(a) Purpose and scope.—Any direct or indirect disposition of
stock of a section 1291 fund within the meaning of paragraphs (b), (c), (d), and (e) of this section
is taxable to the extent provided in section 1291, this section, and § 1.1291-6. For dispositions of
stock of a section 1291 fund that qualify for nonrecognition treatment, see § 1.1291-6. Gain is
determined on a share-by-share basis and is taxed as an excess distribution as provided in
§ 1.1291-2(e)(2). Unless otherwise provided under another provision of the Code, a loss realized
on a disposition of stock of a section 1291 fund is not recognized.
(b) Disposition.—
(1) In general.—For purposes of this section, a disposition is any transac-
tion or event that constitutes an actual or deemed transfer of property for any purpose of the Code
and the regulations thereunder, including (but not limited to) a sale, exchange, gift, or transfer at
death, an exchange pursuant to a liquidation or section 302(a) redemption, or a distribution
described in section 311, 336, 337, 355(c) or 361(c). For purposes of this paragraph (b), any
person receiving a distribution that qualifies under section 355 will be treated as disposing of all of
its stock in the distributing corporation (whether or not there is an actual disposition of such
stock) in exchange for stock of the distributing corporation, the controlled corporation, or both, as
the case may be.
(2) Change of U.S. residence or citizenship.—If a shareholder of a section 1291 fund
becomes a nonresident alien for U.S. tax purposes, the shareholder will be treated as having
disposed of the shareholder’s stock in the section 1291 fund for purposes of section 1291 on the
last day that the shareholder is a U.S. person. Termination of an election under section 6013(g) is
treated as a change of residence (within the meaning of this paragraph (b)(2)) of the spouse who
was a resident solely by reason of the section 6013(g) election.
(c) Direct disposition of stock of a section 1291 fund.—Except to the extent provided in
§ 1.1291-6, a direct shareholder of a section 1291 fund recognizes all gain that it realizes on a
disposition of the stock of such fund.
(d) Stock of a section 1291 fund used as security for an obligation.—
(1) In general.—Except to
the extent provided in paragraphs (d)(3) and (6) of this section, the use of stock of a section 1291
fund as security for the performance of an obligation of a direct or indirect shareholder (or of a
person related within the meaning of section 267(b) to that shareholder), in connection with a
loan, guarantee, margin account, or otherwise (a pledge of stock), is a transaction that results in a
disposition of the stock of the section 1291 fund within the meaning of paragraph (b) of this
section. Such pledged stock will be treated as having been disposed of on the later of the date
when such stock is first used as security with respect to such obligation, or the first day of the first
taxable year of the foreign corporation as a PFIC. Such pledged stock will be treated as having
been disposed of for consideration equal to the lesser of—
(i) The unpaid principal of the obligation secured by the stock on the date of
disposition; or
(ii) The fair market value of the stock immediately before such disposition.
(2) Indirect pledge.—A pledge of stock of a section 1291 fund, as described in paragraph
(d)(1) of this section, will be deemed to occur if such stock serves indirectly as security for the
performance of an obligation described in that paragraph, and a principal purpose for the structure
of the security arrangement was to avoid the rule of that paragraph.
(3) Requirement of gain realized.—This paragraph (d) does not apply if the shareholder
would realize a loss on an actual disposition of the stock of the section 1291 fund at the time the
obligation was secured by the stock.
(4) Increase in value of pledged stock.—An increase in the value of stock being used to
secure the performance of an obligation will not be treated as a disposition of the stock unless the
pledged stock is used to secure additional principal or new indebtedness.
(5) Adjustment to basis; holding period.—If stock of a section 1291 fund is treated as
disposed of under this paragraph (d), adjustments to basis will be made in accordance with rules
similar to those in § 1.1291-6(b)(4). For the holding period of pledged stock, see § 1.1291-1(h)(5).
(6) Transition rule.—Stock of a section 1291 fund that secured an obligation within the
meaning of paragraph (d)(1) of this section as of the effective date of section 1297(b)(6) is not
treated as disposed of as of the first day of the first taxable year of the foreign corporation as a
PFIC, unless such stock continued to secure such obligation 180 days after the effective date. For
a special effective date pertaining to this rule, see § 1.1291-1(j)(2).
(7) Examples.—The following examples illustrate the operation of this paragraph (d).
Example 1.
On November 20, 1995, X, a U.S. person that was a shareholder of FC, a
section 1291 fund, used its stock in FC, valued immediately before the loan at $120,000, as security
for a $100,000 loan. X’s basis in the stock is $70,000. The pledge is treated as a disposition of the
stock for $100,000, which is the lesser of the loan principal secured by the stock and the fair
market value of the stock. S recognizes $30,000 on the disposition, which gain is taxed as an
excess distribution under section 1291 and § 1.1291-2(e)(2). X’s basis in the FC stock is increased
by $30,000, the amount of gain recognized on the deemed disposition. The holding period of the
pledged stock is not adjusted to reflect the disposition because the full amount of the gain inherent
in the stock was not recognized (see § 1.1291-1(h)(5)).
