Comprehensive Study Guide to Corporate Liquidations and Reorganizations

Corporate Liquidations: General Principles and Legal Status

  • Federal Tax Liquidation Status vs. State-Law Dissolution:
    • A complete liquidation for federal income tax purposes occurs when a corporation ceases to be a going concern and its activities are confined to winding up its affairs, paying its debts, and distributing any remaining property to its shareholders.
    • Formal dissolution under state law is not required to achieve complete liquidation status for federal tax purposes under Treas. Reg. § 1.332-2(c) and Treas. Reg. § 1.331-1(a).
    • A corporation may retain a nominal amount of cash or assets solely for the purpose of preserving its legal existence or maintaining its corporate charter without defeating corporate liquidation treatment.
    • A complete liquidation does not require a sale of every corporate asset to an unrelated buyer; distributions in kind of corporate property to shareholders satisfy the liquidation requirements.
    • Case Application (Luna Corporation): Luna ceases operations, winds up business affairs, satisfies creditor claims, and distributes remaining property pursuant to a plan of complete liquidation while retaining a nominal cash reserve solely to maintain its corporate charter. The state has not formally dissolved Luna. For federal tax purposes, Luna qualifies as completely liquidated because formal state-law dissolution is unnecessary and nominal assets retained solely to preserve legal existence do not prevent liquidation treatment.
    • Statutory and Regulatory Authorities: I.R.C. § 331(a); Treas. Reg. § 1.331-1(a); Treas. Reg. § 1.332-2(c).

Taxable Complete Liquidations: Shareholder Taxation under Section 331 and Section 334(a)

  • Shareholder Exchange Treatment under Section 331(a):

    • Amounts distributed to a shareholder in complete liquidation of a corporation are treated as full payment in exchange for the shareholder's stock rather than as an ordinary operating distribution.
    • Section 331(b) expressly provides that Section 301 (governing dividend distributions) does not apply to any distribution of property in complete liquidation.
    • The distributing corporation's accumulated or current earnings and profits (E&P\text{E\&P}) are irrelevant to the shareholder's tax computation; E&P\text{E\&P} does not convert exchange proceeds into dividend income.
    • Computation of shareholder gain or loss under Section 1001:
      • Amount Realized=Cash Received+Fair Market Value (FMV) of Distributed Property−Liabilities Assumed or Attached\text{Amount Realized} = \text{Cash Received} + \text{Fair Market Value (FMV) of Distributed Property} - \text{Liabilities Assumed or Attached}
      • Recognized Gain or Loss=Amount Realized−Adjusted Basis of Surrendered Stock\text{Recognized Gain or Loss} = \text{Amount Realized} - \text{Adjusted Basis of Surrendered Stock}
    • The recognized gain or loss is characterized as capital gain or loss under I.R.C. § 1222, provided the stock is a capital asset in the hands of the shareholder, and is long-term if held for more than one year.
    • Case Application (Iris Corporation & Keira): Iris makes a single, final $130,000\$130,000 cash distribution in complete liquidation to its sole shareholder, Keira. Keira's stock basis is $100,000\$100,000, and Iris has $200,000\$200,000 of E&P\text{E\&P}. Under § 331(a), Keira recognizes $130,000−$100,000=$30,000\$130,000 - \$100,000 = \$30,000 of long-term capital gain. The $200,000\$200,000 of corporate E&P\text{E\&P} does not convert any portion of the liquidating payment into a dividend. Authorities: I.R.C. § 331(a), (b); I.R.C. § 1001(a)–(c); I.R.C. § 1222(3).

  • Shareholder Basis in Property Received under Section 334(a):

    • Under Section 334(a), if property is received in a distribution in complete liquidation and gain or loss is recognized on its receipt, the basis of the property in the hands of the distributee shareholder is its fair market value at the time of distribution.
    • The shareholder's former stock basis is fully recovered and utilized in computing the liquidation exchange gain or loss under Section 331 and does not carry over to the distributed property.
    • Case Application (Atlas Corporation & Nadia): Nadia receives unencumbered land with an FMV of $80,000\$80,000 as the sole liquidating distribution for all her Atlas stock. Nadia's stock basis is $120,000\$120,000. Amount realized is $80,000\$80,000, yielding a recognized long-term capital loss of $80,000−$120,000=−$40,000\$80,000 - \$120,000 = -\$40,000. Nadia's tax basis in the distributed land under § 334(a) is its fair market value of $80,000\$80,000. Recognition of the capital loss is distinct from statutory limitations governing its deduction against other income. Authorities: I.R.C. § 331(a); I.R.C. § 334(a); I.R.C. § 1001(a)–(c); I.R.C. § 1222(4).

