Dividend distribution prior to an F reorganization.

An F reorganization is defined by Sec. 368(a)(1)(F) as "a mere change in identity, form, or place of organization of one corporation" In Rev. Rul. 96-29, the IRS stated that "[a] transaction does not qualify as a reorganization under section 368(a)(1)(F) unless there is no change in existing shareholders or in the assets of the corporation" The Service has, however, permitted changes of less than 1% in stock ownership (Kev. Rul. 66-284).

For changes in assets, the IRS has permitted F reorganizations even though they were part of an integrated plan involving another acquisitive transaction or a corporate restructuring. For example, in Rev. Rul. 96-29, the Service held that the reincorporation of a corporation in another state qualified as an F reorganization even though it was the first step in a transaction in which the corporation issued common stock in a public offering and redeemed its preferred stock. Rev. Rul. 96-29 held that the reincorporation of a parent in another state after it had acquired a target in a forward triangular merger was nevertheless an F reorganization.

Letter Ruling 9902004 now holds that a corporation can dispose of unwanted assets in a Sec. 301 distribution before conducting an F reorganization, provided that there is a time gap between the distribution and the F reorganization.

Letter Ruling 9902004 involved a corporation that had elected to be treated as a real estate investment trust (REIT) for Federal income tax purposes. The REIT conducted its business through a limited partnership (LP) of which it was the sole general partner. The REIT wanted to acquire Target corporation, without some of Target's assets.

To facilitate its anticipated acquisition, Target formed a wholly owned subsidiary and transferred to it the assets the REIT did not want to acquire. Target distributed the new subsidiary's common stock pro rata to its shareholders in a transaction that it represented was a Sec. 301 distribution. Later, Target formed another wholly owned subsidiary that formed a limited liability company (LLC). The letter ruling states that both of these companies were classified as disregarded entities under the check-the-box regulations. (The Service probably only meant to state that the LLC was a disregarded entity under the check-the-box regulations.)

Target then merged with and into the LLC under the applicable state merger laws. In the merger, Target shareholders received stock in the subsidiary company that owned the LLC. This subsidiary company became New Target. Thereafter, New Target was merged into the REIT under state merger law. The REIT then transferred the LLC to the REIT's LP.

The issue was whether the merger of Target into the LLC was an F reorganization for tax purposes, even though it was one step in the integrated transaction described above. The letter ruling noted that Target distributed subsidiary stock with the unwanted assets to its shareholders on a date that preceded the merger of Target into the LLC. Citing Rev. Rul. 96-29, the IRS ruled that the merger qualified as an F reorganization, notwithstanding the preceding Sec. 301 distribution and the subsequent merger of New Target into the REIT.

The Service appears to have reconciled its holding in Letter Ruling 9902004 with its requirement that there be no change in the assets of a corporation effecting an F reorganization, on the grounds that there was an unspecified gap in time between the reorganization and the other related transactions. In the letter ruling, the IRS noted that Target's dropdown of unwanted assets and the Sec. 301 distribution occurred on a date that preceded the date on which Target was merged into the LLC.

FROM DONALD A. BARNES, J.D., AND LORIN D. LOCHS, CPA, J.D., LL.M., WASHINGTON, DC