[Federal Register Volume 63, Number 18 (Wednesday, January 28, 1998)]
[Rules and Regulations]
[Pages 4168-4174]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-1820]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8762]
RIN 1545-AB43
Installment Obligations Received From Liquidating Corporations
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the use
of the installment method to report the gain recognized by a
shareholder who receives, in exchange for the shareholder's stock,
certain installment obligations that are distributed upon the complete
liquidation of a corporation. Changes to the applicable tax law were
made by the Installment Sales Revision Act of 1980 and the Tax Reform
Act of 1986. These regulations affect taxpayers who receive installment
obligations in exchange for their stock upon the complete liquidation
of a corporation.
DATES: This regulation is effective January 28, 1998.
For dates of applicability, see Sec. 1.453-11(e) of these
regulations.
FOR FURTHER INFORMATION CONTACT: George F. Wright, (202) 662-4950 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Section 453(h), relating to the tax treatment of installment
obligations received by a shareholder from a liquidating corporation,
was added to the Internal Revenue Code of 1954 by the Installment Sales
Revision Act of 1980, Pub. L. 96-471, 94 Stat. 2247, 2250. Proposed
regulations under section 453(h) were published in the Federal Register
for January 13, 1984 (49 FR 1742). Subsequently, section
[[Page 4169]]
453(h) was amended as part of the Tax Reform Act of 1986, Pub. L. 99-
514, 100 Stat. 2085, 2274, pursuant to which both C and S corporations
became subject to tax upon making liquidating distributions of
installment obligations to shareholders. The Technical and
Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat. 3342,
3403, added section 453B(h), which provides that no gain or loss is
recognized by S corporations with respect to certain liquidating
distributions of installment obligations. The regulations proposed on
January 13, 1984 (49 FR 1742), were withdrawn by the notice of proposed
rulemaking published on January 22, 1997 (62 FR 3244), except for
paragraph (e) relating to liquidating distributions received in more
than one taxable year, and paragraph (g) containing the effective date
provision. The notice of proposed rulemaking published in the Federal
Register for January 22, 1997, reserved paragraph (d) for liquidating
distributions received in more than one taxable year. Written comments
responding to this notice were received. No public hearing was held
because no hearing was requested. After consideration of all comments
received, the proposed regulations are adopted as revised by this
Treasury decision.
Explanation of Provisions
A. Overview of Provisions
Prior to the Installment Sales Revision Act of 1980, a shareholder
recognized gain or loss on receipt of an installment obligation that
was distributed by a liquidating corporation in exchange for the
shareholder's stock. Gain could not be reported under the installment
sale provisions of section 453 as payments were received on the
obligation distributed by the corporation in the liquidation.
As enacted by the Installment Sales Revision Act of 1980 and
amended by the Tax Reform Act of 1986, section 453(h) provides a
different treatment for certain installment obligations that are
distributed in a complete liquidation to which section 331 applies.
Under section 453(h), a shareholder that does not elect out of the
installment method treats the payments under the obligation, rather
than the obligation itself, as consideration received in exchange for
the stock. The shareholder then takes into account the income from the
payments under the obligation using the installment method. In this
manner, the shareholder generally is treated as if the shareholder sold
the shareholder's stock to an unrelated purchaser on the installment
method.
This treatment under section 453(h) applies generally to
installment obligations received by a shareholder (in exchange for the
shareholder's stock) in a complete liquidation to which section 331
applies if (a) the installment obligations are qualifying installment
obligations, i.e., the installment obligations are acquired in respect
of a sale or exchange of property by the corporation during the 12-
month period beginning on the date a plan of complete liquidation is
adopted, and (b) the liquidation is completed within that 12-month
period. However, an installment obligation acquired in a sale or
exchange of inventory, stock in trade, or property held for sale in the
ordinary course of business qualifies for this treatment only if the
obligation arises from a single bulk sale of substantially all of such
property attributable to a trade or business of the corporation. If an
installment obligation arises from both a sale or exchange of
inventory, etc., that does not comply with the requirements of the
preceding sentence and a sale or exchange of other assets, the portion
of the installment obligation that is attributable to the sale or
exchange of other assets is a qualifying installment obligation.
B. Discussion of Comments
Interaction of Section 453(h) and Limitations on the Installment Method
The regulations provide that, if the stock of a liquidating
corporation is traded on an established securities market, an
installment obligation received by a shareholder from that corporation
as a liquidating distribution is not a qualifying installment
obligation and does not qualify for installment reporting, regardless
of whether the requirements of section 453(h) are otherwise satisfied.
However, if an installment obligation is received by a shareholder from
a liquidating corporation whose stock is not publicly traded, and the
obligation arose from a sale by the corporation of stock or securities
that are traded on an established market, then the obligation generally
is a qualifying installment obligation in the hands of the transferor.