Installment Obligations Distributed in Complete Liquidation

  • Corporate-Level Disposition Rules under Section 453B:

    • Under Section 453B(a)(2), the distribution of an installment obligation triggers corporate gain or loss equal to the difference between the fair market value of the obligation at the time of distribution and the corporation's adjusted basis in the obligation.
    • Basis of an installment obligation is defined under Section 453B(b) as the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full:
      • Basis of Obligation=Face Amount−(Face Amount×Gross Profit Ratio)\text{Basis of Obligation} = \text{Face Amount} - (\text{Face Amount} \times \text{Gross Profit Ratio})
      • Basis of Obligation=Face Amount−Unreported Profit\text{Basis of Obligation} = \text{Face Amount} - \text{Unreported Profit}
    • A C corporation is fully taxable on the distribution of its installment obligation; shareholder-level installment deferral rules under Section 453(h) do not exempt the distributing corporation from corporate-level recognition under Section 453B.

  • Shareholder Deferral under Section 453(h):

    • Under Section 453(h)(1)(A), if a corporation adopts a plan of complete liquidation and within the 12-month12\text{-month} period beginning on the date of plan adoption sells property under an installment obligation and completely liquidates, the shareholder treats payments received on the installment obligation (rather than receipt of the obligation itself) as payments received in exchange for their stock.
    • The shareholder recognizes no gain merely upon the receipt of the qualifying installment obligation.
    • Shareholder installment calculations use the shareholder's own stock basis, not the corporation's basis in the sold property:
      • Shareholder Gross Profit=Contract Price / Face Amount−Shareholder Adjusted Stock Basis\text{Shareholder Gross Profit} = \text{Contract Price / Face Amount} - \text{Shareholder Adjusted Stock Basis}
      • Shareholder Gross Profit Ratio=Shareholder Gross ProfitContract Price\text{Shareholder Gross Profit Ratio} = \frac{\text{Shareholder Gross Profit}}{\text{Contract Price}}
      • Recognized Gain on Principal Collection=Principal Payment Received×Shareholder Gross Profit Ratio\text{Recognized Gain on Principal Collection} = \text{Principal Payment Received} \times \text{Shareholder Gross Profit Ratio}
      • Basis Recovery=Principal Payment Received×(1−Shareholder Gross Profit Ratio)\text{Basis Recovery} = \text{Principal Payment Received} \times (1 - \text{Shareholder Gross Profit Ratio})
    • Interest collections are reported as ordinary income separate from principal recovery.
    • Case Application (Finch Corporation & Daniel): Finch adopts a liquidation plan on January 1 and completely liquidates on September 1. On September 1, Finch sells investment land (basis $40,000\$40,000) to an unrelated buyer for an eligible $100,000\$100,000 installment note (FMV and issue price $100,000\$100,000) and immediately distributes the note to sole shareholder Daniel (stock basis $60,000\$60,000). Daniel later collects $25,000\$25,000 of principal.
      • Finch Corporate Result: Finch has $100,000−$40,000=$60,000\$100,000 - \$40,000 = \$60,000 of gross profit on the land sale (60%60\% gross profit ratio). Finch's basis in the note under § 453B(b) is $100,000−$60,000=$40,000\$100,000 - \$60,000 = \$40,000. Distribution triggers $100,000−$40,000=$60,000\$100,000 - \$40,000 = \$60,000 corporate gain under § 453B(a)(2).
      • Daniel Shareholder Result: Because the sale and liquidation occurred within 1212 months of plan adoption, Daniel recognizes $0\$0 on receipt of the note under § 453(h). Daniel’s gross profit is $100,000−$60,000=$40,000\$100,000 - \$60,000 = \$40,000, producing a shareholder gross profit ratio of $40,000$100,000=40%\frac{\$40,000}{\$100,000} = 40\%. Upon collecting $25,000\$25,000 principal, Daniel recognizes \25,000 \times 40\% = \10,00010,000 capital gain and recovers $15,000\$15,000 basis.
    • Statutory and Regulatory Authorities: I.R.C. § 453(c), (h)(1)(A); I.R.C. § 453B(a), (b), (h); Treas. Reg. § 1.453-11(a)(1)–(3).

Corporate-Level Recognition in Complete Liquidations under Section 336

  • General Recognition Rule under Section 336(a):

    • Except as otherwise provided, a liquidating corporation recognizes gain or loss on the distribution of property in complete liquidation as if the property were sold to the distributee at its fair market value.

