Rev. Rul. 81-83

ISSUE (1) Is the receipt of water lines by a water company from a subdivider "in exchange for stock" within the meaning of section 1032(a) of the Internal Revenue Code?

(2) Should the subdivider add a pro rata portion of the cost of the water lines to the basis of each lot in the subdivision?

(3) Does the subdivider realize any gain or loss upon the receipt of the stock from the water company or upon the subsequent transfer of that stock?

FACTS

The taxpayer is a domestic corporation that is engaged in the business of furnishing water through its facilities to residential and commercial users and is not a regulated public utility.

An increase in the number of residential subdivision developments in the area served by the water company required an expansion of its facilities. Because the water company could not finance all of the required expansion from its earnings or through borrowing, the water company arranged with a subdivider to (1) have the subdivider build an extension of the water company's water lines to the subdivider's subdivision at the subdivider's expense and (2) subsequently convey the water lines to the water company. The subdivider agreed to build the water lines and convey them to the water company because the subdivider needed water for the subdivision in order to make the lots in the subdivision salable. The water company agreed to issue one share of its $10 par value stock in the name of the subdivider for each lot in the subdivision to be served by the extension of the water lines.

Each purchaser of a lot in the subdivision who desires to secure a water connection to the water company's line is required to purchase a share of the water company's stock from the subdivider at a cost of $10. No willing purchaser of a lot would pay more for a lot and a share of stock than the purchaser would pay for a lot with water service, but without a share of stock. Each share of the water company's stock issued to the subdivider is of the same class and entitles the holder to voting rights and to participate in the assets of the water company upon dissolution. The stock does not provide any dividend rights and cannot be caused to be redeemed by a shareholder. The stock may not be transferred apart from the subdivision lot to which it relates and, because of this restriction, the stock by itself has no ascertainable fair market value. The stock represents an insignificant percentage of the water company's total outstanding stock.

LAW AND ANALYSIS

Issue (1)

Section 1032(a) of the Code provides that no gain or loss shall be recognized to a corporation on the receipt of money or other property in exchange for stock (including treasury stock) of such corporation.

In determining whether a corporation has received money or other property "in exchange for stock" for purposes of section 1032(a) of the Code, the courts have considered whether the transferor received a significant proprietary or equity interest in the corporation as well as the transferor's motive or intent for the transfer of the money or other property. See Affiliated Government Employees' Distributing Co. v. Commissioner, 322 F.2d 872 (9th Cir. 1963), cert. denied, 376 U.S. 950 (1964); Community T.V. Ass'n v. United States, 203 F.Supp. 270 (D. Mont. 1962); Oakland Hills Country Club v. Commissioner, 74 T.C. 35 (1980).

Whether the subdivider obtained any equity interest in the water company is determined by examining the rights accompanying the stock received. For each lot to be served by the extension of the water system, the subdivider received one share of stock that did not provide any dividend rights. Even the implicit right of realizing appreciation on the stock had no value for the subdivider because no willing purchaser of a lot would pay more for a lot and a share of stock than the purchaser would pay for a lot with water service, but without a share of stock. Therefore, the subdivider did not receive a significant equity interest in the corporation and the transfer of the water lines was not in exchange for stock but in exchange for water service for the subdivision.

Because the ownership of stock was a precondition to water service, the subdivider was obligated to sell all of the shares of stock if all the lots in the subdivision were sold. In this situation, the subdivider's motive or intent was to convey the water lines to the taxpayer in order to obtain future water service for the subdivision and not to acquire a proprietary interest in the taxpayer.

Also, because the subdivider conveyed the water lines to the taxpayer in order to obtain water service for the subdivision and not to acquire an investment in the taxpayer, the conveyance was not a contribution to capital. Rev. Rul. 75-557, 1975-2 C.B. 33.

Issue (2)

If a subdivider constructs a facility in the subdivision for the purpose of inducing people to buy lots and the subdivider conveys all substantial rights in the facility constructed to a utility, then the cost of the facility is properly includable in the cost basis of the subdivision. See Willow Terrace Development Co. v. Commissioner, 40 T.C. 689 (1963), acq. 1968-2 C.B. 3, aff'd, 345 F.2d 933 (5th Cir. 1965); Estate of Collins v. Commissioner, 31 T.C. 238 (1958); acq., 1959-2 C.B. 4; Rev. Rul. 68-478, 1968-2 C.B. 330.

In the present situation, the subdivider agreed to build the water lines and convey them to the taxpayer because the subdivider needed water service for the subdivision in order to make the lots in the subdivision salable. Once the subdivider conveyed the water lines to the water company, the subdivider retained no rights to the water lines. Therefore, the subdivider must include the cost of the water lines in the basis of the lots.

Issue (3)

The subdivider does not realize any income on the receipt of the stock because the restriction on the transferability of the stock prevents the stock from having an ascertainable fair market value. See Kuchman v. Commissioner, 18 T.C. 154, 163 (1952), acq. 1952-2 C.B. 2. Also, because no willing purchaser of a lot would pay more for a lot and a share of stock than the purchaser would pay for a lot with water service, but without a share of stock, all proceeds received by the subdivider from the sale of a lot and the share of stock related to that lot are attributable to the lot.

HOLDINGS

(1) The receipt of the water lines by the water company from the subdivider is not "in exchange for stock" within the meaning of section 1032(a) of the Code and the water company must include in income the fair market value of the water lines received.

(2) The subdivider should add a pro rata portion of the cost of the water lines to the basis of each lot in the subdivision.

(3) The subdivider does not realize any gain or loss upon the receipt, or upon the subsequent transfer, of the stock received from the water company.