Rev. Rul. 58-40

Advice has been requested as to the treatment, for Federal income tax purposes, of the gain or loss upon the sale of stock, bonds or other securities purchased under the circumstances in the three situations described below.

1. A taxpayer purchases capital stock of a corporation, representing a minority interest and not representing control of the corporation, solely for the purpose of enabling him to acquire inventory goods by the exercise of a right vested in the owner of the corporate stock to purchase a specific amount of such inventory within a specified time. After the acquisition of the inventory goods or the right to acquire such inventory goods, the corporate stock is forthwith sold.

2. A taxpayer, in accordance with the terms of a contract, purchases Government bonds which are placed in escrow in order to guarantee the faithful performance of a contract entered into in the normal course of the taxpayer's business. After the contract is fulfilled, the bonds are promptly sold.

3. A taxpayer, faced with a temporary shortage of inventory, purchases debentures of a supplier of such inventory. These debentures are issued to a limited number of distributors, including the taxpayer, as part of an arrangement under which a specific proportion of the supplier's production is allocated to each distributee. The taxpayer owns no other securities and purchases the debentures solely as a means of obtaining inventory. Shortly thereafter, the debentures become worthless.

Some guidance in the disposition of these cases is provided by the opinion in Corn Products Refining Co. v. Commissioner , 350 U.S. 46, Ct. Dec. 1787, C.B. 1955-2, 511, which states, in part:

* * * Congress intended that profits and losses arising from the every-day operation of a business be considered as ordinary income or loss rather than capital gain or loss. The preferential treatment provided by section 117 applies to transactions and property which are not the normal source of business income. * * *

Accordingly, in the first situation described above, any gain or loss incurred in the sale of the corporate stock is deductible from or includible in the cost of the goods acquired by the taxpayer for the year in which the gain is realized or the loss sustained. See Western Wine & Liquor Co. v. Commissioner , 18 T.C. 1090, acquiescence, page 6, this Bulletin, and Charles A. Clark v. Commissioner , 19 T.C. 48, acquiescence, page 7, this Bulletin.

In the second of the situations described above, the bonds, being closely related to the contract performed by the taxpayer in the regular course of his business, are not capital assets in his hands within the meaning of section 1221 of the Code. Therefore, any gain realized or loss sustained upon the sale of such bonds constitutes ordinary gain or loss, as the case may be, in the year they are sold.

Similarly, in the third of the situations described above, the particular function of the debentures there purchased precludes their treatment as capital assets. Section 165(g) of the Code relating to losses from worthless securities states in part:

(1) GENERAL RULE.-If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset.

(2) SECURITY DEFINED.-For purposes of this subsection, the term `security' means-

(A) a share of stock in a corporation;

(B) a right to subscribe for, or to receive, a share of stock in a corporation; or

(C) a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form.

The debentures in this instance are securities within the meaning of section 165(g)(2)(C) of the Code. However, section 165(g)(1) of the Code applies only to a security `which is a capital asset.' Since the debentures in this instance do not constitute capital assets the provisions of section 165(g) of the Code do not apply. Therefore, if such debentures become worthless or are sold at a loss, the loss incurred is deductible as an ordinary loss under section 165(a) of the Code. Conversely, any gain on the sale of such debentures would be included in gross income under section 61 of the Code and taxable as ordinary income.

The above conclusions contemplate that, in all three instances, the objectives for which the stock or securities are purchased are such as may be accomplished and the stock or securities disposed of within a relatively short time after their acquisition. Compare Logan & Kanawha Coal Co. v. Commissioner , 5 T.C. 1298. Also, compare Gulftex Drug Co., Inc. v. Commissioner , 29 T.C. No. 16, wherein it was held that where stock was purchased in order to obtain rights to purchase whiskey and, years after exercise of the rights, the stock was sold at a loss, a long-term capital loss resulted since the stock constituted a capital asset at the time of its sale.

See Revenue Ruling 58-41, page 86, this Bulletin, which holds that stock of the Federal National Mortgage Association, purchased by a taxpayer, such as a bank or trust company or any other private source dealing in mortgages, in order to enable the taxpayer to sell mortgages to the Association, constitutes a capital asset.