  • Liability Floor Rule under Section 336(b):

    • If any property distributed in liquidation is subject to a liability, or the shareholder assumes a liability of the liquidating corporation in connection with the distribution, the fair market value of the property is treated as not less than the amount of the liability for purposes of determining corporate recognition.
    • Deemed Sales Price=max⁡(Actual FMV,Liability Assumed or Attached)\text{Deemed Sales Price} = \max(\text{Actual FMV}, \text{Liability Assumed or Attached})
    • Corporate Recognized Gain/Loss=Deemed Sales Price−Corporate Adjusted Basis\text{Corporate Recognized Gain/Loss} = \text{Deemed Sales Price} - \text{Corporate Adjusted Basis}
    • Case Application (Ashford Corporation): Ashford distributes land with a basis of $120,000\$120,000 and an actual FMV of $90,000\$90,000, subject to a $150,000\$150,000 liability assumed by the recipient shareholder. Under § 336(b), the deemed sales price is elevated to the liability amount of $150,000\$150,000. Ashford recognizes gain of $150,000−$120,000=$30,000\$150,000 - \$120,000 = \$30,000. The liability floor converts what would have been an apparent $30,000\$30,000 built-in loss into a $30,000\$30,000 corporate gain. Authorities: I.R.C. § 336(a), (b).

  • Comprehensive Liquidating Model (Corporate Gain, Corporate Tax, Shareholder Proceeds, and Reconciliation):

    • Corporate Tax Impact: When corporate taxable gain is generated on liquidation distributions, corporate income tax liability reduces the net cash available for distribution to shareholders.
    • Shareholder Amount Realized: When a shareholder assumes corporate liabilities, the shareholder's amount realized is reduced by the liability assumed under Section 1001(b).
    • Shareholder Basis in Property: Under Section 334(a), the shareholder takes an unreduced gross fair market value basis in the property received; basis is not reduced by assumed liabilities or corporate taxes paid.
    • Comprehensive Scenario (Cypress Corporation & Nina):
      • Pre-Liquidation Assets and Debt: Cypress holds $50,000\$50,000 cash and investment land with an adjusted basis of $80,000\$80,000 and FMV of $200,000\$200,000. The land carries a $40,000\$40,000 mortgage that sole shareholder Nina assumes. Nina's stock basis is $90,000\$90,000. Cypress's corporate tax rate is 21%21\% under § 11(b). Cypress pays corporate tax from cash before final distribution.
      • Step 1: Corporate Recognized Gain: Actual land FMV ($200,000\$200,000) exceeds the mortgage ($40,000\$40,000), so the deemed sales price is $200,000\$200,000. Cypress recognizes gain of $200,000−$80,000=$120,000\$200,000 - \$80,000 = \$120,000. Distributing cash creates $0\$0 gain.
      • Step 2: Corporate Income Tax: Cypress incurs and pays federal corporate tax of \120,000 \times 21\% = \25,20025,200. Remaining cash distributed to Nina is $50,000−$25,200=$24,800\$50,000 - \$25,200 = \$24,800.
      • Step 3: Nina's Net Liquidation Proceeds (Amount Realized): Nina receives $24,800\$24,800 cash plus net land equity of $200,000−$40,000=$160,000\$200,000 - \$40,000 = \$160,000. Total amount realized is $24,800+$160,000=$184,800\$24,800 + \$160,000 = \$184,800.
      • Step 4: Nina's Recognized Result: Nina recognizes long-term capital gain under § 331 of $184,800−$90,000=$94,800\$184,800 - \$90,000 = \$94,800.
      • Step 5: Nina's Basis in Land: Under § 334(a), Nina’s basis in the land is its gross fair market value of $200,000\$200,000.
      • Step 6: Reconciliation of Net Liquidation Value:
        • Gross corporate value before liquidation: \50,000 \text{ (cash)} + \200,000 (land)=$250,000200,000 \text{ (land)} = \$250,000.
        • Less claims paid/assumed: \40,000 \text{ (mortgage)} + \25,200 (tax)=$65,20025,200 \text{ (tax)} = \$65,200.
        • Net liquidation distribution to shareholder: $250,000−$65,200=$184,800\$250,000 - \$65,200 = \$184,800.
        • Shareholder reconciliation: \90,000 \text{ (stock basis recovery)} + \94,800 (recognized gain)=$184,80094,800 \text{ (recognized gain)} = \$184,800.
    • Statutory and Regulatory Authorities: I.R.C. § 11(b); I.R.C. § 331(a); I.R.C. § 334(a); I.R.C. § 336(a), (b); I.R.C. § 1001(a), (b); I.R.C. § 1222(3); Treas. Reg. § 1.331-1(b), (e).

Built-in Losses, Section 351 Transfers, and Section 362(e)(2) Elections

  • Section 362(e)(2) Anti-Loss Duplication Rule:

    • When property is transferred to a corporation in a Section 351 transaction (or capital contribution) and the aggregate adjusted basis of the transferred assets exceeds their aggregate fair market value, the transferee corporation must reduce its basis in the transferred assets to aggregate FMV under Section 362(e)(2)(A).
    • The basis reduction is allocated among the built-in loss assets in proportion to their respective built-in losses.