An exception to the above rule applies if the liquidating corporation
is formed or availed of for a principal purpose of avoiding limitations
on the availability of installment sales treatment, such as section
453(k), through the use of a related party.
One commentator suggested that the anti-abuse rule directed at
cases in which there is a principal purpose to avoid section 453(k) is
not necessary. The commentator suggests that the effect of a
contribution of publicly-traded stock to a nonpublicly-traded
corporation, followed by the sale of the publicly-traded stock for an
installment obligation and the liquidation of the nonpublicly-traded
corporation, is the creation of two levels of tax because the
liquidating corporation must recognize gain on the distribution of the
installment obligation. Accordingly, the commentator does not believe
that the transaction offers any tax avoidance opportunities that
warrant a specific anti-abuse rule.
The anti-abuse rule is directed at circumvention of the prohibition
in section 453(k) against the use of the installment method for a sale
of publicly-traded securities. It is designed to prevent a shareholder
from indirectly entering into such a sale on the installment method
when the shareholder could not have done so through a direct sale.
Accordingly, the anti-abuse rule has been retained.
Liquidating Distributions Received in More Than One Year
Under Sec. 1.453-2(e) proposed on January 13, 1984, if liquidating
distributions, including qualifying installment obligations, are
received in more than one taxable year, a shareholder must file an
amended return if the reallocation of basis required under section
453(h)(2) affects the computation of gain recognized in an earlier
year. If the shareholder has transferred the installment obligation to
a person whose basis in the obligation is determined by reference to
the shareholder's basis, then the transferee generally is required to
reallocate basis and, if necessary, file an amended return. The
proposed effective date applied to distributions of qualifying
installment obligations made after March 31, 1980.
In the preamble to the 1997 proposed regulations, the IRS and
Treasury Department suggested that an alternative to the amended return
requirement would be to require the shareholder to recognize in the
current year the additional amount of gain that would have been
recognized in the earlier year had the total amount of the liquidating
distributions been known in the earlier year. Comments were requested
regarding these and any other methods of accomplishing the basis
reallocation. Proposed Sec. 1.453-11(d) relating to liquidating
distributions received in more than one taxable year was reserved.
One commentator questioned whether amended returns were necessary
and noted that the alternative method
[[Page 4170]]
discussed in the preamble is simpler and less burdensome for taxpayers.
The commentator then suggested an ordering rule as another method of
achieving the intended purpose. Under the proposed ordering rule, basis
first would be allocated to assets other than installment obligations
distributed in the liquidation with the remainder allocated to the
installment obligations. The commentator acknowledged that it might not
be appropriate to implement this approach by regulation without
amending the statute.
The proposed ordering rule does not satisfy the basis reallocation
requirement of section 453(h)(2) and would require complex provisions
to implement it. Accordingly, the suggested approach is not adopted in
the final regulations.
The purpose underlying section 453(h)(2) is to ensure that gain is
recognized in the appropriate year when liquidating distributions are
received in more than one taxable year. The IRS and Treasury Department
believe that this purpose can be substantially fulfilled without
imposing the burden of filing amended returns. Accordingly, the final
regulations incorporate a current-year recognition rule. Under the
current-year recognition rule, a shareholder is required to recognize
in the current year the additional amount of gain that would have been
recognized in the earlier year had the total amount of the liquidating
distributions been known in the earlier year. In allocating basis to
calculate the gain to be reported in the first year in which a
liquidating distribution is received, a shareholder is required to
reasonably estimate the anticipated aggregate distributions. For this
purpose, the shareholder must take into account distributions and other
events occurring up to the time at which the return for the first
taxable year is filed. Section 1.453-2(e) of the 1984 proposal is
adopted as revised by this Treasury decision. The effective date
provision in Sec. 1.453-2(g) of the proposal is not adopted.
Recognition of Gain or Loss to the Distributing Corporation Under
Section 453B
Under section 453B, the disposition of an installment obligation
generally results in the recognition of gain or loss to the transferor.
Thus, in accordance with sections 453B and 336, a C corporation
generally recognizes gain or loss upon the distribution of an
installment obligation to a shareholder in exchange for the
shareholder's stock, including complete liquidations covered by section
453(h). Section 453B(d) provides an exception to this general rule if
the installment obligation is distributed in a liquidation to which
section 337(a) applies (regarding certain complete liquidations of 80
percent or more owned subsidiaries). However, that exception does not
apply to liquidations under section 331.
In the case of a liquidating distribution by an S corporation,
however, section 453B(h) provides that if an S corporation distributes
an installment obligation in exchange for a shareholder's stock, and
payments under the obligation are treated as consideration for the
stock pursuant to section 453(h)(1), then the distribution generally is
not treated as a disposition of the obligation by the S corporation.
