOU EITHER HELD OR SOLD UNDER THE CIRCUMSTANCES DESCRIBED IN
TREASURY REGULATIONS SECTION 1.338-2T(e)(4). FOR POSSIBLE UNITED
STATES FEDERAL INCOME TAX CONSEQUENCES UNDER SECTION 551, 951, 1248,
OR 1293 OF THE INTERNAL REVENUE CODE OF 1986 THAT MAY APPLY TO YOU,
SEE TREASURY REGULATIONS SECTION 1.338-9(b). YOU MAY BE REQUIRED TO
ATTACH THE INFORMATION ATTACHED TO THIS NOTICE TO CERTAIN RETURNS.

(iv) Timing of notice. The notice required by this paragraph (e)(4)
must be delivered to the U.S. person on or before the later of the
120th day after the acquisition date of the particular target or the
day on which Form 8023 is filed.

The notice is considered delivered on the date it is mailed to the
proper address (or an address similar enough to complete delivery),
unless the date it is mailed cannot be reasonably determined. The
date of mailing will be determined under the rules of section 7502.
For example, the date of mailing is the date of U.S.

postmark or the applicable date recorded or marked by a designated
delivery service.

(v) Consequence of failure to comply. A statement of section 338
election is not valid if timely notice is not given to one or more
U.S. persons described in this paragraph (e)(4). If the form of
notice fails to comply with all requirements of this paragraph (e)
(4), the section 338 election is valid, but the waiver rule of
�1.338-10T(b)(1) does not apply.

(vi) Good faith effort to comply. The purchasing corporation will be
considered to have complied with this paragraph (e)(4), even though
it failed to provide notice or provide timely notice to each person
described in this paragraph (e)(4), if the Commissioner determines
that the purchasing corporation made a good faith effort to identify
and provide timely notice to those U.S. persons.

�1.338-3T Qualification for the section 338 election (temporary).

(a) Scope. This section provides rules on whether certain
acquisitions of stock are qualified stock purchases and on other
miscellaneous issues under section 338.

(b) Rules relating to qualified stock purchases--(1) Purchasing
corporation requirement. An individual cannot make a qualified stock
purchase of target. Section 338(d)(3) requires, as a condition of a
qualified stock purchase, that a corporation purchase the stock of
target. If an individual forms a corporation (new P) to acquire
target stock, new P can make a qualified stock purchase of target if
new P is considered for tax purposes to purchase the target stock.
Facts that may indicate that new P does not purchase the target
stock include new P's merging downstream into target, liquidating,
or otherwise disposing of the target stock following the purported
qualified stock purchase.

(2) Purchase--(i) Definition. The term purchase has the same meaning
as in section 338(h)(3).

(ii) Purchase of target. [Reserved] (iii) Purchase of target
affiliate. Stock in a target affiliate acquired by new target in the
deemed asset sale of target's assets is considered purchased if,
under general principles of tax law, new target is considered to own
stock of the target affiliate meeting the requirements of section
1504(a)(2), notwithstanding that no amount may be allocated to
target's stock in the target affiliate.

(3) Acquisitions of stock from related corporations--(i) In general.
Stock acquired by a purchasing corporation from a related
corporation (R) is generally not considered acquired by purchase.
See section 338(h)(3)(A)(iii).

(ii) Time for testing relationship. For purposes of section 338(h)
(3)(A)(iii), a purchasing corporation is treated as related to
another person if the relationship specified in section 338(h)(3)(A)
(iii) exists--

(A) In the case of a single transaction, immediately after the
purchase of Target stock;

(B) In the case of a series of acquisitions otherwise constituting a
qualified stock purchase within the meaning of section 338(d)(3),
immediately after the last acquisition in such series; and

(C) In the case of a series of transactions effected pursuant to an
integrated plan to dispose of Target stock, immediately after the
last transaction in such series.

(iii) Cases where section 338(h)(3)(C) applies--acquisitions treated
as purchases. If section 338(h)(3)(C) applies and the purchasing
corporation is treated as acquiring stock by purchase from R, solely
for purposes of determining when the stock is considered acquired,
target stock acquired from R is considered to have been acquired by
the purchasing corporation on the day on which the purchasing
corporation is first considered to own that stock under section
318(a) (other than section 318(a)(4)).

(iv) Examples. The following examples illustrate this paragraph (b)
(3): Example 1. (i) S is the parent of a group of corporations that
are engaged in various businesses. Prior to January 1, Year 1, S
decided to discontinue its involvement in one line of business. To
accomplish this, S forms a new corporation, Newco, with a nominal
amount of cash. Shortly thereafter, on January 1, Year 1, S
transfers all the stock of the subsidiary conducting the unwanted
business (Target) to Newco in exchange for 100 shares of Newco
common stock and a Newco promissory note. Prior to January 1, Year
1, S and Underwriter (U) had entered into a binding agreement
pursuant to which U would purchase 60 shares of Newco common stock
from S and then sell those shares in an Initial Public Offering
(IPO). On January 6, Year 1, the IPO closes.

(ii) Newco's acquisition of Target stock is one of a series of
transactions undertaken pursuant to one integrated plan. The series
of transactions ends with the closing of the IPO and the transfer of
all the shares of stock in accordance with the agreements.
Immediately after the last transaction effected pursuant to the
plan, S owns 40 percent of Newco, which does not give rise to a
relationship described in section 338(h)(3)(A)(iii). See
�1.338-2T(b)(3)(ii)(C).

Accordingly, S and Newco are not related for purposes of section
338(h)(3)(A)(iii).

(iii) Further, because Newco's basis in the Target stock is not
determined by reference to S's basis in the Target stock and because
the transaction is not an exchange to which section 351, 354, 355,
or 356 applies, Newco's acquisition of the Target stock is a
purchase within the meaning of section 338(h)(3).

Example 2. (i) On January 1 of Year 1, P purchases 75 percent in
value of the R stock. On that date, R owns 4 of the 100 shares of T
stock. On June 1 of Year 1, R acquires an additional 16 shares of T
stock. On December 1 of Year 1, P purchases 70 shares of T stock
from an unrelated person and 12 of the 20 shares of T stock held by
R.

(ii) Of the 12 shares of T stock purchased by P from R on December 1
of Year 1, 3 of those shares are deemed to have been acquired by P
on January 1 of Year 1, the date on which 3 of the 4 shares of T
stock held by R on that date were first considered owned by P under
section 318(a)(2)(C) (i.e., 4 � .75). The remaining 9 shares of T
stock purchased by P from R on December 1 of Year 1, are deemed to
have been acquired by P on June 1 of Year 1, the date on which an
additional 12 of the 20 shares of T stock owned by R on that date
were first considered owned by P under section 318(a)(2)(C) (i.e.,
(20 � .75) -3). Because stock acquisitions by P sufficient for a
qualified stock purchase of T occur within a 12-month period (i.e.,
3 shares constructively on January 1 of Year 1, 9 shares
constructively on June 1 of Year 1, and 70 shares actually on
December 1 of Year 1), a qualified stock purchase is made on
December 1 of Year 1.

Example 3. (i) On February 1 of Year 1, P acquires 25 percent in
value of the R stock from B (the sole shareholder of P). That R
stock is not acquired by purchase. See section 338(h)(3)(A)(iii). On
that date, R owns 4 of the 100 shares of T stock. On June 1 of Year
1, P purchases an additional 25 percent in value of the R stock, and
on January 1 of Year 2, P purchases another 25 percent in value of
the R stock. On June 1 of Year 2, R acquires an additional 16 shares
of the T stock. On December 1 of Year 2, P purchases 68 shares of
the T stock from an unrelated person and 12 of the 20 shares of the
T stock held by R.

(ii) Of the 12 shares of the T stock purchased by P from R on
December 1 of Year 2, 2 of those shares are deemed to have been
acquired by P on June 1 of Year 1, the date on which 2 of the 4
shares of the T stock held by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e., 4 � .5).

For purposes of this attribution, the R stock need not be acquired
by P by purchase. See section 338(h)(1). (By contrast, the
acquisition of the T stock by P from R does not qualify as a
purchase unless P has acquired at least 50 percent in value of the R
stock by purchase. Section 338(h)(3)(C)(i).) Of the remaining 10
shares of the T stock purchased by P from R on December 1 of Year 2,
1 of those shares is deemed to have been acquired by P on January 1
of Year 2, the date on which an additional 1 share of the 4 shares
of the T stock held by R on that date was first considered owned by
P under section 318(a)(2)(C) (i.e., (4 � .75) -2). The remaining 9
shares of the T stock purchased by P from R on December 1 of Year 2,
are deemed to have been acquired by P on June 1 of Year 2, the date
on which an additional 12 shares of the T stock held by R on that
date were first considered owned by P under section 318(a)(2)(C)
(i.e., (20 � .75) -3). Because a qualified stock purchase of T by P
is made on December 1 of Year 2, only if all 12 shares of the T
stock purchased by P from R on that date are considered acquired
during a 12-month period ending on that date (so that, in
conjunction with the 68 shares of the T stock P purchased on that
date from the unrelated person, 80 of T's 100 shares are acquired by
P during a 12-month period) and because 2 of those 12 shares are
considered to have been acquired by P more than 12 months before
December 1 of Year 2 (i.e., on June 1 of Year 1), a qualified stock
purchase is not made. (Under �1.338-8(j)(2), for purposes of
applying the consistency rules, P is treated as making a qualified
stock purchase of T if, pursuant to an arrangement, P purchases T
stock satisfying the requirements of section 1504(a)(2) over a
period of more than 12 months.) Example 4. Assume the same facts as
in Example 3, except that on February 1 of Year 1, P acquires 25
percent in value of the R stock by purchase.

The result is the same as in Example 3.

(4) Acquisition date for tiered targets--(i) Stock sold in deemed
asset sale.

If an election under section 338 is made for target, old target is
deemed to sell target's assets and new target is deemed to acquire
those assets. Under section 338(h)(3)(B), new target's deemed
purchase of stock of another corporation is a purchase for purposes
of section 338(d)(3) on the acquisition date of target. If new
target's deemed purchase causes a qualified stock purchase of the
other corporation and if a section 338 election is made for the
other corporation, the acquisition date for the other corporation is
the same as the acquisition date of target. However, the deemed sale
and purchase of the other corporation's assets is considered to take
place after the deemed sale and purchase of target's assets.

(ii) Examples. The following examples illustrate this paragraph (b)
(4): Example 1. A owns all of the T stock. T owns 50 of the 100
shares of X stock. The other 50 shares of X stock are owned by
corporation Y, which is unrelated to A, T, or P. On January 1 of
Year 1, P makes a qualified stock purchase of T from A and makes a
section 338 election for T. On December 1 of Year 1, P purchases the
50 shares of X stock held by Y. A qualified stock purchase of X is
made on December 1 of Year 1, because the deemed purchase of 50
shares of X stock by new T because of the section 338 election for T
and the actual purchase of 50 shares of X stock by P are treated as
purchases made by one corporation. Section 338(h)(8). For purposes
of determining whether those purchases occur within a 12-month
acquisition period as required by section 338(d)(3), T is deemed to
purchase its X stock on T's acquisition date, i.e., January 1 of
Year 1.

Example 2. On January 1 of Year 1, P makes a qualified stock
purchase of T and makes a section 338 election for T. On that day, T
sells all of the stock of T1 to A. Although T held all of the T1
stock on T's acquisition date, T is not considered to have purchased
the T1 stock because of the section 338 election for T. In order for
T to be treated as purchasing the T1 stock, T must hold the T1 stock
when T's deemed asset sale occurs. The deemed asset sale is
considered the last transaction of old T at the close of T's
acquisition date.

Accordingly, the T1 stock actually disposed of by T on the
acquisition date is not included in the deemed asset sale. Thus, T
does not make a qualified stock purchase of T1.

(5) Effect of redemptions--(i) General rule. Except as provided in
this paragraph (b)(5), a qualified stock purchase is made on the
first day on which the percentage ownership requirements of section
338(d)(3) are satisfied by reference to target stock that is both--

(A) Held on that day by the purchasing corporation; and

(B) Purchased by the purchasing corporation during the 12-month
period ending on that day.

(ii) Redemptions from persons unrelated to the purchasing
corporation.

Target stock redemptions from persons unrelated to the purchasing
corporation that occur during the 12-month acquisition period are
taken into account as reductions in target's outstanding stock for
purposes of determining whether target stock purchased by the
purchasing corporation in the 12-month acquisition period satisfies
the percentage ownership requirements of section 338(d)(3).

(iii) Redemptions from the purchasing corporation or related persons
during 12-month acquisition period--(A) General rule. For purposes
of the percentage ownership requirements of section 338(d)(3), a
redemption of target stock during the 12-month acquisition period
from the purchasing corporation or from any person related to the
purchasing corporation is not taken into account as a reduction in
target's outstanding stock.

(B) Exception for certain redemptions from related corporations. A
redemption of target stock during the 12-month acquisition period
from a corporation related to the purchasing corporation is taken
into account as a reduction in target's outstanding stock to the
extent that the redeemed stock would have been considered purchased
by the purchasing corporation (because of section 338(h)(3)(C))
during the 12-month acquisition period if the redeemed stock had
been acquired by the purchasing corporation from the related
corporation on the day of the redemption. See paragraph (b)(3) of
this section.

(iv) Examples. The following examples illustrate this paragraph (b)
(5): Example 1. QSP on stock purchase date; redemption from
unrelated person during 12-month period. A owns all 100 shares of T
stock. On January 1 of Year 1, P purchases 40 shares of the T stock
from A. On July 1 of Year 1, T redeems 25 shares from A. On December
1 of Year 1, P purchases 20 shares of the T stock from A. P makes a
qualified stock purchase of T on December 1 of Year 1, because the
60 shares of T stock purchased by P within the 12-month period
ending on that date satisfy the 80-percent ownership requirements of
section 338(d)(3) (i.e., 60/75 shares), determined by taking into
account the redemption of 25 shares.

Example 2. QSP on stock redemption date; redemption from unrelated
person during 12-month period. The facts are the same as in Example
1, except that P purchases 60 shares of T stock on January 1 of Year
1 and none on December 1 of Year 1. P makes a qualified stock
purchase of T on July 1 of Year 1, because that is the first day on
which the T stock purchased by P within the preceding 12-month
period satisfies the 80-percent ownership requirements of section
338(d)(3) (i.e., 60/75 shares), determined by taking into account
the redemption of 25 shares.

Example 3. Redemption from purchasing corporation not taken into
account. On December 15 of Year 1, T redeems 30 percent of its stock
from P.

The redeemed stock was held by P for several years and constituted
P's total interest in T. On December 1 of Year 2, P purchases the
remaining T stock from A. P does not make a qualified stock purchase
of T on December 1 of Year 2.

For purposes of the 80-percent ownership requirements of section
338(d)(3), the redemption of P's T stock on December 15 of Year 1 is
not taken into account as a reduction in T's outstanding stock.

Example 4. Redemption from related person taken into account. On
January 1 of Year 1, P purchases 60 of the 100 shares of X stock. On
that date, X owns 40 of the 100 shares of T stock. On April 1 of
Year 1, T redeems X's T stock and P purchases the remaining 60
shares of T stock from an unrelated person. For purposes of the 80-
percent ownership requirements of section 338(d)(3), the redemption
of the T stock from X (a person related to P) is taken into account
as a reduction in T's outstanding stock. If P had purchased the 40
redeemed shares from X on April 1 of Year 1, all 40 of the shares
would have been considered purchased (because of section 338(h)(3)
(C)(i)) during the 12- month period ending on April 1 of Year 1 (24
of the 40 shares would have been considered purchased by P on
January 1 of Year 1 and the remaining 16 shares would have been
considered purchased by P on April 1 of Year 1). See paragraph (b)
(3) of this section. Accordingly, P makes a qualified stock purchase
of T on April 1 of Year 1, because the 60 shares of T stock
purchased by P on that date satisfy the 80-percent ownership
requirements of section 338(d)(3) (i.e., 60/60 shares), determined
by taking into account the redemption of 40 shares.

(c) Effect of post-acquisition events on eligibility for section 338
election-- (1) Post-acquisition elimination of target. (i) The
purchasing corporation may make an election under section 338 for
target even though target is liquidated on or after the acquisition
date. If target liquidates on the acquisition date, the liquidation
is considered to occur on the following day and immediately after
new target's deemed purchase of assets. The purchasing corporation
may also make an election under section 338 for target even though
target is merged into another corporation, or otherwise disposed of
by the purchasing corporation provided that, under the facts and
circumstances, the purchasing corporation is considered for tax
purposes as the purchaser of the target stock.

(ii) The following examples illustrate this paragraph (c)(1):
Example 1. On January 1 of Year 1, P purchases 100 percent of the
outstanding common stock of T. On June 1 of Year 1, P sells the T
stock to an unrelated person. Assuming that P is considered for tax
purposes as the purchaser of the T stock, P remains eligible, after
June 1 of Year 1, to make a section 338 election for T that results
in a deemed asset sale of T's assets on January 1 of Year 1.

Example 2. On January 1 of Year 1, P makes a qualified stock
purchase of T. On that date, T owns the stock of T1. On March 1 of
Year 1, T sells the T1 stock to an unrelated person. On April 1 of
Year 1, P makes a section 338 election for T. Notwithstanding that
the T1 stock was sold on March 1 of Year 1, the section 338 election
for T on April 1 of Year 1 results in a qualified stock purchase by
T of T1 on January 1 of Year 1. See paragraph (b)(4)(i) of this
section.

(2) Post-acquisition elimination of the purchasing corporation. An
election under section 338 may be made for target after the
acquisition of assets of the purchasing corporation by another
corporation in a transaction described in section 381(a), provided
that the purchasing corporation is considered for tax purposes as
the purchaser of the target stock. The acquiring corporation in the
section 381(a) transaction may make an election under section 338
for target.

(3) Consequences of post-acquisition elimination of target--(i)
Scope.

The rules of this paragraph (c)(3) apply to the transfer of target
assets to the purchasing corporation (or another member of the same
affiliated group as the purchasing corporation) (the transferee)
following a qualified stock purchase of target stock, if the
purchasing corporation does not make a section 338 election for
target. Notwithstanding the rules of this paragraph (c)(3), section
354(a) (and so much of section 356 as relates to section 354) cannot
apply to any person other than the purchasing corporation or another
member of the same affiliated group as the purchasing corporation
unless the transfer of target assets is pursuant to a reorganization
as determined without regard to this paragraph (c)(3).