  • Joint Section 362(e)(2)(C) Election:

    • The transferor shareholder and the transferee corporation may jointly elect under Section 362(e)(2)(C) to avoid reducing corporate asset basis.
    • If elected, the corporation maintains a carryover basis in the transferred assets, and the transferor shareholder reduces their stock basis under Section 358 down to the aggregate fair market value of the transferred property.
    • The election requires mutual agreement by both parties and cannot be made unilaterally by the shareholder.
    • Comparison Table of Default Rule vs. Joint Section 362(e)(2)(C) Election:
      • Default § 362(e)(2)(A): Corporate asset basis = Stepped down to FMV; Shareholder stock basis = Carryover basis (§ 358).
      • Joint Election § 362(e)(2)(C): Corporate asset basis = Carryover basis (§ 362(a)); Shareholder stock basis = Reduced to FMV.
    • Case Application (Lena & Stone Corporation): Lena transfers an unencumbered asset with a $140,000\$140,000 basis and $90,000\$90,000 FMV to Stone solely for stock in a qualifying § 351 exchange (net built-in loss is $50,000\$50,000). Under the default rule of § 362(e)(2)(A), Stone takes an asset basis of $90,000\$90,000, while Lena takes a stock basis of $140,000\$140,000. With a valid joint § 362(e)(2)(C) election, Stone retains the $140,000\$140,000 asset basis, and Lena's stock basis is limited to $90,000\$90,000. Neither alternative generates an immediate deduction. Authorities: I.R.C. § 351(a); I.R.C. § 358(a); I.R.C. § 362(a), (e)(2); Treas. Reg. § 1.362-4(a), (b), (d).

Corporate Loss Disallowance and Anti-Stuffing Rules under Section 336(d)

  • Related-Person Loss Disallowance Rules under Section 336(d)(1):

    • Related Person Definition: A person is related to the liquidating corporation under Section 267(b)(2) if they own, directly or constructively under Section 267(c), more than 50%50\% in value of the outstanding corporate stock.
    • Non-Pro-Rata Rule (§ 336(d)(1)(A)(i)): No loss is recognized by a liquidating corporation on the distribution of any property to a related person if the distribution of that specific property is not pro rata among shareholders.
      • Distributing whole assets to specific shareholders and equalizing values with cash or other assets does not constitute a pro rata asset distribution.
      • Case Application (Grove Corporation & Victor): Victor owns 60%60\% of Grove (related person under § 267(b)(2)), and an unrelated individual owns 40%40\%. Grove distributes land (basis $100,000\$100,000, FMV $60,000\$60,000, realized loss $40,000\$40,000) entirely to Victor, and $40,000\$40,000 cash to the unrelated shareholder. Although the aggregate dollar values correspond to their 60%/40%60\%/40\% equity percentages, the land distribution is not pro rata as to the asset. Grove's entire $40,000\$40,000 loss is disallowed under § 336(d)(1)(A)(i). The fact that Grove purchased the land 77 years earlier removes the disqualified property rule but does not excuse the non-pro-rata violation. Recognized corporate loss is $0\$0. Authorities: I.R.C. § 336(a), (d)(1)(A); I.R.C. § 267(b)(2).
    • Disqualified Property Rule (§ 336(d)(1)(A)(ii) & § 336(d)(1)(B)): No loss is recognized on property distributed to a related person if the property is "disqualified property."
      • Disqualified property is any property acquired by the liquidating corporation in a Section 351 transfer or as a contribution to capital during the 5-year5\text{-year} period ending on the date of distribution.
      • Disallowance applies to distributions of disqualified property to related persons even if the distribution of the property is strictly pro rata.
      • Case Application (Harborwick Corporation, Alice, & Ben): Alice owns 60%60\% of Harborwick (related person); Ben owns 40%40\% (unrelated). Land was contributed to corporate capital 33 years earlier (basis $75,000\$75,000, FMV $75,000\$75,000). Current land basis is $75,000\$75,000, and FMV is $50,000\$50,000 (total realized loss $25,000\$25,000). Harborwick distributes a 60%60\% undivided interest to Alice and a 40%40\% undivided interest to Ben (pro rata).
        • Alice’s Share: Basis $45,000\$45,000, FMV $30,000\$30,000, realized loss $15,000\$15,000. Because Alice is a related person and the land was acquired within 55 years as a capital contribution, the property is disqualified property under § 336(d)(1)(B). Section 336(d)(1)(A)(ii) disallows the $15,000\$15,000 loss.
        • Ben’s Share: Basis $30,000\$30,000, FMV $20,000\$20,000, realized loss $10,000\$10,000. Ben is unrelated, so § 336(d)(1) does not apply. Harborwick recognizes a $10,000\$10,000 corporate loss.
      • Authorities: I.R.C. § 336(a), (d)(1); I.R.C. § 267(b)(2).

