In a chief counsel advice memorandum (CCA 201421015), the IRS ruled that a loss disallowed under Section 311(a) reduced a shareholder's basis in S corporation stock and reduced the S corporation's accumulated adjustment account (AAA).
In general, Section 311(a), which applies to both C corporations and S corporations, provides that a corporation does not recognize loss on the distribution of built-in loss property to its shareholders. Section 1367(a)(2)(D) states that a shareholder's basis in S corporation stock must be decreased by any S corporation expense that is not deductible in computing taxable income and cannot be properly charged to capital. Similarly, Treas. Reg. Sec. 1.1368-2(a)(3) provides that an S corporation's AAA must be decreased by any S corporation expense that is not deductible in computing taxable income and cannot be properly charged to capital.
In CCA 201421015, the taxpayer, an S corporation, distributed certain real estate to its shareholder. The S corporation's basis in the distributed real estate was greater than the fair market value of the real estate at the time of the distribution. As a result, the distributing S corporation realized a loss on the distribution, but the loss was permanently disallowed under Section 311(a).
The IRS ruled that the distributing S corporation and transferee shareholder must treat the Section 311(a) loss as a nondeductible, noncapital expense in determining the shareholder's stock basis and the S corporation's AAA. Thus, the Section 311(a) loss caused a downward adjustment to the shareholder's basis in the S corporation stock and to the S corporation's AAA.
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