(ii) Continuity of interest. By virtue of section 338, in
determining whether the continuity of interest requirement of
�1.368-1(b) is satisfied on the transfer of assets from target to
the transferee, the purchasing corporation's target stock acquired
in the qualified stock purchase represents an interest on the part
of a person who was an owner of the target's business enterprise
prior to the transfer that can be continued in a reorganization.

(iii) Control requirement. By virtue of section 338, the acquisition
of target stock in the qualified stock purchase will not prevent the
purchasing corporation from qualifying as a shareholder of the
target transferor for the purpose of determining whether,
immediately after the transfer of target assets, a shareholder of
the transferor is in control of the corporation to which the assets
are transferred within the meaning of section 368(a)(1)(D).

(iv) Example. The following example illustrates this paragraph (c)
(3): Example. (i) Facts. P, T, and X are domestic corporations. T
and X each operate a trade or business. A and K, individuals
unrelated to P, own 85 and 15 percent, respectively, of the stock of
T. P owns all of the stock of X. The total adjusted basis of T's
property exceeds the sum of T's liabilities plus the amount of
liabilities to which T's property is subject. P purchases all of A's
T stock for cash in a qualified stock purchase. P does not make an
election under section 338(g) with respect to its acquisition of T
stock. Shortly after the acquisition date, and as part of the same
plan, T merges under applicable state law into X in a transaction
that, but for the question of continuity of interest, satisfies all
the requirements of section 368(a)(1)(A). In the merger, all of T's
assets are transferred to X. P and K receive X stock in exchange for
their T stock. P intends to retain the stock of X indefinitely.

(ii) Status of transfer as a reorganization. By virtue of section
338, for the purpose of determining whether the continuity of
interest requirement of �1.368- 1(b) is satisfied, P's T stock
acquired in the qualified stock purchase represents an interest on
the part of a person who was an owner of T's business enterprise
prior to the transfer that can be continued in a reorganization
through P's continuing ownership of X. Thus, the continuity of
interest requirement is satisfied and the merger of T into X is a
reorganization within the meaning of section 368(a)(1)(A). Moreover,
by virtue of section 338, the requirement of section 368(a)(1)(D)
that a target shareholder control the transferee immediately after
the transfer is satisfied because P controls X immediately after the
transfer.

In addition, all of T's assets are transferred to X in the merger
and P and K receive the X stock exchanged therefor in pursuance of
the plan of reorganization. Thus, the merger of T into X is also a
reorganization within the meaning of section 368(a)(1)(D).

(iii) Treatment of T and X. Under section 361(a), T recognizes no
gain or loss in the merger. Under section 362(b), X's basis in the
assets received in the merger is the same as the basis of the assets
in T's hands. X succeeds to and takes into account the items of T as
provided in section 381.

(iv) Treatment of P. By virtue of section 338, the transfer of T
assets to X is a reorganization. Pursuant to that reorganization, P
exchanges its T stock solely for stock of X, a party to the
reorganization. Because P is the purchasing corporation, section 354
applies to P's exchange of T stock for X stock in the merger of T
into X. Thus, P recognizes no gain or loss on the exchange. Under
section 358, P's basis in the X stock received in the exchange is
the same as the basis of P's T stock exchanged therefor.

(v) Treatment of K. Because K is not the purchasing corporation (or
an affiliate thereof), section 354 cannot apply to K's exchange of T
stock for X stock in the merger of T into X unless the transfer of
T's assets is pursuant to a reorganization as determined without
regard to this paragraph (c)(3). Under general principles of tax law
applicable to reorganizations, the continuity of interest
requirement is not satisfied because P's stock purchase and the
merger of T into X are pursuant to an integrated transaction in
which A, the owner of 85 percent of the stock of T, received solely
cash in exchange for A's T stock. See, e.g., Yoc Heating v.
Commissioner, 61 T.C. 168 (1973); Kass v. Commissioner, 60 T.C. 218
(1973), aff'd, 491 F.2d 749 (3d Cir. 1974). Thus, the requisite
continuity of interest under �1.368-1(b) is lacking and section 354
does not apply to K's exchange of T stock for X stock. K recognizes
gain or loss, if any, pursuant to section 1001(c) with respect to
its T stock. ��1.338-4 and 1.338-5 [Redesignated as ��1.338-8 and
1.338-9 ] Par. 5. Sections 1.338-4 and 1.338-5 are redesignated as
��1.338-8 and 1.338-9, respectively.

Par. 6. New ��1.338-4T and 1.338-5T are added to read as follows:
�1.338-4T Aggregate deemed sale price; various aspects of taxation
of the deemed asset sale (temporary).

(a) Scope. This section provides rules under section 338(a)(1) to
determine the aggregate deemed sale price (ADSP) for target. ADSP is
the amount for which old target is deemed to have sold all of its
assets in the deemed asset sale. ADSP is allocated among target's
assets in accordance with �1.338-6T to determine the amount for
which each asset is deemed to have been sold. When an increase or
decrease with respect to an element of ADSP is required, under
general principles of tax law, after the close of new target's first
taxable year, redetermined ADSP is allocated among target's assets
in accordance with �1.338-7T. This section also provides rules
regarding the recognition of gain or loss on the deemed sale of
target affiliate stock.

Notwithstanding section 338(h)(6)(B)(ii), stock held by a target
affiliate in a foreign corporation or in a corporation that is a
DISC or that is described in section 1248(e) is not excluded from
the operation of section 338.

(b) Determination of ADSP--(1) General rule. ADSP is the sum of--
(i) The grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased
target stock (as defined in section 338(b)(6)(A)); and

(ii) The liabilities of old target.

(2) Time and amount of ADSP--(i) Original determination. ADSP is
initially determined at the beginning of the day after the
acquisition date of target. General principles of tax law apply in
determining the timing and amount of the elements of ADSP.

(ii) Redetermination of ADSP. ADSP is redetermined at such time and
in such amount as an increase or decrease would be required, under
general principles of tax law, for the elements of ADSP. For
example, ADSP is redetermined because of an increase or decrease in
the amount realized for recently purchased stock or because
liabilities not originally taken into account in determining ADSP
are subsequently taken into account. An increase or decrease to one
element of ADSP may cause an increase or decrease to the other
element of ADSP. For example, if an increase in the amount realized
for recently purchased stock of target is taken into account after
the acquisition date, any increase in the tax liability of target
for the deemed sale gain is also taken into account when ADSP is
redetermined. Increases or decreases with respect to the elements of
ADSP that are taken into account before the close of new target's
first taxable year are taken into account for purposes of
determining ADSP and the deemed sale gain as if they had been taken
into account at the beginning of the day after the acquisition date.
Increases or decreases with respect to the elements of ADSP that are
taken into account after the close of new target's first taxable
year result in the reallocation of ADSP among target's assets under
�1.338-7T.

(iii) Example. The following example illustrates this paragraph (b)
(2): Example. In Year 1, T, a manufacturer, purchases a customized
delivery truck from X with purchase money indebtedness having a
stated principal amount of $100,000. P acquires all of the stock of
T in Year 3 for $700,000 and makes a section 338 election for T.
Assume T has no liabilities other than its purchase money
indebtedness to X. In Year 4, when T is neither insolvent nor in a
title 11 case, T and X agree to reduce the amount of the purchase
money indebtedness to $80,000. Assume further that the reduction
would be a purchase price reduction under section 108(e)(5). T and
X's agreement to reduce the amount of the purchase money
indebtedness would not, under general principles of tax law that
would apply if the deemed asset sale had actually occurred, change
the amount of liabilities of old target taken into account in
determining its amount realized. Accordingly, ADSP is not
redetermined at the time of the reduction. See �1.338-5T(b)(2)(iii)
Example 1 for the effect on AGUB.

(c) Grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased
target stock--(1) Determination of amount. The grossed-up amount
realized on the sale to the purchasing corporation of the purchasing
corporation's recently purchased target stock is an amount equal
to--

(i) The amount realized on the sale to the purchasing corporation of
the purchasing corporation's recently purchased target stock
determined as if old target were the selling shareholder and the
installment method were not available and determined without regard
to the selling costs taken into account in paragraph (c)(1)(iii) of
this section;

(ii) Divided by the percentage of target stock (by value, determined
on the acquisition date) attributable to that recently purchased
target stock;

(iii) Less the selling costs incurred by the selling shareholders in
connection with the sale to the purchasing corporation of the
purchasing corporation's recently purchased target stock that reduce
their amount realized on the sale of the stock (e.g., brokerage
commissions and any similar costs to sell the stock).

(2) Example. The following example illustrates this paragraph (c):
Example. T has two classes of stock outstanding, voting common stock
and preferred stock not taken into account for purposes of section
1504(a)(2).

On March 1 of Year 1, P purchases 40 percent of the outstanding T
stock from S1 for $500, 20 percent of the outstanding T stock from
S2 for $225, and 20 percent of the outstanding T stock from S3 for
$275. On that date, the fair market value of all the T voting common
stock is $1,250 and the preferred stock $750. S1, S2, and S3
respectively incur $40, $35, and $25 of selling costs. S1 continues
to own the remaining 20 percent of the outstanding T stock. The
grossed-up amount realized on the sale to P of P's recently
purchased T stock is calculated as follows: The total amount
realized (without regard to selling costs) is $1,000 (500 + 225 +
275). The percentage of T stock by value on the acquisition date
attributable to the recently purchased T stock is 50% (1,000/(1,250
+ 750)). The selling costs are $100 (40 + 35 + 25). The grossed-up
amount realized is $1,900 (1,000/.5 ! 100).

(d) Liabilities of old target--(1) In general. The liabilities of
old target are the liabilities of target (and the liabilities to
which target's assets are subject) as of the beginning of the day
after the acquisition date (other than liabilities that were neither
liabilities of old target nor liabilities to which old target's
assets were subject). In order to be taken into account in ADSP, a
liability must be a liability of target that is properly taken into
account in amount realized under general principles of tax law that
would apply if old target had sold its assets to an unrelated person
for consideration that included that person's assumption of, or
taking subject to, the liability. Thus, ADSP takes into account both
tax credit recapture liability arising because of the deemed asset
sale and the tax liability for the deemed sale gain unless the tax
liability is borne by some person other than the target. For
example, ADSP would not take into account the tax liability for the
deemed sale gain when a section 338(h)(10) election is made for a
target S corporation because the S corporation shareholders bear
that liability.

However, if a target S corporation is subject to a tax under section
1374 or 1375, the liability for tax imposed by those sections is a
liability of target taken into account in ADSP (unless the S
corporation shareholders expressly assume that liability).

(2) Time and amount of liabilities. The time for taking into account
liabilities of old target in determining ADSP and the amount of the
liabilities taken into account is determined as if old target had
sold its assets to an unrelated person for consideration that
included the unrelated person's assumption of or taking subject to
the liabilities. For example, if no amount of a target liability is
properly taken into account in amount realized as of the beginning
of the day after the acquisition date, the liability is not
initially taken into account in determining ADSP (although it may be
taken into account at some later date). As a further example, an
increase or decrease in a liability that does not affect the amount
of old target's basis, deductions, or noncapital nondeductible items
arising from the incurrence of the liability is not taken into
account in redetermining ADSP.

(3) Interaction with deemed sale gain. Though deemed sale gain
increases or decreases ADSP by creating or reducing a tax liability,
the amount of the tax liability itself is a function of the size of
the deemed sale gain. Thus, the determination of ADSP may require
trial and error computations.

(e) Calculation of deemed sale gain. Deemed sale gain on each asset
is computed by reference to the ADSP allocated to that asset.

(f) Other rules apply in determining ADSP. ADSP may not be applied
in such a way as to contravene other applicable rules. For example,
a capital loss cannot be applied to reduce ordinary income in
calculating the tax liability on the deemed sale for purposes of
determining ADSP.

(g) Examples. The following examples illustrate this section. For
purposes of the examples in this paragraph (g), unless otherwise
stated, T is a calendar year taxpayer that files separate returns
and that has no loss, tax credit, or other carryovers to Year 1.
Depreciation for Year 1 is not taken into account. T has no
liabilities other than the Federal income tax liability resulting
from the deemed asset sale, and the T shareholders have no selling
costs.

Assume that T's tax rate for any ordinary income or net capital gain
resulting from the deemed sale of assets is 34 percent and that any
capital loss is offset by capital gain. On July 1 of Year 1, P
purchases all of the stock of T and makes a section 338 election for
T. The examples are as follows:

Example 1. One class. (i) On July 1 of Year 1, T's only asset is an
item of section 1245 property with an adjusted basis to T of
$50,400, a recomputed basis of $80,000, and a fair market value of
$100,000. P purchases all of the T stock for $75,000, which also
equals the amount realized for the stock determined as if old target
were the selling shareholder. (ii) ADSP is determined as follows (In
the following formula, G is the grossed-up amount realized on the
sale to P of P's recently purchased T stock, L is T's liabilities
other than T's tax liability for the deemed sale gain, T is the R
applicable tax rate, and B is the adjusted basis of the asset deemed
sold):

ADSP = G + L + T � (ADSP ! B) R ADSP = ($75,000/1) + $0 + .34 �
(ADSP ! $50,400) ADSP = $75,000 + .34ADSP ! $17,136 .66ADSP =
$57,864 ADSP = $87,672.72

(iii) Because ADSP for T ($87,672.72) does not exceed the fair
market value of T's asset ($100,000), a Class V asset, T's entire
ADSP is allocated to that asset. Thus, T has deemed sale gain of
$37,272.72 (consisting of $29,600 of ordinary income and $7,672.72
of capital gain).

(iv) The facts are the same as in paragraph (i) of this Example 1,
except that on July 1 of Year 1, P purchases only 80 of the 100
shares of T stock for $60,000. The grossed-up amount realized on the
sale to P of P's recently purchased T stock (G) is $75,000
($60,000/.8). Consequently, ADSP and deemed sale gain are the same
as in paragraphs (ii) and (iii) of this Example 1.

(v) The facts are the same as in paragraph (i) of this Example 1,
except that T also has goodwill (a Class VII asset) with an
appraised value of $10,000.

The results are the same as in paragraphs (ii) and (iii) of this
Example 1.

Because ADSP does not exceed the fair market value of the Class V
asset, no amount is allocated to the Class VII asset (goodwill).

Example 2. More than one class. (i) P purchases all of the T stock
for $140,000, which also equals the amount realized for the stock
determined as if old target were the selling shareholder. On July 1
of Year 1, T has liabilities (not including the tax liability for
the deemed sale gain) of $50,000, cash (a Class I asset) of $10,000,
actively traded securities (a Class II asset) with a basis of $4,000
and a fair market value of $10,000, goodwill (a Class VII asset)
with a basis of $3,000, and the following Class V assets:

Asset                     Basis      FMV       Ratio of
                                               asset fmv
                                               to total
                                               Class V
                                               fmv
Land .................... $5,000     $35,000   .14
Building................. 10,000      50,000   .20
Equipment A (Recomputed    5,000      90,000   .36
basis $80,000) ...........
Equipment B (Recomputed   10,000      75,000   .30
basis $20,000) ............
Totals..............     $30,000    $250,000  1.00

(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to the
cash and $10,000 to the actively traded securities. The amount
allocated to an asset (other than a Class VII asset) cannot exceed
its fair market value (however, the fair market value of any
property subject to nonrecourse indebtedness is treated as being not
less than the amount of such indebtedness; see �1.338-6T(a)(2)). See
�1.338-6T(c)(1) (relating to fair market value limitation).

(iii) The portion of ADSP allocable to the Class V assets is
preliminarily determined as follows (in the formula, the amount
allocated to the Class I assets is referred to as I and the amount
allocated to the Class II assets as II): ADSP = (G ! (I + II)) + L +
T � [(II ! B ) + (ADSP ! B )] V RIIVV ADSP = ($140,000 ! ($10,000 +
$10,000)) + $50,000 + .34 � [($10,000 ! V $4,000) + (ADSP ! ($5,000
+ $10,000 + $5,000 + $10,000))] V ADSP = $161,840 + .34 ADSP V V .66
ADSP = $161,840 V ADSP = $245,212.12 V

(iv) Because, under the preliminary calculations of ADSP, the amount
to be allocated to the Class I, II, III, IV, V, and VI assets does
not exceed their aggregate fair market value, no ADSP amount is
allocated to goodwill.

Accordingly, the deemed sale of the goodwill results in a capital
loss of $3,000. The portion of ADSP allocable to the Class V assets
is finally determined by taking into account this loss as follows:
ADSP = (G ! (I + II)) + L + T � [(II ! B ) + (ADSP ! B ) + (ADSP ! V
RIIVVVII B )] VII ADSP = ($140,000 ! ($10,000 + $10,000)) + $50,000
+ .34 � [($10,000 ! V $4,000) + (ADSP ! $30,000) + ($0 ! $3,000)] V
ADSP = $160,820 + .34 ADSP V V .66 ADSP = $160,820 V ADSP =
$243,666.67 V

(v) The allocation of ADSP among the Class V assets is in proportion to V
their fair market values, as follows:

Asset                      ADSP         Gain
Land ....................  $34,113.33   $29,113.33
(capital gain)
Building..................  48,733.34   38,733.34
(capital gain)
Equipment A..............   87,720.00   82,720.00
(75,000 ordinary
income
7,720 capital gain)
Equipment B..............   73,100.00   63,100.00
(10,000 ordinary
income
53,100 capital gain)
Totals..............      $243,666.67 $213,666.67

Example 3. More than one class. (i) The facts are the same as in
Example 2, except that P purchases the T stock for $150,000, rather
than $140,000. The amount realized for the stock determined as if
old target were the selling shareholder is also $150,000.

(ii) As in Example 2, ADSP exceeds $20,000. Thus, $10,000 of ADSP is
allocated to the cash and $10,000 to the actively traded securities.
(iii) The portion of ADSP allocable to the Class V assets as
preliminarily determined under the formula set forth in paragraph
(iii) of Example 2 is $260,363.64. The amount allocated to the Class
V assets cannot exceed their aggregate fair market value ($250,000).
Thus, preliminarily, the ADSP amount allocated to Class V assets is
$250,000.

