FINAL REGS DESCRIBE WHEN TRANSFERS TO INVESTMENT COMPANIES WILL NOT CAUSE DIVERSIFICATION.

The IRS has issued final regulations (T.D. 8663) under section 351(e) relating to transfers to investment companies. The regulations describe when some transfers will not cause a diversification of the transferors' interests.

Proposed regulations (CO-19-95) were issued in August 1995. (For a summary, see TaxPractice, Aug. 21, 1995, p. 235.) The final rules add reg. section 1.351-1(c)(6) and concern the 25 percent and 50 percent tests of section 368(a)(2)(F)(ii).

In response to comments, the final regs clarify that government securities, although included in total assets, are not treated as "securities of an issuer" for purposes of the numerator of the 25 percent and 50 percent tests.

The IRS did not follow a suggestion that the final regulations clarify that any person, not merely corporate transferors, may satisfy the modified diversification test. The IRS explained that it does not intend to limit application of the final regs to corporate transferors, and it pointed out that under the regs a portfolio "will be diversified if it satisfies the 25 percent and 50 percent tests of section 368(a)(2)(F)(ii) (as modified), rather than section 368(a)(2)(F)(ii), generally."

The IRS also declined a suggestion to adopt a rule that transfers of real property would not result in diversification of the transferors' interests if each transferor transfers a diversified portfolio of real property to a real estate investment trust.

Generally, the final regulations are effective as of May 2, 1996. Taxpayers who transfer diversified, but nonidentical, portfolios of stocks and securities before May 2 may choose to treat the transfers consistent with the final regs or as transfers resulting in diversification. Transfers completed on or after May 2 are subject to the final regs.

FULL TEXT: 61 F.R. 19544-19546; Doc 96-13188 (3 pages)