  • Multi-Asset Liquidation Model under Section 336(d)(1) (Dune Corporation, Ali, & Beck):

    • Facts: Ali owns 60%60\% (related person); Beck owns 40%40\% (unrelated). Dune distributes a 60%60\% undivided interest in each asset to Ali and a 40%40\% undivided interest in each to Beck (pro rata distribution pattern).
    • Asset A: Purchased from an unrelated seller 77 years ago. Basis $200,000\$200,000, FMV $100,000\$100,000. Total realized loss = $100,000\$100,000.
      • Asset A is not disqualified property (purchased, not contributed, and acquired outside 55 years).
      • Because the distribution is pro rata, § 336(d)(1)(A)(i) does not apply.
      • Ali’s 60%60\% portion (basis $120,000\$120,000, FMV $60,000\$60,000): $60,000\$60,000 loss recognized.
      • Beck’s 40%40\% portion (basis $80,000\$80,000, FMV $40,000\$40,000): $40,000\$40,000 loss recognized.
      • Total recognized loss on Asset A: $100,000\$100,000.
    • Asset B: Transferred via § 351 33 years ago (within 55 years) when basis and FMV were both $150,000\$150,000. Current basis $150,000\$150,000, FMV $90,000\$90,000. Total realized loss = $60,000\$60,000.
      • Asset B is disqualified property under § 336(d)(1)(B).
      • Ali’s 60%60\% portion (basis $90,000\$90,000, FMV $54,000\$54,000, loss $36,000\$36,000): Disallowed under § 336(d)(1)(A)(ii) because Ali is a related person.
      • Beck’s 40%40\% portion (basis $60,000\$60,000, FMV $36,000\$36,000, loss $24,000\$24,000): Recognized because Beck is not a related person.
    • Reconciliation of Dune Corporate Results:
      • Total realized loss: \100,000 \text{ (Asset A)} + \60,000 (Asset B)=$160,00060,000 \text{ (Asset B)} = \$160,000.
      • Total disallowed loss: $36,000 (Ali’s Asset B portion)\$36,000 \text{ (Ali’s Asset B portion)}.
      • Total recognized loss: \100,000 \text{ (Asset A)} + \24,000 (Beck’s Asset B)=$124,00024,000 \text{ (Beck’s Asset B)} = \$124,000.
    • Authorities: I.R.C. § 336(a), (d)(1); I.R.C. § 267(b)(2).

  • Section 336(d)(2) Anti-Stuffing Limitation for Built-in Loss Property:

    • Statutory Rule: If property is acquired by a liquidating corporation in a Section 351 transaction or as a contribution to capital, and the acquisition was part of a plan a principal purpose of which was to recognize a loss on corporate liquidation, the corporation’s adjusted basis in the property is reduced (solely for measuring loss recognition on liquidation) by the built-in loss existing at the contribution date.
    • Two-Year Presumption: Any transfer occurring within the 2-year2\text{-year} period ending on the date the liquidation plan is adopted is presumed to have been part of such a tax-avoidance plan, absent regulatory exceptions.
    • Scope and Application: Unlike § 336(d)(1), Section 336(d)(2) applies to sales, exchanges, and distributions to any shareholder (related or unrelated).
    • Loss Separation Mechanism:
      • Pre-contribution Built-in Loss=Acquisition Basis−Acquisition Date FMV\text{Pre-contribution Built-in Loss} = \text{Acquisition Basis} - \text{Acquisition Date FMV}
      • §336(d)(2) Loss Computation Basis=Current Adjusted Basis−Pre-contribution Built-in Loss\text{\S 336(d)(2) Loss Computation Basis} = \text{Current Adjusted Basis} - \text{Pre-contribution Built-in Loss}
      • Recognized Corporate Loss=Liquidation FMV−§336(d)(2) Loss Computation Basis\text{Recognized Corporate Loss} = \text{Liquidation FMV} - \text{\S 336(d)(2) Loss Computation Basis}
      • Disallowed Loss=Pre-contribution Built-in Loss\text{Disallowed Loss} = \text{Pre-contribution Built-in Loss}
    • Distinction between Two-Year and Five-Year Rules:
      • The 5-year5\text{-year} rule (§ 336(d)(1)) disallows all realized loss (pre- and post-contribution) on disqualified property, but applies only to distributions to related persons.
      • The 2-year2\text{-year} rule (§ 336(d)(2)) disallows only the pre-contribution built-in loss, but applies to distributions or sales to both related and unrelated parties.
    • Case Application (Coral Corporation): Coral acquired land via § 351 11 year before adopting its liquidation plan. At acquisition, basis was $220,000\$220,000 and FMV was $160,000\$160,000 ($60,000\$60,000 pre-contribution built-in loss). A valid joint § 362(e)(2)(C) election preserved Coral’s $220,000\$220,000 asset basis. The acquisition was part of a plan with a principal purpose of recognizing liquidation loss. Six months after plan adoption, Coral distributes the land (current FMV $130,000\$130,000) to an unrelated 40%40\% shareholder.
      • Unadjusted Realized Loss: $130,000−$220,000=−$90,000\$130,000 - \$220,000 = -\$90,000.
      • Loss Computation Basis: $220,000−$60,000 (pre-contribution loss)=$160,000\$220,000 - \$60,000 \text{ (pre-contribution loss)} = \$160,000.
      • Recognized Corporate Loss: $130,000−$160,000=−$30,000\$130,000 - \$160,000 = -\$30,000 (representing post-contribution decline).
      • Excluded Built-in Loss: $60,000\$60,000.
      • Recipient Basis: Section 336(d)(2) adjusts corporate loss measurement only; the unrelated distributee receives a fair market value basis of $130,000\$130,000 under Section 334(a).
    • Statutory Authorities: I.R.C. § 336(d)(1), (d)(2); I.R.C. § 362(e)(2)(C); I.R.C. § 267(b)(2).