Thus, except for purposes of sections 1374 and 1375 (relating to
certain built-in gains and passive investment income), the S
corporation does not recognize gain or loss on the distribution of the
installment obligation to a shareholder in a complete liquidation
covered by section 453(h). One commentator believed that it is
inequitable to allow a shareholder to recognize gain on the installment
basis while the liquidating C corporation has immediate recognition
upon distribution of an obligation. As an alternative, the commentator
suggested that the corporation's tax liability arising from the
distribution of an obligation carry over to the shareholders and be
taken into account by them as payments are received on the obligation.
The suggested approach would be inconsistent with the statutory
provisions of sections 336 and 453B and, accordingly, is not adopted in
the final regulations.
Another commentator requested that the regulations provide relief
from a bunching of income that occurs for shareholders receiving
liquidating distributions from S corporations. The bunching can occur,
for example, by virtue of the interrelationship of the S corporation
and installment sale provisions if, in the year in which assets are
sold, an S corporation receives a payment on an installment obligation
arising from the sale before the corporation liquidates. The
commentator suggested that the regulations allow a shareholder first to
apply the basis in the stock against the initial payment received, with
any remaining basis allocated to any additional payments to be
received. Since the bunching of income results from the successive
application of section 453(c) at the corporate and shareholder levels
and no statutory exception for shareholders of S corporations is
provided, this issue cannot be appropriately addressed in these final
regulations.
Incorporation of Guidance on Section 338(h)(10) Elections
Three commentators suggested that the regulations be expanded to
address the use of the installment method to the sale of stock of a
corporation with respect to which an election under section 338(h)(10)
has been made. This issue does not arise under section 453(h) and is
beyond the scope of these regulations.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the regulations do not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Drafting Information
The principal author of these regulations is George F. Wright of
the Office of Assistant Chief Counsel (Income Tax and Accounting).
However, other personnel from the IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Sec. 1.453-11 also issued under 26 U.S.C. 453(j)(1) and (k). * * *
Par. 2. Section 1.453-11 is added to read as follows:
Sec. 1.453-11 Installment obligations received from a liquidating
corporation.
(a) In general--(1) Overview. Except as provided in section
453(h)(1)(C)
[[Page 4171]]
(relating to installment sales of depreciable property to certain
closely related persons), a qualifying shareholder (as defined in
paragraph (b) of this section) who receives a qualifying installment
obligation (as defined in paragraph (c) of this section) in a
liquidation that satisfies section 453(h)(1)(A) treats the receipt of
payments in respect of the obligation, rather than the receipt of the
obligation itself, as a receipt of payment for the shareholder's stock.
The shareholder reports the payments received on the installment method
unless the shareholder elects otherwise in accordance with
Sec. 15a.453-1(d) of this chapter.
(2) Coordination with other provisions--(i) Deemed sale of stock
for installment obligation. Except as specifically provided in section
453(h)(1)(C), a qualifying shareholder treats a qualifying installment
obligation, for all purposes of the Internal Revenue Code, as if the
obligation is received by the shareholder from the person issuing the
obligation in exchange for the shareholder's stock in the liquidating
corporation. For example, if the stock of a corporation that is
liquidating is traded on an established securities market, an
installment obligation distributed to a shareholder of the corporation
in exchange for the shareholder's stock does not qualify for
installment reporting pursuant to section 453(k)(2).
(ii) Special rules to account for the qualifying installment
obligation--(A) Issue price. A qualifying installment obligation is
treated by a qualifying shareholder as newly issued on the date of the
distribution. The issue price of the qualifying installment obligation
on that date is equal to the sum of the adjusted issue price of the
obligation on the date of the distribution (as determined under
Sec. 1.1275-1(b)) and the amount of any qualified stated interest (as
defined in Sec. 1.1273-1(c)) that has accrued prior to the distribution
but that is not payable until after the distribution. For purposes of
the preceding sentence, if the qualifying installment obligation is
subject to Sec. 1.446-2 (e.g., a debt instrument that has unstated
interest under section 483), the adjusted issue price of the obligation
is determined under Sec. 1.446-2(c) and (d).
(B) Variable rate debt instrument. If the qualifying installment
obligation is a variable rate debt instrument (as defined in
Sec. 1.1275-5), the shareholder uses the equivalent fixed rate debt
instrument (within the meaning of Sec. 1.1275-5(e)(3)(ii)) constructed
for the qualifying installment obligation as of the date the obligation
was issued to the liquidating corporation to determine the accruals of
original issue discount, if any, and interest on the obligation.
