Section 336: Liquidation Gains, Loss Limits, and 337 Exception

A corporation in complete liquidation under Section 336 of the Internal Revenue Code generally recognizes gain or loss on every asset it distributes to shareholders, computed as if the corporation had sold each asset to the shareholder at fair market value on the distribution date. That single deemed-sale rule is the heart of the statute. Everything else, including the parent-subsidiary exception, the loss-limitation rules, and the elective deemed asset sale, is either a carve-out from that rule or a targeted restriction on it.

How the Deemed Sale Works

Section 336(a) treats a distribution of property in complete liquidation as a sale of that property at fair market value.¹ The corporation compares fair market value against adjusted basis to compute gain or loss on each asset. Land with a $100,000 adjusted basis and a $500,000 fair market value produces $400,000 of gain when distributed, exactly as if the corporation had sold the land for cash. The result is the same whether the corporation distributes assets in kind or sells them first and distributes the proceeds.

At the current 21% federal corporate rate, this first layer of tax can absorb a meaningful share of the assets before shareholders receive anything. The gain is reported on the corporation’s final Form 1120 with the “Final return” box checked.²

Liabilities Set a Floor on Value

Section 336(b) prevents a corporation from claiming an artificially low value on encumbered property. If distributed property is subject to a liability, or a shareholder assumes a liability in connection with the distribution, the fair market value of the property is treated as no less than the amount of the liability.¹ A building with a $200,000 adjusted basis, a $350,000 fair market value, and a $400,000 mortgage produces a deemed sale price of $400,000 rather than $350,000, pushing the recognized gain from $150,000 up to $200,000. The IRS has historically taken the position that contingent liabilities are disregarded for this purpose, with the shareholder taking a capital loss later if and when the contingent liability is paid.

Character of the Gain

Not every dollar of recognized gain is taxed the same way. Depreciable personal property such as equipment and vehicles triggers Section 1245 depreciation recapture, which recharacterizes gain as ordinary income to the extent of prior depreciation.³ Real property improvements can trigger partial Section 1250 recapture. Land and investment capital assets generally produce capital gain. A corporation liquidating with heavily depreciated equipment often faces an effective bill larger than the headline rate suggests, because a big slice of the gain is ordinary rather than capital in character.

Losses the Corporation Cannot Deduct

Section 336 allows loss recognition as a general matter, but two targeted rules cut off losses in the situations Congress viewed as most susceptible to abuse. Both target contrived losses; neither affects gain.

Related-Party Distributions

A liquidating corporation cannot recognize a loss on property distributed to a related person if either the distribution is not pro rata or the property is “disqualified property.”¹ Related persons are defined by reference to Section 267, which reaches family members, trusts, and entities linked through specified ownership. Disqualified property is any asset the corporation acquired in a Section 351 transaction or as a capital contribution during the five years ending on the distribution date, along with property whose basis is determined by reference to such contributed property. If a controlling shareholder transferred depreciated property into the corporation three years ago and the corporation now distributes it back in liquidation, no loss is allowed.

Built-In Loss Property

Section 336(d)(2) reaches further, targeting property contributed to a corporation as part of a plan to generate a liquidation loss. When the corporation acquired property through a Section 351 transfer or capital contribution, and that acquisition is treated as part of a plan with a principal purpose of recognizing loss on liquidation, the corporation’s adjusted basis in that property is reduced by the built-in loss that existed when the property came in.¹ The reduction equals the excess of adjusted basis at contribution over fair market value at that time.

An asset contributed with an $80,000 basis and a $50,000 value one year before the liquidation plan is adopted has its basis reduced to $50,000 for the loss calculation, stripping out the $30,000 built-in loss that existed on day one. Any property acquired within two years before the plan is adopted is presumed to have been acquired as part of a loss-generating plan, and the taxpayer must prove otherwise.

The Parent-Subsidiary Exception Under Section 337

The largest carve-out from Section 336 applies when a subsidiary liquidates into its parent corporation. Section 337 provides that the liquidating subsidiary recognizes no gain or loss on property distributed to an “80-percent distributee,” meaning a corporate parent that meets the ownership requirements of Section 332.⁴ This exception is mandatory when its conditions are met. A parent cannot elect out to trigger a loss on the subsidiary’s depreciated assets.

The 80% Test

The parent must own stock meeting Section 1504(a)(2): at least 80% of the subsidiary’s total voting power and at least 80% of the total value of the subsidiary’s stock.⁵ The ownership must exist on the date the plan of liquidation is adopted and continue uninterrupted until the subsidiary finishes transferring all of its property.

