Reg. § 1.1296-1 Mark to market election for marketable stock.
(a) Definitions
(1) Eligible RIC An eligible RIC is a regulated investment company that offers for sale, or has outstanding, any stock of which it is the issuer and which is redeemable at net asset value, or that publishes net asset valuations at least annually.
(2) Section 1296 stock The term section stock means marketable stock in a passive foreign investment company (PFIC), including any PFIC stock owned directly or indirectly by an eligible RIC, for which there is a valid section election. Section stock does not include stock of a foreign corporation that previously had been a PFIC, and for which a section election remains in effect.
(3) Unreversed inclusions
(i) General rule The term unreversed inclusions means with respect to any section stock, the excess, if any, of—
(A) The amount of mark to market gain included in gross income of the United States person under of this section with respect to such stock for prior taxable years; over
(B) The amount allowed as a deduction to the United States person under of this section with respect to such stock for prior taxable years.
(ii) Section 1291 adjustment The amount referred to in of this section shall include any amount subject to section under the coordination rule of of this section.
(iii) Example An example of the computation of unreversed inclusions is as follows:
Example. A, a United States person, acquired stock in Corp X, a foreign corporation, on January 1, 2005 for $150. At such time and at all times thereafter, Corp X was a PFIC and A's stock in Corp X was marketable. For taxable years 2005 and 2006, Corp X was a nonqualified fund subject to taxation under section . A made a timely section election with respect to the X stock, effective for taxable year 2007. The fair market value of the X stock was $200 as of December 31, 2006, and $240 as of December 31, 2007. Additionally, Corp X made no distribution with respect to its stock for the taxable years at issue. In 2007, pursuant to of this section, A must include the $90 gain in the X stock in accordance with the rules of section for purposes of determining the deferred tax amount and any applicable interest. Nonetheless, for purposes of determining the amount of the unreversed inclusions pursuant to of this section, A will include the $90 of gain that was taxed under section and not the interest thereon.
(iv) Special rule for regulated investment companies In the case of a regulated investment company which had elected to mark to market the PFIC stock held by such company as of the last day of the taxable year preceding such company's first taxable year for which such company makes a section election, the amount referred to in of this section shall include amounts previously included in gross income by the company pursuant to such mark to market election with respect to such stock for prior taxable years. For further guidance, see Notice 92-53 (1992-2 C.B. 384) (see also 601.601(d)(2) of this chapter).
(b) Application of section 1296 election
(1) In general Any United States person and any controlled foreign corporation (CFC) that owns directly, or is treated as owning under this section, marketable stock, as defined in , in a PFIC may make an election to mark to market such stock in accordance with the provisions of section and this section.
(2) Election applicable to specific United States person A section election applies only to the United States person (or CFC that is treated as a U.S. person under of this section) that makes the election. Accordingly, a United States person's section election will not apply to a transferee of section stock.
(3) Election applicable to specific corporation only A section election is made with respect to a single foreign corporation, and thus a separate section election must be made for each foreign corporation that otherwise meets the requirements of this section. A United States person's section election with respect to stock in a foreign corporation applies to all marketable stock of the corporation that the person owns directly, or is treated as owning under of this section, at the time of the election or that is subsequently acquired.
(c) Effect of election
(1) Recognition of gain If the fair market value of section stock on the last day of the United States person's taxable year exceeds its adjusted basis, the United States person shall include in gross income for its taxable year the excess of the fair market value of such stock over its adjusted basis (mark to market gain).
(2) Character of gain Mark to market gain, and any gain on the sale or other disposition of section stock, shall be treated as ordinary income.
(3) Recognition of loss If the adjusted basis of section stock exceeds its fair market value on the last day of the United States person's taxable year, such person shall be allowed a deduction for such taxable year equal to the lesser of the amount of such excess or the unreversed inclusions with respect to such stock (mark to market loss).
(4) Character of loss
(i) Losses not in excess of unreversed inclusions Any mark to market loss allowed as a deduction under of this section, and any loss on the sale or other disposition of section stock, to the extent that such loss does not exceed the unreversed inclusions attributable to such stock, shall be treated as an ordinary loss, deductible in computing adjusted gross income.
(ii) Losses in excess of unreversed inclusions Any loss recognized on the sale or other disposition of section stock in excess of any prior unreversed inclusions will be subject to the rules generally applicable to losses provided elsewhere in the Internal Revenue Code and the regulations thereunder.