(3) Liquidating distributions treated as selling price. All amounts
distributed or treated as distributed to a qualifying shareholder
incident to the liquidation, including cash, the issue price of
qualifying installment obligations as determined under paragraph
(a)(2)(ii)(A) of this section, and the fair market value of other
property (including obligations that are not qualifying installment
obligations) are considered as having been received by the shareholder
as the selling price (as defined in Sec. 15a.453-1(b)(2)(ii) of this
chapter) for the shareholder's stock in the liquidating corporation.
For the proper method of reporting liquidating distributions received
in more than one taxable year of a shareholder, see paragraph (d) of
this section. An election not to report on the installment method an
installment obligation received in the liquidation applies to all
distributions received in the liquidation.
(4) Assumption of corporate liability by shareholders. For purposes
of this section, if in the course of a liquidation a shareholder
assumes secured or unsecured liabilities of the liquidating
corporation, or receives property from the corporation subject to such
liabilities (including any tax liabilities incurred by the corporation
on the distribution), the amount of the liabilities is added to the
shareholder's basis in the stock of the liquidating corporation. These
additions to basis do not affect the shareholder's holding period for
the stock. These liabilities do not reduce the amounts received in
computing the selling price.
(5) Examples. The provisions of this paragraph (a) are illustrated
by the following examples. Except as otherwise provided, assume in each
example that A, an individual who is a calendar-year taxpayer, owns all
of the stock of T corporation. A's adjusted tax basis in that stock is
$100,000. On February 1, 1998, T, an accrual method taxpayer, adopts a
plan of complete liquidation that satisfies section 453(h)(1)(A) and
immediately sells all of its assets to unrelated B corporation in a
single transaction. The examples are as follows:
Example 1. (i) The stated purchase price for T's assets is
$3,500,000. In consideration for the sale, B makes a down payment of
$500,000 and issues a 10-year installment obligation with a stated
principal amount of $3,000,000. The obligation provides for interest
payments of $150,000 on January 31 of each year, with the total
principal amount due at maturity.
(ii) Assume that for purposes of section 1274, the test rate on
February 1, 1998, is 8 percent, compounded semi-annually. Also
assume that a semi-annual accrual period is used. Under Sec. 1.1274-
2, the issue price of the obligation on February 1, 1998, is
$2,368,450. Accordingly, the obligation has $631,550 of original
issue discount ($3,000,000-$2,368,450). Between February 1 and July
31, $19,738 of original issue discount and $75,000 of qualified
stated interest accrue with respect to the obligation and are taken
into account by T.
(iii) On July 31, 1998, T distributes the installment obligation
to A in exchange for A's stock. No other property is ever
distributed to A. On January 31, 1999, A receives the first annual
payment of $150,000 from B.
(iv) When the obligation is distributed to A on July 31, 1998,
it is treated as if the obligation is received by A in an
installment sale of shares directly to B on that date. Under
Sec. 1.1275-1(b), the adjusted issue price of the obligation on that
date is $2,388,188 (original issue price of $2,368,450 plus accrued
original issue discount of $19,738). Accordingly, the issue price of
the obligation under paragraph (a)(2)(ii)(A) of this section is
$2,463,188, the sum of the adjusted issue price of the obligation on
that date ($2,388,188) and the amount of accrued but unpaid
qualified stated interest ($75,000).
(v) The selling price and contract price of A's stock in T is
$2,463,188, and the gross profit is $2,363,188 ($2,463,188 selling
price less A's adjusted tax basis of $100,000). A's gross profit
ratio is thus 96 percent (gross profit of $2,363,188 divided by
total contract price of $2,463,188).
(vi) Under Secs. 1.446-2(e)(1) and 1.1275-2(a), $98,527 of the
$150,000 payment is treated as a payment of the interest and
original issue discount that accrued on the obligation from July 31,
1998, to January 31, 1999 ($75,000 of qualified stated interest and
$23,527 of original issue discount). The balance of the payment
($51,473) is treated as a payment of principal. A's gain recognized
in 1999 is $49,414 (96 percent of $51,473).
Example 2. (i) T owns Blackacre, unimproved real property, with
an adjusted tax basis of $700,000. Blackacre is subject to a
mortgage (underlying mortgage) of $1,100,000. A is not personally
liable on the underlying mortgage and the T shares held by A are not
encumbered by the underlying mortgage. The other assets of T consist
of $400,000 of cash and $600,000 of accounts receivable attributable
to sales of inventory in the ordinary course of business. The
unsecured liabilities of T total $900,000.