(iv) Based on the preliminary allocation, the ADSP is determined as
follows (in the formula, the amount allocated to the Class I assets
is referred to as I, the amount allocated to the Class II assets as
II, and the amount allocated to the Class V assets as V): ADSP = G +
L + T � [(II ! B ) + (V ! B ) + (ADSP ! (I + II + V+ B ))] R IIV VII
ADSP = $150,000 + $50,000 + .34 � [($10,000 ! $4,000) + ($250,000 !
$30,000) + (ADSP ! ($10,000 + $10,000 + $250,000 + $3,000))] ADSP =
$200,000 + .34ADSP ! $15,980 .66ADSP = $184,020 ADSP = $278,818.18

(v) Because ADSP as determined exceeds the aggregate fair market
value of the Class I, II, III, IV, V, and VI assets, the $250,000
amount preliminarily allocated to the Class V assets is appropriate.
Thus, the amount of ADSP allocated to Class V assets equals their
aggregate fair market value ($250,000), and the allocated ADSP
amount for each Class V asset is its fair market value. Further,
because there are no Class VI assets, the allocable ADSP amount for
the Class VII asset (goodwill) is $8,818.18 (the excess of ADSP over
the aggregate ADSP amounts for the Class I, II, III, IV, V and VI
assets).

Example 4. Amount allocated to T1 stock. (i) The facts are the same
as in Example 2, except that T owns all of the T1 stock (instead of
the building), and T1's only asset is the building. The T1 stock and
the building each have a fair market value of $50,000, and the
building has a basis of $10,000. A section 338 election is made for
T1 (as well as T), and T1 has no liabilities other than the tax
liability for the deemed sale gain. T is the common parent of a
consolidated group filing a final consolidated return described in
�1.338-10T(a)(1).

(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to the
cash and $10,000 to the actively traded securities.

(iii) Because T does not recognize any gain on the deemed sale of
the T1 stock under paragraph (h)(2) of this section, appropriate
adjustments must be made to reflect accurately the fair market value
of the T and T1 assets in determining the allocation of ADSP among
T's Class V assets (including the T1 stock). In preliminarily
calculating ADSP in this case, the T1 stock can be V disregarded
and, because T owns all of the T1 stock, the T1 asset can be treated
as a T asset. Under this assumption, ADSP is $243,666.67. See V
paragraph (iv) of Example 2.

(iv) Because the portion of the preliminary ADSP allocable to Class
V assets ($243,666.67) does not exceed their fair market value
($250,000), no amount is allocated to Class VII assets for T.
Further, this amount ($243,666.67) is allocated among T's Class V
assets in proportion to their fair market values. See paragraph (v)
of Example 2. Tentatively, $48,733.34 of this amount is allocated to
the T1 stock.

(v) The amount tentatively allocated to the T1 stock, however,
reflects the tax incurred on the deemed sale of the T1 asset equal
to $13,169.34 (.34 � ($48,733.34 ! $10,000)). Thus, the ADSP
allocable to the Class V assets of T, and the ADSP allocable to the
T1 stock, as preliminarily calculated, each must be reduced by
$13,169.34. Consequently, these amounts, respectively, are
$230,497.33 and $35,564.00. In determining ADSP for T1, the grossed-
up amount realized on the deemed sale to new T of new T's recently
purchased T1 stock is $35,564.00.

(vi) The facts are the same as in paragraph (i) of this Example 4,
except that the T1 building has a $12,500 basis and a $62,500 value,
all of the outstanding T1 stock has a $62,500 value, and T owns 80
percent of the T1 stock. In preliminarily calculating ADSP , the T1
stock can be disregarded but, V because T owns only 80 percent of
the T1 stock, only 80 percent of T1 asset basis and value should be
taken into account in calculating T's ADSP. By taking into account
80 percent of these amounts, the remaining calculations and results
are the same as in paragraphs (ii), (iii), (iv), and (v) of this
Example 4, except that the grossed-up amount realized on the sale of
the recently purchased T1 stock is $44,455.00 ($35,564.00/0.8).

(h) Deemed sale of target affiliate stock--(1) Scope. This paragraph
(h) prescribes rules relating to the treatment of gain or loss
realized on the deemed sale of stock of a target affiliate when a
section 338 election (but not a section 338(h)(10) election) is made
for the target affiliate. For purposes of this paragraph (h), the
definition of domestic corporation in �1.338-2T(c)(9) is applied
without the exclusion therein for DISCs, corporations described in
section 1248(e), and corporations to which an election under section
936 applies.

(2) In general. Except as otherwise provided in this paragraph (h),
if a section 338 election is made for target, target recognizes no
gain or loss on the deemed sale of stock of a target affiliate
having the same acquisition date and for which a section 338
election is made if--

(i) Target directly owns stock in the target affiliate satisfying
the requirements of section 1504(a)(2);

(ii) Target and the target affiliate are members of a consolidated
group filing a final consolidated return described in �1.338-10T(a)
(1); or

(iii) Target and the target affiliate file a combined return under
�1.338- 10T(a)(4).

(3) Deemed sale of foreign target affiliate by a domestic target. A
domestic target recognizes gain or loss on the deemed sale of stock
of a foreign target affiliate. For the proper treatment of such gain
or loss, see, e.g., sections 1246, 1248, 1291 et seq., and 338(h)
(16) and �1.338-9.

(4) Deemed sale producing effectively connected income. A foreign
target recognizes gain or loss on the deemed sale of stock of a
foreign target affiliate to the extent that such gain or loss is
effectively connected (or treated as effectively connected) with the
conduct of a trade or business in the United States.

(5) Deemed sale of insurance company target affiliate electing under
section 953(d). A domestic target recognizes gain (but not loss) on
the deemed sale of stock of a target affiliate that has in effect an
election under section 953(d) in an amount equal to the lesser of
the gain realized or the earnings and profits described in section
953(d)(4)(B).

(6) Deemed sale of DISC target affiliate. A foreign or domestic
target recognizes gain (but not loss) on the deemed sale of stock of
a target affiliate that is a DISC or a former DISC (as defined in
section 992(a)) in an amount equal to the lesser of the gain
realized or the amount of accumulated DISC income determined with
respect to such stock under section 995(c). Such gain is included in
gross income as a dividend as provided in sections 995(c)(2) and
996(g).

(7) Anti-stuffing rule. If an asset the adjusted basis of which
exceeds its fair market value is contributed or transferred to a
target affiliate as transferred basis property (within the meaning
of section 7701(a)(43)) and a purpose of such transaction is to
reduce the gain (or increase the loss) recognized on the deemed sale
of such target affiliate's stock, the gain or loss recognized by
target on the deemed sale of stock of the target affiliate is
determined as if such asset had not been contributed or transferred.

(8) Examples. The following examples illustrate this paragraph (h):
Example 1. (i) P makes a qualified stock purchase of T and makes a
section 338 election for T. T's sole asset, all of the T1 stock, has
a basis of $50 and a fair market value of $150. T's deemed purchase
of the T1 stock results in a qualified stock purchase of T1 and a
section 338 election is made for T1. T1's assets have a basis of $50
and a fair market value of $150.

(ii) T realizes $100 of gain on the deemed sale of the T1 stock, but
the gain is not recognized because T directly owns stock in T1
satisfying the requirements of section 1504(a)(2) and a section 338
election is made for T1.

(iii) T1 recognizes gain of $100 on the deemed sale of its assets.

Example 2. The facts are the same as in Example 1, except that P
does not make a section 338 election for T1. Because a section 338
election is not made for T1, the $100 gain realized by T on the
deemed sale of the T1 stock is recognized.

Example 3. (i) P makes a qualified stock purchase of T and makes a
section 338 election for T. T owns all of the stock of T1 and T2.
T's deemed purchase of the T1 and T2 stock results in a qualified
stock purchase of T1 and T2 and section 338 elections are made for
T1 and T2. T1 and T2 each own 50 percent of the vote and value of T3
stock. The deemed purchases by T1 and T2 of the T3 stock result in a
qualified stock purchase of T3 and a section 338 election is made
for T3. T is the common parent of a consolidated group and all of
the deemed asset sales are reported on the T group's final
consolidated return. See �1.338-10T(a)(1).

(ii) Because T, T1, T2 and T3 are members of a consolidated group
filing a final consolidated return, no gain or loss is recognized by
T, T1 or T2 on their respective deemed sales of target affiliate
stock.

Example 4. (i) T's sole asset, all of the FT1 stock, has a basis of
$25 and a fair market value of $150. FT1's sole asset, all of the
FT2 stock, has a basis of $75 and a fair market value of $150. FT1
and FT2 each have $50 of accumulated earnings and profits for
purposes of section 1248(c) and (d). FT2's assets have a basis of
$125 and a fair market value of $150, and their sale would not
generate subpart F income under section 951. The sale of the FT2
stock or assets would not generate income effectively connected with
the conduct of a trade or business within the United States. FT1
does not have an election in effect under section 953(d) and neither
FT1 nor FT2 is a passive foreign investment company.

(ii) P makes a qualified stock purchase of T and makes a section 338
election for T. T's deemed purchase of the FT1 stock results in a
qualified stock purchase of FT1 and a section 338 election is made
for FT1. Similarly, FT1's deemed purchase of the FT2 stock results
in a qualified stock purchase of FT2 and a section 338 election is
made for FT2.

(iii) T recognizes $125 of gain on the deemed sale of the FT1 stock
under paragraph (h)(3) of this section. FT1 does not recognize $75
of gain on the deemed sale of the FT2 stock under paragraph (h)(2)
of this section. FT2 recognizes $25 of gain on the deemed sale of
its assets. The $125 gain T recognizes on the deemed sale of the FT1
stock is included in T's income as a dividend under section 1248,
because FT1 and FT2 have sufficient earnings and profits for full
recharacterization ($50 of accumulated earnings and profits in FT1,
$50 of accumulated earnings and profits in FT2, and $25 of deemed
sale earnings and profits in FT2). �1.338-9(b). For purposes of
sections 901 through 908, the source and foreign tax credit
limitation basket of $25 of the recharacterized gain on the deemed
sale of the FT1 stock is determined under section 338(h)(16).

�1.338-5T Adjusted grossed-up basis (temporary).

(a) Scope. This section provides rules under section 338(b) to
determine the adjusted grossed-up basis (AGUB) for target. AGUB is
the amount for which new target is deemed to have purchased all of
its assets in the deemed purchase under section 338(a)(2). AGUB is
allocated among target's assets in accordance with �1.338-6T to
determine the price at which the assets are deemed to have been
purchased. When an increase or decrease with respect to an element
of AGUB is required, under general principles of tax law, after the
close of new target's first taxable year, redetermined AGUB is
allocated among target's assets in accordance with �1.338-7T.

(b) Determination of AGUB--(1) General rule. AGUB is the sum of--

(i) The grossed-up basis in the purchasing corporation's recently
purchased target stock;

(ii) The purchasing corporation's basis in nonrecently purchased
target stock; and

(iii) The liabilities of new target.

(2) Time and amount of AGUB--(i) Original determination. AGUB is
initially determined at the beginning of the day after the
acquisition date of target. General principles of tax law apply in
determining the timing and amount of the elements of AGUB.

(ii) Redetermination of AGUB. AGUB is redetermined at such time and
in such amount as an increase or decrease would be required, under
general principles of tax law, with respect to an element of AGUB.
For example, AGUB is redetermined because of an increase or decrease
in the amount paid or incurred for recently purchased stock or
nonrecently purchased stock or because liabilities not originally
taken into account in determining AGUB are subsequently taken into
account. An increase or decrease to an element of ADSP may cause an
increase or decrease to an element of AGUB. For example, if an
increase in the amount realized for recently purchased stock of
target is taken into account after the acquisition date, any
increase in tax liability of target for the deemed sale gain is also
taken into account when AGUB is redetermined. An increase or
decrease to one element of AGUB may also cause an increase or
decrease to another element of AGUB. For example, if there is an
increase in the amount paid or incurred for recently purchased stock
after the acquisition date, any increase in the basis of nonrecently
purchased stock because a gain recognition election was made is also
taken into account when AGUB is redetermined. Increases or decreases
with respect to the elements of AGUB that are taken into account
before the close of new target's first taxable year are taken into
account for purposes of determining AGUB and the basis of target's
assets as if they had been taken into account at the beginning of
the day after the acquisition date. Increases or decreases with
respect to the elements of AGUB that are taken into account after
the close of new target's first taxable year result in the
reallocation of AGUB among target's assets under �1.338-7T.

(iii) Examples. The following examples illustrate this paragraph (b)
(2): Example 1. In Year 1, T, a manufacturer, purchases a customized
delivery truck from X with purchase money indebtedness having a
stated principal amount of $100,000 . P acquires all of the stock of
T in Year 3 for $700,000 and makes a section 338 election for T.
Assume T has no liabilities other than its purchase money
indebtedness to X. In Year 4, when T is neither insolvent nor in a
title 11 case, T and X agree to reduce the amount of the purchase
money indebtedness to $80,000. Assume that the reduction would be a
purchase price reduction under section 108(e)(5). T and X's
agreement to reduce the amount of the purchase money indebtedness
would, under general principles of tax law that would apply if the
deemed asset sale had actually occurred, change the amount of
liabilities of old target taken into account in determining its
basis. Accordingly, AGUB is redetermined at the time of the
reduction. See paragraph (e)(2) of this section. Thus the purchase
price reduction affects the basis of the truck only indirectly,
through the mechanism of ��1.338-6T and 1.338-7T. See �1.338-4T(b)
(2)(iii) Example for the effect on ADSP.

Example 2. T, an accrual basis taxpayer, is a chemical manufacturer.
In Year 1, T is obligated to remediate environmental contamination
at the site of one of its plants. Assume that all the events have
occurred that establish the fact of the liability and the amount of
the liability can be determined with reasonable accuracy but
economic performance has not occurred with respect to the liability
within the meaning of section 461(h). P acquires all of the stock of
T in Year 1 and makes a section 338 election for T. Assume that, if
a corporation unrelated to T had actually purchased T's assets and
assumed T's obligation to remediate the contamination, the
corporation would not satisfy the economic performance requirements
until Year 5. Under section 461(h), the assumed liability would not
be treated as incurred and taken into account in basis until that
time. The incurrence of the liability in Year 5 under the economic
performance rules is an increase in the amount of liabilities
properly taken into account in basis and results in the
redetermination of AGUB. (Respecting ADSP, compare �1.461-4(d)(5),
which provides that economic performance occurs for old T as the
amount of the liability is properly taken into account in amount
realized on the deemed asset sale. Thus ADSP is not redetermined
when new T satisfies the economic performance requirements.)

(c) Grossed-up basis of recently purchased stock. The purchasing
corporation's grossed-up basis of recently purchased target stock
(as defined in section 338(b)(6)(A)) is an amount equal to--

(1) The purchasing corporation's basis in recently purchased target
stock at the beginning of the day after the acquisition date
determined without regard to the acquisition costs taken into
account in paragraph (c)(3) of this section;

(2) Multiplied by a fraction, the numerator of which is 100 percent
minus the percentage of target stock (by value, determined on the
acquisition date) attributable to the purchasing corporation's
nonrecently purchased target stock, and the denominator of which is
the percentage of target stock (by value, determined on the
acquisition date) attributable to the purchasing corporation's
recently purchased target stock;

(3) Plus the acquisition costs the purchasing corporation incurred
in connection with its purchase of the recently purchased stock that
are capitalized in the basis of such stock (e.g., brokerage
commissions and any similar costs incurred by the purchasing
corporation to acquire the stock).

(d) Basis of nonrecently purchased stock; gain recognition
election--(1) No gain recognition election. In the absence of a gain
recognition election under section 338(b)(3) and this section, the
purchasing corporation retains its basis in the nonrecently
purchased stock.

(2) Procedure for making gain recognition election. A gain
recognition election may be made for nonrecently purchased stock of
target (or a target affiliate) only if a section 338 election is
made for target (or the target affiliate).

The gain recognition election is made by attaching a gain
recognition statement to a timely filed Form 8023 for target. The
gain recognition statement must contain the information specified in
the form and its instructions. The gain recognition election is
irrevocable. If a section 338(h)(10) election is made for target,
see �1.338(h)(10)-1T(d)(1) (providing that the purchasing
corporation is automatically deemed to have made a gain recognition
election for its nonrecently purchased T stock).

(3) Effect of gain recognition election--(i) In general. If the
purchasing corporation makes a gain recognition election, then for
all purposes of the Internal Revenue Code--

(A) The purchasing corporation is treated as if it sold on the
acquisition date the nonrecently purchased target stock for the
basis amount determined under paragraph (d)(3)(ii) of this section;
and

(B) The purchasing corporation's basis on the acquisition date in
nonrecently purchased target stock immediately following the deemed
sale in paragraph (d)(3)(i)(A) of this section is the basis amount.

(ii) Basis amount. The basis amount is equal to the amount in
paragraph

(c)(1) of this section (the purchasing corporation's basis in
recently purchased target stock at the beginning of the day after
the acquisition date determined without regard to the acquisition
costs taken into account in paragraph (c)(3) of this section)
multiplied by a fraction the numerator of which is the percentage of
target stock (by value, determined on the acquisition date)
attributable to the purchasing corporation's nonrecently purchased
target stock and the denominator of which is 100 percent minus the
numerator amount. Thus, if target has a single class of outstanding
stock, the purchasing corporation's basis in each share of
nonrecently purchased target stock after the gain recognition
election is equal to the average price per share of the purchasing
corporation's recently purchased target stock.

(iii) Losses not recognized. Only gains (unreduced by losses) on the
nonrecently purchased target stock are recognized.

(iv) Stock subject to election. The gain recognition election
applies to--

(A) All nonrecently purchased target stock; and

(B) Any nonrecently purchased stock in a target affiliate having the
same acquisition date as target if such target affiliate stock is
held by the purchasing corporation on such date.

(e) Liabilities of new target--(1) In general. The liabilities of
new target are the liabilities of target (and the liabilities to
which target's assets are subject) as of the beginning of the day
after the acquisition date (other than liabilities that were neither
liabilities of old target nor liabilities to which old target's
assets were subject). In order to be taken into account in AGUB, a
liability must be a liability of target that is properly taken into
account in basis under general principles of tax law that would
apply if new target had acquired its assets from an unrelated person
for consideration that included the assumption of, or taking subject
to, the liability. See �1.338-4T(d)(1) for examples of when tax
liabilities are considered liabilities assumed by new target.

(2) Time and amount of liabilities. The time for taking into account
liabilities of old target in determining AGUB and the amount of the
liabilities taken into account is determined as if new target had
acquired its assets from an unrelated person for consideration that
included the assumption of, or taking subject to, the liabilities.
For example, an increase or decrease in a liability that does not
affect the amount of new target's basis arising from the assumption
of, or taking subject to, the liability is not taken into account in
redetermining AGUB.

(3) Interaction with deemed sale gain. See �1.338-4T(d)(3).

