Rev. Rul. 72-264

Advice has been requested as to certain of the Federal income tax consequences following from the sale of corporate stock for cash and convertible debentures and from the conversion of such convertible debentures and the transmission of such debentures otherwise than by sale or exchange. The following illustrates the situations with respect to which advice has been requested.

In 1965, Z corporation offered to purchase all of the outstanding stock of Y corporation at $110 per share. This offer was accepted by A, an individual, who owned 20 shares of Y stock that he had purchased for investment in 1963 at $55 per share.

The agreed price of $110 per share was to be paid as follows: $10 in cash on April 1, 1965, followed by two installments of $50 each on April 1, 1970 and April 1, 1975.

Each of the deferred installments was evidenced by two separate $500 Z debentures in registered form and bearing interest at 6 percent. A therefore received four Z debentures, each with a face amount of $500. Each of the debentures was convertible into common stock of Z, at the option of the holder, upon terms specified in the debenture.

A received $200 in cash on April 1, 1965 and elected on his income tax return for that calendar year to report his gain on the installment method. A received an additional $1000 in cash when the first two debentures came due on April 1, 1970. On June 1, 1971, A exercised his right to convert one of the $500 debentures due April 1, 1975 into common stock of Z. A received 10 shares of Z stock with a fair market value of $80 per share in exchange for the debenture.

On the same day A transferred the other $500 debenture without consideration to his son, B. On June 1, 1971, the fair market value of each $500 debenture due April 1, 1975, was $800.

Section 453(b)(1) of the Internal Revenue Code of 1954 provides, in general, that income from a casual sale or other casual disposition of personal property for a price exceeding $1000 may be returned under the installment method of accounting.

Section 453(d)(1) of the Code provides, in part, that if an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result. In the case of satisfaction at other than face value or a sale or exchange, the measure of gain or loss is the difference between the basis of the obligation and the amount realized. In the case of a disposition, transmission, or disposition otherwise than by sale or exchange, the measure of gain or loss is the difference between the basis of the obligation and the fair market value of the obligation at the time of the distribution, transmission, or disposition.

Section 1.453-9(a) of the Income Tax Regulations provides, in part, that the entire amount of gain or loss resulting from any distribution or satisfaction of installment obligations, computed in accordance with section 453(d) of the Code, is recognized in the taxable year of such disposition or satisfaction and shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received by the taxpayer.

A's election to convert one of the Z debentures that he received on the sale of the Y stock accomplishes a satisfaction of an installment obligation at other than its face value under section 453(d)(1)(A) of the Code. A will therefore recognize gain or loss to the extent of the difference between the amount realized determined under section 1001(b) of the Code and the basis of the obligation determined under section 453(d)(2) of the Code. A's transfer of one of the Z debentures to his son, B, constitutes a disposition of an installment obligation under section 453(d)(1)(B) of the Code. A will therefore recognize gain or loss to the extent of the difference between the fair market value of the installment obligation on the day of disposition and its basis determined under section 453(d)(2) of the Code.

A's gain on the installment sale is determined as follows:

 Proceeds from April 1, 1965 sale ___________________  $2,200.00