(ii) On February 1, 1998, T adopts a plan of complete
liquidation complying with section 453(h)(1)(A), and promptly sells
Blackacre to B for a 4-year mortgage note (bearing adequate stated
interest and otherwise meeting all of the requirements of section
453) in the face amount of $4 million. Under the agreement between T
and B, T (or its successor) is to continue to make principal and
interest payments on the underlying mortgage. Immediately
thereafter, T completes its liquidation by distributing to A its
remaining cash of $400,000 (after
[[Page 4172]]
payment of T's tax liabilities), accounts receivable of $600,000,
and the $4 million B note. A assumes T's $900,000 of unsecured
liabilities and receives the distributed property subject to the
obligation to make payments on the $1,100,000 underlying mortgage. A
receives no payments from B on the B note during 1998.
(iii) Unless A elects otherwise, the transaction is reported by
A on the installment method. The selling price is $5 million (cash
of $400,000, accounts receivable of $600,000, and the B note of $4
million). The total contract price also is $5 million. A's adjusted
tax basis in the T shares, initially $100,000, is increased by the
$900,000 of unsecured T liabilities assumed by A and by the
obligation (subject to which A takes the distributed property) to
make payments on the $1,100,000 underlying mortgage on Blackacre,
for an aggregate adjusted tax basis of $2,100,000. Accordingly, the
gross profit is $2,900,000 (selling price of $5 million less
aggregate adjusted tax basis of $2,100,000). The gross profit ratio
is 58 percent (gross profit of $2,900,000 divided by the total
contract price of $5 million). The 1998 payments to A are $1 million
($400,000 cash plus $600,000 receivables) and A recognizes gain in
1998 of $580,000 (58 percent of $1 million).
(iv) In 1999, A receives payment from B on the B note of $1
million (exclusive of interest). A's gain recognized in 1999 is
$580,000 (58 percent of $1 million).
(b) Qualifying shareholder. For purposes of this section,
qualifying shareholder means a shareholder to which, with respect to
the liquidating distribution, section 331 applies. For example, a
creditor that receives a distribution from a liquidating corporation,
in exchange for the creditor's claim, is not a qualifying shareholder
as a result of that distribution regardless of whether the liquidation
satisfies section 453(h)(1)(A).
(c) Qualifying installment obligation--(1) In general. For purposes
of this section, qualifying installment obligation means an installment
obligation (other than an evidence of indebtedness described in
Sec. 15a.453-1(e) of this chapter, relating to obligations that are
payable on demand or are readily tradable) acquired in a sale or
exchange of corporate assets by a liquidating corporation during the
12-month period beginning on the date the plan of liquidation is
adopted. See paragraph (c)(4) of this section for an exception for
installment obligations acquired in respect of certain sales of
inventory. Also see paragraph (c)(5) of this section for an exception
for installment obligations attributable to sales of certain property
that do not generally qualify for installment method treatment.
(2) Corporate assets. Except as provided in section 453(h)(1)(C),
in paragraph (c)(4) of this section (relating to certain sales of
inventory), and in paragraph (c)(5) of this section (relating to
certain tax avoidance transactions), the nature of the assets sold by,
and the tax consequences to, the selling corporation do not affect
whether an installment obligation is a qualifying installment
obligation. Thus, for example, the fact that the fair market value of
an asset is less than the adjusted basis of that asset in the hands of
the corporation; or that the sale of an asset will subject the
corporation to depreciation recapture (e.g., under section 1245 or
section 1250); or that the assets of a trade or business sold by the
corporation for an installment obligation include depreciable property,
certain marketable securities, accounts receivable, installment
obligations, or cash; or that the distribution of assets to the
shareholder is or is not taxable to the corporation under sections 336
and 453B, does not affect whether installment obligations received in
exchange for those assets are treated as qualifying installment
obligations by the shareholder. However, an obligation received by the
corporation in exchange for cash, in a transaction unrelated to a sale
or exchange of noncash assets by the corporation, is not treated as a
qualifying installment obligation.
(3) Installment obligations distributed in liquidations described
in section 453(h)(1)(E)--(i) In general. In the case of a liquidation
to which section 453(h)(1)(E) (relating to certain liquidating
subsidiary corporations) applies, a qualifying installment obligation
acquired in respect of a sale or exchange by the liquidating subsidiary
corporation will be treated as a qualifying installment obligation if
distributed by a controlling corporate shareholder (within the meaning
of section 368(c)) to a qualifying shareholder. The preceding sentence
is applied successively to each controlling corporate shareholder, if
any, above the first controlling corporate shareholder.
(ii) Examples. The provisions of this paragraph (c)(3) are
illustrated by the following examples:
Example 1. (i) A, an individual, owns all of the stock of T
corporation, a C corporation. T has an operating division and three
wholly-owned subsidiaries, X, Y, and Z. On February 1, 1998, T, Y,
and Z all adopt plans of complete liquidation.