(f) Adjustments by the Internal Revenue Service. In connection with
the examination of a return, the District Director may increase (or
decrease) AGUB under the authority of section 338(b)(2) and allocate
such amounts to target's assets under the authority of section
338(b)(5) so that AGUB and the basis of target's assets properly
reflect the cost to the purchasing corporation of its interest in
target's assets. Such items may include distributions from target to
the purchasing corporation, capital contributions from the
purchasing corporation to target during the 12-month acquisition
period, or acquisitions of target stock by the purchasing
corporation after the acquisition date from minority shareholders.

(g) Examples. The following examples illustrate this section. For
purposes of the examples in this paragraph (g), T has no liabilities
other than the tax liability for the deemed sale gain, T
shareholders incur no costs in selling the T stock, and P incurs no
costs in acquiring the T stock. The examples are as follows:

Example 1. (i) Before July 1 of Year 1, P purchases 10 of the 100
shares of T stock for $5,000. On July 1 of Year 2, P purchases 80
shares of T stock for $60,000 and makes a section 338 election for
T. As of July 1 of Year 2, T's only asset is raw land with an
adjusted basis to T of $50,400 and a fair market value of $100,000.
T has no loss or tax credit carryovers to Year 2. T's marginal tax
rate for any ordinary income or net capital gain resulting from the
deemed asset sale is 34 percent. The 10 shares purchased before July
1 of Year 1 constitute nonrecently purchased T stock with respect to
P's qualified stock purchase of T stock on July 1 of Year 2.

(ii) The ADSP formula as applied to these facts is the same as in
�1.338- 4T(g) Example 1. Accordingly, the ADSP for T is $87,672.72.
The existence of nonrecently purchased T stock is irrelevant for
purposes of the ADSP formula, because that formula treats P's
nonrecently purchased T stock in the same manner as T stock not held
by P.

(iii) The total tax liability resulting from T's deemed asset sale,
as calculated under the ADSP formula, is $12,672.72.

(iv) If P does not make a gain recognition election, the AGUB of new
T's assets is $85,172.72, determined as follows (In the following
formula below, GRP is the grossed-up basis in P's recently purchased
T stock, BNP is P's basis in nonrecently purchased T stock, L is T's
liabilities, and X is P's acquisition costs for the recently
purchased T stock): AGUB = GRP + BNP + L + X AGUB = $60,000 � [(1 !
.1)/.8] + $5,000 + $12,672.72 + 0 AGUB = $85,172.72 (v) If P makes a
gain recognition election, the AGUB of new T's assets is $87,672.72,
determined as follows: AGUB = $60,000 � [(1 ! .1)/.8] + $60,000 �
[(1 ! .1)/.8] � [.1/(1 ! .1)] + $12,672.72 AGUB = $87,672.72 (vi)
The calculation of AGUB if P makes a gain recognition election may
be simplified as follows: AGUB = $60,000/.8 + $12,672.72 AGUB =
$87,672.72 (vii) As a result of the gain recognition election, P's
basis in its nonrecently purchased T stock is increased from $5,000
to $7,500 (i.e., $60,000 � [(1 ! .1)/.8] � [.1/(1 ! .1)]). Thus, P
recognizes a gain in Year 2 with respect to its nonrecently
purchased T stock of $2,500 (i.e., $7,500 ! $5,000).

Example 2. On January 1 of Year 1, P purchases one-third of the T
stock.

On March 1 of Year 1, T distributes a dividend to all of its
shareholders. On April 15 of Year 1, P purchases the remaining T
stock and makes a section 338 election for T. In appropriate
circumstances, the District Director may decrease the AGUB of T to
take into account the payment of the dividend and properly reflect
the fair market value of T's assets deemed purchased.

Example 3. (i) T's sole asset is a building worth $100,000. At this
time, T has 100 shares of stock outstanding. On August 1 of Year 1,
P purchases 10 of the 100 shares of T stock for $8,000. On June 1 of
Year 2, P purchases 50 shares of T stock for $50,000. On June 15 of
Year 2, P contributes a tract of land to the capital of T and
receives 10 additional shares of T stock as a result of the
contribution. Both the basis and fair market value of the land at
that time are $10,800. On June 30 of Year 2, P purchases the
remaining 40 shares of T stock for $40,000 and makes a section 338
election for T. The AGUB of T is $108,800.

(ii) To prevent the shifting of basis from the contributed property
to other assets of T, the District Director may allocate $10,800 of
the AGUB to the land, leaving $98,000 to be allocated to the
building. See paragraph (f) of this section. Otherwise, applying the
allocation rules of �1.338-6T would, on these facts, result in an
allocation to the recently contributed land of an amount less than
its value of $10,800, with the difference being allocated to the
building already held by T. Par. 7. Sections 1.338-6T and 1.338-7T
are added to read as follows: �1.338-6T Allocation of ADSP and AGUB
among target assets (temporary).

(a) Scope--(1) In general. This section prescribes rules for
allocating ADSP and AGUB among the acquisition date assets of a
target for which a section 338 election is made.

(2) Fair market value--(i) In general. Generally, the fair market
value of an asset is its gross fair market value (i.e., fair market
value determined without regard to mortgages, liens, pledges, or
other liabilities). However, for purposes of determining the amount
of old target's deemed sale gain, the fair market value of any
property subject to a nonrecourse indebtedness will be treated as
being not less than the amount of such indebtedness. (For purposes
of the preceding sentence, a liability that was incurred because of
the acquisition of the property is disregarded to the extent that
such liability was not taken into account in determining old
target's basis in such property.)

(ii) Transaction costs. Transaction costs are not taken into account
in allocating ADSP or AGUB to assets in the deemed sale (except
indirectly through their effect on the total ADSP or AGUB to be
allocated).

(iii) Internal Revenue Service authority. In connection with the
examination of a return, the Internal Revenue Service may challenge
the taxpayer's determination of the fair market value of any asset
by any appropriate method and take into account all factors,
including any lack of adverse tax interests between the parties. For
example, in certain cases the Internal  Revenue Service may
make an independent showing of the value of goodwill and going
concern value as a means of calling into question the validity of
the taxpayer's valuation of other assets.

(b) General rule for allocating ADSP and AGUB--(1) Reduction in the
amount of consideration for Class I assets. Both ADSP and AGUB, in
the respective allocation of each, are first reduced by the amount
of Class I acquisition date assets. Class I assets are cash and
general deposit accounts (including savings and checking accounts)
other than certificates of deposit held in banks, savings and loan
associations, and other depository institutions. If the amount of
Class I assets exceeds AGUB, new target will immediately realize
ordinary income in an amount equal to such excess. The amount of
ADSP or AGUB remaining after the reduction is to be allocated to the
remaining acquisition date assets.

(2) Other assets--(i) In general. Subject to the limitations and
other rules of paragraph (c) of this section, ADSP and AGUB (as
reduced by the amount of Class I assets) are allocated among Class
II acquisition date assets of target in proportion to the fair
market values of such Class II assets at such time, then among Class
III assets so held in such proportion, then among Class IV assets so
held in such proportion, then among Class V assets so held in such
proportion, then among Class VI assets so held in such proportion,
and finally to Class VII assets.

(ii) Class II assets. Class II assets are actively traded personal
property  within the meaning of section 1092(d)(1) and
�1.1092(d)-1 (determined without regard to section 1092(d)(3)). In
addition, Class II assets include certificates of deposit and
foreign currency even if they are not actively traded personal
property. Examples of Class II assets include U.S. government
securities and publicly traded stock.

(iii) Class III assets. Class III assets are accounts receivable,
mortgages, and credit card receivables from customers which arise in
the ordinary course of business.

(iv) Class IV assets. Class IV assets are stock in trade of the
taxpayer or other property of a kind which would properly be
included in the inventory of taxpayer if on hand at the close of the
taxable year, or property held by the taxpayer primarily for sale to
customers in the ordinary course of its trade or business.

(v) Class V assets. Class V assets are all assets other than Class
I, II, III, IV, VI, and VII assets.

(vi) Class VI assets. Class VI assets are all section 197
intangibles, as defined in section 197, except goodwill and going
concern value.

(vii) Class VII assets. Class VII assets are goodwill and going
concern value (whether or not the goodwill or going concern value
qualifies as a section 197 intangible).

(3) Other items designated by the Internal Revenue Service. Similar
items may be added to any class described in this paragraph (b) by
designation  in the Internal Revenue Bulletin by the Internal
Revenue Service (see �601.601(d)(2) of this Chapter).

(c) Certain limitations and other rules for allocation to an
asset--(1) Allocation not to exceed fair market value. The amount of
ADSP or AGUB allocated to an asset (other than Class VII assets)
cannot exceed the fair market value of that asset at the beginning
of the day after the acquisition date.

(2) Allocation subject to other rules. The amount of ADSP or AGUB
allocated to an asset is subject to other provisions of the Internal
Revenue Code or general principles of tax law in the same manner as
if such asset were transferred to or acquired from an unrelated
person in a sale or exchange. For example, if the deemed asset sale
is a transaction described in section 1056(a) (relating to basis
limitation for player contracts transferred in connection with the
sale of a franchise), the amount of AGUB allocated to a contract for
the services of an athlete cannot exceed the limitation imposed by
that section. As another example, the amount of AGUB allocated to an
amortizable section 197 intangible resulting from an assumption-
reinsurance transaction is determined under section 197(f)(5).

(3) Special rule for allocating AGUB when purchasing corporation has
nonrecently purchased stock--(i) Scope. This paragraph (c)(3)
applies if at the beginning of the day after the acquisition date--

(A) The purchasing corporation holds nonrecently purchased stock for
which a gain recognition election under section 338(b)(3) and
�1.338-5T(d) is  not made; and

(B) The hypothetical purchase price determined under paragraph (c)
(3)(ii) of this section exceeds the AGUB determined under
�1.338-5T(b).

(ii) Determination of hypothetical purchase price. Hypothetical
purchase price is the AGUB that would result if a gain recognition
election were made.

(iii) Allocation of AGUB. Subject to the limitations in paragraphs
(c)(1) and (2) of this section, the portion of AGUB (after reduction
by the amount of Class I assets) to be allocated to each Class II,
III, IV, V, VI, and VII asset of target held at the beginning of the
day after the acquisition date is determined by multiplying--

(A) The amount that would be allocated to such asset under the
general rules of this section were AGUB equal to the hypothetical
purchase price; by

(B) A fraction, the numerator of which is actual AGUB (after
reduction by the amount of Class I assets) and the denominator of
which is the hypothetical purchase price (after reduction by the
amount of Class I assets).

(4) Liabilities taken into account in determining amount realized on
subsequent disposition. In determining the amount realized on a
subsequent sale or other disposition of property deemed purchased by
new target, the entire amount of any liability taken into account in
AGUB is considered to be an amount taken into account in determining
new target's basis in property that secures the liability for
purposes of applying �1.1001-2(a). Thus, if a liability is taken
into account in AGUB, �1.1001-2(a)(3) does not prevent the amount
of  such liability from being treated as discharged within the
meaning of �1.1001- 2(a)(4) as a result of new target's sale or
disposition of the property which secures such liability.

(d) Examples. The following examples illustrate ��1.338-4T,
1.338-5T, and this section: Example 1. (i) T owns 90 percent of the
outstanding T1 stock. P purchases 100 percent of the outstanding T
stock for $2,000. There are no acquisition costs. P makes a section
338 election for T and, as a result, T1 is considered acquired in a
qualified stock purchase. A section 338 election is made for T1. The
grossed-up basis of the T stock is $2,000 (i.e., $2,000 � 1/1).

(ii) The liabilities of T as of the beginning of the day after the
acquisition date (including the tax liability for the deemed sale
gain) that would, under general principles of tax law, be properly
taken into account before the close of new T's first taxable year,
are as follows:

Liabilities (nonrecourse mortgage 
plus unsecured liabilities) .................... $ 700
Taxes Payable .................................... 300
                                                  ____
Total......................................... $ 1,000
(iii) The AGUB of T is determined as follows:
Grossed-up basis............................... $2,000
Total liabilities............................... 1,000
                                                  ____
AGUB.......................................... $ 3,000

(iv) Assume that ADSP is also $3,000.

(v) Assume that, at the beginning of the day after the acquisition
date, T's cash and the fair market values of T's Class II, III, IV,
and V assets are as follows:

Asset  Asset                                    Fair
Class                                           market
                                                value
I      Cash.................................... $ 200*
II     Portfolio of actively traded securities .. 300
III    Accounts receivable ...................... 600
IV     Inventory................................. 300
V      Building.................................. 800
V      Land ..................................... 200
V      Investment in T1.......................... 450
                                                 _____
Total........................................ $ 2,850
*Amount

(vi) Under paragraph (b)(1) of this section, the amount of ADSP and
AGUB allocable to T's Class II, III, IV, and V assets is reduced by
the amount of cash to $2,800, i.e., $3,000 ! $200. $300 of ADSP and
of AGUB is then allocated to actively traded securities. $600 of
ADSP and of AGUB is then allocated to accounts receivable. $300 of
ADSP and of AGUB is then allocated to the inventory. Since the
remaining amount of ADSP and of AGUB is $1,600 (i.e., $3,000 ! ($200
+ $300 + $600 + $300)), an amount which exceeds the sum of the fair
market values of T's Class V assets, the amount of ADSP and of AGUB
allocated to each Class V asset is its fair market value:

Building......................................... 800
Land ............................................ 200
Investment in T1................................. 450
                                                 ____
Total........................................ $ 1,450

(vii) T has no Class VI assets. The amount of ADSP and of AGUB
allocated to T's Class VII assets (goodwill and going concern value)
is $150, i.e., $1,600 ! $1,450.

(viii) The grossed-up basis of the T1 stock is $500, i.e., $450 �
1/.9.  (ix) The liabilities of T as of the beginning of the
day after the acquisition date (including the tax liability for the
deemed sale gain) that would, under general principles of tax law,
be properly taken into account before the close of new T's first
taxable year, are as follows:

General Liabilities ........................... $ 100
Taxes Payable .................................... 20
                                                 ____
Total.......................................... $ 120
(x) The AGUB of T1 is determined as follows:
Grossed-up basis of T1 Stock .................. $ 500
Liabilities ..................................... 120
                                                 ____
AGUB........................................... $ 620
(xi) Assume that ADSP is also $620.

(xii) Assume that at the beginning of the day after the acquisition
date, T1's cash and the fair market values of its Class IV and VI
assets are as follows:

Asset  Asset                                     Fair
Class                                            Market
                                                 Value
I      Cash.................................... $ 50*
IV     Inventory................................. 200
VI     Patent ................................... 350
                                                 ____
Total ......................................... $ 600
* Amount.

(xiii) The amount of ADSP and of AGUB allocable to T1's Class IV and
VI assets is first reduced by the $50 of cash.

(xiv) Because the remaining amount of ADSP and of AGUB ($570) is an
amount which exceeds the fair market value of T1's only Class IV
asset, the  inventory, the amount allocated to the inventory
is its fair market value ($200).

After that, the remaining amount of ADSP and of AGUB ($370) exceeds
the fair market value of T1's only Class VI asset, the patent. Thus,
the amount of ADSP and of AGUB allocated to the patent is its fair
market value ($350).

(xv) The amount of ADSP and of AGUB allocated to T1's Class VII
assets (goodwill and going concern value) is $20, i.e., $570 ! $550.

Example 2. (i) Assume that the facts are the same as in Example 1
except that P has, for five years, owned 20 percent of T's stock,
which has a basis in P's hands at the beginning of the day after the
acquisition date of $100, and P purchases the remaining 80 percent
of T's stock for $1,600. P does not make a gain recognition election
under section 338(b)(3).

(ii) Under �1.338-5T(c), the grossed-up basis of recently purchased
T stock is $1,600, i.e., $1,600 � (1 ! .2)/.8.

(iii) The AGUB of T is determined as follows: Grossed-up basis of
recently purchased stock as determined under �1.338-5T(c) ($1,600 �
(1 ! .2)/.8)....................................... $ 1,600
Basis of nonrecently purchased stock .................. 100
Liabilities ......................................... 1,000
                                                      _____
AGUB............................................... $ 2,700

(iv) Since P holds nonrecently purchased stock, the hypothetical
purchase price of the T stock must be computed and is determined as
follows: Grossed-up basis of recently purchased stock as determined
under �1.338-5T(c) ($1,600 � (1 ! .2)/.8).......... $ 1,600

Basis of nonrecently purchased stock as if the gain recognition
election under �1.338-5T(d)(2) had been made ($1,600 � .2/(1 ! .2))
............................... ....................... 400
Liabilities ......................................... 1,000
                                                      _____
Total ............................................. $ 3,000

(v) Since the hypothetical purchase price ($3,000) exceeds the AGUB
($2,700) and no gain recognition election is made under section
338(b)(3), AGUB is allocated under paragraph (c)(3) of this section.

(vi) First, an AGUB amount equal to the hypothetical purchase price
($3,000) is allocated among the assets under the general rules of
this section.

The allocation is set forth in the column below entitled Original
Allocation. Next, the allocation to each asset in Class II through
Class VII is multiplied by a fraction having a numerator equal to
the actual AGUB reduced by the amount of Class I assets ($2,700 !
$200 = $2,500) and a denominator equal to the hypothetical purchase
price reduced by the amount of Class I assets ($3,000 ! $200 =
$2,800), or 2,500/2,800. This produces the Final Allocation:

Class   Asset                    Original Final
                               Allocation Allocation
I       Cash.......................  $200 $200
II      Portfolio of 
        actively traded...............300 268*
        securities ...................
III Accounts receivable ............. 600 536
IV Inventory......................... 300 268
V Building........................... 800 714
V Land .............................. 200 178
V Investment in T1................... 450 402
VII Goodwill and going concern value. 150 134
                                    _____ _____
Total............................  $3,000 $2,700

* All numbers rounded for convenience.

�1.338-7T Allocation of redetermined ADSP and AGUB among target assets
(temporary).

(a) Scope. ADSP and AGUB are redetermined at such time and in such
amount as an increase or decrease would be required under general
principles of tax law for the elements of ADSP or AGUB. This section
provides rules for allocating redetermined ADSP or AGUB when
increases or decreases with respect to the elements of ADSP or AGUB
are required after the close of new target's first taxable year. For
determining and allocating ADSP or AGUB when increases or decreases
are required with respect to the elements of ADSP or AGUB before the
close of new target's first taxable year, see ��1.338-4T, 1.338- 5T,
and 1.338-6T.