Nonrecognition Liquidations of Controlled Subsidiaries under Section 332

  • Statutory Qualification Requirements for Section 332:

    • Corporate Parent Distributee: The recipient of the liquidation distributions must be an entity taxed as a corporation. Non-corporate individuals cannot qualify under Section 332.
    • 80% Stock Ownership Requirement (§ 1504(a)(2)): The parent corporation must own at least 80%80\% of the total voting power and at least 80%80\% of the total value of the subsidiary's stock.
    • Continuous Ownership Requirement: The requisite 80%80\% vote-and-value ownership must exist on the date the liquidation plan is adopted and continue continuously until the final liquidating distribution is completed. If ownership drops below 80%80\% (e.g., to 79%79\%) prior to completion, Section 332 is rendered entirely inapplicable.
    • Solvency and Stock Payment Requirement (Treas. Reg. § 1.332-2(b)): The subsidiary must be solvent. Section 332 applies only where the parent receives at least partial payment for its stock. If an insolvent subsidiary distributes assets solely to satisfy creditor claims and the parent receives nothing with respect to its equity stock, Section 332 does not apply; the parent instead claims a worthless security deduction under Section 165(g).
    • Timing Rules under Section 332(b):
      • Single Taxable Year (§ 332(b)(2)): The liquidation is completed within the taxable year in which the first distribution occurs.
      • Three-Year Completion Rule (§ 332(b)(3)): If the liquidation occurs across a series of distributions, the plan must state that the transfer of all property is to be completed within 33 years from the close of the taxable year during which the first distribution is made.
      • Measurement Example (Parent P & Subsidiary S): Calendar-year Subsidiary S makes its first liquidating distribution to Parent P on December 10, 2026. The taxable year closes December 31, 2026. The statutory completion deadline under § 332(b)(3) is December 31, 2029 (33 years from the close of the 2026 taxable year, not December 10, 2029).
    • Statutory and Regulatory Authorities: I.R.C. § 332(a), (b); I.R.C. § 1504(a)(2); Treas. Reg. § 1.332-2(a)–(c).

  • Corporate Consequences in Section 332 Liquidations:

    • Parent Nonrecognition (§ 332(a)): The parent recognizes no gain or loss upon the receipt of property distributed in complete liquidation of its controlled subsidiary.
    • Subsidiary Nonrecognition (§ 337(a)): The liquidating subsidiary recognizes no gain or loss on the distribution of property to the 80%80\% corporate parent.
    • Parent Basis in Distributed Property (§ 334(b)(1)): The parent takes a carryover basis in each asset received equal to the subsidiary's adjusted basis in that asset.
    • Extinguishment of Parent Stock Basis: The parent’s adjusted basis in the canceled subsidiary stock is completely extinguished. It is neither deducted as a loss nor added to the basis of the distributed assets.
    • Carryover of Corporate Tax Attributes (§ 381): Under Section 381(a)(1), the parent succeeds to and takes into account the subsidiary’s tax attributes (e.g., net operating loss carryovers, earnings and profits, capital loss carryovers), subject to statutory limitations.
    • Case Application (Meridian & Lumen): Meridian owns all the stock of solvent Lumen with a $400,000\$400,000 stock basis. Lumen completely liquidates under § 332, distributing unencumbered property with a $220,000\$220,000 basis and $600,000\$600,000 FMV to Meridian. Lumen recognizes $0\$0 gain (§ 337(a)), and Meridian recognizes $0\$0 gain (§ 332(a)). Under § 334(b)(1), Meridian takes Lumen’s carryover basis of $220,000\$220,000 in the property. Meridian’s $400,000\$400,000 stock basis is extinguished. Authorities: I.R.C. § 332(a); I.R.C. § 337(a); I.R.C. § 334(b)(1); I.R.C. § 381(a)(1), (c).

