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   (1) Gross interest derived by Y in 1973 from producer's loans..   $7,000(2) Amount of gain on depreciable property (lower of Y's          20,000 recognized gain ($25,000) or X's gain not recognized on section 1245 property ($20,000))..............................(3) Amount of gain on stock (lower of X's gain not recognized      5,000 or Y's recognized gain ($8,000) ($5,000)).....................(4) One-half excess of taxable income for 1973 over the sum of    34,000 lines (1), (2), and (3) (1/2 of ($100,000 minus $32,000)).....                                                                --------(5) Limitation on lines (1) through (4):  (a) Sum of lines (1) through (4).............................   66,000  (b) Earnings and profits for 1973............................   72,000                                                                --------  (c) Lower of lines (a) and (b)...............................   66,000                                                                --------(6) Amount under paragraph (a)(5) of this section:    (a) Foreign investment attributable to producer's loans       10,000     under § 1.995-5......................................    (b) Sum of the lower of accumulated earnings and profits at   11,000     beginning of 1973 ($5,000) or accumulated DISC income at     beginning of 1973 ($6,000) and excess of earnings and     profits for 1973 over line (5)(c) ($72,000 minus $66,000).                                                                --------    (c) Lower of lines (a) and (b).............................   10,000                                                                --------(7) Total deemed distribution (sum of lines (5)(c) and (6)(c)).   76,000                                                                ======== 

Example 2.  Assume the facts are the same as in example 1, except that earnings and profits for 1973 amount to only $60,000. Under these facts, X is treated as receiving a deemed distribution taxable as a dividend of $65,000 on December 31, 1973, determined as follows:

   (5) Limitation on lines (1) through (4):    (a) Line (5)(a) of example 1..............................   $66,000    (b) Earnings and profits for 1973.........................    60,000                                                               ---------    (c) Lower of lines (a) and (b)............................    60,000                                                               ---------(6) Amount under paragraph (a)(5) of this section:    (a) Line (6)(a) of example 1..............................    10,000    (b) Sum of the lower of accumulated earnings and profits       5,000     at beginning of 1973 ($5,000) or accumulated DISC income     at beginning of 1973 ($6,000) plus excess of earnings and     profits for 1973 over line (5)(c) ($60,000 minus $60,000)                                                               ---------    (c) Lower of lines (a) and (b)............................     5,000                                                               ---------(7) Total deemed distribution (sum of lines (5)(c) and (6)(c))    65,000                                                               ========= 

Example 3.  Assume the facts are the same as in example 1, except that Y has a deficit in accumulated earnings and profits at the beginning of 1973 of $4,000. Such deficit is comprised of accumulated DISC income of $1,000, no previously taxed income, and a deficit in other earnings and profits of $5,000. Under these facts, X is treated as receiving a deemed distribution taxable as a dividend in the amount of $72,000 on December 31, 1973, determined as follows:

   (5) Limitation on lines (1) through (4):  (a) Line (5)(a) of example 1................................   $66,000  (b) Earnings and profits for 1973...........................    72,000                                                               ---------  (c) Lower of lines (a) and (b)..............................    66,000                                                               ---------(6) Amount under paragraph (a)(5) of this section:  (a) Line (6)(a) of example 1................................    10,000  (b) Sum of accumulated earnings and profits at beginning of      6,000   1973 (not less than $0), and excess of earnings and profits   for 1973 over amount in line (5)(c) ($72,000 minus $66,000)                                                               ---------  (c) Lower of lines (a) and (b)..............................     6,000                                                               ---------(7) Total deemed distribution sum of lines (5)(c) and (6)(c)..    72,000                                                               ========= 

(d) Special rules for certain tax-free acquisitions of property by the DISC. (1) For purposes of paragraph (a)(2)(i) and (3)(i) of this section, if—

(i) A DISC acquires property in a first transaction and in a second transaction it disposes of such property in exchange for other property, and

(ii) By reason of the application of section 1031 (relating to like-kind exchanges) or section 1033 (relating to involuntary conversions), the basis in the DISC's hands of the other property acquired in such second transaction is determined in whole or in part with reference to the basis of the property acquired in the first transaction,

then upon a disposition of such other property in a third transaction by the DISC such other property shall be treated as though it had been transferred to the DISC in the first transaction. Thus, if the first transaction is a purchase of the property for cash, then paragraphs (a)(2) and (3) of this section will not apply to a sale by the DISC of the other property acquired in the second transaction.

