Rev. Rul. 73-423

Advice has been requested as to the Federal income tax consequences of the transfer of an installment obligation in a transaction described in section 351 of the Internal Revenue Code of 1954 under the circumstances described below.

A, an individual, sold certain business assets for 710x dollars to X, a corporation in which he owned 78 percent of the outstanding stock. A received 10x dollars in cash at the time of the sale and a note executed by X for the balance of the purchase price (700x dollars) which was to be paid, with interest, in equal annual installments over a ten year period. A elected to report the gain on the sale on the installment method under section 453 of the Code. Three years later, in response to X's need for working capital, A transferred the installment obligation to X in return for shares of X stock equal in value to the fair market value at that time of the installment obligation. The stock of X received by A in this transaction, together with the stock of X already owned by A, amounted to more than eighty percent of X's outstanding stock. The fair market value of the X stock received in the exchange exceeded A's basis in the obligation as determined under section 453(d)(2). The installment obligation was cancelled on X's books after the transfer.

Section 351(a) of the Code states, in part, that no gain or loss will be recognized if property is transferred to a corporation solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.

Section 453(d)(1) of the Code states 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 to the extent of the difference between the basis of the obligation and (A) the amount realized, in the case of satisfaction at other than face value or a sale or exchange, or (B) the fair market value of the obligation at the time of distribution, transmission, or disposition, in the case of the distribution, transmission, or disposition otherwise than by sale or exchange. Section 453(d)(2) provides that the basis of an installment obligation is the excess of the face value of the obligation over an amount equal to the income which would be returnable if the obligation were satisfied in full.

Section 1.453-9(c)(2) of the Income Tax Regulations provides, in part, that certain dispositions of an installment obligation, including transfers to corporations under section 351 of the Code, will result in no gain or loss under section 453(d).

The transfer of the installment obligation by A in exchange for X stock accomplishes a satisfaction of the installment obligation at other than its face value under section 453(d)(1)(A) of the Code. Furthermore, the nonrecognition rules of section 1.453-9(c) of the regulations are not applicable where an installment obligation is satisfied under section 453(d)(1)(A) rather than distributed, transmitted or disposed of under section 453(d)(1)(B), since when a satisfaction occurs the installment obligation ceases to exist.

See Rev. Rul. 72-264, 1972-1 C.B. 131, which discusses a situation where a taxpayer sells his stock in a corporation to another corporation for cash and debentures (convertible into stock of the purchasing corporation) evidencing deferred installment payments due from the purchasing corporation for the balance of the purchase price of the stock. Rev. Rul. 72-264 holds that the conversion of the debentures by the taxpayer into stock of the debtor-corporation is a satisfaction of the installment obligation at other than its face value under section 453(d)(1)(A) of the Code, and, therefore, the taxpayer must recognize gain or loss to the extent of the difference between the amount realized determined under section 1001(b) and the basis of the obligation determined under section 453(d)(2).

Since the transfer of the installment obligation by A in exchange for X stock accomplishes a satisfaction of the installment obligation at other than its face value under section 453(d)(1)(A) of the Code, gain must be recognized by A, even though the exchange meets the requirements of section 351, to the extent of the difference between the amount realized determined under section 1001(b) (the fair market value of the X stock received in exchange for X's installment obligation) and the basis of the installment obligation determined under section 453(d)(2).

Under section 1032(a) of the Code, X does not recognize any gain or loss from the transaction since it received property (its own installment obligation) in exchange for shares of X stock. See Jack Ammann Photogrammetric Engineers, Inc. v. Commissioner, 341 F.2d 466 (5th Cir. 1965).