Timing

Section 332(b) requires that the liquidation either be completed within a single taxable year or, if the distributions span multiple years, that all property transfer within three years from the close of the taxable year in which the first liquidating distribution is made.⁶ Missing the three-year window, or dropping below 80% at any point, blows the entire liquidation out of Section 332. Every distribution then falls back under the general Section 336 rules, and the tax must be recomputed year by year.

Carryover Basis to the Parent

When Section 332 applies, the parent takes the subsidiary’s historical adjusted basis in each received asset rather than a fair-market-value basis.⁷ The built-in gain is preserved and will be recognized when the parent eventually sells or disposes of the property. The tax is deferred, not eliminated.

Minority Shareholders

The Section 337 non-recognition rule reaches only distributions to the qualifying 80% parent. Property distributed to minority shareholders falls back under Section 336, but with an asymmetric result: the subsidiary must recognize gain on appreciated property distributed to minority shareholders, but cannot recognize loss on property distributed to them.¹ Appreciated property produces tax; depreciated property does not produce a deduction.

The Section 336(e) Deemed Asset Sale Election

Section 336(e) is a separate mechanism that reaches asset-sale tax treatment without a formal liquidation. When a parent corporation sells at least 80% of a subsidiary’s stock within a 12-month period, the seller and buyer can jointly elect to treat the transaction as if the subsidiary sold all of its assets to an unrelated party on the date of the stock disposition.⁸ The subsidiary recognizes gain or loss on the deemed asset sale, and the stock sale itself is treated as a non-taxable event for the seller. The buyer takes a stepped-up basis in the subsidiary’s assets, which is the payoff that motivates the election.

Section 336(e) is broader than the more familiar Section 338(h)(10) election. A 338(h)(10) election requires that the buyer be a corporation; a 336(e) election can apply when the buyer is an individual, a partnership, or another non-corporate acquirer. Section 336(e) also reaches certain non-sale dispositions such as distributions and exchanges, as long as the 80% threshold is met within 12 months.

When the target is an S corporation, every S corporation shareholder, including those who do not dispose of stock, must enter into a written binding agreement to make the election, executed no later than the due date (including extensions) of the S corporation’s federal income tax return for the year of the disposition.⁸ A single holdout can block the election.

S Corporations

Section 336’s deemed-sale rule applies to S corporations as well as C corporations. An S corporation distributing appreciated property in a complete liquidation recognizes gain on each asset as if sold at fair market value. Because the S corporation is a pass-through, that gain flows through to shareholders rather than being taxed at the entity level.

One trap catches recently converted corporations. If an S corporation was previously a C corporation and still has built-in gains from the C period, the Section 1374 built-in gains tax can impose a corporate-level tax on those gains on top of the shareholder-level pass-through. The recognition period is generally five years after the S election takes effect, so a corporation that converts and then liquidates inside that window can face an unexpected corporate bill on pre-conversion appreciation.

Filing Requirements

A liquidating corporation must file IRS Form 966 within 30 days after the board adopts a resolution or plan of dissolution or liquidation, with a certified copy of the resolution or plan attached.⁹ If the plan is amended, a new Form 966 must be filed within 30 days of the amendment, referencing the original filing date.

The final Form 1120 reports all Section 336 gain and loss, including depreciation recapture, and must have the “Final return” box checked.² Missing the 30-day Form 966 deadline does not change the tax owed, but it is a procedural miss that can draw IRS attention. Articles of dissolution must also be filed with the relevant secretary of state, with fees and procedures that vary by jurisdiction.

1
Office of the Law Revision Counsel. 26 U.S. Code 336 – Gain or Loss Recognized on Property Distributed in Complete Liquidation
2
Internal Revenue Service. U.S. Corporation Income Tax Return – Form 1120
3
Office of the Law Revision Counsel. 26 U.S. Code 1245 – Gain From Dispositions of Certain Depreciable Property
4
Office of the Law Revision Counsel. 26 U.S. Code 337 – Nonrecognition for Property Distributed to Parent in Complete Liquidation of Subsidiary
5
Office of the Law Revision Counsel. 26 USC 1504
6
GovInfo. 26 USC 332 – Complete Liquidations of Subsidiaries
7
Office of the Law Revision Counsel. 26 USC 334
8
eCFR. 26 CFR 1.336-2 – Availability, Mechanics, and Consequences of Section 336(e) Election
9
Internal Revenue Service. Form 966 – Corporate Dissolution or Liquidation