(5) Application of election to separate lots of stock In the case in which a United States person purchased or acquired shares of stock in a PFIC at different prices, the rules of this section shall be applied in a manner consistent with the rules of .
(6) Source rules The source of any amount included in gross income under of this section, or the allocation and apportionment of any amount allowed as a deduction under of this section, shall be determined in the same manner as if such amounts were gain or loss (as the case may be) from the sale of stock in the PFIC.
(7) Examples The following examples illustrate this :
Example 1. Treatment of gain as ordinary income. A, a United States individual, purchases stock in FX, a foreign corporation that is not a PFIC, in 1990 for $1,000. On January 1, 2005, when the fair market value of the FX stock is $1,100, FX becomes a PFIC. A makes a timely section election for taxable year 2005. On December 31, 2005, the fair market value of the FX stock is $1,200. For taxable year 2005, A includes $200 of mark to market gain (the excess of the fair market value of FX stock ($1,200) over A's adjusted basis ($1,000)) in gross income as ordinary income and pursuant to of this section increases his basis in the FX stock by that amount.
Example 2. Treatment of gain as capital gain. The facts are the same as in Example 1. For taxable year 2006, FX does not satisfy either the asset test or the income test of section . A does not revoke the section election it made with respect to the FX stock. On December 1, 2006, A sells the FX stock when the fair market value of the stock is $1,500. For taxable year 2006, A includes $300 of gain (the excess of the fair market value of FX stock ($1,500) over A's adjusted basis ($1,200)) in gross income as long-term capital gain because at the time of sale of the FX stock by A, FX did not qualify as a PFIC, and, therefore, the FX stock was not section stock at the time of the disposition. Further, A's holding period for non-PFIC purposes was more than one year.
Example 3. Treatment of losses as ordinary where they do not exceed unreversed inclusions. The facts are the same as in Example 1. On December 1, 2006, A sells the stock in FX for $1,100. At that time, A's unreversed inclusions (the amount A included in income as mark to market gain) with respect to the stock in FX are $200. Accordingly, for taxable year 2006, A recognizes a loss on the sale of the FX stock of $100, (the fair market value of the FX stock ($1,100) minus A's adjusted basis ($1,200) in the stock) that is treated as an ordinary loss because the loss does not exceed the unreversed inclusions attributable to the stock of FX.
Example 4. Treatment of losses as long-term capital losses. The facts are the same as in Example 3, except that FX does not satisfy either the asset test or the income test of section for taxable year 2006. For taxable year 2006, A's $100 loss from the sale of the FX stock is treated as long-term capital loss because at the time of the sale of the FX stock by A FX did not qualify as a PFIC, and, therefore, the FX stock was not section stock at the time of the disposition. Further, A's holding period in the FX stock for non-PFIC purposes was more than one year.
Example 5. Long-term capital loss treatment of losses in excess of unreversed inclusions. The facts are the same as in Example 3, except that A sells his FX stock for $900. At the time of A's sale of the FX stock on December 1, 2006, A's unreversed inclusions with respect to the FX stock are $200. Accordingly, the $300 loss recognized by A on the disposition is treated as an ordinary loss to the extent of his unreversed inclusions ($200). The amount of the loss in excess of A's unreversed inclusions ($100) will be treated as a long-term capital loss because A's holding period in the FC stock for non-PFIC purposes was more than one year.
Example 6. Application of section 1296 election to separate lots of stock. On January 1, 2005, Corp A, a domestic corporation, purchased 100 shares (first lot) of stock in FX, a PFIC, for $500 ($5 per share). On June 1, 2005, Corp A purchased 100 shares (second lot) of FX stock for $1,000 ($10 per share). Corp A made a timely section election with respect to its FX stock for taxable year 2005. On December 31, 2005, the fair market value of FX stock was $8 per share. For taxable year 2005, Corp A includes $300 of gain in gross income as ordinary income under of this section with respect to the first lot, and adjusts its basis in that lot to $800 pursuant to of this section. With respect to the second lot, Corp A is not permitted to recognize a loss under of this section for taxable year 2005. Although Corp A's adjusted basis in that stock exceeds its fair market value by $200, Corp A has no unreversed inclusions with respect to that particular lot of stock. On July 1, 2006, Corp A sells 100 shares of FX stock for $900. Assuming that Corp A adequately identifies (in accordance with the rules of ) the shares of FX stock sold as being from the second lot, Corp A recognizes $100 of long term capital loss pursuant to of this section.