(ii) On March 1, 1998, the following sales are made to unrelated
purchasers: T sells the assets of its operating division to B for
cash and an installment obligation. T sells the stock of X to C for
an installment obligation. Y sells all of its assets to D for an
installment obligation. Z sells all of its assets to E for cash. The
B, C, and D installment obligations bear adequate stated interest
and meet the requirements of section 453.
(iii) In June 1998, Y and Z completely liquidate, distributing
their respective assets (the D installment obligation and cash) to
T. In July 1998, T completely liquidates, distributing to A cash and
the installment obligations respectively issued by B, C, and D. The
liquidation of T is a liquidation to which section 453(h) applies
and the liquidations of Y and Z into T are liquidations to which
section 332 applies.
(iv) Because T is in control of Y (within the meaning of section
368(c)), the D obligation acquired by Y is treated as acquired by T
pursuant to section 453(h)(1)(E). A is a qualifying shareholder and
the installment obligations issued by B, C, and D are qualifying
installment obligations. Unless A elects otherwise, A reports the
transaction on the installment method as if the cash and installment
obligations had been received in an installment sale of the stock of
T corporation. Under section 453B(d), no gain or loss is recognized
by Y on the distribution of the D installment obligation to T. Under
sections 453B(a) and 336, T recognizes gain or loss on the
distribution of the B, C, and D installment obligations to A in
exchange for A's stock.
Example 2. (i) A, a cash-method individual taxpayer, owns all of
the stock of P corporation, a C corporation. P owns 30 percent of
the stock of Q corporation. The balance of the Q stock is owned by
unrelated individuals. On February 1, 1998, P adopts a plan of
complete liquidation and sells all of its property, other than its Q
stock, to B, an unrelated purchaser for cash and an installment
obligation bearing adequate stated interest. On March 1, 1998, Q
adopts a plan of complete liquidation and sells all of its property
to an unrelated purchaser, C, for cash and installment obligations.
Q immediately distributes the cash and installment obligations to
its shareholders in completion of its liquidation. Promptly
thereafter, P liquidates, distributing to A cash, the B installment
obligation, and a C installment obligation that P received in the
liquidation of Q.
(ii) In the hands of A, the B installment obligation is a
qualifying installment obligation. In the hands of P, the C
installment obligation was a qualifying installment obligation.
However, in the hands of A, the C installment obligation is not
treated as a qualifying installment obligation because P owned only
30 percent of the stock of Q. Because P did not own the requisite 80
percent stock interest in Q, P was not a controlling corporate
shareholder of Q (within the meaning of section 368(c)) immediately
before the liquidation. Therefore, section 453(h)(1)(E) does not
apply. Thus, in the hands of A, the C obligation is considered to be
a third-party note (not a purchaser's evidence of indebtedness) and
is treated as a payment to A in the year of distribution.
Accordingly, for 1998, A reports as payment the cash and the fair
market value of the C obligation distributed to A in the liquidation
of P.
(iii) Because P held 30 percent of the stock of Q, section
453B(d) is inapplicable to P. Under sections 453B(a) and 336,
accordingly,
[[Page 4173]]
Q recognizes gain or loss on the distribution of the C obligation. P
also recognizes gain or loss on the distribution of the B and C
installment obligations to A in exchange for A's stock. See sections
453B and 336.
(4) Installment obligations attributable to certain sales of
inventory--(i) In general. An installment obligation acquired by a
corporation in a liquidation that satisfies section 453(h)(1)(A) in
respect of a broken lot of inventory is not a qualifying installment
obligation. If an installment obligation is acquired in respect of a
broken lot of inventory and other assets, only the portion of the
installment obligation acquired in respect of the broken lot of
inventory is not a qualifying installment obligation. The portion of
the installment obligation attributable to other assets is a qualifying
installment obligation. For purposes of this section, the term broken
lot of inventory means inventory property that is sold or exchanged
other than in bulk to one person in one transaction involving
substantially all of the inventory property attributable to a trade or
business of the corporation. See paragraph (c)(4)(ii) of this section
for rules for determining what portion of an installment obligation is
not a qualifying installment obligation and paragraph (c)(4)(iii) of
this section for rules determining the application of payments on an
installment obligation only a portion of which is a qualifying
installment obligation.
(ii) Rules for determining nonqualifying portion of an installment
obligation. If a broken lot of inventory is sold to a purchaser
together with other corporate assets for consideration consisting of an
installment obligation and either cash, other property, the assumption
of (or taking property subject to) corporate liabilities by the
purchaser, or some combination thereof, the installment obligation is
treated as having been acquired in respect of a broken lot of inventory
only to the extent that the fair market value of the broken lot of
inventory exceeds the sum of unsecured liabilities assumed by the
purchaser, secured liabilities which encumber the broken lot of
inventory and are assumed by the purchaser or to which the broken lot
of inventory is subject, and the sum of the cash and fair market value
of other property received. This rule applies solely for the purpose of
determining the portion of the installment obligation (if any) that is
attributable to the broken lot of inventory.