Subsidiary Liquidations with Indebtedness and Minority Shareholders

  • Subsidiary Indebtedness to Parent Discharged with Appreciated Property:

    • Subsidiary Nonrecognition under Section 337(b)(1): If a subsidiary is indebted to its 80%80\% corporate parent on the date the liquidation plan is adopted, any transfer of property to satisfy the indebtedness is treated as a distribution in liquidation. The subsidiary recognizes no gain or loss on the transfer of appreciated or depreciated property to discharge the debt.
    • Parent Creditor Recognition: Section 337 does not protect the parent in its capacity as a creditor. Under Section 1001, the parent recognizes gain or loss if the amount realized on debt satisfaction differs from its basis in the debt. If debt basis equals face value, creditor gain is $0\$0.
    • Parent Basis in Debt-Payment Property (§ 334(b)(1)): Section 334(b)(1) explicitly applies to transfers described in Section 337(b)(1). The parent takes a carryover basis in the property received in satisfaction of the debt, equal to the subsidiary’s adjusted basis.
    • Case Application (Vega & Orion): Solvent Vega owes corporate parent Orion $120,000\$120,000 on a debt existing when the liquidation plan is adopted. Orion's debt basis is $120,000\$120,000. In a § 332 liquidation, Vega transfers land (basis $80,000\$80,000, FMV $120,000\$120,000) to satisfy the debt. Under § 337(b)(1), Vega recognizes $0\$0 gain. Orion receives $120,000\$120,000 value on a $120,000\$120,000 basis debt, recognizing $0\$0 creditor gain. Under § 334(b)(1), Orion takes Vega’s carryover basis of $80,000\$80,000 in the land. Authorities: I.R.C. § 337(a), (b)(1); I.R.C. § 334(b)(1); I.R.C. § 1001(a)–(c).

  • Minority Shareholder Tax Treatment in Section 332 Liquidations:

    • Minority Shareholder Level (§ 331 & § 334(a)): Nonrecognition under Section 332 is strictly limited to the qualifying 80%80\% corporate parent. Minority shareholders must report distributions as taxable exchanges under Section 331(a), recognizing capital gain or loss, and taking a fair market value basis in distributed property under Section 334(a).
    • Distributing Corporation Level (§ 336(a) & § 336(d)(3)):
      • Appreciated Property: The liquidating subsidiary recognizes gain under Section 336(a) on distributions of appreciated property to minority shareholders, because Section 337(a) nonrecognition applies solely to distributions to the 80%80\% parent.
      • Depreciated Property: Under Section 336(d)(3), no loss is recognized by the liquidating subsidiary on any distribution of property to a minority shareholder in a Section 332 liquidation.
    • Case Application (Halcyon & Elena): Halcyon liquidates under § 332 (corporate parent owns 80%80\%). Unrelated minority owner Elena (stock basis $70,000\$70,000) receives property with a basis of $140,000\$140,000 and FMV of $100,000\$100,000.
      • Halcyon Corporate Consequence: Halcyon's realized loss of $100,000−$140,000=−$40,000\$100,000 - \$140,000 = -\$40,000 is completely disallowed under § 336(d)(3).
      • Elena Shareholder Consequence: Elena treats the receipt as an exchange under § 331, recognizing $100,000−$70,000=$30,000\$100,000 - \$70,000 = \$30,000 long-term capital gain. Under § 334(a), her basis in the property is its FMV of $100,000\$100,000.
    • Statutory Authorities: I.R.C. § 336(a), (d)(3); I.R.C. § 337(a); I.R.C. § 331(a); I.R.C. § 334(a); I.R.C. § 1222(3).

  • Comprehensive Synthesis of Subsidiary Liquidation (Harbor, Tide, & Erin):