(b) Allocation of redetermined ADSP and AGUB. When ADSP or AGUB is
redetermined, a new allocation of ADSP or AGUB is made by allocating
the redetermined ADSP or AGUB amount under the rules of �1.338-6T.
If the allocation of the redetermined ADSP or AGUB amount under
�1.338-6T to a given asset is different from the original allocation
to it, the difference is added to or subtracted from the original
allocation to the asset, as appropriate. Amounts allocable to an
acquisition date asset (or with respect to a disposed-of acquisition
date asset) are subject to all the asset allocation rules (for
example, the fair market value limitation in �1.338-6T(c)(1)) as if
the redetermined ADSP or AGUB were the ADSP or AGUB on the
acquisition date.

(c) Special rules for ADSP--(1) Increases or decreases in deemed
sale gain taxable notwithstanding old target ceases to exist. To the
extent general principles of tax law would require a seller in an
actual asset sale to account for events relating to the sale that
occur after the sale date, target must make such an accounting.
Target is not precluded from realizing additional deemed sale gain
because the target is treated as a new corporation after the
acquisition date.

(2) Procedure for transactions in which section 338(h)(10) is not
elected--

(i) Deemed sale gain included in new target's return. If an election
under section 338(h)(10) is not made, any additional deemed sale
gain of old target resulting from an increase or decrease in the
ADSP is included in new target's income tax return for new target's
taxable year in which the increase or decrease is taken into
account. For example, if after the acquisition date there is an
increase in the allocable ADSP of section 1245 property for which
the recomputed basis (but not the adjusted basis) exceeds the
portion of the ADSP allocable to that particular asset on the
acquisition date, the additional gain is treated as ordinary income
to the extent it does not exceed such excess amount. See paragraph
(c)(2)(ii) of this section for the special treatment of old target's
carryovers and carrybacks. Although included in new target's income
tax return, the deemed sale gain is separately accounted for as an
item of old target and may not be offset by income, gain, deduction,
loss, credit, or other amount of new target.

The amount of tax on income of old target resulting from an increase
or decrease in the ADSP is determined as if such deemed sale gain
had been recognized in old target's taxable year ending at the close
of the acquisition date.

(ii) Carryovers and carrybacks--(A) Loss carryovers to new target
taxable years. A net operating loss or net capital loss of old
target may be carried forward to a taxable year of new target, under
the principles of section 172 or 1212, as applicable, but is allowed
as a deduction only to the extent of any  recognized income of
old target for such taxable year, as described in paragraph (c)(2)
(i) of this section. For this purpose, however, taxable years of new
target are not taken into account in applying the limitations in
section 172(b)(1) or 1212(a)(1)(B) (or other similar limitations).
In applying sections 172(b) and 1212(a)(1), only income, gain, loss,
deduction, credit, and other amounts of old target are taken into
account. Thus, if old target has an unexpired net operating loss at
the close of its taxable year in which the deemed asset sale
occurred that could be carried forward to a subsequent taxable year,
such loss may be carried forward until it is absorbed by old
target's income.

(B) Loss carrybacks to taxable years of old target. An ordinary loss
or capital loss accounted for as a separate item of old target under
paragraph (c)(2)(i) of this section may be carried back to a taxable
year of old target under the principles of section 172 or 1212, as
applicable. For this purpose, taxable years of new target are not
taken into account in applying the limitations in section 172(b) or
1212(a) (or other similar limitations).

(C) Credit carryovers and carrybacks. The principles described in
paragraphs (c)(2)(ii)(A) and (B) of this section apply to carryovers
and carrybacks of amounts for purposes of determining the amount of
a credit allowable under part IV, subchapter A, chapter 1 of the
Internal Revenue Code.

Thus, for example, credit carryovers of old target may offset only
income tax attributable to items described in paragraph (c)(2)(i) of
this section.

(3) Procedure for transactions in which section 338(h)(10) is
elected. If  an election under section 338(h)(10) is made, any
additional deemed sale gain resulting from an increase or decrease
in the ADSP is accounted for in determining the taxable income (or
other amount) of the member of the selling consolidated group, the
selling affiliate, or the S corporation shareholders to which such
income, loss, or other amount is attributable for the taxable year
in which such increase or decrease is taken into account.

(d) Special rules for AGUB--(1) Effect of disposition or
depreciation of acquisition date assets. If an acquisition date
asset has been disposed of, depreciated, amortized, or depleted by
new target before an amount is added to the original allocation to
the asset, the increased amount otherwise allocable to such asset is
taken into account under general principles of tax law that apply
when part of the cost of an asset not previously taken into account
in basis is paid or incurred after the asset has been disposed of,
depreciated, amortized, or depleted. A similar rule applies when an
amount is subtracted from the original allocation to the asset. For
purposes of the preceding sentence, an asset is considered to have
been disposed of to the extent that its allocable portion of the
decrease in AGUB would reduce its basis below zero.

(2) Section 38 property. Section 1.47-2(c) applies to a reduction in
basis of section 38 property under this section.

(e) Examples. The following examples illustrate this section. Any
amount described in the following examples is exclusive of interest.
For rules characterizing deferred contingent payments as principal
or interest, see  ��1.483-4, 1.1274-2(g), and 1.1275-4(c). The
examples are as follows: Example 1. (i)(A) T's assets other than
goodwill and going concern value, and their fair market values at
the beginning of the day after the acquisition date, are as follows:

Asset   Asset                               Fair
Class                                       Market
                                            Value
V       Building........................... $ 100
V       Stock of X (not a target)............ 200
                                            _____
Total...................................... $ 300

(B) T has no liabilities other than a contingent liability that
would not be taken into account under general principles of tax law
in an asset sale between unrelated parties when the buyer assumed
the liability or took property subject to it.

(ii)(A) On September 1, 2000, P purchases all of the outstanding
stock of T for $270 and makes a section 338 election for T. The
grossed-up basis of the T stock and T's AGUB are both $270. The AGUB
is ratably allocated among T's Class V assets in proportion to their
fair market values as follows:

Asset     Basis
Building ($270 � 100/300) ......................... $ 90
Stock ($270 � 200/300) ............................. 180
                                                    ____
Total.............................................. $270

(B) No amount is allocated to the Class VII assets. New T is a
calendar year taxpayer. Assume that the X stock is a capital asset
in the hands of new T.

(iii) On January 1, 2001, new T sells the X stock and uses the
proceeds to purchase inventory.

(iv) Pursuant to events on June 30, 2002, the contingent liability
of old T is at that time properly taken into account under general
principles of tax law.

The amount of the liability is $60.

(v) T's AGUB increases by $60 from $270 to $330. This $60 increase
in AGUB is first allocated among T's acquisition date assets in
accordance with the provisions of �1.338-6T. Because the
redetermined AGUB for T ($330) exceeds the sum of the fair market
values at the beginning of the day after the acquisition date of the
Class V acquisition date assets ($300), AGUB allocated to those
assets is limited to those fair market values under �1.338-6T(c)(1).
As there are no Class VI assets, the remaining AGUB of $30 is
allocated to goodwill and going concern value (Class VII assets).
The amount of increase in AGUB allocated to each acquisition date
asset is determined as follows:

Asset              Original Redetermined Increase
                   AGUB     AGUB
Building.......... $ 90     $ 100        $ 10
X Stock ..........  180       200          20
Goodwill and going    0        30          30
concern value..... ____      ____         ____
Total.......      $ 270     $ 330        $ 60

(vi) Since the X stock was disposed of before the contingent
liability was properly taken into account for tax purposes, no
amount of the increase in AGUB attributable to such stock may be
allocated to any T asset. Rather, such amount ($20) is allowed as a
capital loss to T for the taxable year 2002 under the principles of
Arrowsmith v. Commissioner, 344 U.S. 6 (1952). In addition, the $10
increase in AGUB allocated to the building and the $30 increase in
AGUB allocated to the goodwill and going concern value are treated
as basis redeterminations in 2002. See paragraph (d)(1) of this
section.

Example 2. (i) On January 1, 2002, P purchases all of the
outstanding stock of T and makes a section 338 election for T.
Assume that ADSP and AGUB of T are both $500 and are allocated among
T's acquisition date assets as follows:

Asset Asset                                 Basis
Class
V     Machinery............................ $ 150
V     Land .................................  250
VII   Goodwill and going concern value .....  100
                                              ___
Total...................................... $ 500

(ii) On September 30, 2004, P filed a claim against the selling
shareholders of T in a court of appropriate jurisdiction alleging
fraud in the sale of the T stock.

(iii) On January 1, 2007, the former shareholders refund $140 of the
purchase price to P in a settlement of the lawsuit. Assume that,
under general principles of tax law, both the seller and the buyer
properly take into account such refund when paid. Assume also that
the refund has no effect on the tax liability for the deemed sale
gain. This refund results in a decrease of T's ADSP and AGUB of
$140, from $500 to $360.

(iv) The redetermined ADSP and AGUB of $360 is allocated among T's
acquisition date assets. Because ADSP and AGUB do not exceed the
fair market value of the Class V assets, the ADSP and AGUB amounts
are allocated to the Class V assets in proportion to their fair
market values at the beginning of the day after the acquisition
date. Thus, $135 ($150 � ($360/($150 + $250))) is allocated to the
machinery and $225 ($250 � ($360/($150 + $250))) is allocated to the
land. Accordingly, the basis of the machinery is reduced by $15
($150 original allocation ! $135 redetermined allocation) and the
basis of the land is reduced by $25 ($250 original allocation ! $225
redetermined allocation). No amount is allocated to the Class VII
assets. Accordingly, the basis of the goodwill and going concern
value is reduced by $100 ($100 original allocation ! $0 redetermined
allocation).

(v) Assume that, as a result of deductions under section 168, the
adjusted basis of the machinery immediately before the decrease in
AGUB is zero. The machinery is treated as if it were disposed of
before the decrease is taken into account. In 2007, T recognizes
income of $15, the character of which is determined under the
principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and the
tax benefit rule. No adjustment to the basis of T's assets is made
for any tax paid on this amount. Assume also that, as a result of
amortization deductions, the adjusted basis of the goodwill and
going concern  value immediately before the decrease in AGUB
is $40. A similar adjustment to income is made in 2007 with respect
to the $60 of previously amortized goodwill and going concern value.

(vi) In summary, the basis of T's acquisition date assets, as of
January 1, 2007, is as follows:

Asset                                             Basis
Machinery........................................ $ 0
Land ............................................ 225
Goodwill and going concern value .................. 0

Example 3. (i) Assume that the facts are the same as �1.338-6T(d)

Example 2 except that the recently purchased stock is acquired for
$1,600 plus additional payments that are contingent upon T's future
earnings. Assume that, under general principles of tax law, such
later payments are properly taken into account when paid. Thus, T's
AGUB, determined as of the beginning of the day after the
acquisition date (after reduction by T's cash of $200), is $2,500
and is allocated among T's acquisition date assets under
�1.338-6T(c)(3)(iii) as follows:

Class Asset                                    Final
                                               Allocation
I     Cash.................................... $ 200
II    Portfolio of actively traded securities .. 268*
III   Accounts receivable ...................... 536
IV    Inventory................................. 268
V     Building.................................. 714
V     Land ..................................... 178
V     Investment in T1.......................... 402
VII   Goodwill and going concern value ......... 134
                                                _____
Total....................................... $ 2,700

* All numbers rounded for convenience.

(ii) After the close of new target's first taxable year, P pays an
additional $200 for its recently purchased T stock. Assume that the
additional consideration paid would not increase T's tax liability
for the deemed sale gain.

(iii) T's AGUB increases by $200, from $2,700 to $2,900. This $200
increase in AGUB is accounted for in accordance with the provisions
of �1.338- 6T(c)(3)(iii).

(iv) The hypothetical purchase price of the T stock is redetermined
as follows: Grossed-up basis of recently purchased stock as
determined under �1.338-5T(c) ($1,800 � (1 ! .2)/.8)...............
$ 1,800 Basis of nonrecently purchased stock as if the gain
recognition election under �1.338-5T(d)(2) had been made ($1,800 �
.2/(1 ! .2)) ......................................... 450
Liabilities ........................................ 1,000
                                                     _____
Total............................................. $ 3,250

(v) Since the redetermined hypothetical purchase price ($3,250)
exceeds the redetermined AGUB ($2,900) and no gain recognition
election was made under section 338(b)(3), the rules of �1.338-6T(c)
(3)(iii) are reapplied using the redetermined hypothetical purchase
price and the redetermined AGUB.

(vi) First, an AGUB amount equal to the redetermined hypothetical
purchase price ($3,250) is allocated among the assets under the
general rules of �1.338-6T. The allocation is set forth in the
column below entitled Hypothetical Allocation. Next, the allocation
to each asset in Class II through Class VII is multiplied by a
fraction with a numerator equal to the actual redetermined AGUB
reduced by the amount of Class I assets ($2,900 ! $200 = $2,700) and
a denominator equal to the redetermined hypothetical purchase price
reduced by the amount of Class I assets ($3,250 ! $200 = $3,050), or
2,700/3,050. This produces the Final Allocation:

Class Asset             Hypothetical Final
                        Allocation   Allocation

I     Cash................. $ 200 $ 200
II    Portfolio of actively   300   266*
      traded securities 
III   Accounts receivable ... 600   531
IV    Inventory.............. 300   266
V     Building............... 800   708
V     Land .................. 200   177
V     Investment in T1....... 450   398
VII   Goodwill and going 
      concern value.......... 400   354
                             _____ _____
Total.................... $ 3,250 $ 2900
* All numbers rounded for convenience.

(vii) As illustrated by this example, reapplying �1.338-6T(c)(3)
results in a basis increase for some assets and a basis decrease for
other assets. The amount of redetermined AGUB allocated to each
acquisition date asset is determined as follows:

Asset                  Original   Redetermined Increase
                       (c)(3)     (c)(3)      (decrease)
                       allocation allocation

Portfolio of actively  $268       $266         $(2)
traded securities . . .
Accounts receivable     536        531          (5)
Inventory . . . . . . . 268        266          (2)
Building..........      714        708          (6)
Land ............       178        177          (1)
Investment in T1 . . .  402        398          (4)
Goodwill and going      134        354         220
concern value.....     _____      _____        ____
Total.......         $2,500     $2,700       $ 200

Example 4. (i) On January 1, 2001, P purchases all of the
outstanding T stock and makes a section 338 election for T. P pays
$700 of cash and promises also to pay a maximum $300 of contingent
consideration at various times in the future. Assume that, under
general principles of tax law, such later payments are properly
taken into account by P when paid. Assume also, however, that the
current fair market value of the contingent payments is reasonably
ascertainable. The fair market value of T's assets (other than
goodwill and going concern value) as of the beginning of the
following day is as follows:

Asset Assets                                      Fair
      Class                                       market
                                                  value
V     Equipment ...............................   $200
V     Non-actively traded securities ............  100
V     Building..................................   500
                                                   ___
Total...........................................   800

(ii) T has no liabilities. The AGUB is $700. In calculating ADSP,
assume that, under �1.1001-1, the current amount realized
attributable to the contingent consideration is $200. ADSP is
therefore $900 ($700 cash plus $200).

(iii) (A) The AGUB of $700 is ratably allocated among T's Class V
acquisition date assets in proportion to their fair market values as
follows:

Asset                                             Basis
Equipment ($700 � 200/800) ...................... $175.00
Non-actively traded securities ($700 � 100/800) ... 87.50
Building ($700 � 500/800) ........................ 437.50
                                                   ______
Total...........................................  $700.00

(B) No amount is allocated to goodwill or going concern value.

(iv) (A) The ADSP of $900 is ratably allocated among T's Class V
acquisition date assets in proportion to their fair market values as
follows:

Asset                                            Basis
Equipment ....................................   $200
Non-actively traded securities .................. 100
Building.......................................   500
                                                 _____
Total........................................... $800

(B) The remaining ADSP, $100, is allocated to goodwill and going
concern value (Class VII).

(v) P and T file a consolidated return for 2001 and each following
year with P as the common parent of the affiliated group.

(vi) In 2004, a contingent amount of $120 is paid by P. Assume that,
under general principles of tax law, the payment is properly taken
into account by P at the time made. In 2004, there is an increase in
T's AGUB of $120. The amount of the increase allocated to each
acquisition date asset is determined as follows:

Asset             Original  Redetermined Increase
                  AGUB      AGUB
Equipment ......  $175.00   $200.00      $25.00
Land ............   87.50    100.00       12.50
Building........   437.50    500.00       62.50
Goodwill and going   0.00     20.00       20.00
concern value..... ______    ______      ______
Total.......      $700.00   $820.00     $120.00

Par. 8. Section 1.338-10T is added to read as follows: �1.338-10T
Filing of returns (temporary).

(a) Returns including tax liability from deemed asset sale--(1) In
general.

Except as provided in paragraphs (a)(2) and (3) of this section, any
deemed sale gain is reported on the final return of old target filed
for old target's taxable year that ends at the close of the
acquisition date. If old target is the common parent of an
affiliated group, the final return may be a consolidated return (any
such consolidated return must also include any deemed sale gain of
any members of the consolidated group that are acquired by the
purchasing corporation on the same acquisition date as old target).

(2) Old target's final taxable year otherwise included in
consolidated return of selling group--(i) General rule. If the
selling group files a consolidated return for the period that
includes the acquisition date, old target is disaffiliated from that
group immediately before the deemed asset sale and must file a
deemed sale return separate from the group that includes only the
deemed sale gain and the carryover items specified in paragraph (a)
(2)(iii) of this section. The deemed asset sale occurs at the close
of the acquisition date and is the last transaction of old target.
Any transactions of old target occurring on the acquisition date
other than the deemed asset sale are included in the selling group's
consolidated return. A deemed sale return includes a combined deemed
sale return as defined in paragraph (a)(4) of this section.

(ii) Separate taxable year. The deemed asset sale included in the
deemed sale return under this paragraph (a)(2) occurs in a separate
taxable year, except that old target's taxable year of the sale and
the consolidated year of the selling group that includes the
acquisition date are treated as the same year for purposes of
determining the number of years in a carryover or carryback period.

(iii) Carryover and carryback of tax attributes. Target's attributes
may be carried over to, and carried back from, the deemed sale
return under the rules applicable to a corporation that ceases to be
a member of a consolidated group.

(iv) Old target is a component member of purchasing corporation's
controlled group. For purposes of its deemed sale return, target is
a component member of the controlled group of corporations including
the purchasing corporation unless target is treated as an excluded
member under section 1563(b)(2).