Example 2.
The facts are the same as in Example 1. In addition, on August 12, 1996, X
borrows an additional $30,000 (for a total outstanding loan balance on that day of $130,000). The
value of the FC stock immediately before the additional loan is $130,000. Pursuant to
§ 1.1291-3(d)(4), there is a disposition within the meaning of § 1.1291-3(d)(1) to the extent the
value of the FC stock secures additional indebtedness. The FC stock first secured a loan of
$100,000, which was less than its full value. The second loan results in a disposition to the extent
that the previously unrecognized appreciation and any additional appreciation secure additional
indebtedness. Accordingly, there is an excess distribution of $30,000. X’s basis in its FC stock is
increased by $30,000, the amount of gain recognized. X’s holding period in the FC stock for
section 1291 purposes is treated as beginning on the day after the effective date of the second
borrowing (see § 1.1291-1(h)(5)).
(e) Indirect dispositions.—
(1) In general.—Except as otherwise provided in this paragraph
(e) and § 1.1291-6, an indirect shareholder of a section 1291 fund is taxable under section 1291 and
this section on an indirect disposition of stock of the section 1291 fund.
(2) Indirect disposition defined.—An indirect disposition is—
(i) Any disposition of stock of a section 1291 fund by its actual owner if such stock is
attributed to an indirect shareholder under § 1.1291-1(b)(8);
(ii) Any disposition, by an indirect shareholder or any other person, of any interest
in a person, if by virtue of such interest the indirect shareholder was treated as owning stock of a
section 1291 fund under § 1.1291-1(b)(8); or
(iii) Any other transaction as a result of which an indirect shareholder’s ownership
of a section 1291 fund is reduced or terminated.
Paragraph (e)(2)(i) of this section applies without regard to whether the indirect shareholder’s
ownership of a section 1291 fund is changed by the disposition. However, paragraph (e)(2)(ii) of
this section does not apply if the disposition does not result in a reduction in the indirect
shareholder’s ownership of the fund or an increase in the basis of the stock of the fund in the
hands of the actual owner.
(3) Examples.—The following examples illustrate paragraph (e)(2) of this section.
Example 1. T, a U.S. person, and M, a foreign person, are equal partners of FP, a foreign
partnership that owns 10 shares of stock of FC, a PFIC. Pursuant to § 1.1291-1(b)(8)(iii), T is an
indirect shareholder of one-half of the shares of FC stock held by FP. T did not elect under section
1295 to treat FC as a QEF. On August 14, 1994, H, a U.S. person, joins the partnership as an equal
partner. As a result of H’s acquisition of one-third of FP, H is an indirect shareholder of one-third
of the FC stock held by FP. H’s acquisition of the FP interest is a disposition pursuant to
§ 1.1291-3(e)(2)(iii), taxable to T, of one-third of T’s interest in the FC stock.
Example 2. E, a U.S. person, and R, a foreign person, each own 50% of the outstanding
stock of Distributing, a foreign corporation that is not a PFIC or a controlled foreign corporation
within the meaning of section 957(a). Distributing owns all the stock of Controlled, a PFIC.
Pursuant to § 1.1291-1(b)(8)(ii)(A), E is an indirect shareholder of Controlled. E did not elect
under section 1295 to treat Controlled as a QEF. In a transaction that qualifies under section
355(a), Distributing distributes all the Controlled stock to R. As a result of the distribution, E’s
interest in Controlled is terminated. The distribution is an indirect disposition of E’s ownership of
Controlled, within the meaning of § 1.1291-3(e)(2)(i), taxable to E under § 1.1291-3(e).
Example 3. C, a U.S. person, owns 51% of the stock of CFC, a foreign corporation that is
not a PFIC. Several foreign persons own the remaining 49% of CFC. CFC owns 100 shares of FYZ,
a PFIC. Pursuant to § 1.1291-1(b)(8)(ii)(A), C is an indirect shareholder of 51 shares of the FYZ
stock held by CFC. C did not elect under section 1295 to treat FYZ as a QEF. To raise capital, CFC
makes a public offering of its stock. After the offering, C owns only 35% of the CFC stock. The
reduction of C’s ownership of CFC terminated C’s indirect ownership of the FYZ stock, and
therefore is an indirect disposition of the FYZ stock, pursuant to § 1.1291-3(e)(2)(iii), taxable to C
under § 1.1291-3(e).
(4) General rules.—
(i) Amount and treatment of gain.—If a shareholder with respect to a
share of stock of a section 1291 fund is taxable on an indirect disposition of that share, the
shareholder is treated as recognizing an amount of gain with respect to that share equal to the
shareholder’s pro rata share of the gain realized by the actual owner of that share (in the case of a
disposition described in paragraph (e)(2)(i) of this section), or the gain the actual owner would
have realized on an actual disposition of such stock (in the case of other dispositions). The gain
taxable to the shareholder is an excess distribution, taxable in the manner provided in
§ 1.1291-2(e)(2). The gain is allocated over the shareholder’s holding period of the stock of the
section 1291 fund as determined in § 1.1291-1(h)(4).
