Rev. Rul. 77-256

Advice has been requested whether a corporation will recognize gain or loss pursuant to section 311 of the Internal Revenue Code of 1954 when it transfers property in payment of a note under the circumstances described below.

The corporation had outstanding only shares of common stock. Individual A owned 15 percent of the outstanding stock of the corporation at all times prior to December 31, 1973, when, pursuant to a plan, A surrendered all of A's common stock to the corporation, receiving in exchange therefor an interest-bearing promissory note of the corporation calling for annual payments to the shareholder. The total amount to be paid (less interest) is equal to the fair market value of the stock surrendered. The distribution of this bona fide promissory note to A in 1973 qualified as a distribution in complete termination of A's interest in the corporation under section 302(b)(3) of the Code. The redemption was treated by A as a distribution in full payment in exchange for A's stock under section 302(a). In January 1975, the corporation transferred appreciated real property to A as a payment due on the note. The fair market value of the property was equal in amount to the payment due on the note. At the time of the redemption there was no plan or present intent to satisfy the note with appreciated property.

Section 311(a) of the Code provides, in part, that, except as provided in section 311(d), no gain or loss shall be recognized to a corporation on the distribution, with respect to its stock, of property.

Section 311(d)(1) of the Code provides, in general, that if a corporation distributes appreciated property to a shareholder in redemption of stock then gain will be recognized to the distributing corporation in the amount of the appreciation as if the property had been sold by the distributing corporation at the time of distribution. An exception to this rule is provided under section 311(d)(2)(A) if the distribution qualifies in general as a termination of interest under section 302(b)(3) and the shareholder at all times within the 12-month period ending on the date of such distribution owns at least 10 percent in value of the outstanding stock.

Section 1.311-1(e)(1) of the Income Tax Regulations states that section 311 of the Code "is limited to distributions which are made by reason of the corporation-stockholder relationship. Section 311 does not apply to transactions between a corporation and a shareholder in his capacity as debtor, creditor, employee, or vendee, where the fact that such debtor, creditor, employee, or vendee is a shareholder is incidental to the transaction."

Here, the note is the property distributed to A by the corporation with respect to its stock. Upon receipt of the note, A ceased to be a shareholder of the corporation and became a creditor of the corporation.

Accordingly, section 311 of the Code has no application to the payment of the note because A received the property in 1975 solely as a creditor. Therefore, gain is recognized to the corporation in 1975 upon the transfer of appreciated real property to A as payment on the note measured by the difference between the fair market value of the property on that date and its adjusted basis to the corporation. Sections 1001 and 1002.