(d) Adjustment to basis
(1) Stock held directly The adjusted basis of the section stock shall be increased by the amount included in the gross income of the United States person under of this section with respect to such stock, and decreased by the amount allowed as a deduction to the United States person under of this section with respect to such stock.
(2) Stock owned through certain foreign entities
(i) In the case of section stock that a United States person is treated as owning through certain foreign entities pursuant to of this section, the basis adjustments under of this section shall apply to such stock in the hands of the foreign entity actually holding such stock, but only for purposes of determining the subsequent treatment under chapter 1 of the Internal Revenue Code of the United States person with respect to such stock. Such increase or decrease in the adjusted basis of the section stock shall constitute an adjustment to the basis of partnership property only with respect to the partner making the section election. Corresponding adjustments shall be made to the adjusted basis of the United States person's interest in the foreign entity and in any intermediary entity described in of this section through which the United States person holds the PFIC stock.
(ii) Example The following example illustrates this :
Example. FP is a foreign partnership. Corp A, a domestic corporation, owns a 20 percent interest in FP. Corp B, a domestic corporation, owns a 30 percent interest in FP. Corp C, a foreign corporation, with no direct or indirect shareholders that are U.S. persons, owns a 50% interest in FP. Corp A, Corp B, and FP all use a calendar year for their taxable year. In 2005, FP purchases stock in FX, a foreign corporation and a PFIC, for $1,000. Corp A makes a timely section election for taxable year 2005. On December 31, 2005, the fair market value of the PFIC stock is $1,100. Corp A includes $20 of ordinary income in taxable year 2005 under and of this section. Corp A increases its basis in its FP partnership interest by $20. FP increases its basis in the FX stock to $1,020 solely for purposes of determining the subsequent treatment of Corp A, under chapter 1 of the Internal Revenue Code, with respect to such stock. In 2006, FP sells the FX stock for $1,200. For purposes of determining the amount of gain of Corp A, FP will be treated as having $180 in gain of which $20 is allocated to Corp A. Corp A's $20 of gain will be treated as ordinary income under of this section. For purposes of determining the amount of gain attributable to Corp B, FP will be treated as having $200 gain, $60 of which will be allocated to Corp B.
(3) Stock owned indirectly by an eligible RIC of this section shall also apply to an eligible RIC which is an indirect shareholder under of stock in a PFIC and has a valid section election in effect with respect to the PFIC stock.
(4) Stock acquired from a decedent In the case of stock of a PFIC that is acquired by bequest, devise, or inheritance (or by the decedent's estate) and with respect to which a section election was in effect as of the date of the decedent's death, notwithstanding section or section , the basis of such stock in the hands of the person so acquiring it shall be the adjusted basis of such stock in the hands of the decedent immediately before his death (or, if lesser, the basis that would have been determined under section or section without regard to this ).
(5) Transition rule for individuals becoming subject to United States income taxation
(i) In general If any individual becomes a United States person in a taxable year beginning after December 31, 1997, solely for purposes of this section, the adjusted basis, before adjustments under this , of any section stock owned by such individual on the first day of such taxable year shall be treated as being the greater of its fair market value or its adjusted basis on such first day.
(ii) An example of the transition rule for individuals becoming subject to United States income taxation is as follows:
Example. A, a nonresident alien individual, purchases marketable stock in FX, a PFIC, for $50 in 1995. On January 1, 2005, A becomes a United States person and makes a timely section election with respect to the stock in accordance with of this section. The fair market value of the FX stock on January 1, 2005, is $100. The fair market value of the FX stock on December 31, 2005, is $110. Under of this section, A computes the amount of mark to market gain or loss for the FX stock in 2005 by reference to an adjusted basis of $100, and therefore A includes $10 in gross income as mark to market gain under of this section. Additionally, under of this section, A's adjusted basis in the FX stock for purposes of this section is increased to $110 (and to $60 for all other tax purposes). A sells the FX stock in 2006 for $120. For purposes of applying section , A must use its original basis of $50, with any adjustments under of this section, $10 in this case, and therefore A recognizes $60 of gain. Under of this section (which is applied using an adjusted basis of $110), $10 of such gain is treated as ordinary income. The remaining $50 of gain from the sale of the FX stock is long term capital gain because A held such stock for more than one year.
