Rev. Rul. 56-303

Advice has been requested as to the Federal income tax consequences of a transfer by a corporation of cash and unimproved real property to its newly organized wholly-owned subsidiary in exchange for stock and short-term notes of the subsidiary corporation.

M corporation owns and operates a retail department store in the downtown section of a large city. Prior to 1950, it did not own any real property unrelated to the operation of its store. In 1950, the corporation determined to open an additional retail store in an outlying section of the city. After considerable study with respect to appropriate locations, it purchased 100 acres of land. Solely as a protective measure to maintain the value of this acreage for retail store purposes, the corporation also purchased a plot having 1,000 feet of frontage on the opposite side of the highway.

Architects were employed and plot plans were prepared for the most efficient shape and arrangement of the new store and supplemental shopping center on the 100-acre tract. However, before actual working drawings could be commenced, an independent speculator informed the corporation that he had acquired 300 acres of land adjacent to the corporation's property. This 300-acre tract appeared clearly to be more suitable for the construction of an outstanding store and shopping center and to offer better access and more satisfactory parking facilities. In addition, the corporation was faced with the possibility that this tract might be acquired by a competitor or that it might be developed in a way which would otherwise adversely affect the corporation's contemplated store. For these reasons, it purchased the 300-acre tract late in the year 1950.

After new plot plans and working drawings were completed, it was decided to erect the proposed store and shopping center with attendant parking facilities on 180 acres of the 300-acre tract. Accordingly, in 1951, the corporation organized a subsidiary, N corporation, and conveyed the said 180 acres and cash to N corporation in exchange for stock of the latter corporation. The second corporation proceeded to construct the store, shopping center, and parking facilities. The project was completed early in 1954.

M corporation, which is engaged exclusively in the retail department store business, originally acquired all of the above-mentioned land solely for the purpose of establishing its new branch store and to protect the growth thereof. Apart from the transfer of the 180 acres to N corporation, the parent corporation has not attempted in any way to sell or otherwise dispose of any of the remaining land so acquired. Nor has it taken any steps or made any effort to improve or develop any of such vacant remaining land.

Some or all of the remaining land has increased in value. Now that its new branch store is in operation, M corporation desired to convert into cash its investment in some part of the remaining land. At the same time, the corporation was continuing to engage exclusively in the retail department store business and was unwilling itself to understake in any degree to develop and improve or otherwise hold any of such remaining land primarily for sale in the ordinary course of business. It was not to the best interests of the corporation for any of such lands to be developed or improved along lines competitive or otherwise prejudicial to the successful operation of its branch store.

In these circumstances, the M corporation formed a new corporation, O corporation, with an authorized capital stock of 10,000 common shares of the par value of $10 each. Thereupon, it transferred to the new corporation 150x dollars in cash and a portion of the 100-acre tract originally purchased. In exchange for such cash and land, the new corporation transferred to the M corporation 6,000 shares of its common stock and short-term negotiable interest-bearing promissory notes of the new corporation in the aggregate face amount of 600x dollars. All of the notes will mature in less than four years, the average period being about two and one-half years.

This portion of such tract of land had a total basis to M corporation of 400x dollars. The fair market value of the land at the date of the transaction was 1,000x dollars.

The O corporation contemplates putting in streets and curbing, laying down sidewalks, building sewers and other facilities, and otherwise subdividing and improving the land for sale to purchasers, in lots or otherwise, for residential and/or industrial and commercial construction and occupancy.

M corporation is continuing to hold the balance of the unimproved land solely for investment purposes. Though it has no present fixed intention with regard to the disposition of this property, it may eventually transfer part or all of such remaining unimproved property to the O corporation or sell it direct to a prospective purchaser.

Section 351 of the Internal Revenue Code of 1954, relating to a transfer to a corporation controlled by the transferor, provides in part:

(a) GENERAL RULE.--No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. * * *

(b) RECEIPT OF PROPERTY.--If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock or securities permitted to be received under subsection (a), other property or money, then--

(1) gain (if any) to such recipient shall be recognized, but not in excess of--

(A) the amount of money received, plus

(B) the fair market value of such other property received; and

(2) no loss to such recipient shall be recognized.

Accordingly, based solely upon the facts in the instant case, it is held as follows:

(1) Pursuant to the provisions of section 351(b) of the Code, the gain realized by M corporation on the exchange, measured by the excess of (a) the fair market value on the date of the exchange of 6,000 shares of common stock of the new corporation, plus the short-term promissory notes, over (b) the basis to the M corporation of that portion of the original 100-acre tract, plus 150x dollars, is recognized, but in an amount not in excess of the fair market value of the said short-term promissory notes. Such recognized gain constitutes a capital gain, subject to the provisions of Subchapter P of Chapter 1 of the Code.

(2) Under section 362(a)(1) of such Code, the basis of the said land in the hands of the O corporation is the same as the basis of the property in the hands of M corporation, increased in the amount of gain recognized to M corporation on the transfer.