(2) For purposes of paragraphs (a)(2)(i) and (3)(i) of this section, if a DISC acquires property in a first transaction and it transfers such property to a transferee DISC in a second transaction in which the transferor DISC's gain is not recognized in whole or in part, then such property shall be treated as though it had been transferred to the transferee DISC in the same manner in which it was acquired in the first transaction by the transferor DISC. For example, if X and Y both qualify as DISC's and X transfers property to Y in a second transaction in which gain or loss is not recognized, paragraph (a)(2) or (3) of this section does not apply to a sale of such property by Y in a third transaction if X had acquired the property in a first transaction by a purchase for cash. If, however, X acquired the property from a transferor other than a DISC in the first transaction in which the transferor's realized gain was not recognized, then paragraph (a)(2) or (3) of this section may apply to the sale by Y if the other conditions of such paragraph (a)(2) or (3) are met.

(3) If a DISC acquires property in a second transaction described in subparagraph (1) or (2) of this paragraph in which it (or, in the case of a second transaction described in subparagraph (2) of this paragraph, the transferor DISC) recognizes a portion (but not all) of the realized gain, then the amount described in paragraph (a)(2)(ii) or (a)(3)(ii) of this section with respect to a disposition by the DISC of such acquired property in a third transaction shall not exceed the transferor's gain which was not recognized on the first transaction minus the amount of gain recognized by the DISC (or transferor DISC) on the second transaction.

(4) The provisions of this paragraph may be illustrated by the following examples:

Example 1.  X and Y are corporations each of which qualifies as a DISC and uses the calendar year as its taxable year. In 1972, X acquires section 1245 property in a first transaction in which the transferor's entire realized gain of $17 is not recognized. In 1973, X transfers such property to Y in a second transaction in which X realizes a gain of $20 of which only $4 is recognized. (On December 31, 1973, X's shareholders are treated as having received a deemed distribution of a dividend which includes such $4 under paragraph (a)(3) of this section, provided the limitation in paragraph (b) of this section is met.) In a third transaction in 1974, Y sells such property and recognizes a gain of $25. With respect to Y's shareholders on December 31, 1974, the amount described in paragraph (a)(3)(ii) of this section would be limited to $13, which is the amount of the transferor's gain which was not recognized on the first transaction ($17) minus the amount of gain recognized by X on the second transaction ($4).

Example 2.  Z is a DISC using the calendar year as its taxable year. In a first transaction in 1972, in exchange for its stock, Z acquires section 1245 property from A, an individual who is its sole shareholder, in a transaction in which A's realized gain of $30 is not recognized by reason of the application of section 351(a). In a second transaction in 1973, Z exchanges such property for other property in a like-kind exchange to which section 1031(b) applies and recognizes $10 of a realized gain of $35. (On December 31, 1973, A is treated as having received a deemed distribution of a dividend which includes such $10 under paragraph (a)(3) of this section, provided the limitation in paragraph (b) of this section is met.) In a third transaction in 1974, Z sells the property acquired in the like-kind exchange and recognizes a gain of $25. With respect to A on December 31, 1974, the amount described in paragraph (a)(3)(ii) of this section is limited to $20, which is the amount of A's gain which was not recognized on the first transaction ($30) minus the amount of gain recognized by Z on the second transaction ($10).

(e) Carry back of net operating loss and capital loss to prior DISC taxable year. For purposes of sections 991, 995, and 996, the amount of the deduction for the taxable year under section 172 for a net operating loss carryback or carryover or under section 1212 for a capital loss carryback or carryover shall be determined in the same manner as if the DISC were a domestic corporation which had not elected to be treated as a DISC. Thus, the amount of the deduction will be the same whether or not the corporation was a DISC in the year of the loss or in the year to which the loss is carried. For provisions setting forth adjustments to the DISC's, or former DISC's, deemed distributions, adjustments to its divisions of earnings and profits, and other tax consequences arising from such carrybacks, see §1.996–8.

(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal Revenue Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10); 90 Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))

[T.D. 7324, 39 FR 35110, Sept. 30, 1974, as amended by T.D. 7862, 47 FR 56492, Dec. 17, 1982; T.D. 7984, 49 FR 40018, Oct. 12, 1984]

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