Rev. Rul. 80-221

ISSUE

Whether the nonrecognition of gain provisions of section 311(a) of the Internal Revenue Code apply where a corporation issues its "preferred stock" for cash for the purpose of redeeming the "stock" from the purchaser with appreciated property owned by the corporation.

FACTS

Corporation X is engaged in a manufacturing business and owned a piece of vacant land which it originally acquired for use in its manufacturing business. X abandoned its plans for the use of the land in its business. The land had an adjusted basis of 100x dollars and a fair market value of 10,000x dollars. Y, an unrelated corporation, offered to purchase the land at its fair market value of 10,000x dollars. However, X, in order to avoid the recognition of gain on the sale of the land, entered into the following transaction with Y. On March 31, 1979, Y purchased for 10,000x dollars one share of 10,000x-dollar-par-value nonvoting "preferred stock" of X. This share of "stock" called for payment of a quarterly cumulative dividend of 300x dollars. The "stock" was redeemable at the option of the shareholder 13 months after issuance solely by the transfer of legal title and possession of the land to the shareholder. However, if an event occurred that would excuse X from transferring title to Y (such as a condemnation of the land by the state), X would be required to redeem the "stock" with a payment of 10,000x dollars in cash. The "stock" was also callable by X under the same terms 14 months after issuance.

X was entitled to full use and possession of the land while the "stock" was outstanding, but could not waste, sell, or otherwise dispose of the land. X was liable for the real estate taxes on the property during the period the "stock" was outstanding. The real estate taxes on the land were nominal. On March 31, 1979, Y gave 10,000x dollars to X in exchange for this one share of X "preferred stock." The fair market value of the land on that date was 10,000x dollars.

On May 1, 1980, 13 months after the issuance of the "preferred stock", Y, who had received no dividends on the "preferred stock," demanded redemption of the share of "preferred stock." Y received a deed transferring legal title to the land to Y. Y also received 1,200x dollars in cash for the accrued quarterly dividends on the stock. The value of the "stock" during the 12-month period immediately prior to the distribution in redemption thereof represented at least 10 percent in value of all the outstanding stock of X during that period. Y had no other interest in X.

LAW AND ANALYSIS

Section 61(a)(3) of the Code states that gross income includes gains derived from dealings in property. Section 1001(a) provides, in part, that the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain. Section 311(a) provides, in part, that except as provided in subsection (d), no gain or loss shall be recognized to a corporation on a distribution, with respect to its stock or property. Section 311(d)(1) provides that a corporation shall recognize gain if it distributes appreciated property in redemption of its stock. However, section 311(d)(2)(A) provides that the exception of section 311(d)(1) to the general rule of nonrecognition of section 311(a) will not apply if the redemption is (1) a distribution in complete redemption of all of the stock of a shareholder, who (2) for the 12-month period immediately prior to the distribution (3) holds at least 10 percent in value of the outstanding stock of the distributing corporation.

The form of the transaction in this case (a purchase of X stock by Y followed by a redemption of this stock with X distributing the vacant land to Y in full payment in exchange therefor) was chosen solely for the purpose of attempting by the application of section 311(a) of the Code, to avoid the tax on the gain that otherwise would have been recognized to X. Y had no interest in acquiring "stock" ownership in X, and Y did so only to accommodate the tax avoidance motives of X. Y's objectives were solely to purchase the land from X, and X's objectives were to sell the land to Y. Y's "stock" ownership in X was transitory and was not intended to represent a normal shareholder interest. Rather, the "stock" represented Y's right to receive the land at a specified time and to receive payment for giving X the purchase price of the land prior to Y receiving title to the land.

The two steps of the transaction of the purchase of the "stock" and its "redemption" for the land were part of a prearranged integrated plan and may not be considered independently of each other for federal income tax purposes. See Rev. Rul. 70-140, 1970-1 C.B. 73, which concluded that the transfer by an individual of assets of proprietorship, pursuant to an integrated plan, followed by the corporation's acquisition by an unrelated corporation did not qualify under the nonrecognition provisions of section 351 and that gain or loss was recognized under section 1001. Compare Idol v. Commissioner, 38 T.C. 444, aff'd, 319 F.2d 647 (6th Cir 1963), in which section 311(a) of the Code was held not to apply to a redemption of stock that had been acquired solely for the purpose of having it redeemed by the distribution of appreciated assets. In Bush Brothers and Co. v. Commissioner, 73 T.C. No. 37 (1979), the United States Tax Court stated that the nonrecognition provisions of section 311(a) of the Code were not intended to apply to transactions that are motivated primarily by tax avoidance and without any substantial business purpose.

HOLDING

Section 311(a) of the Code is not applicable to the subject transaction, and gain is recognized to X on the sale of the land to Y under section 1001.