(3) Old target is an S corporation. If target is an S corporation
for the period that ends on the day before the acquisition date, old
target must file a deemed sale return as a C corporation. For this
purpose, the principles of paragraph (a)(2) of this section apply.
This paragraph (a)(3) does not apply if an election under section
338(h)(10) is made for the S corporation.

(4) Combined deemed sale return--(i) General rule. Under section
338(h)(15), a combined deemed sale return (combined return) may be
filed for all targets from a single selling consolidated group (as
defined in �1.338(h)(10)-1T( b)(3)) that are acquired by the
purchasing corporation on the same acquisition date and that
otherwise would be required to file separate deemed sale returns.
The combined return must include all such targets. For example, T
and T1 may be included in a combined return if--

(A) T and T1 are directly owned subsidiaries of S;

(B) S is the common parent of a consolidated group; and

(C) P makes qualified stock purchases of T and T1 on the same
acquisition date.

(ii) Gain and loss offsets. Gains and losses recognized on the
deemed asset sales by targets included in a combined return are
treated as the gains and losses of a single target. In addition,
loss carryovers of a target that were not subject to the separate
return limitation year restrictions (SRLY restrictions) of the
consolidated return regulations while that target was a member of
the selling consolidated group may be applied without limitation to
the gains of other targets included in the combined return. If,
however, a target has loss carryovers that were subject to the SRLY
restrictions while that target was a member of the selling
consolidated group, the use of those losses in the combined return
continues to be subject to those restrictions, applied in the same
manner as if the combined return were a consolidated return. A
similar rule applies, when appropriate, to other tax attributes.

(iii) Procedure for filing a combined return. A combined return is
made by filing a single corporation income tax return in lieu of
separate deemed sale returns for all targets required to be included
in the combined return. The combined return reflects the deemed
asset sales of all targets required to be included in the combined
return. If the targets included in the combined return constitute a
single affiliated group within the meaning of section 1504(a), the
income tax return is signed by an officer of the common parent of
that group.

Otherwise, the return must be signed by an officer of each target
included in the combined return. Rules similar to the rules in
�1.1502-75(j) apply for purposes of preparing the combined return.
The combined return must include an attachment prominently
identified as an "ELECTION TO FILE A COMBINED RETURN UNDER SECTION
338(h)(15)." The attachment must--

(A) Contain the name, address, and employer identification number of
each target required to be included in the combined return;

(B) Contain the following declaration (or a substantially similar
declaration):

EACH TARGET IDENTIFIED IN THIS ELECTION TO FILE A COMBINED RETURN
CONSENTS TO THE FILING OF A COMBINED RETURN;

(C) For each target, be signed by a person who states under
penalties of perjury that he or she is authorized to act on behalf
of such target.

(iv) Consequences of filing a combined return. Each target included
in a combined return is severally liable for any tax associated with
the combined return. See �1.338-1T(b)(3).

(5) Deemed sale excluded from purchasing corporation's consolidated
return. Old target may not be considered a member of any affiliated
group that includes the purchasing corporation with respect to its
deemed asset sale.

(6) Due date for old target's final return--(i) General rule. Old
target's final return is generally due on the 15th day of the third
calendar month following the month in which the acquisition date
occurs. See section 6072 (time for filing income tax returns).

(ii) Application of �1.1502-76(c)--(A) In general. Section
1.1502-76(c) applies to old target's final return if old target was
a member of a selling group that did not file consolidated returns
for the taxable year of the common parent that precedes the year
that includes old target's acquisition date. If the selling group
has not filed a consolidated return that includes old target's
taxable period that ends on the acquisition date, target may, on or
before the final return due date (including extensions), either--

(1) File a deemed sale return on the assumption that the selling
group will file the consolidated return; or

(2) File a return for so much of old target's taxable period as ends
at the close of the acquisition date on the assumption that the
consolidated return will not be filed.

(B) Deemed extension. For purposes of applying �1.1502-76(c)(2), an
extension of time to file old target's final return is considered to
be in effect until the last date for making the election under
section 338.

(C) Erroneous filing of deemed sale return. If, under this paragraph
(a)(6)(ii), target files a deemed sale return but the selling group
does not file a consolidated return, target must file a substituted
return for old target not later than the due date (including
extensions) for the return of the common parent with which old
target would have been included in the consolidated return. The
substituted return is for so much of old target's taxable year as
ends at the close of the acquisition date. Under �1.1502-76(c)(2),
the deemed sale return is not considered a return for purposes of
section 6011 (relating to the general requirement of filing a
return) if a substituted return must be filed.

(D) Erroneous filing of return for regular tax year. If, under this
paragraph (a)(6)(ii), target files a return for so much of old
target's regular taxable year as ends at the close of the
acquisition date but the selling group files a consolidated return,
target must file an amended return for old target not later than the
due date (including extensions) for the selling group's consolidated
return. (The amended return is a deemed sale return.)

(E) Last date for payment of tax. If either a substituted or amended
final return of old target is filed under this paragraph (a)(6)(ii),
the last date prescribed for payment of tax is the final return due
date (as defined in paragraph (a)(6)(i) of this section).

(7) Examples. The following examples illustrate this paragraph (a):

Example 1. (i) S is the common parent of a consolidated group that
includes T. The S group files calendar year consolidated returns. At
the close of June 30 of Year 1, P makes a qualified stock purchase
of T from S. P makes a section 338 election for T, and T's deemed
asset sale occurs as of the close of T's acquisition date (June 30).

(ii) T is considered disaffiliated for purposes of reporting the
deemed sale gain. Accordingly, T is included in the S group's
consolidated return through T's acquisition date except that the tax
liability for the deemed sale gain is reported in a separate deemed
sale return of T. Provided that T is not treated as an excluded
member under section 1563(b)(2), T is a component member of P's
controlled group for the taxable year of the deemed asset sale, and
the taxable income bracket amounts available in calculating tax on
the deemed sale return must be limited accordingly.

(iii) If P purchased the stock of T at 10 a.m. on June 30 of Year 1,
the results would be the same. See paragraph (a)(2)(i) of this
section.

Example 2. The facts are the same as in Example 1, except that the S
group does not file consolidated returns. T must file a separate
return for its taxable year ending on June 30 of Year 1, which
return includes the deemed asset sale.

(b) Waiver--(1) Certain additions to tax. An addition to tax or
additional amount (addition) under subchapter A of chapter 68 of the
Internal Revenue Code arising on or before the last day for making
the election under section 338 because of circumstances that would
not exist but for an election under section 338, is waived if--

(i) Under the particular statute the addition is excusable upon a
showing of reasonable cause; and

(ii) Corrective action is taken on or before the last day.

(2) Notification. The Internal Revenue Service should be notified at
the time of correction (e.g., by attaching a statement to a return
that constitutes corrective action) that the waiver rule of this
paragraph (b) is being asserted.

(3) Elections or other actions required to be specified on a timely
filed return--(i) In general. If paragraph (b)(1) of this section
applies or would apply if there were an underpayment, any election
or other action that must be specified on a timely filed return for
the taxable period covered by the late filed return described in
paragraph (b)(1) of this section is considered timely if specified
on a late-filed return filed on or before the last day for making
the election under section 338.

(ii) New target in purchasing corporation's consolidated return. If
new target is includible for its first taxable year in a
consolidated return filed by the affiliated group of which the
purchasing corporation is a member on or before the last day for
making the election under section 338, any election or other action
that must be specified in a timely filed return for new target's
first taxable year (but which is not specified in the consolidated
return) is considered timely if specified in an amended return filed
on or before such last day, at the place where the consolidated
return was filed.

(4) Examples. The following examples illustrate this paragraph (b):
Example 1. T is an unaffiliated corporation with a tax year ending
March 31. At the close of September 20 of Year 1, P makes a
qualified stock purchase of T. P does not join in filing a
consolidated return. P makes a section 338 election for T on or
before June 15 of Year 2, which causes T's taxable year to end as of
the close of September 20 of Year 1. An income tax return for T's
taxable period ending on September 20 of Year 1 was due on December
15 of Year 1. Additions to tax for failure to file a return and to
pay tax shown on a return will not be imposed if T's return is filed
and the tax paid on or before June 15 of Year 2. (This waiver
applies even if the acquisition date coincides with the last day of
T's former taxable year, i.e., March 31 of Year 2.) Interest on any
underpayment of tax for old T's short taxable year ending September
20 of Year 1 runs from December 15 of Year 1. A statement indicating
that the waiver rule of this paragraph is being asserted should be
attached to T's return.

Example 2. Assume the same facts as in Example 1. Assume further
that new T adopts the calendar year by filing, on or before June 15
of Year 2, its first return (for the period beginning on September
21 of Year 1 and ending on December 31 of Year 1) indicating that a
calendar year is chosen. See �1.338- 1T(b)(1). Any additions to tax
or amounts described in this paragraph (b) that arise because of the
late filing of a return for the period ending on December 31 of Year
1 are waived, because they are based on circumstances that would not
exist but for the section 338 election. Notwithstanding this waiver,
however, the return is still considered due March 15 of Year 2, and
interest on any underpayment runs from that date.

Example 3. Assume the same facts as in Example 2, except that T's
former taxable year ends on October 31. Although prior to the
election old T had a return due on January 15 of Year 2 for its year
ending October 31 of Year 1, that return need not be filed because a
timely election under section 338 was made. Instead, old T must file
a final return for the period ending on September 20 of Year 1,
which is due on December 15 of Year 1.

��1.338(b)-1,1.338(b)-2T,1.338(b)-3T,and 1.338(h)(10)-1 [Removed]
Par. 9. Sections 1.338(b)-1, 1.338(b)-2T, and 1.338(b)-3T, and
1.338(h)(10)-1 are removed.

Par. 10. Section 1.338(h)(10)-1T is added to read as follows:
�1.338(h)(10)-1T Deemed asset sale and liquidation (temporary).

(a) Scope. This section prescribes rules for qualification for a
section 338(h)(10) election and for making a section 338(h)(10)
election. This section also prescribes the consequences of such
election. The rules of this section are in addition to the rules of
��1.338-0T through 1.338-7T, 1.338-8, 1.338-9, 1.338- 10T, and
1.338(i)-1T and, in appropriate cases, apply instead of the rules of
��1.338-0T through 1.338-7T, 1.338-8, 1.338-9, 1.338-10T, and
1.338(i)-1T.

(b) Definitions--(1) Consolidated target. A consolidated target is a
target that is a member of a consolidated group within the meaning
of �1.1502-1(h) on the acquisition date and is not the common parent
of the group on that date.

(2) Selling consolidated group. A selling consolidated group is the
consolidated group of which the consolidated target is a member on
the acquisition date.

(3) Selling affiliate; affiliated target. A selling affiliate is a
domestic corporation that owns on the acquisition date an amount of
stock in a domestic target, which amount of stock is described in
section 1504(a)(2), and does not join in filing a consolidated
return with the target. In such case, the target is an affiliated
target.

(4) S corporation target. An S corporation target is a target that
is an S corporation immediately before the acquisition date.

(5) S corporation shareholders. S corporation shareholders are the S
corporation target's shareholders. Unless otherwise indicated, a
reference to S corporation shareholders refers both to S corporation
shareholders who do and those who do not sell their target stock.

(6) Liquidation. Any reference in this section to a liquidation is
treated as a reference to the transfer described in paragraph (d)(4)
of this section notwithstanding its ultimate characterization for
Federal income tax purposes.

(c) Section 338(h)(10) election--(1) In general. A section 338(h)
(10)  election may be made for T if P acquires stock meeting
the requirements of section 1504(a)(2) from a selling consolidated
group, a selling affiliate, or the S corporation shareholders in a
qualified stock purchase.

(2) Simultaneous joint election requirement. A section 338(h)(10)
election is made jointly by P and the selling consolidated group (or
the selling affiliate or the S corporation shareholders) on Form
8023 in accordance with the instructions to the form. S corporation
shareholders who do not sell their stock must also consent to the
election. The section 338(h)(10) election must be made not later
than the 15th day of the 9th month beginning after the month in
which the acquisition date occurs.

(3) Irrevocability. A section 338(h)(10) election is irrevocable. If
a section 338(h)(10) election is made for T, a section 338 election
is deemed made for T.

(4) Effect of invalid election. If a section 338(h)(10) election for
T is not valid, the section 338 election for T is also not valid.

(d) Certain consequences of section 338(h)(10) election. For
purposes of subtitle A of the Internal Revenue Code (except as
provided in �1.338-1T(b)(2)), the consequences to the parties of
making a section 338(h)(10) election for T are as follows: (1) P. P
is automatically deemed to have made a gain recognition election for
its nonrecently purchased T stock, if any. The effect of a gain
recognition election includes a taxable deemed sale by P on the
acquisition date of any nonrecently purchased target stock. See
�1.338-5T(d).

(2) New T. The AGUB for new T's assets is determined under �1.338-5T
and is allocated among the acquisition date assets under ��1.338-6T
and 1.338- 7T. Notwithstanding paragraph (d)(4) of this section
(deemed liquidation of old T), new T remains liable for the tax
liabilities of old T (including the tax liability for the deemed
sale gain). For example, new T remains liable for the tax
liabilities of the members of any consolidated group that are
attributable to taxable years in which those corporations and old T
joined in the same consolidated return. See �1.1502-6(a).

(3) Old T--deemed sale--(i) In general. Old T is treated as
transferring all of its assets to an unrelated person in exchange
for consideration that includes the assumption of or taking subject
to liabilities in a single transaction at the close of the
acquisition date (but before the deemed liquidation). See �1.338-
1T(a) regarding the tax characterization of the deemed asset sale.
ADSP for old T is determined under �1.338-4T and allocated among the
acquisition date assets under ��1.338-6T and 1.338-7T. Old T
realizes the deemed sale gain from the deemed asset sale before the
close of the acquisition date while old T is a member of the selling
consolidated group (or owned by the selling affiliate or owned by
the S corporation shareholders). If T is an affiliated target, or an
S corporation target, the principles of ��1.338-2T(c)(10) and
1.338-10T(a)(1), (5), and (6)(i) apply to the return on which the
deemed sale gain is reported. When T is an S corporation target, T's
S election continues in effect through the close of the acquisition
date (including the time of the deemed asset sale and the deemed
liquidation) notwithstanding section 1362(d)(2)(B). Also, when T is
an S corporation target, any direct and indirect subsidiaries of T
which T has elected to treat as qualified subchapter S subsidiaries
under section 1361(b)(3) remain qualified subchapter S subsidiaries
through the close of the acquisition date. No similar rule applies
when a qualified subchapter S subsidiary, as opposed to the S
corporation that is its owner, is the target the stock of which is
actually purchased.

(ii) Tiered targets. In the case of parent-subsidiary chains of
corporations making elections under section 338(h)(10), the deemed
asset sale of a parent corporation is considered to precede that of
its subsidiary. See �1.338-3T(4)(i).

(4) Old T and selling consolidated group, selling affiliate, or S
corporation shareholders--deemed liquidation; tax
characterization--(i) In general. Old T is treated as if, before the
close of the acquisition date, after the deemed asset sale in
paragraph (d)(3) of this section, and while old T is a member of the
selling consolidated group (or owned by the selling affiliate or
owned by the S corporation shareholders), it transferred all of its
assets to members of the selling consolidated group, the selling
affiliate, or S corporation shareholders and ceased to exist. The
transfer from old T is characterized for Federal income tax purposes
in the same manner as if the parties had actually engaged in the
transactions deemed to occur because of this section and taking into
account other transactions that actually occurred or are deemed to
occur. For example, the transfer may be treated as a distribution in
pursuance of a plan of reorganization, a distribution in complete
cancellation or redemption of all its stock, one of a series of
distributions in complete cancellation or redemption of all its
stock in accordance with a plan of liquidation, or part of a
circular flow of cash. In most cases, the transfer will be treated
as a distribution in complete liquidation to which section 336 or
337 applies.

(ii) Tiered targets. In the case of parent-subsidiary chains of
corporations making elections under section 338(h)(10), the deemed
liquidation of a subsidiary corporation is considered to precede the
deemed liquidation of its parent.

(5) Selling consolidated group, selling affiliate, or S corporation
shareholders--(i) In general. If T is an S corporation target, S
corporation shareholders (whether or not they sell their stock) take
their pro rata share of the deemed sale gain into account under
section 1366 and increase or decrease their basis in T stock under
section 1367. Members of the selling consolidated group, the selling
affiliate, or S corporation shareholders are treated as if, after
the deemed asset sale in paragraph (d)(3) of this section and before
the close of the acquisition date, they received the assets
transferred by old T in the transaction described in paragraph (d)
(4)(i) of this section. In most cases, the transfer will be treated
as a distribution in complete liquidation to which section 331 or
332 applies.

(ii) Basis and holding period of T stock not acquired. A member of
the selling consolidated group (or the selling affiliate or an S
corporation shareholder) retaining T stock is treated as acquiring
the stock so retained on the day after the acquisition date for its
fair market value. The holding period for the retained stock starts
on the day after the acquisition date. For purposes of this
paragraph, the fair market value of all of the T stock equals the
grossed-up amount realized on the sale to P of P's recently
purchased target stock. See �1.338-4T(c).

(iii) T stock sale. Members of the selling consolidated group (or
the selling affiliate or S corporation shareholders) recognize no
gain or loss on the sale or exchange of T stock included in the
qualified stock purchase (although they may recognize gain or loss
on the T stock in the deemed liquidation).

(6) Nonselling minority shareholders other than nonselling S
corporation shareholders--(i) In general. This paragraph (d)(6)
describes the treatment of shareholders of old T other than the
following: members of the selling consolidated group, the selling
affiliate, S corporation shareholders (whether or not they sell
their stock), and P. For a description of the treatment of S
corporation shareholders, see paragraph (d)(5) of this section. A
shareholder to which this paragraph (d)(6) applies is called a
minority shareholder.

(ii) T stock sale. A minority shareholder recognizes gain or loss on
the shareholder's sale or exchange of T stock included in the
qualified stock purchase.

(iii) T stock not acquired. A minority shareholder does not
recognize gain or loss under this section with respect to shares of
T stock retained by the shareholder. The shareholder's basis and
holding period for that T stock is not affected by the section
338(h)(10) election.

(7) Consolidated return of selling consolidated group. If P acquires
T in a qualified stock purchase from a selling consolidated group--

(i) The selling consolidated group must file a consolidated return
for the taxable period that includes the acquisition date;

(ii) A consolidated return for the selling consolidated group for
that period may not be withdrawn on or after the day that a section
338(h)(10) election is made for T; and

(iii) Permission to discontinue filing consolidated returns cannot
be granted for, and cannot apply to, that period or any of the
immediately preceding taxable periods during which consolidated
returns continuously have been filed.