(e) Stock owned through certain foreign entities
(1) In general Except as provided in of this section, the following rules shall apply in determining stock ownership for purposes of this section. PFIC stock owned, directly or indirectly, by or for a foreign partnership, foreign trust (other than a foreign trust described in sections through ), or foreign estate shall be considered as being owned proportionately by its partners or beneficiaries. PFIC stock owned, directly or indirectly, by or for a foreign trust described in sections through shall be considered as being owned proportionately by its grantors or other persons treated as owners under sections through of any portion of the trust that includes the stock. The determination of a person's proportionate interest in a foreign partnership, foreign trust or foreign estate will be made on the basis of all the facts and circumstances. Stock considered owned by reason of this paragraph shall, for purposes of applying the rules of this section, be treated as actually owned by such person.
(2) Stock owned indirectly by eligible RICs The rules for attributing ownership of stock contained in will apply to determine the indirect ownership of PFIC stock by an eligible RIC.
(f) Holding period Solely for purposes of sections through , if section applied to stock with respect to the taxpayer for any prior taxable year, the taxpayer's holding period in such stock shall be treated as beginning on the first day of the first taxable year beginning after the last taxable year for which section so applied.
(g) Special rules
(1) Certain dispositions of stock To the extent a United States person is treated as actually owning stock in a PFIC under of this section, any disposition which results in the United States person being treated as no longer owning such stock, and any disposition by the person owning such stock, shall be treated as a disposition by the United States person of the stock in the PFIC.
(2) Treatment of CFC as a United States person In the case of a CFC that owns, or is treated as owning under of this section, section stock:
(i) Other than with respect to the sourcing rules in of this section, this section shall apply to the CFC in the same manner as if such corporation were a United States person. The CFC will be treated as a foreign person for purposes of applying the source rules of paragraph (c)(6).
(ii) For purposes of subpart F of part III of subchapter N of the Internal Revenue Code—
(A) Amounts included in the CFC's gross income under or of this section shall be treated as foreign personal holding company income under section ; and
(B) Amounts allowed as a deduction under of this section shall be treated as a deduction allocable to foreign personal holding company income for purposes of computing net foreign base company income under .
(iii) A United States shareholder, as defined in section , of the CFC shall not be subject to section with respect to any stock of the PFIC for the period during which the section election is in effect for that stock, and the holding period rule of of this section shall apply to such United States shareholder.
(iv) The rules of this shall not apply to a United States person that is a shareholder of the PFIC for purposes of section , but is not a United States shareholder under section with respect to the CFC making a section election.
(3) Timing of inclusions for stock owned through certain foreign entities In the case of section stock that a United States person is treated as owning through certain foreign entities pursuant to of this section, the mark to market gain or mark to market loss is determined in accordance with and of this section as of the last day of the taxable year of the foreign partnership, foreign trust or foreign estate and then included in the taxable year of such United States person that includes the last day of the taxable year of the entity.
(h) Elections
(1) Timing and manner for making a section 1296 election
(i) United States persons A United States person that owns marketable stock in a PFIC, or is treated as owning marketable stock under of this section, on the last day of the taxable year of such person, and that wants to make a section election, must make a section election for such taxable year on or before the due date (including extensions) of the United States person's income tax return for that year. The section election must be made on the Form 8621, “Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund”, included with the original tax return of the United States person for that year, or on an amended return, provided that the amended return is filed on or before the election due date.
(ii) Controlled foreign corporations A section election by a CFC shall be made by its controlling United States shareholders, as defined in , and shall be included with the Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations”, for that CFC by the due date (including extensions) of the original income tax returns of the controlling United States shareholders for that year. A section election by a CFC shall be binding on all United States shareholders of the CFC.
(iii) Retroactive elections for PFIC stock held in prior years A late section election may be permitted only in accordance with .
(2) Effect of section 1296 election
(i) A section election will apply to the taxable year for which such election is made and remain in effect for each succeeding taxable year unless such election is revoked or terminated pursuant to of this section.
(ii) Cessation of a foreign corporation as a PFIC A United States person will not include mark to market gain or loss pursuant to of this section with respect to any stock of a foreign corporation for any taxable year that such foreign corporation is not a PFIC under section or treated as a PFIC under section (taking into account the holding period rule of of this section). Cessation of a foreign corporation's status as a PFIC will not, however, terminate a section election. Thus, if a foreign corporation is a PFIC in a taxable year after a year in which it is not treated as a PFIC, the United States person's original election (unless revoked or terminated in accordance with of this section) continues to apply and the shareholder must include any mark to market gain or loss in such year.
