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How to beat Rev. Rul. 68-55.

Rev. Rul. 68-55 addressed the allocation of boot received in a Sec. 351 transfer, and generally required that gain or loss be computed on an asset-by-asset basis and allocated in proportion to relative asset values. Some of the adverse effects of this requirement can be avoided by interposing a holding company into the transaction.

To illustrate the allocation method adopted by Rev. Rul. 68-55, suppose individual A owns two parcels of real estate, Blackacre and Whiteacre. Blackacre has a fair market value (FMV) of $100 and a tax basis of $100. Whiteacre has an FMV of $100 and a tax basis of $0. If A transfers these two parcels to Newco in exchange for $100 of Newco stock and $100 cash, Rev. Rul. 68-55 required A to allocate the $100 boot received between the two assets transferred. Thus, A would be deemed to have received $50 of stock and $50 of cash for each. This means that A must recognize no gain with respect to Blackacre and $50 of gain with respect to Whiteacre.

Can A avoid this result? Suppose A were to specify that Whiteacre was being contributed to Newco in exchange for Newco stock and that Blackacre was being contributed to Newco in exchange for cash. Could such explicit allocation override the procedure described in Rev. Rul. 68-55? The answer is no; see Rev. Rul. 85-164. Further, Rev. Rul. 85-164 seemed to foreclose attempts to separate the transfers in time to achieve an explicit allocation, "if the transfers were part of a single integrated transaction."

There is, however, a structure that would permit A to place Blackacre and Whiteacre in corporate solution without recognizing gain. A could transfer Whiteacre to Newco solely for Newco stock (a tax-free Sec. 351 transaction). Newco could then transfer Whiteacre to a newly formed, wholly owned subsidiary of Newco (Sub) solely for Sub stock. This second transfer is also a valid tax-free Sec. 351 transaction that does not affect the validity of the Sec. 351 transfer of Whiteacre from A to Newco; see Rev. Ruls. 77-449 (second transfer to wholly owned subsidiary) and 83-34 (second transfer to 80%-owned subsidiary). Finally, Sub could borrow $100 and use the proceeds to purchase Blackacre from A. The cash for Sub's purchase of Blackacre might also be borrowed by Newco and transferred to Sub; see Rev. Rul. 60-262, citing M.O.J. Corp., 274 F2d 713 (5th Cir. 1960) (respecting the formation of a corporation formed solely to purchase property).

The sale by A to Sub would not be part of any Sec. 351 transaction because, to be part of a Sec. 351 transfer, the person transferring property must either receive Sub stock or previously own Substock. A satisfies neither test (see Rev. Rul. 79-70); thus,the sale would be governed by Sec. 1001, and because Blackacre's tax basis equals its FMV, there would be no gain or loss on the sale.

The same approach could also be used to permit A to recognize a loss if Blackacre had a tax basis in excess of its FMV. The loss would be disallowed by Sec. 267, however, if A owned (directly or indirectly) 50% or more of the value of Sub. Thus, loss recognition, would require the presence of other unrelated owners of Newco or Sub stock.

From Richard W. Bailine, J.D., LL.M., Washington, D.C.
COPYRIGHT 1997 American Institute of CPA's
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Title Annotation:IRC section 351 allocation method
Author:Bailine, Richard W.
Publication:The Tax Adviser
Date:Jun 1, 1997
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