(iii) Application of payments. If, by reason of the application of
paragraph (c)(4)(ii) of this section, a portion of an installment
obligation is not a qualifying installment obligation, then for
purposes of determining the amount of gain to be reported by the
shareholder under section 453, payments on the obligation (other than
payments of qualified stated interest) shall be applied first to the
portion of the obligation that is not a qualifying installment
obligation.
(iv) Example. The following example illustrates the provisions of
this paragraph (c)(4). In this example, assume that all obligations
bear adequate stated interest within the meaning of section 1274(c)(2)
and that the fair market value of each nonqualifying installment
obligation equals its face amount. The example is as follows:
Example. (i) P corporation has three operating divisions, X, Y,
and Z, each engaged in a separate trade or business, and a minor
amount of investment assets. On July 1, 1998, P adopts a plan of
complete liquidation that meets the criteria of section
453(h)(1)(A). The following sales are promptly made to purchasers
unrelated to P: P sells all of the assets of the X division
(including all of the inventory property) to B for $30,000 cash and
installment obligations totalling $200,000. P sells substantially
all of the inventory property of the Y division to C for a $100,000
installment obligation, and sells all of the other assets of the Y
division (excluding cash but including installment receivables
previously acquired in the ordinary course of the business of the Y
division) to D for a $170,000 installment obligation. P sells \1/3\
of the inventory property of the Z division to E for $100,000 cash,
\1/3\ of the inventory property of the Z division to F for a
$100,000 installment obligation, and all of the other assets of the
Z division (including the remaining \1/3\ of the inventory property
worth $100,000) to G for $60,000 cash, a $240,000 installment
obligation, and the assumption by G of the liabilities of the Z
division. The liabilities assumed by G, which are unsecured
liabilities and liabilities encumbering the inventory property
acquired by G, aggregate $30,000. Thus, the total purchase price G
pays is $330,000.
(ii) P immediately completes its liquidation, distributing the
cash and installment obligations, which otherwise meet the
requirements of section 453, to A, an individual cash-method
taxpayer who is its sole shareholder. In 1999, G makes a payment to
A of $100,000 (exclusive of interest) on the $240,000 installment
obligation.
(iii) In the hands of A, the installment obligations issued by
B, C, and D are qualifying installment obligations because they were
timely acquired by P in a sale or exchange of its assets. In
addition, the installment obligation issued by C is a qualifying
installment obligation because it arose from a sale to one person in
one transaction of substantially all of the inventory property of
the trade or business engaged in by the Y division.
(iv) The installment obligation issued by F is not a qualifying
installment obligation because it is in respect of a broken lot of
inventory. A portion of the installment obligation issued by G is a
qualifying installment obligation and a portion is not a qualifying
installment obligation, determined as follows: G purchased part of
the inventory property (with a fair market value of $100,000) and
all of the other assets of the Z division by paying cash ($60,000),
issuing an installment obligation ($240,000), and assuming
liabilities of the Z division ($30,000). The assumed liabilities
($30,000) and cash ($60,000) are attributed first to the inventory
property. Therefore, only $10,000 of the $240,000 installment
obligation is attributed to inventory property. Accordingly, in the
hands of A, the G installment obligation is a qualifying installment
obligation to the extent of $230,000, but is not a qualifying
installment obligation to the extent of the $10,000 attributable to
the inventory property.
(v) In the 1998 liquidation of P, A receives a liquidating
distribution as follows:
------------------------------------------------------------------------
Qualifying Cash and
Item installment other
obligations property
------------------------------------------------------------------------
Cash............................................ ........... $190,000
B note.......................................... $200,000 .........
C note.......................................... $100,000 .........
D note.......................................... $170,000 .........
F note.......................................... ........... $100,000
G note \1\...................................... $230,000 $ 10,000
-----------------------
Total....................................... $700,000 $300,000
------------------------------------------------------------------------
\1\ Face amount $240,000.
(vi) Assume that A's adjusted tax basis in the stock of P is
$100,000. Under the installment method, A's selling price and the
contract price are both $1 million, the gross profit is $900,000
(selling price of $1 million less adjusted tax basis of $100,000),
and the gross profit ratio is 90 percent (gross profit of $900,000
divided by the contract price of $1 million). Accordingly, in 1998,
A reports gain of $270,000 (90 percent of $300,000 payment in cash
and other property). A's adjusted tax basis in each of the
qualifying installment obligations is an amount equal to 10 percent
of the obligation's respective face amount. A's adjusted tax basis
in the F note, a nonqualifying installment obligation, is $100,000,
i.e., the fair market value of the note when received by A. A's
adjusted tax basis in the G note, a mixed obligation, is $33,000 (10
percent of the $230,000 qualifying installment obligation portion of
the note, plus the $10,000 nonqualifying portion of the note).