(ii) Coordination with current inclusion rules.—If gain from an indirect disposition
would be taxable to a shareholder under this section, and would, but for this paragraph (e)(4)(ii),
also be included in the gross income of the shareholder under section 551(a), 951(a)(1), or
1293(a), the indirect disposition is taxable only under this section.
(iii) Adjustment to basis; holding period.—The shareholder’s adjusted basis of the
stock or other property that is owned directly by the shareholder and through which ownership of
the section 1291 fund is attributed to the shareholder is increased by the amount of gain
recognized by the shareholder pursuant to paragraph (e)(4)(i) of this section. In addition, solely
for purposes of determining the subsequent treatment under the Code of a direct or indirect
shareholder of the stock of the section 1291 fund treated as transferred in an indirect disposition,
the adjusted basis of the actual owner of the stock of the section 1291 fund is increased by the
amount of gain recognized by the shareholder. For the holding period rule for stock that is treated
as disposed of under paragraph (e)(2) of this section, see § 1.1291-1(h)(5).
(iv) Treatment of previously taxed amounts.—The principles of sections 959 and 961
apply with respect to distributions by a foreign corporation through which a shareholder was
considered to own stock of a section 1291 fund, to the extent that such distributions are
attributable to amounts previously taxed under this paragraph (e) on a disposition of the stock of
such fund.
(5) Pass-through entities.—
(i) Section 1291 fund stock held by former C corporation.—
Solely for purposes of calculating the aggregate amount of interest under § 1.1291-4(d)(1), the S
corporation shareholder’s gain is determined without regard to section 1366(f)(2). Accordingly,
the excess distribution for this purpose includes the amount of the S corporation’s liability for tax
attributable to the built-in gain in the stock of the section 1291 fund pursuant to section 1374. For
an illustration of the rule of this paragraph (e)(5)(i), see § 1.1291-4(e), Example 2. For the taxation
of the S corporation on the disposition of the stock of a section 1291 fund, see section 1374.
(ii) Taxation of trusts, estates, and their beneficiaries.—[Reserved]
(iii) Information reporting.—The information reporting obligations to which pass-
through entities are subject with respect to indirect distributions also apply with respect to indirect
dispositions. See § 1.1291-2(f)(2)(ii).
(6) Exceptions.—
(i) Disposition of PFIC’s wholly-owned PFIC.—A direct shareholder of a
section 1291 fund (first-tier fund) will not be taxable on an indirect disposition of a section 1291
fund (second-tier fund) that is a wholly owned subsidiary of the first-tier fund if the second-tier
fund annually distributed all its earnings and profits for each year that is included in the
shareholder’s holding period of the second-tier fund.
(ii) Other exceptions.—[Reserved]
(f) Transfers within a consolidated group.—For purposes of applying sections 1291 through
1297 to the stock of a PFIC, transfers by one member of a consolidated group to another member
are ignored. Thus, the basis of the transferred stock in the hands of the transferee is the adjusted
basis of such stock in the hands of the transferor, and the holding period of such stock held by a
member of the consolidated group includes the holding period of all members of the group that
have transferred the stock.
(g) Installment sales.—If the gain from a disposition of a share of stock of a section 1291 fund
is reported on the installment basis, there is an excess distribution on the receipt of each
installment or portion thereof in the amount of the gain to be reported in accordance with section
453 with respect to such share. For purposes of allocating each excess distribution under
§ 1.1291-2(e)(2)(i), the holding period of the transferred stock, which begins on the date deter-
mined under § 1.1291-1(h), is treated as ending on the date of each installment.
(h) Series of liquidation distributions.—For purposes of allocating the gain recognized on a
distribution of property that is one of a series of distributions in liquidation of a section 1291 fund,
the holding period of the stock of the liquidating corporation, which begins on the date deter-
mined under § 1.1291-1(h), is treated as ending on the date of each liquidation distribution with
respect to which gain is recognized.
(i) Sections 1246 and 1248 inapplicable.—Sections 1246 and 1248 do not apply to the
disposition of stock of a section 1291 fund that is taxable under section 1291. See sections 1246(g)
and 1248(g)(2).
(j) Estate tax deduction.—If a shareholder acquired the stock of a section 1291 fund from a
decedent (other than a decedent who was a nonresident alien at all times during the holding
period of the stock), and the decedent did not recognize any gain on the transfer of his or her
stock at death pursuant to § 1.1291-6(c)(2)(iii)(A), the shareholder may deduct from gross income,
for the taxable year of the disposition of the stock of the section 1291 fund that is taxable to the
shareholder, an amount equal to that portion of the decedent’s estate tax deemed paid which is
attributable to the excess of (A) the value at which such stock was taken into account for purposes
of determining the value of the decedent’s gross estate, over (B) the value at which it would have
been so taken into account if such value had been the basis of the stock in the hands of the
shareholder determined under § 1.1291-6(b)(4)(iii). [Prop. Reg. § 1.1291-3.]
[Proposed 4-1-92.]