(3) Revocation or termination of election
(i) In general A United States person's section election is terminated if the section stock ceases to be marketable; if the United States person elects, or is required, to mark to market the section stock under another provision of chapter 1 of the Internal Revenue Code; or if the Commissioner, in the Commissioner's discretion, consents to the United States person's request to revoke its section election upon a finding of a substantial change in circumstances. A substantial change in circumstances for this purpose may include a foreign corporation ceasing to be a PFIC.
(ii) Timing of termination or revocation Where a section election is terminated automatically (e.g., the stock ceases to be marketable), section will cease to apply beginning with the taxable year in which such termination occurs. Where a section election is revoked with the consent of the Commissioner, section will cease to apply beginning with the first taxable year of the United States person after the revocation is granted unless otherwise provided by the Commissioner.
(4) Examples The operation of the rules of this is illustrated by the following examples:
Example 1. A, a United States person, owns stock in FX, a PFIC. A makes a QEF election in 1996 with respect to the FX stock. For taxable year 2005, A makes a timely section election with respect to its stock, and thus its QEF election is automatically terminated pursuant to . In 2006, A's stock in FX ceases to be marketable, and therefore its section election is automatically terminated under of this section. Beginning with taxable year 2006, A is subject to the rules of section with respect to its FX stock unless it makes a new QEF election. See .
Example 2. The facts are the same as in Example 1, except that A's stock in FX becomes marketable again in 2007. A may make a new section election with respect to the FX stock for its taxable year 2007, or thereafter. A will be subject to the coordination rules under of this section unless it made a new QEF election in 2006.
(i) Coordination rules for first year of election
(1) In general Notwithstanding any provision in this section to the contrary, the rules of this shall apply to the first taxable year in which a section election is effective with respect to marketable stock of a PFIC if such foreign corporation was a PFIC for any taxable year, prior to such first taxable year, during the United States person's holding period (as defined in of this section) in such stock, and for which such corporation was not treated as a QEF with respect to such United States person.
(2) Shareholders other than regulated investment companies For the first taxable year of a United States person (other than a regulated investment company) for which a section election is in effect with respect to the stock of a PFIC, such United States person shall, in lieu of the rules of and of this section—
(i) Apply the rules of section to any distributions with respect to, or disposition of, section stock;
(ii) Apply section to the amount of the excess, if any, of the fair market value of such section stock on the last day of the United States person's taxable year over its adjusted basis, as if such amount were gain recognized from the disposition of stock on the last day of the taxpayer's taxable year; and
(iii) Increase its adjusted basis in the section stock by the amount of excess, if any, subject to section under of this section.
(3) Shareholders that are regulated investment companies For the first taxable year of a regulated investment company for which a section election is in effect with respect to the stock of a PFIC, such regulated investment company shall increase its tax under section by the amount of interest that would have been imposed under section for such taxable year if such regulated investment company were subject to the rules of of this section, and not this . No deduction or increase in basis shall be allowed for the increase in tax imposed under this .
(4) The operation of the rules of this is illustrated by the following examples:
Example (1). A, a United States person and a calendar year taxpayer, owns marketable stock in FX, a PFIC that it acquired on January 1, 1992. At all times, A's FX stock was a nonqualified fund subject to taxation under section . A made a timely section election effective for taxable year 2005. At the close of taxable year 2005, the fair market value of A's FX stock exceeded its adjusted basis by $10. Pursuant to of this section, A must treat the $10 gain under section as if the FX stock were disposed of on December 31, 2005. Further, A increases its adjusted basis in the FX stock by the $10 in accordance with of this section.
Example (2). Assume the same facts as in Example (1), except that A is a RIC that had not made an election prior to 2005 to mark to market the PFIC stock. In taxable year 2005, A includes $10 of ordinary income under of this section, and such amount is not subject to section . A also increases its tax imposed under section by the amount of interest that would have been determined under section , and no deduction is permitted for such amount. Finally, under of this section, A increases its adjusted basis in the FX stock by $10.
(j) Effective/applicability date The provisions in this section are applicable for taxable years beginning on or after May 3, 2004. The provisions of of this section relating to section are effective on and after January 19, 2017.
[T.D. 9123, 69 FR 24074, May 3, 2004, as amended by T.D. 9811, 82 FR 6242, Jan. 19, 2017]