Rev. Rul. 74-211

Advice has been requested whether, under the circumstances described below, the basis of assets received upon complete liquidation of a subsidiary under section 332 of the Internal Revenue Code of 1954 is determined by reference to section 334(b)(1) or section 334(b)(2).

In 1970, S corporation, a manufacturer and distributor of musical instruments, purchased all the outstanding stock of T corporation, engaged in the piano repairing business, for 45x dollars.

On December 1, 1973, P corporation purchased all the outstanding stock of S for cash. Thus, P owned 100 percent of the stock of S and S owned 100 percent of the stock of T. On December 31, 1973 S distributed all the T stock to P. Immediately before the distribution, the adjusted basis of the T stock in the hands of S was 45x dollars, and the fair market value was 40x dollars. Immediately upon receipt of the T stock, P, pursuant to a plan of liquidation, completely liquidated T within the meaning of section 332(b) of the Code.

The specific question presented is whether the acquisition of the T stock by P is a purchase of such stock within the meaning of section 334(b)(3) of the Code, thus permitting P to determine the basis of the assets received upon the liquidation of T under the provisions of section 334(b)(2).

The basis of the assets received by a corporation upon the liquidation of another corporation within the meaning of section 332(b) of the Code is generally a carryover basis under section 334(b)(1). However, an exception to this general rule is contained in section 334(b)(2), which provides that the basis of assets so received in complete liquidation will be determined with reference to the adjusted basis of the parent corporation in the stock of the liquidated subsidiary, provided that the requirements of section 334(b)(2) are met. One of such requirements, contained in section 334(b)(2)(B), is that a specified percentage of all of the stock of the subsidiary be acquired by purchase during a specified 12-month period. Purchase is defined in section 334(b)(3) which provides, in part, as follows:

(3) Purchase defined.--For purposes of paragraph (2)(B), the term 'purchase' means any acquisition of stock, but only if--

(A) the basis of the stock in the hands of the distributee is not determined (i) in whole or in part by reference to the adjusted basis of such stock in the hands of the person from whom acquired, . . .

(B) the stock is not acquired in an exchange to which section 351 applies,

(C) the stock is not acquired from a person the ownership of whose stock would, under section 318(a), be attributed to the person acquiring such stock.

Notwithstanding subparagraph (C) of this paragraph, for purposes of paragraph (2)(B), the term 'purchase' also means an acquisition of stock from a corporation when ownership of such stock would be attributed under section 318(a) to the person acquiring such stock, if the stock of such corporation by reason of which such ownership would be attributed was acquired by purchase (within the meaning of the preceding sentence).

Since the T stock was not acquired by P in an exchange to which section 351 of the Code applies, such acquisition is not excluded from the term "purchase" by section 334(b)(3)(B).

P acquired the T stock from a person (S) the ownership of whose stock (S's ownership of T stock) would be attributable to the person acquiring such stock (P) within the meaning of section 318(a)(2)(C). Thus, the acquisition by P of the T stock from a related party (S) violates the purchase rules of section 334(b)(3)(C). However, the last sentence of section 334(b)(3) provides that section 334(b)(3)(C) will not preclude an otherwise qualifying purchase where the stock of the related corporation (S) is acquired by purchase, within the meaning of section 334(b)(3), within the same 12-month period that the acquiring person (P) acquired stock of the subsidiary corporation (T). Since P acquired control of the related corporation S for cash within the same 12-month period that P acquired all of the stock of the liquidated corporation, T, section 334(b)(3)(C) does not preclude the acquisition of the stock from qualifying as a purchase. See section 1.334-1(c)(7) of the Income Tax Regulations.

Section 334(b)(3)(A) of the Code precludes an acquisition of stock from qualifying as a purchase if the basis of the stock in the hands of the distributee is determined in whole or part by reference to the adjusted basis of stock in the hands of the person from whom the stock was acquired. In the instant case, the distribution of the T stock by S to P was a distribution of property subject to the provisions of section 301. The basis of the T stock received by P, as determined under section 301(d)(2), is the lesser of its fair market value (40x dollars) or its adjusted basis in the hands of S immediately before the distribution (45x dollars). Therefore, the basis of the T stock to P is its fair market value of 40x dollars. Consequently, P's basis in the T stock is determined by reference to its fair market value, rather than by reference to the adjusted basis of the stock in the hands of the person from whom acquired, (S).

Accordingly, since the T stock was acquired by P by purchase within the meaning of section 334(b)(3) of the Code and the other requirements of section 334(b)(2) are met, the basis of the T assets in the hands of P is determined under section 334(b)(2) by reference to the adjusted basis of the T stock in the hands of P (40x dollars).

If, in the instant case, the fair market value of the T stock had been 50x dollars and its adjusted basis in the hands of S was 45x dollars immediately before the distribution, the acquisition of the T stock by P (by distribution from S) would not be a purchase of the stock within the meaning of section 334(b)(3) of the Code, by reason of section 334(b)(3)(A), since the basis of the T stock in the hands of P would be determined, pursuant to section 301(d)(2), by reference to the adjusted basis of such stock in the hands of S. Therefore, upon the liquidation of T the basis of its assets in the hands of P would be a carryover basis under section 334(b)(1).