(vii) With respect to the $100,000 payment received from G in
1999, $10,000 is treated as the recovery of the adjusted tax basis
of the nonqualifying portion of the G installment obligation and
$9,000 (10 percent of $90,000) is treated as the recovery of the
adjusted tax basis of the portion of the note that is a qualifying
installment obligation. The remaining $81,000 (90 percent of
$90,000) is reported as gain from the sale of A's stock. See
paragraph (c)(4)(iii) of this section.
[[Page 4174]]
(5) Installment obligations attributable to sales of certain
property--(i) In general. An installment obligation acquired by a
liquidating corporation, to the extent attributable to the sale of
property described in paragraph (c)(5)(ii) of this section, is not a
qualifying obligation if the corporation is formed or availed of for a
principal purpose of avoiding section 453(b)(2) (relating to dealer
dispositions and certain other dispositions of personal property),
section 453(i) (relating to sales of property subject to recapture), or
section 453(k) (relating to dispositions under a revolving credit plan
and sales of stock or securities traded on an established securities
market) through the use of a party bearing a relationship, either
directly or indirectly, described in section 267(b) to any shareholder
of the corporation.
(ii) Covered property. Property is described in this paragraph
(c)(5)(ii) if, within 12 months before or after the adoption of the
plan of liquidation, the property was owned by any shareholder and--
(A) The shareholder regularly sold or otherwise disposed of
personal property of the same type on the installment plan or the
property is real property that the shareholder held for sale to
customers in the ordinary course of a trade or business (provided the
property is not described in section 453(l)(2) (relating to certain
exceptions to the definition of dealer dispositions));
(B) The sale of the property by the shareholder would result in
recapture income (within the meaning of section 453(i)(2)), but only if
the amount of the recapture income is equal to or greater than 50
percent of the property's fair market value on the date of the sale by
the corporation;
(C) The property is stock or securities that are traded on an
established securities market; or
(D) The sale of the property by the shareholder would have been
under a revolving credit plan.
(iii) Safe harbor. Paragraph (c)(5)(i) of this section will not
apply to the liquidation of a corporation if, on the date the plan of
complete liquidation is adopted and thereafter, less than 15 percent of
the fair market value of the corporation's assets is attributable to
property described in paragraph (c)(5)(ii) of this section.
(iv) Example. The provisions of this paragraph (c)(5) are
illustrated by the following example:
Example. Ten percent of the fair market value of the assets of T
is attributable to stock and securities traded on an established
securities market. T owns no other assets described in paragraph
(c)(5)(ii) of this section. T, after adopting a plan of complete
liquidation, sells all of its stock and securities holdings to C
corporation in exchange for an installment obligation bearing
adequate stated interest, sells all of its other assets to B
corporation for cash, and distributes the cash and installment
obligation to its sole shareholder, A, in a complete liquidation
that satisfies section 453(h)(1)(A). Because the C installment
obligation arose from a sale of publicly traded stock and
securities, T cannot report the gain on the sale under the
installment method pursuant to section 453(k)(2). In the hands of A,
however, the C installment obligation is treated as having arisen
out of a sale of the stock of T corporation. In addition, the
general rule of paragraph (c)(5)(i) of this section does not apply,
even if a principal purpose of the liquidation was the avoidance of
section 453(k)(2), because the fair market value of the publicly
traded stock and securities is less than 15 percent of the total
fair market value of T's assets. Accordingly, section 453(k)(2) does
not apply to A, and A may use the installment method to report the
gain recognized on the payments it receives in respect of the
obligation.
(d) Liquidating distributions received in more than one taxable
year. If a qualifying shareholder receives liquidating distributions to
which this section applies in more than one taxable year, the
shareholder must reasonably estimate the gain attributable to
distributions received in each taxable year. In allocating basis to
calculate the gain for a taxable year, the shareholder must reasonably
estimate the anticipated aggregate distributions. For this purpose, the
shareholder must take into account distributions and other relevant
events or information that the shareholder knows or reasonably could
know up to the date on which the federal income tax return for that
year is filed. If the gain for a taxable year is properly taken into
account on the basis of a reasonable estimate and the exact amount is
subsequently determined the difference, if any, must be taken into
account for the taxable year in which the subsequent determination is
made. However, the shareholder may file an amended return for the
earlier year in lieu of taking the difference into account for the
subsequent taxable year.
(e) Effective date. This section is applicable to distributions of
qualifying installment obligations made on or after January 28, 1998.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Approved: December 18, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 98-1820 Filed 1-27-98; 8:45 am]
BILLING CODE 4830-01-U
