Rev. Rul. 62-12

The Internal Revenue Service will not follow the decision of the United States Court of Appeals for the Fifth Circuit in Commissioner v. James B. Kelley, et al., 293 Fed. (2d) 904(1961).

In the Kelley case a real estate development corporation, prior to the time its taxpayer-stockholders had sold their stock in the corporation, had realized one-third of the total net income it might expect to derive from its property.

The Service contended that the taxpayer-stockholders should have reported the gain from the sale of their stock as ordinary income and not capital gain since the corporation was a collapsible one under section 117(m) of the Internal Revenue Code of 1939.

The Service's position is that a corporation is collapsible under section 117(m)(2)(A) of the 1939 Code and section 341(b)(1)(A) of the Internal Revenue Code of 1954 if prior to the sale of the stock by the shareholders there remains a substantial part of the net income yet to be derived from the property. See the decision of the United States Court of Appeals for the Third Circuit in the case of J. D. Abbott, et al. v. Commissioner, 258 Fed. (2d) 537(1958).

The Service contended in the Kelley case since a substantial amount (two-thirds) of the net income remained to be derived prior to the sale of stock, the corporation was collapsible. However, the court held that the phrase "substantial part" appearing in section 117(m)(2)(A) of the 1939 Code, which defines a collapsible corporation, has reference to that part of the total anticipated net income to be derived from the property which had already been realized at the time of the stock sale, and since one-third of the income realized by the corporation prior to the sale of the stock is a substantial part of the total net income to be derived from the property, the corporation was not collapsible.

Although review by the Supreme Court of the United States was not requested in the Kelley case, the decision will not be followed as a precedent in the disposition of similar cases, and the Internal Revenue Service position will be maintained pending further clarification of the issue.

¹ Based on Technical Information Release 349, dated December 11, 1961.