(8) Availability of the section 453 installment method. Solely for
purposes of applying sections 453, 453A, and 453B, and the
regulations thereunder (the installment method) to determine the
consequences to old T in the deemed asset sale and to old T (and its
shareholders, if relevant) in the deemed liquidation, the rules in
paragraphs (d)(1) through (7) of this section are modified as
follows:

(i) In deemed asset sale. Old T is treated as receiving in the
deemed asset sale new T installment obligations, the terms of which
are identical (except as to the obligor) to P installment
obligations issued in exchange for recently purchased stock of T.
Old T is treated as receiving in cash all other consideration in the
deemed asset sale other than the assumption of, or taking subject
to, old T liabilities. For example, old T is treated as receiving in
cash any amounts attributable to the grossing-up of amount realized
under �1.338-4T(c).

The amount realized for recently purchased stock taken into account
in determining ADSP is adjusted (and, thus, ADSP is redetermined) to
reflect the amounts paid under an installment obligation for the
stock when the total payments under the installment obligation are
greater or less than the amount realized.

(ii) In deemed liquidation. Old T is treated as distributing in the
deemed liquidation the new T installment obligations that it is
treated as receiving in the deemed asset sale. The members of the
selling consolidated group, the selling affiliate, or the S
corporation shareholders are treated as receiving in the deemed
liquidation the new T installment obligations that correspond to the
P installment obligations they actually received individually in
exchange for their recently purchased stock. The new T installment
obligations may be recharacterized under other rules. See for
example �1.453-11(a)(2) which, in certain circumstances, treats the
new T installment obligations deemed distributed by old T as if they
were issued by new T in exchange for the members' of the selling
consolidated group, the selling affiliate's, or the S corporation
shareholders' stock in old T. The members of the selling
consolidated group, the selling affiliate, or the S corporation
shareholders are treated as receiving all other consideration in the
deemed liquidation in cash.

(9) Treatment consistent with an actual asset sale. Old T may not
assert any provision in section 338(h)(10) or this section to obtain
a tax result that would not be obtained if the parties had actually
engaged in the transactions deemed to occur because of this section
and taking into account other transactions that actually occurred or
are deemed to occur.

(e) Examples. The following examples illustrate this section:
Example 1. (i) S1 owns all of the T stock and T owns all of the
stock of T1 and T2. S1 is the common parent of a consolidated group
that includes T, T1, and T2. P makes a qualified stock purchase of
all of the T stock from S1. S1 joins with P in making a section
338(h)(10) election for T and for the deemed purchase of T1. A
section 338 election is not made for T2.

(ii) S1 does not recognize gain or loss on the sale of the T stock
and T does not recognize gain or loss on the sale of the T1 stock
because section 338(h)(10) elections are made for T and T1. Thus,
for example, gain or loss realized on the sale of the T or T1 stock
is not taken into account in earnings and profits. However, because
a section 338 election is not made for T2, T must recognize any gain
or loss realized on the deemed sale of the T2 stock. See
�1.338-4T(h).

(iii) The results would be the same if S1, T, T1, and T2 are not
members of any consolidated group, because S1 and T are selling
affiliates.

Example 2. (i) S and T are solvent corporations. S owns all of the
outstanding stock of T. S and P agree to undertake the following
transaction: T will distribute half its assets to S, and S will
assume half of T's liabilities. Then, P will purchase the stock of T
from S. S and P will jointly make a section 338(h)(10) election with
respect to the sale of T. The corporations then complete the
transaction as agreed.

(ii) Under section 338(a), the assets present in T at the close of
the acquisition date are deemed sold by old T to new T. Under
paragraph (d)(4) of this section, the transactions described in
paragraph (d) of this section are treated in the same manner as if
they had actually occurred. Because S and P had agreed that, after
T's actual distribution to S of part of its assets, S would sell T
to P pursuant to an election under section 338(h)(10), and because
paragraph (d)(4) of this section deems T subsequently to have
transferred all its assets to its shareholder, T is deemed to have
adopted a plan of complete liquidation under section 332. T's actual
transfer of assets to S is treated as a distribution pursuant to
that plan of complete liquidation.

Example 3. (i) S1 owns all of the outstanding stock of both T and
S2. All three are corporations. S1 and P agree to undertake the
following transaction.

T will transfer substantially all of its assets and liabilities to
S2, with S2 issuing no stock in exchange therefor, and retaining its
other assets and liabilities.

Then, P will purchase the stock of T from S1. S1 and P will jointly
make a section 338(h)(10) election with respect to the sale of T.
The corporations then complete the transaction as agreed.

(ii) Under section 338(a), the assets present in T at the close of
the acquisition date are deemed sold by old T to new T. Under
paragraph (d)(4) of this section, the transactions described in this
section are treated in the same manner as if they had actually
occurred. Because old T transferred substantially all of its assets
to S2, and is deemed to have distributed all its remaining assets
and gone out of existence, the transfer of assets to S2, taking into
account the related transfers, deemed and actual, qualifies as a
reorganization under section 368(a)(1)(D). Section 361(c)(1) and not
section 332 applies to T's deemed liquidation.

Example 4. (i) T owns two assets: an actively traded security (Class
II) with a fair market value of $100 and an adjusted basis of $100,
and inventory (Class IV) with a fair market value of $100 and an
adjusted basis of $100. T has no liabilities. S is negotiating to
sell all the stock in T to P for $100 cash and contingent
consideration. Assume that under generally applicable tax accounting
rules, P's adjusted basis in the T stock immediately after the
purchase would be $100, because the contingent consideration is not
taken into account. Thus, under the rules of �1.338-5T, AGUB would
be $100. Under the allocation rules of �1.338-6T, the entire $100
would be allocated to the Class II asset, the actively traded
security, and no amount would be allocated to the inventory. P,
however, plans immediately to cause T to sell the inventory, but not
the actively traded security, so it requests that, prior to the
stock sale, S cause T to create a new subsidiary, Newco, and
contribute the actively traded security to the capital of Newco.
Because the stock in Newco, which would not be actively traded, is a
Class V asset, under the rules of �1.338-6T $100 of AGUB would be
allocated to the inventory and no amount of AGUB would be allocated
to the Newco stock. Newco's own AGUB, $0 under the rules of
�1.338-5T, would be allocated to the actively traded security. When
P subsequently causes T to sell the inventory, T would realize no
gain or loss instead of realizing gain of $100.

(ii) Assume that, if the T stock had not itself been sold but T had
instead sold both its inventory and the Newco stock to P, T would
for tax purposes be deemed instead to have sold both its inventory
and actively traded security directly to P, with P deemed then to
have created Newco and contributed the actively traded security to
the capital of Newco. Section 338, if elected, generally
recharacterizes a stock sale as a deemed sale of assets. The tax
results of the deemed sale of assets should, where possible, be like
those of an actual asset sale. Hence, the deemed sale of assets
under section 338(h)(10) should be treated as one of the inventory
and actively traded security themselves, not of the inventory and
Newco stock. That is the substance of the transaction. The anti-
abuse rule of �1.338-1T(c) does not apply, because the substance of
the deemed sale of assets is a sale of the inventory and the
actively traded security themselves, not of the inventory and the
Newco stock.

Otherwise, the anti-abuse rule might apply.

Example 5. (i) T, a member of a selling consolidated group, has only
one class of stock, all of which is owned by S1. On March 1 of Year
2, S1 sells its T stock to P for $80,000, and joins with P in making
a section 338(h)(10) election for T. There are no selling costs or
acquisition costs. On March 1 of Year 2, T owns land with a $50,000
basis and $75,000 fair market value and equipment with a $30,000
adjusted basis, $70,000 recomputed basis, and $60,000 fair market
value. T also has a $40,000 liability. S1 pays old T's allocable
share of the selling group's consolidated tax liability for Year 2
including the tax liability for the deemed sale gain (a total of
$13,600).

(ii) ADSP of $120,000 ($80,000 + $40,000 + 0) is allocated to each
asset as follows:

Assets         Basis    FMV     Fraction  Allocable
ADSP
Land ......... $50,000  $75,000 5/9       $66,667
Equipment ....  30,000   60,000 4/9        53,333
                ______   ______ ___       _______
Total....      $80,000 $135,000  1       $120,000

(iii) Under paragraph (d)(3) of this section, old T has gain on the
deemed sale of $40,000 (consisting of $16,667 of capital gain and
$23,333 of ordinary income).

(iv) Under paragraph (d)(5)(iii) of this section, S1 recognizes no
gain or loss upon its sale of the old T stock to P. S1 also
recognizes no gain or loss upon the deemed liquidation of T. See
paragraph (d)(4) of this section and section 332.

(v) P's basis in new T stock is P's cost for the stock, $80,000. See
section 1012.

(vi) Under �1.338-5T, the AGUB for new T is $120,000, i.e., P's cost
for the old T stock ($80,000) plus T's liability ($40,000). This
AGUB is allocated as basis among the new T assets under ��1.338-6T
and 1.338-7T.

Example 6. (i) The facts are the same as in Example 5, except that
S1 sells 80 percent of the old T stock to P for $64,000, rather than
100 percent of the old T stock for $80,000.

(ii) The consequences to P, T, and S1 are the same as in Example 5,
except that: (A) P's basis for its 80-percent interest in the new T
stock is P's $64,000 cost for the stock. See section 1012.

(B) Under �1.338-5T, the AGUB for new T is $120,000 (i.e.,
$64,000/.8 + $40,000 + $0).

(C) Under paragraph (d)(4) of this section, S1 recognizes no gain or
loss with respect to the retained stock in T. See section 332.

(D) Under paragraph (d)(5)(ii) of this section, the basis of the T
stock retained by S1 is $16,000 (i.e., $120,000 ! $40,000 (the ADSP
amount for the old T assets over the sum of new T's liabilities
immediately after the acquisition date) � .20 (the proportion of T
stock retained by S1)).

Example 7. (i) The facts are the same as in Example 6, except that
K, a shareholder unrelated to T or P, owns the 20 percent of the T
stock that is not acquired by P in the qualified stock purchase. K's
basis in its T stock is $5,000.

(ii) The consequences to P, T, and S1 are the same as in Example 6.

(iii) Under paragraph (d)(6)(iii) of this section, K recognizes no
gain or loss, and K's basis in its T stock remains at $5,000.

Example 8. (i) The facts are the same as in Example 5, except that
the equipment is held by T1, a wholly-owned subsidiary of T, and a
section 338(h)(10) election is also made for T1. The T1 stock has a
fair market value of $60,000. T1 has no assets other than the
equipment and no liabilities. S1 pays old T's and old T1's allocable
shares of the selling group's consolidated tax liability for Year 2
including the tax liability for T and T1's deemed sale gain. (ii)
ADSP for T is $120,000, allocated $66,667 to the land and $53,333 to
the stock. Old T's deemed sale gain is $16,667 (the capital gain on
its deemed sale of the land). Under paragraph (d)(5)(iii) of this
section, old T does not recognize gain or loss on its deemed sale of
the T1 stock. See section 332.

(iii) ADSP for T1 is $53,333 (i.e., $53,333 + $0 + $0). On the
deemed sale of the equipment, T1 recognizes ordinary income of
$23,333.

(iv) Under paragraph (d)(5)(iii) of this section, S1 does not
recognize gain or loss upon its sale of the old T stock to P.

Example 9. (i) The facts are the same as in Example 8, except that P
already owns 20 percent of the T stock, which is nonrecently
purchased stock with a basis of $6,000, and that P purchases the
remaining 80 percent of the T stock from S1 for $64,000.

(ii) The results are the same as in Example 8, except that under
paragraph (d)(1) of this section and �1.338-5T(d), P is deemed to
have made a gain recognition election for its nonrecently purchased
T stock. As a result, P recognizes gain of $10,000 and its basis in
the nonrecently purchased T stock is increased from $6,000 to
$16,000. P's basis in all the T stock is $80,000 (i.e., $64,000 +
$16,000). The computations are as follows:

(A) P's grossed-up basis for the recently purchased T stock is
$64,000 (i.e., $64,000 (the basis of the recently purchased T stock)
� (1 ! .2)/(.8) (the fraction in section 338(b)(4))).

(B) P's basis amount for the nonrecently purchased T stock is
$16,000 (i.e., $64,000 (the grossed-up basis in the recently
purchased T stock) � (.2)/(1.0 ! .2) (the fraction in section 338(b)
(3)(B))).

(C) The gain recognized on the nonrecently purchased stock is
$10,000 (i.e., $16,000 ! $6,000).

Example 10. (i) T is an S corporation whose sole class of stock is
owned 40 percent each by A and B and 20 percent by C. T, A, B, and C
all use the cash method of accounting. A and B each has an adjusted
basis of $10,000 in the stock. C has an adjusted basis of $5,000 in
the stock. A, B, and C hold no installment obligations to which
section 453A applies. On March 1 of Year 1, A sells its stock to P
for $40,000 in cash and B sells its stock to P for a $25,000 note
issued by P and real estate having a fair market value of $15,000.
The $25,000 note, due in full in Year 7, is not publicly traded and
bears adequate stated interest. A and B have no selling expenses.
T's sole asset is real estate, which has a value of $110,000 and an
adjusted basis of $35,000. Also, T's real estate is encumbered by
long-outstanding purchase-money indebtedness of $10,000. The real
estate does not have built-in gain subject to section 1374. A, B,
and C join with P in making a section 338(h)(10) election for T.

(ii) Solely for purposes of application of sections 453, 453A, and
453B, old T is considered in its deemed asset sale to receive back
from new T the $25,000 note (considered issued by new T) and $75,000
of cash (total consideration of $80,000 paid for all the stock sold,
which is then divided by .80 in the grossing-up, with the resulting
figure of $100,000 then reduced by the amount of the installment
note). Absent an election under section 453(d), gain is reported by
old T under the installment method.

(iii) In applying the installment method to old T's deemed asset
sale, the contract price for old T's assets deemed sold is $100,000,
the $110,000 selling price reduced by the indebtedness of $10,000 to
which the assets are subject.

(The $110,000 selling price is itself the sum of the $80,000
grossed-up in paragraph (ii) above to $100,000 and the $10,000
liability.) Gross profit is $75,000 ($110,000 selling price ! old
T's basis of $35,000). Old T's gross profit ratio is 0.75 (gross
profit of $75,000 � $100,000 contract price). Thus, $56,250 (0.75 �
the $75,000 cash old T is deemed to receive in Year 1) is Year 1
gain attributable to the sale, and $18,750 ($75,000 ! $56,250) is
recovery of basis.

(iv) In its liquidation, old T is deemed to distribute the $25,000
note to B, since B actually sold the stock partly for that
consideration. To the extent of the remaining liquidating
distribution to B, it is deemed to receive, along with A and C, the
balance of old T's liquidating assets in the form of cash. Under
section 453(h), B, unless it makes an election under section 453(d),
is not required to treat the receipt of the note as a payment for
the T stock; P's payment of the $25,000 note in Year 7 to B is a
payment for the T stock. Because section 453(h) applies to B, old
T's deemed liquidating distribution of the note is, under section
453B(h), not treated as a taxable disposition by old T.

(v) Under section 1366, A reports 40 percent, or $22,500, of old T's
$56,250 gain recognized in Year 1. Under section 1367, this
increases A's $10,000 adjusted basis in the T stock to $32,500.
Next, in old T's deemed liquidation, A is considered to receive
$40,000 for its old T shares, causing it to recognize an additional
$7,500 gain in Year 1.

(vi) Under section 1366, B reports 40 percent, or $22,500, of old
T's $56,250 gain recognized in Year 1. Under section 1367, this
increases B's $10,000 adjusted basis in its T stock to $32,500.
Next, in old T's deemed liquidation, B is considered to receive the
$25,000 note and $15,000 of other consideration. Applying section
453, including section 453(h), to the deemed liquidation, B's
selling price and contract price are both $40,000. Gross profit is
$7,500 ($40,000 selling price ! B's basis of $32,500). B's gross
profit ratio is 0.1875 (gross profit of $7,500 � $40,000 contract
price). Thus, $2,812.50 (0.1875 � $15,000) is Year 1 gain
attributable to the deemed liquidation. In Year 7, when the $25,000
note is paid, B has $4,687.50 (0.1875 � $25,000) of additional gain.

(vii) Under section 1366, C reports 20 percent, or $11,250, of old
T's $56,250 gain recognized in Year 1. Under section 1367, this
increases C's $5,000 adjusted basis in its T stock to $16,250. Next,
in old T's deemed liquidation, C is considered to receive $20,000
for its old T shares, causing it to recognize an additional $3,750
gain in Year 1. Finally, under paragraph (d)(5)(ii) of this section,
C is considered to acquire its stock in T on the day after the
acquisition date for $20,000 (fair market value = grossed-up amount
realized of $100,000 � 20%). C's holding period in the stock deemed
received in new T begins at that time.

(f) Inapplicability of provisions. The provisions of section 6043,
�1.331- 1(d), and �1.332-6 (relating to information returns and
recordkeeping requirements for corporate liquidations) do not apply
to the deemed liquidation of old T under paragraph (d)(4) of this
section.

(g) Required information. The Commissioner may exercise the
authority granted in section 338(h)(10)(C)(iii) to require provision
of any information deemed necessary to carry out the provisions of
section 338(h)(10) by requiring submission of information on any tax
reporting form.

�1.338(i)-1 [Removed ] Par. 11. Section 1.338(i)-1 is removed.

Par. 12. Section 1.338(i)-1T is added to read as follows:
�1.338(i)-1T Effective dates (temporary).

The provisions of ��1.338-0T through 1.338-7T, 1.338-10T and
1.338(h)(10)-1T apply to any qualified stock purchase occurring
after January 5, 2000. For rules applicable to qualified stock
purchases on or before January 5, 2000, see ��1.338-0 through
1.338-5, 1.338(b)-1, 1.338(b)-2T, 1.338(b)-3T, 1.338(h)(10)-1, and
1.338(i)-1 in effect prior to January 6, 2000 (see 26 CFR part 1
revised April 1, 1999).

Par. 13. Section 1.1060-1T is revised to read as follows: �1.1060-1T
Special allocation rules for certain asset acquisitions (temporary).

