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to which C corporations are subject. Such an eligible
corporation may elect, under the provisions of section 1362, to
be an S corporation with the consent of all its shareholders.
Section 1374 was enacted in 1986 to prevent corporations from
electing to be S corporations for the purpose of avoiding tax on
built-in gains. Tax Reform Act of 1986, Pub. L. 99-514, sec.
633(d)(8), 100 Stat. 2280. Section 1374 requires that if a
corporation holds appreciated capital assets before it makes an
election under section 1362, and any of the appreciated capital
assets are sold within 10 years of the election, it will be
subject to corporate-level tax on the amount the corporation
realizes over its basis in the sold assets (built-in gain). The
corporation is taxed only on the built-in gain present on the
effective date of the election; any gain after the effective date
is passed through to the corporation’s shareholders. Therefore,
if an asset with built-in gain has uncertain value, the proper
valuation date for the asset is the effective date of the
corporation’s election.
Petitioner agrees that because it elected to be an S
corporation as of January 1, 1997, it will be taxed on the built-
in gain on its assets as of that date. The parties dispute the
value of petitioner’s primary asset, the water right, on that
date.
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