Category: Corporations; Real Estate
Subject: Property, Sale of
Title: Comments on Suggestions to Shelter Property with Very Low Tax Basis
IRC Sections:
Filename: 1261.html
Date Produced: 08/95 Copyright 1998, The Tax Resource Group. All rights reserved. Telephone
800-578-3498. Internet: www.taxresourcegroup.com Background
XYZ Company, a C corporation, owns highly appreciated property with a value
in excess of $1 million. The property has a very low tax basis. You have
asked me to comment on two suggestions for reducing or eliminating federal
income tax on the sale of the property. You have also requested that I offer
any other suggestions I might have. Proposal No. 1: Merger with a Public Company
Suppose XYZ merges the entire company into a wholly-owned subsidiary of
a public company which desires ownership of the land. The shareholders of
XYZ would presumably exchange their XYZ shares for shares of the public
company. First, note that on further consideration of this option, I have come
to question one of the barriers we discussed earlier. Accordingly, instead
of dismissing this option out of hand, I have looked at it more carefully.
After reading this, we should discuss the issues. This option may not be viable for several reasons, both tax and nontax.
While it is true that a merger could be arranged to meet the statutory requirements
of a tax free reorganization, there are several broader tax principles that
must be met as well. Failure to comply with any of these principles is fatal
to tax-free reorganization status. The transaction set forth above may fail
at least one of the broader requirements. Business Purpose
A tax-free reorganization must have a substantial, non-tax, corporate business
purpose. Regulations Section 1.368-1(b), 1.368-1(c), and 1.368-2(g). Admittedly,
skilled attorneys could possibly concoct a substantial, non-tax, corporate
business purpose that would at least pass muster on cursory review of the
situation; however, I feel that if the transaction were really scrutinized,
the underlying tax motivation might well become obvious. The business purpose
test is the most difficult, clearly applicable tax obstacle. Obviously,
this is a factual issue. We should discuss it. Continuity of Interest
Parties to a reorganization must retain a substantial proprietary interest
in the corporation resulting from the purported tax-free reorganization.
This test focuses on the amount of acquiring company stock used as consideration
in the acquisition of the target company. In other words, it is not permissible
to acquire a target company with only a small proportion of the consideration
in the form of acquiring company stock and the remainder in the form of
cash or short term notes. This looks too much like a sale to be a tax-free
reorganization. This is essentially a quantitative test. When we spoke on the phone, I said it is not permissible in a tax-free
reorganization for the owners of a closely held business to become minuscule
equity participants in a publicly held company, because the quality of the
proprietary interest is too dissimilar. This may not be true according to
Bittker and Eustice, considered to be the ultimate authorities on such matters.
This may warrant further study. The other aspect of the continuity of interest principle is the length
of time the target shareholders retain the stock of the public company.
Obviously, immediate turnover of the stock received in the reorganization
is not acceptable. How long are the XYZ shareholders willing to wait? Tax Motivated Transactions
Since time immemorial, the IRS has successfully attacked transaction having
tax avoidance as their principal motivation. This is particularly true in
the reorganization area. Clearly, that is non-quantifiable risk in this
transaction. Other Factors
In a tax-free reorganization, the publicly-held stock would have a basis
in the hands of the XYZ shareholders equal to the basis of the XYZ stock
given up (presumably a very low number). The basis of the land in the hands
of the public "buyer" would be carried over from XYZ. An astute
buyer would discount the purchase price to take into account the disparity
in basis and fair market value. Given both these items taken in tandem,
would a tax-free reorganization accomplish anything assuming it were available? Proposal No. 2: 45-Year or 99-Year Lease
As I told you on the telephone, I find it very difficult to believe that
a very long term lease that would satisfy the needs of XYZ would not be
viewed as a de facto sale. Clearly, the IRS has both the power and the predisposition
to recast a transaction to comport with its own view of the economic reality
of such transaction. Each case must be evaluated on its own merits, and
if the attorneys wish to propose something, we can evaluate whatever they
come up with. I am not optimistic that it is possible to succeed. | 
