Rev. Rul. 66-25

Advice has been requested regarding the Federal income tax consequences of a transfer of the assets of a partnership, which had elected to be taxed as a corporation under section 1361 of the Internal Revenue Code of 1954, to an actual corporation under the circumstances described below.

In 1960, a partnership, consisting of individuals A and B , made an election under section 1361 of the Code to be taxed as a domestic corporation.

In 1964, the enterprise ceased doing business as a partnership and all of its assets were transferred to an actual corporation, organized by A and B , in exchange for stock sufficient to give A and B control of the new corporation within the meaning of section 368(c) of the Code. Thereafter, the business formerly conducted by the partnership was carried on by the corporation.

Section 1361(a) of the Code provides, in effect, that, if certain qualifications are met, the proprietor or the partners of an unincorporated enterprise engaged in the operation of a trade or business may elect to have the enterprise treated as a domestic corporation for Federal income tax purposes. However, section 1361(m) of the Code provides, in part, that, with certain exceptions not here pertinent, a `section 1361 corporation' shall not be considered a corporation for purposes of parts III and IV of subchapter C of the Code, relating to corporate organizations and reorganizations.

Section 1.1361-5(b) of the Income Tax Regulations provides, in part, that if the owners of a section 1361 corporation `* * * cease conducting the business of the enterprise in an unincorporated form the election terminates and the assets of the enterprise are deemed to have been distributed to the owners in a complete liquidation of the section 1361 corporation. The effect of the liquidation on the owners shall be determined under the provisions of section 331, 334(a), and, in appropriate cases, 341. Therefore, if a substantial part of the business is transferred to an actual corporation, the transaction shall be treated as if immediately before the transfer all of the assets of the enterprise had been distributed to the owners in a complete liquidation. Accordingly, the transfer of the assets to the actual corporation shall be treated as a transfer made by the owners in their individual capacities immediately after the liquidation.'

Section 331(a)(1) of the Code provides that amounts distributed in partial or complete liquidation of a corporation will be treated as in full payment in exchange for the stock of the corporation.

Section 1.331-1(b) of the regulations provides, in part, that the gain or loss recognized to a shareholder from a distribution in partial or complete liquidation will be subject to the provisions of sections 1201 through 1223 of the Code, relating to capital gains and losses.

Section 334(a) of the Code provides the general rule that if property is received in a distribution in partial or complete liquidation (other than a distribution to which section 333 of the Code applies), and if gain or loss is recognized on receipt of such property, then the basis of the property in the hands of the distributee shall be the fair market value of such property at the time of the distribution.

Section 351 of the Code, which is in part III of subchapter C of the Code, provides, in part, as follows:

(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. * * *

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(d) CROSS REFERENCES.

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(2) For the basis of stock, securities, or property received in an exchange to which this section applies, see sections 358 and 362.

In view of the specific language of section 1.1361-5(b) of the regulations, the partnership's election under section 1361 of the Code terminated, and the assets of the enterprise are deemed to have been distributed to A and B in a complete liquidation, on the date that the assets of the enterprise were transferred to the actual corporation.

It is assumed that there are no facts which would require taxing the distribution in liquidation under section 341(a) of the Code.

In accordance with the provisions of section 1.1361-5(b) of the regulations, the effect of the liquidation on A and B will be determined under sections 331 and 334(a) of the Code and the transfer of the assets to the actual corporation is treated as a transfer made by A and B in their individual capacities immediately after the liquidation. See Estate of David Wein , 40 T.C. 454 (1963), affirmed per curiam 330 Fed.(2d) 957 (1964) and Estate of J. O. Willett , T.C. Memo. 1964-125.

Based on the foregoing, it is held as follows: (1) Under section 331 of the Code, the gain or loss recognized to A and B from the distribution in liquidation is subject to the provisions of section 1201 through 1223 of the Code, relating to capital gains and losses; (2) under section 334(a) of the Code, the basis of the property of the partnership in the hands of A and B is its fair market value at the time of the distribution; (3) under section 351(a) of the Code no gain or loss will be recognized to A and B upon the transfer of the property received in the liquidation of the partnership to the corporation in exchange for its stock; (4) under section 362(a) of the Code, the basis of the property transferred to the corporation will be the same in its hands as the basis of the property in the hands of A and B immediately prior to the transfer; and (5) under section 358(a)(1) of the Code, the basis of the stock of the corporation received by A and B will be the same as the basis of the property transferred in exchange therefor.

Any earned but unreported income of the unincorporated enterprise at the time of the liquidation (incorporation), is includible in the gross income of the unincorporated enterprise in its final return. See Estate of David Wein, supra, Henry A. Kuckenberg, Transferee, et al. v. Commissioner , 35 T.C. 473 (1960), affirmed in part, 309 Fed.(2d) 202 (1962), certiorari denied, 373 U.S. 909 (1963), and Jud Plumbing & Heating, Inc. v. Commissioner , 5 T.C. 127 (1945), affirmed, 153 Fed.(2d) 681 (1946).