Rev. Rul. 74-87

Advice has been requested whether, under the circumstances described below, gain is recognized to a corporation under section 311(d)(1) of the Internal Revenue Code of 1954.

Corporation X had outstanding 100x shares of common stock. A owned 4x shares, B owned 3x shares, and C owned 3x shares. These shares, in the aggregate, represented 10 percent in value of the outstanding stock of X. All three shareholders were unrelated to each other and to the other shareholders. A, B, and C have each owned their respective shares for more than one year. Pursuant to a partnership agreement, they contributed all their shares to a partnership formed by them in exchange for interests in the partnership equal in value to the value of the stock transferred. Thereafter, as part of an over-all plan, X redeemed its stock held by the partnership, using as payment therefor appreciated real estate on which X's plant is located. This real estate constituted appreciated property within the meaning of section 311(d)(1)(B) of the Code. In an arm's length transaction, the partnership then leased back the real estate to X for a period of ten years. The partnership further served as the managing agent for the property and rendered various related services to X.

Section 302(a) of the Code provides, in part, that a redemption will be treated as a distribution in part or full payment in exchange for the stock if, pursuant to section 302(b)(3), the redemption is in complete redemption of all of the stock of the corporation owned by the shareholders.

Section 311(a) of the Code provides, in part, that no gain or loss will be recognized to a corporation on the distribution, with respect to its stock, of property, except as provided in sections 311(b), 311(c), and 311(d). Under section 311(d)(1), gain is recognized to a corporation upon a distribution of appreciated property (property the fair market value of which exceeds its adjusted basis in the hands of the distributing corporation) in redemption of its stock. Section 311(d)(1), however, does not apply where, as provided by section 311(d)(2)(A), a distribution is in complete redemption of all of the stock of the shareholder who, at all times within the twelve-month period ending on the date of distribution, owns at least 10 percent in value of the outstanding stock of the corporation, but only if the redemption qualifies under section 302(b)(3).

Section 1.311-2(b)(2) of the Income Tax Regulations provides, in part, that for the purposes of the twelve-month ownership requirement of section 311(d)(2)(A) of the Code, a shareholder will be considered to have owned stock during the period he is considered to have held the stock by reason of the application of section 1223. Under section 1223(2), by reason of section 723 and section 1.723-1 of the regulations, the holding period of property contributed to a partnership by a partner includes the period for which the property was held by the partner.

In the instant case, the ownership of the X stock by the partnership was transitory and illusory since, as part of one overall plan, the partnership then surrendered the X stock for property of X. This transitory step thus must be disregarded as being wholly without substance. Bassick v. Commissioner, 85 F.2d 8 (2nd Cir. 1936), cert. denied 299 U.S. 592 (1936); Rev. Rul. 70-522, 1970-2 C.B. 81. Therefore, the transaction is treated as a redemption by X of its stock held by A, B, and C, followed by a contribution to the partnership by A, B, and C of the real property received upon redemption of their X stock. See generally Edgar S. Idol, 38 T. C. 444 (1962), aff'd 318 F.2d 647 (8th Cir. 1963); Commissioner v. Court Holding Co., 324 U.S. 331 (1945), 1945 C.B. 58.

Accordingly, it is held that (1) the redemption of the X stock qualifies as a termination of the interests of A, B, and C in X under section 302(b)(3) of the Code, and (2) under section 311(d)(1) gain is recognized by X upon the redemptions to the extent that the fair market value of the property distributed exceeds its adjusted basis to X, since, for purposes of section 311(d)(2)(A), none of the redeeming shareholders owned at least 10 percent in value of X's stock at all times within the twelve-month period ending on the date of redemption.