Rev. Rul. 72-137

Advice has been requested whether, under the circumstances described below, all of the assets of a corporation are considered to be distributed in complete liquidation within the meaning of section 331 of the Internal Revenue Code of 1954 so as to satisfy the requirements of section 337 of the Code.

A corporation, whose stock was owned by 25 individuals, was engaged in the sand and gravel business. Because its deposits of sand and gravel were playing out, the shareholders of the corporation, on December 28, 1969, approved and adopted a plan of complete liquidation requiring the sale of the assets, distribution of the proceeds or remaining assets, surrender and cancellation of the stock, and dissolution of the corporation. Pursuant to the plan, the corporation sold all of its assets except its real property for cash. Part of the real property consisted of a parcel of land from which the corporation continued to receive payments pursuant to a lease with a tenant farmer. Within the 12-month period specified in section 337 of the Code, the corporation distributed pro rata to its shareholders all of its assets except for 10x dollars and the real property. However, the corporation, within the 12-month period, transferred the 10x dollars and real property to a trust for the benefit of the shareholders with an independent trustee selected by the shareholders, which trust was permissible under state law.

The real property was transferred to the trust because the corporation had been unable to sell it at a fair price during the 12-month period. The property's marketability would be seriously impaired if distributed in undivided fractional interests to the corporation's shareholders. The corporation transferred the 10x dollars to the trust to meet claims against the corporation consisting of known liabilities and contingent liabilities that were not feasible to settle during the 12-month period.

The possibility of not being able to sell all of the corporation's property was recognized when the plan was adopted so that the plan authorized the Board of Directors to call a special meeting of the shareholders for the purpose of the shareholders' selecting a liquidating trustee and establishing the terms and conditions of an indenture of trust. The purpose of the trust was limited to receiving the property, selling the property, maintaining and collecting the income from the property prior to sale, collecting the proceeds of sale and distributing to the beneficiary-shareholders the net income and proceeds of the property. The trust indenture provided that the trust would terminate upon sale of the property and distribution of the proceeds or at the end of one year, subject to extension for not more than three years by unanimous consent of the beneficiary-shareholders. There was no objective to carry on a business and divide the gains therefrom. The trust is classified as a trust for Federal income tax purposes under Subpart E, Subchapter J, Chapter 1, Subtitle A of the Code and not as an association taxable as a corporation.

Section 337(a) of the Code states the general rule that, if a corporation adopts a plan of complete liquidation, and within a 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims, then no gain or loss will be recognized to such corporation from the sale or exchange by it of property within such 12-month period.

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

Section 1.337-2(b) of the Income Tax Regulations provides, in part, that the nonrecognition provisions of section 337 of the Code will not apply unless all of the corporate assets (other than those retained to meet claims) are distributed within 12-months after the date of the adoption of the plan of complete liquidation. In addition, section 1.337-2(b) of the regulations provides that a corporation will be considered to have distributed all of its property other than assets retained to meet claims even though it has retained an amount of cash equal to its known liabilities and liquidating expenses plus an amount of cash set aside under arrangements for the payment after the close of 12-month period of unascertained or contingent liabilities and contingent expenses.

Revenue Ruling 63-245, C.B. 1963-2, 144, provides that where an asset is not reasonably susceptible of sale or distribution among the shareholders within the 12-month period, the complete transfer of the asset within such period to a trustee selected by the shareholders will be considered a distribution of the asset by the corporation to the shareholders, provided such transfer is permissible under the applicable state law. Since the real property in the instant case was not reasonably susceptible of sale or distribution among the shareholders during the 12-month period, the transfer of the real property to the trustee of the grantor trust is considered a distribution by the corporation of the real property to the shareholders within such period. See also Revenue Ruling 65-257, C.B. 1965-2, 89.

The transfer by the corporation of the 10x dollars to the trustee is also considered a distribution by the corporation of this property. The ability of the corporation to retain assets for the purpose of meeting expected or contingent claims, as provided in section 1.337-2(b) of the regulations, does not prevent an alternative procedure of transferring funds to a trustee for the same purpose.

Accordingly, under the foregoing circumstances, the transfer by the corporation of the real property and the 10x dollars to an independent trustee on behalf of the shareholders was a distribution within the 12-month period described in section 337 of the Code and therefore the corporation distributed all of its assets within such period in complete liquidation within the meaning of section 331(a)(1) of the Code. Thus, the provisions of section 337 of the Code are applicable to the corporation.

In addition to the property distributed directly to the shareholders, the distribution of property to the trust also constitutes a distribution of property in complete liquidation to the shareholders in exchange for their stock under section 331(a)(1) of the Code since the shareholders are considered the owners of the trust. The amount of such distribution is reduced by the amount of known liabilities. See Revenue Ruling 59-228, C.B. 1959-2, 59. If in a subsequent year, the shareholders or the trust discharge a contingent liability of the corporation, such discharge will give rise to a capital loss in the year of discharge. See F. Donald Arrowsmith v. Commissioner, 344 U.S. 6 (1952), Ct. D. 1752, C.B. 1952-2, 136.

Since the shareholders are considered the "owners" of the trust and are taxable on the income therefrom, any income which is taxable to the shareholders should not be reported on Form 1041, but such income and the amount of deductions and credits applicable thereto should be shown in a separate statement to be attached to Form 1041 (see section 1.671-4 of the regulations).