(a) Scope--(1) In general. This section prescribes rules relating to
the requirements of section 1060, which, in the case of an
applicable asset acquisition, requires the transferor (the seller)
and the transferee (the purchaser) each to allocate the
consideration paid or received in the transaction among the assets
transferred in the same manner as amounts are allocated under
section 338(b)(5) (relating to the allocation of adjusted grossed-up
basis among the assets of the target corporation when a section 338
election is made). In the case of an applicable asset acquisition
described in paragraph (b)(1) of this section, sellers and
purchasers must allocate the consideration under the residual method
as described in ��1.338-6T and 1.338-7T in order to determine,
respectively, the amount realized from, and the basis in, each of
the transferred assets. For rules relating to distributions of
partnership property or transfers of partnership interests which are
subject to section 1060(d), see �1.755-2T.

(2) Effective date. The provisions of this section apply to any
asset acquisition occurring after January 5, 2000. For rules
applicable to asset acquisitions on or before January 5, 2000, see
�1.1060-1T in effect prior to January 6, 2000 (see 26 CFR part 1
revised April 1, 1999).

(3) Outline of topics. In order to facilitate the use of this
section, this paragraph (a)(3) lists the major paragraphs in this
section as follows: (a) Scope.

(1) In general.

(2) Effective date.

(3) Outline of topics.

(b) Applicable asset acquisition.

(1) In general.

(2) Assets constituting a trade or business.

(i) In general.

(ii) Goodwill or going concern value.

(iii) Factors indicating goodwill or going concern value.

(3) Examples.

(4) Asymmetrical transfers of assets.

(5) Related transactions.

(6) More than a single trade or business.

(7) Covenant entered into by the seller.

(8) Partial non-recognition exchanges.

(c) Allocation of consideration among assets under the residual
method.

(1) Consideration.

(2) Allocation of consideration among assets.

(3) Certain costs.

(4) Effect of agreement between parties.

(d) Examples.

(e) Reporting requirements.

(1) Applicable asset acquisitions.

(i) In general.

(ii) Time and manner of reporting.

(A) In general.

(B) Additional reporting requirement.

(2) Transfers of interests in partnerships.

(b) Applicable asset acquisition--(1) In general. An applicable
asset acquisition is any transfer, whether direct or indirect, of a
group of assets if the assets transferred constitute a trade or
business in the hands of either the seller or the purchaser and,
except as provided in paragraph (b)(8) of this section, the
purchaser's basis in the transferred assets is determined wholly by
reference to the purchaser's consideration.

(2) Assets constituting a trade or business--(i) In general. For
purposes of this section, a group of assets constitutes a trade or
business if--

(A) The use of such assets would constitute an active trade or
business under section 355; or

(B) Its character is such that goodwill or going concern value could
under any circumstances attach to such group.

(ii) Goodwill or going concern value. Goodwill is the value of a
trade or business attributable to the expectancy of continued
customer patronage. This expectancy may be due to the name or
reputation of a trade or business or any other factor. Going concern
value is the additional value that attaches to property because of
its existence as an integral part of an ongoing business activity.
Going concern value includes the value attributable to the ability
of a trade or business (or a part of a trade or business) to
continue functioning or generating income without interruption
notwithstanding a change in ownership.

It also includes the value that is attributable to the immediate use
or availability of an acquired trade or business, such as, for
example, the use of the revenues or net earnings that otherwise
would not be received during any period if the acquired trade or
business were not available or operational.

(iii) Factors indicating goodwill or going concern value. In making
the determination in this paragraph (b)(2), all the facts and
circumstances surrounding the transaction are taken into account.
Whether sufficient consideration is available to allocate to
goodwill or going concern value after the residual method is applied
is not relevant in determining whether goodwill or going concern
value could attach to a group of assets. Factors to be considered
include--

(A) The presence of any intangible assets (whether or not those
assets are section 197 intangibles), provided, however, that the
transfer of such an asset in the absence of other assets will not be
a trade or business for purposes of section 1060;

(B) The existence of an excess of the total consideration over the
aggregate book value of the tangible and intangible assets purchased
(other than goodwill and going concern value) as shown in the
financial accounting books and records of the purchaser; and

(C) Related transactions, including lease agreements, licenses, or
other similar agreements between the purchaser and seller (or
managers, directors, owners, or employees of the seller) in
connection with the transfer.

(3) Examples. The following examples illustrate paragraphs (b)(1)
and (2) of this section:

Example 1. S is a high grade machine shop that manufactures
microwave connectors in limited quantities. It is a successful
company with a reputation within the industry and among its
customers for manufacturing unique, high quality products. Its
tangible assets consist primarily of ordinary machinery for working
metal and plating. It has no secret formulas or patented drawings of
value. P is a company that designs, manufactures, and markets
electronic components. It wants to establish an immediate presence
in the microwave industry, an area in which it previously has not
been engaged. P is acquiring assets of a number of smaller companies
and hopes that these assets will collectively allow it to offer a
broad product mix. P acquires the assets of S in order to augment
its product mix and to promote its presence in the microwave
industry. P will not use the assets acquired from S to manufacture
microwave connectors. The assets transferred are assets that
constitute a trade or business in the hands of the seller. Thus, P's
purchase of S's assets is an applicable asset acquisition. The fact
that P will not use the assets acquired from S to continue the
business of S does not affect this conclusion.

Example 2. S, a sole proprietor who operates a car wash, both leases
the building housing the car wash and sells all of the car wash
equipment to P. S's use of the building and the car wash equipment
constitute a trade or business.

P begins operating a car wash in the building it leases from S.
Because the assets transferred together with the asset leased are
assets which constitute a trade or business, P's purchase of S's
assets is an applicable asset acquisition.

Example 3. S, a corporation, owns a retail store business in State X
and conducts activities in connection with that business enterprise
that meet the active trade or business requirement of section 355. P
is a minority shareholder of S. S distributes to P all the assets of
S used in S's retail business in State X in complete redemption of
P's stock in S held by P. The distribution of S's assets in
redemption of P's stock is treated as a sale or exchange under
sections 302(a) and 302(b)(3), and P's basis in the assets
distributed to it is determined wholly by reference to the
consideration paid, the S stock. Thus, S's distribution of assets
constituting a trade or business to P is an applicable asset
acquisition.

Example 4. S is a manufacturing company with an internal financial
bookkeeping department. P is in the business of providing a
financial bookkeeping service on a contract basis. As part of an
agreement for P to begin providing financial bookkeeping services to
S, P agrees to buy all of the assets associated with S's internal
bookkeeping operations and provide employment to any of S's
bookkeeping department employees who choose to accept a position
with P. In addition to selling P the assets associated with its
bookkeeping operation, S will enter into a long term contract with P
for bookkeeping services.

Because assets transferred from S to P, along with the related
contract for bookkeeping services, are a trade or business in the
hands of P, the sale of the bookkeeping assets from S to P is an
applicable asset acquisition.

(4) Asymmetrical transfers of assets. If, under general principles
of tax law, a seller is not treated as transferring the same assets
as the purchaser is treated as acquiring, the assets acquired by the
purchaser constitute a trade or business, and, except as provided in
paragraph (b)(8) of this section, the purchaser's basis in the
transferred assets is determined wholly by reference to the
purchaser's consideration, then the purchaser is subject to section
1060.

(5) Related transactions. Whether the assets transferred constitute
a trade or business is determined by aggregating all transfers from
the seller to the purchaser in a series of related transactions.
Except as provided in paragraph (b)(8) of this section, all assets
transferred from the seller to the purchaser in a series of related
transactions are included in the group of assets among which the
consideration paid or received in such series is allocated under the
residual method. The principles of �1.338-1T(c) are also applied in
determining which assets are included in the group of assets among
which the consideration paid or received is allocated under the
residual method.

(6) More than a single trade or business. If the assets transferred
from a seller to a purchaser include more than one trade or
business, then, in applying this section, all of the assets
transferred (whether or not transferred in one transaction or a
series of related transactions and whether or not part of a trade or
business) are treated as a single trade or business.

(7) Covenant entered into by the seller. If, in connection with an
applicable asset acquisition, the seller enters into a covenant
(e.g., a covenant not to compete) with the purchaser, that covenant
is treated as an asset transferred as part of a trade or business.

(8) Partial non-recognition exchanges. A transfer may constitute an
applicable asset acquisition notwithstanding the fact that no gain
or loss is recognized with respect to a portion of the group of
assets transferred. All of the assets transferred, including the
non-recognition assets, are taken into account in determining
whether the group of assets constitutes a trade or business. The
allocation of consideration under paragraph (c) of this section is
done without taking into account either the non-recognition assets
or the amount of money or other property that is treated as
transferred in exchange for the non-recognition assets (together,
the non-recognition exchange property). The basis in and gain or
loss recognized with respect to the non-recognition exchange
property are determined under such rules as would otherwise apply to
an exchange of such property. The amount of the money and other
property treated as exchanged for non-recognition assets is the
amount by which the fair market value of the non-recognition assets
transferred by one party exceeds the fair market value of the non-
recognition assets transferred by the other (to the extent of the
money and the fair market value of property transferred in the
exchange). The money and other property that are treated as
transferred in exchange for the non-recognition assets (and which
are not included among the assets to which section 1060 applies) are
considered to come from the following assets in the following order:
first from Class I assets, then from Class II assets, then from
Class III assets, then from Class IV assets, then from Class V
assets, then from Class VI assets, and then from Class VII assets.
For this purpose, liabilities assumed (or to which a non-recognition
exchange property is subject) are treated as Class I assets. See
Example 1 in paragraph (d) of this section for an example of the
application of section 1060 to a single transaction which is, in
part, a non-recognition exchange.

(c) Allocation of consideration among assets under the residual
method -- (1) Consideration. The seller's consideration is the
amount, in the aggregate, realized from selling the assets in the
applicable asset acquisition under section 1001(b). The purchaser's
consideration is the amount, in the aggregate, of its cost of
purchasing the assets in the applicable asset acquisition that is
properly taken into account in basis.

(2) Allocation of consideration among assets. For purposes of
determining the seller's amount realized for each of the assets sold
in an applicable asset acquisition, the seller allocates
consideration to all the assets sold by using the residual method
under ��1.338-6T and 1.338-7T, substituting consideration for ADSP.
For purposes of determining the purchaser's basis in each of the
assets purchased in an applicable asset acquisition, the purchaser
allocates consideration to all the assets purchased by using the
residual method under ��1.338-6T and 1.338-7T, substituting
consideration for AGUB. In allocating consideration, the rules set
forth in paragraphs (c)(3) and (4) of this section apply in addition
to the rules in ��1.338-6T and 1.338-7T.

(3) Certain costs. The seller and purchaser each adjusts the amount
allocated to an individual asset to take into account the specific
identifiable costs incurred in transferring that asset in connection
with the applicable asset acquisition (e.g., real estate transfer
costs or security interest perfection costs).

Costs so allocated increase, or decrease, as appropriate, the total
consideration that is allocated under the residual method. No
adjustment is made to the amount allocated to an individual asset
for general costs associated with the applicable asset acquisition
as a whole or with groups of assets included therein (e.g., non-
specific appraisal fees or accounting fees). These latter amounts
are taken into account only indirectly through their effect on the
total consideration to be allocated.

(4) Effect of agreement between parties. If, in connection with an
applicable asset acquisition, the seller and purchaser agree in
writing as to the allocation of any amount of consideration to, or
as to the fair market value of, any of the assets, such agreement is
binding on them to the extent provided in this paragraph (c)(4).
Nothing in this paragraph (c)(4) restricts the Commissioner's
authority to challenge the allocations or values arrived at in an
allocation agreement. This paragraph (c)(4) does not apply if the
parties are able to refute the allocation or valuation under the
standards set forth in Commissioner v. Danielson, 378 F.2d 771 (3d
Cir.), cert. denied, 389 U.S. 858 (1967) (a party wishing to
challenge the tax consequences of an agreement as construed by the
Commissioner must offer proof that, in an action between the parties
to the agreement, would be admissible to alter that construction or
show its unenforceability because of mistake, undue influence,
fraud, duress, etc.).

(d) Examples. The following examples illustrate this section:
Example 1. (i) On January 1, 2001, A transfers assets X, Y, and Z to
B in exchange for assets D, E, and F plus $1,000 cash.

(ii) Assume the exchange of assets constitutes an exchange of like-
kind property to which section 1031 applies. Assume also that
goodwill or going concern value could under any circumstances attach
to each of the DEF and XYZ groups of assets and, therefore, each
group constitutes a trade or business under section 1060.

(iii) Assume the fair market values of the assets and the amount of
money transferred are as follows:

                      By A                  By B
Asset                 Fair Asset            Fair
                      Market                Market
                      Value                 Value
X..................   $400 D .............. $40
Y..................    400 E ............... 30
Z ..................   200 F ............... 30
Cash (amount) ...... 1,000
Total..........     $1,000 Total ....... $1,100

(iv) Under paragraph (b)(8) of this section, for purposes of
allocating consideration under paragraph (c) of this section, the
like-kind assets exchanged and any money or other property that are
treated as transferred in exchange for the like-kind property are
excluded from the application of section 1060.

(v) Since assets X, Y, and Z are like-kind property, they are
excluded from the application of the section 1060 allocation rules.

(vi) Since assets D, E, and F are like-kind property, they are
excluded from the application of the section 1060 allocation rules.
In addition, $900 of the $1,000 cash B gave to A for A's like-kind
assets is treated as transferred in exchange for the like-kind
property in order to equalize the fair market values of the like-
kind assets. Therefore, $900 of the cash is excluded from the
application of the section 1060 allocation rules.

(vii) $100 of the cash is allocated under section 1060 and paragraph
(c) of this section.

(viii) A, as transferor of assets X, Y, and Z, received $100 that
must be allocated under section 1060 and paragraph (c) of this
section. Since A transferred no Class I, II, III, IV, V, or VI
assets to which section 1060 applies, in determining its amount
realized for the part of the exchange to which section 1031 does not
apply, the $100 is allocated to Class VII assets (goodwill and going
concern value).

(ix) A, as transferee of assets D, E, and F, gave consideration only
for assets to which section 1031 applies. Therefore, the allocation
rules of section 1060 and paragraph (c) of this section are not
applied to determine the bases of the assets A received.

(x) B, as transferor of assets D, E, and F, received consideration
only for assets to which section 1031 applies. Therefore, the
allocation rules of section 1060 do not apply in determining B's
gain or loss.

(xi) B, as transferee of assets X, Y, and Z, gave A $100 that must
be allocated under section 1060 and paragraph (c) of this section.
Since B received from A no Class I, II, III, IV, V, or VI assets to
which section 1060 applies, the $100 consideration is allocated by B
to Class VII assets (goodwill and going concern value).

Example 2. (i) On January 1, 2001, S, a sole proprietor, sells to P,
a corporation, a group of assets that constitutes a trade or
business under paragraph (b)(2) of this section. S, who plans to
retire immediately, also executes in P's favor a covenant not to
compete. P pays S $3,000 in cash and assumes $1,000 in liabilities.
Thus, the total consideration is $4,000.

(ii) On the purchase date, P and S also execute a separate agreement
that states that the fair market values of the Class II, Class III,
Class V, and Class VI assets S sold to P are as follows:

Asset  Asset                               Fair
Class                                      Market
                                           Value
II     Actively traded securities ........ $500
                                           ____
Total Class II ........................     500

III    Accounts receivable ...............  200
                                           ____
Total Class III........................     200

V      Furniture and fixtures ............. 800
       Building............................ 800
       Land ............................... 200
       Equipment .......................... 400
                                           ____
Total Class V ........................    2,200

VI Covenant not to compete ................ 900
Total Class VI .......................      900

(iii) P and S each allocate the consideration in the transaction
among the assets transferred under paragraph (c) of this section in
accordance with the agreed upon fair market values of the assets, so
that $500 is allocated to Class II assets, $200 is allocated to the
Class III asset, $2,200 is allocated to Class V assets, $900 is
allocated to Class VI assets, and $200 ($4,000 total consideration
less $3,800 allocated to assets in Classes II, III, V, and VI) is
allocated to the Class VII assets (goodwill and going concern
value).

(iv) In connection with the examination of P's return, the District
Director, in determining the fair market values of the assets
transferred, may disregard the parties' agreement. Assume that the
District Director correctly determines that the fair market value of
the covenant not to compete was $500. Since the allocation of
consideration among Class II, III, V, and VI assets results in
allocation up to the fair market value limitation, the $600 of
unallocated consideration resulting from the District Director's
redetermination of the value of the covenant not to compete is
allocated to Class VII assets (goodwill and going concern value).

(e) Reporting requirements--(1) Applicable asset acquisitions--(i)
In general. Unless otherwise excluded from this requirement by the
Commissioner, the seller and the purchaser in an applicable asset
acquisition each must report information concerning the amount of
consideration in the transaction and its allocation among the assets
transferred. They also must report information concerning subsequent
adjustments to consideration.

(ii) Time and manner of reporting--(A) In general. The seller and
the purchaser each must file asset acquisition statements on Form
8594 with their income tax returns or returns of income for the
taxable year that includes the first date assets are sold pursuant
to an applicable asset acquisition. This reporting requirement
applies to all asset acquisitions described in this section. For
reporting requirements relating to asset acquisitions occurring
before January 6, 2000, as described in paragraph (a)(2) of this
section, see the temporary regulations under section 1060 in effect
prior to January 6, 2000 (�1.1060-1T as contained in 26 CFR part 1
revised April 1, 1999).

(B) Additional reporting requirement. When an increase or decrease
in consideration is taken into account after the close of the first
taxable year that includes the first date assets are sold in an
applicable asset acquisition, the seller and the purchaser each must
file a supplemental asset acquisition statement on Form 8594 with
the income tax return or return of income for the taxable year in
which the increase (or decrease) is properly taken into account. (2)
Transfers of interests in partnerships. For reporting requirements
relating to the transfer of a partnership interest, see
�1.755-2T(c).

PART 602--OMB CONTROL NUMBERS UNDER PAPERWORK REDUCTION ACT

Par. 14. The authority citation for part 602 continues to read as
follows: Authority: 26 U.S.C. 7805.

Par. 15. In �602.101, paragraph (b) is amended by removing the
entries for ��1.338-1, 1.338(b)-1, 1.338(h)(10)-1, and 1.1060-1T
from the tables and adding new entries to the table in numerical
order to read as follows: �602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section where identified and de- Current OMB control
scribed No.

* * * * *

1.338-2T 1545-1658

1.338-5T 1545-1658

1.338-10T 1545-1658

1.338(h)(10)-1T 1545-1658

* * * * *

1.1060-1T 1545-1658

* * * * *

Robert E. Wenzel
Deputy Commissioner of Internal Revenue
Approved: December 22, 1999
Jonathan Talisman
Acting Assistant Secretary of the Treasury

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