On October 16, 2026, the U.S. Department of the Treasury and the Internal Revenue Service published final regulations (T.D. 10059) addressing the treatment of certain liabilities assumed in section 351 transactions between members of a consolidated group. The guidance clarifies that certain liabilities, principally those whose payment would give rise to a deduction, do not reduce the transferor member’s basis in the transferee member’s stock. Although narrow, the new rules resolve a long-standing coordination question involving sections 357 and 358 and the consolidated return rules under Treasury Regulation (“Treas. Reg.”) section 1.1502-80. These final regulations are particularly relevant to consolidated groups undertaking internal restructurings involving transfers of assets and liabilities among group members.
Generally Applicable Rules
Section 351 generally provides that no gain or loss is recognized when one or more persons transfer property to a corporation solely in exchange for its stock and the transferor(s) control the corporation immediately after the exchange. If the transferor receives money or other property (i.e., “boot”) in addition to stock, the transferor generally must recognize gain up to the amount of that boot.[1] A transferee’s assumption of the transferor’s liabilities is generally not treated as boot and does not prevent the exchange from qualifying for nonrecognition.[2]
However, section 357(c) generally requires the transferor to recognize gain when the liabilities assumed exceed the aggregate adjusted basis of the transferred property. Section 357(c)(3)(A) generally excludes from the calculation of section 357(c) gain liabilities whose payment would give rise to a deduction and certain obligations described in section 736(a).[3]
Section 358 separately determines the transferor’s basis in the stock received. The transferor generally starts with the basis of the transferred property, reduces that basis by money and other property received, and increases it by gain recognized. Under section 358(d)(1), an assumed liability generally is treated as money received and therefore reduces the transferor’s stock basis. However, liabilities whose payment would give rise to a deduction (i.e., liabilities as described in section 357(c)(3)(A)) are excluded from this stock basis reduction.[4]
How the Rules Differ Within a Consolidated Group
Treas. Reg. section 1.1502-80(d)(1) provides that section 357(c) does not apply to a transaction subject to the intercompany transaction rules of Treas. Reg. section 1.1502-13, including intragroup section 351 exchanges to which those rules apply. Accordingly, an intragroup section 351 exchange generally cannot trigger section 357(c) gain, even where liabilities assumed are in excess of basis, because section 357(c) does not apply to such transactions.[5]
Section 358 nevertheless continues to determine the transferor member’s basis in the transferee member’s stock. This raised a technical question: If section 357(c) does not apply to an intragroup exchange, does section 358(d)(2) continue to exclude qualifying section 357(c)(3)(A) liabilities from the stock-basis reduction?
The final regulations confirm that it does. Revised Treas. Reg. section 1.1502-80(d)(1) provides that section 358(d)(2) excludes liabilities described in section 357(c)(3)(A) from the liabilities treated as money received under section 358(d)(1). The exclusion does not apply to liabilities also described in section 357(c)(3)(B), and therefore other assumed liabilities that are capitalized into the basis of property may reduce stock basis and may either create or increase an excess loss account.
The final regulations illustrate the rule with an example in which S1 transfers assets with a $30 aggregate adjusted basis to a newly formed subsidiary, S2, in exchange for S2 stock and S2’s assumption of $40 of liabilities. Of those liabilities, $5 is described in section 357(c)(3)(A), but not section 357(c)(3)(B), while the remaining $35 is not described in section 357(c)(3)(A). Because the transfer is an intragroup section 351 exchange, section 357(c) does not apply, so there cannot be gain recognition under that rule. For purposes of determining S1’s basis in the S2 stock, the $5 qualifying liability is excluded, while the remaining $35 reduces S1’s $30 basis. S1 therefore has a $5 excess loss account in the S2 stock.
Since section 357(c) does not apply, S1 recognizes no section 357(c) gain that would correspondingly increase its stock basis under section 358. The example highlights an important distinction from the rules outside consolidation. Assume the same facts as above, except that S1 and S2 are not members of a consolidated group. Outside of consolidation, section 357(c) applies, resulting in $5 of section 357(c) gain. Therefore, in determining S1’s basis in S2’s stock, S1’s $30 carryover basis is increased by the $5 of gain recognized and decreased by the $35 of liabilities not described in section 357(c)(3)(A), resulting in $0 stock basis.
History and Applicability of the Final Regulations
Treas. Reg. section 1.1502-80 was enacted in 1992. Treasury and the IRS proposed coordinating rules for certain liabilities in 2001, withdrew those proposed rules in 2023 as part of a broader regulatory modernization project, and reproposed substantially the same approach as the 2001 proposed rules in 2024. The final regulations adopt the 2024 proposal with only non-substantive revisions after Treasury and the IRS received no comments and no request for a public hearing.
The final regulations apply to transactions occurring in consolidated return years for which the due date of the return, determined without regard to extensions, is after the regulations’ publication date.
The revised rules do not apply if the transferor or transferee becomes a nonmember of the consolidated group as part of the same plan or arrangement. Accordingly, an internal transfer connected with a planned sale or other deconsolidating transaction may require additional analysis.
Practical Considerations
Consolidated groups should regularly monitor stock basis in their subsidiary members, as the general tax basis rules (including those described above) as well as those under Treas. Reg. section 1.1502-13 create a complex web of adjustments that dictate basis in subsidiary stock. Understanding tax basis in subsidiary stock is particularly important when considering a sale, liquidation, or other disposition of a member. Taxpayers that monitor subsidiary stock basis may also become aware of built-in losses in member stock that can be monetized into a capital or even ordinary loss and deduction.
WilliamsMarston advises clients on the federal income tax consequences of corporate transactions and internal restructurings, including section 351 exchanges, consolidated return matters (including excess loss accounts), and stock basis calculations. Companies that file a consolidated return or that are contemplating an internal or external transaction should consult with WilliamsMarston to evaluate the application and potential tax consequences of these rules.
[1] Section 351(b).
[2] Section 357(a).
[3] To the extent the incurrence of a liability created or increased the basis of property, the liability is not eligible for the section 357(c)(3)(A) exclusion. Section 357(c)(3)(B).
[4] Section 358(d)(2).
[5] This is because the consolidated return regulations permit excess loss accounts with respect to member stock, a term signifying that the tax basis in a consolidated group member can be negative. See Treas. Reg. sections 1.1502-32 and 1.1502-19.