    • Context: Harbor owns 80%80\% of Tide (stock basis $500,000\$500,000); unrelated individual Erin owns 20%20\% (stock basis $70,000\$70,000). Preexisting debt of $50,000\$50,000 is owed by Tide to Harbor (Harbor's debt basis is $50,000\$50,000). Total equity value is $500,000\$500,000 ($400,000\$400,000 to Harbor; $100,000\$100,000 to Erin).
    • Distributions:
      • To Harbor (for stock): Land (basis $150,000\$150,000, FMV $400,000\$400,000).
      • To Harbor (for debt): Equipment (basis $30,000\$30,000, FMV $50,000\$50,000).
      • To Erin (for stock): Asset C (basis $20,000\$20,000, FMV $60,000\$60,000) and Asset D (basis $50,000\$50,000, FMV $40,000\$40,000).
    • Tide Corporate Recognition:
      • Land to Harbor: $250,000\$250,000 appreciation is unrecognized under § 337(a).
      • Equipment to Harbor: $20,000\$20,000 appreciation is unrecognized under § 337(b)(1).
      • Asset C to Erin: $60,000−$20,000=$40,000\$60,000 - \$20,000 = \$40,000 gain recognized under § 336(a).
      • Asset D to Erin: $40,000−$50,000=−$10,000\$40,000 - \$50,000 = -\$10,000 loss disallowed under § 336(d)(3).
      • Total corporate recognition: $40,000\$40,000 gain and $0\$0 loss.
    • Harbor Parent Tax Consequences:
      • Stock exchange: $0\$0 gain or loss recognized under § 332(a). Harbor's $500,000\$500,000 stock basis is extinguished.
      • Creditor settlement: \50,000 \text{ (FMV)} - \50,000 (basis)=$050,000 \text{ (basis)} = \$0 creditor gain.
      • Received asset bases: Land takes carryover basis of $150,000\$150,000 (§ 334(b)(1)); Equipment takes carryover basis of $30,000\$30,000 (§ 334(b)(1) via § 337(b)(1)). Total parent property basis = $180,000\$180,000.
    • Erin Minority Tax Consequences:
      • Exchange gain: Total proceeds = $60,000+$40,000=$100,000\$60,000 + \$40,000 = \$100,000. Gain recognized under § 331 is $100,000−$70,000=$30,000\$100,000 - \$70,000 = \$30,000 long-term capital gain.
      • Property bases: Asset C basis = $60,000\$60,000; Asset D basis = $40,000\$40,000 (fair market value bases under § 334(a)).
    • Statutory Authorities: I.R.C. § 332(a), (b); I.R.C. § 337(a), (b)(1); I.R.C. § 334(a), (b)(1); I.R.C. § 336(a), (d)(3); I.R.C. § 331(a); I.R.C. § 1001(a), (b); I.R.C. § 1222(3).

Stock Purchases Treated as Asset Acquisitions under Section 338

  • Qualified Stock Purchase (QSP) Requirements (§ 338(d)(3)):

    • Corporate Purchaser: The purchaser must be a corporation. Individuals cannot execute a Section 338 election.
    • 80% Vote and Value Threshold: The purchasing corporation must acquire by purchase stock meeting the Section 1504(a)(2) requirements (80%80\% total voting power and 80%80\% total value).
    • 12-Month Acquisition Period: The 80%80\% stock threshold must be acquired within an acquisition period of not more than 1212 months.
    • Definition of Purchase (§ 338(h)(3)): Stock acquired from related sellers under Section 318, stock with carryover or substituted basis, stock acquired from a decedent, or stock acquired in nonrecognition exchanges such as Section 351, 354, 355, or 356 does not qualify as a purchase.
    • No Actual Liquidation Required: An actual liquidation or dissolution of the target corporation is not required to obtain the benefits of a Section 338 election.

  • Election Procedure and Deadlines (§ 338(g)):

    • Under Section 338(g)(1), the election must be made by the purchasing corporation no later than the 15th15\text{th} day of the 9th9\text{th} month beginning after the month in which the acquisition date occurs.
    • Once made, a Section 338 election is irrevocable under Section 338(g)(3).
    • Deadline Calculation Example (Pella & Juniper): Pella executes a QSP of Juniper on September 18, 2026 (the acquisition date). The acquisition month is September 2026. The 9-month count begins in October 2026 (Month 1 = Oct, 2 = Nov, 3 = Dec, 4 = Jan, 5 = Feb, 6 = Mar, 7 = Apr, 8 = May, 9 = June 2027). The statutory deadline is June 15, 2027. Authorities: I.R.C. § 338(g)(1), (g)(3), (h)(2).

  • Deemed Sale Mechanics and Residual Basis Allocation (ADSP and AGUB):

    • Deemed Transactions: Target ("Old Target") is treated as selling all its assets at the close of the acquisition date at Aggregate Deemed Sale Price (ADSP) in a single fully taxable transaction. On the following day, Target ("New Target") is treated as a new corporation purchasing all assets for Adjusted Grossed-Up Basis (AGUB).
    • Residual Allocation Method (Treas. Reg. § 1.338-6): Both ADSP (deemed proceeds) and AGUB (new basis) are allocated sequentially among seven asset classes:
      • Class I: Cash and general deposit accounts.
      • Class II: Actively traded personal property, U.S. government securities, publicly traded stock.
      • Class III: Assets marked-to-market at least annually for federal tax purposes, debt instruments.
      • Class IV: Inventory and property held primarily for sale to customers.
      • Class V: All assets not in Classes I, II, III, IV, VI, or VII (includes equipment, buildings, and land).
      • Class VI: Section 197 intangibles (other than goodwill and going concern value).
      • Class VII: Goodwill and going concern value.
    • Allocation within a Class: If aggregate amounts are insufficient or in excess of an entire class, the amount is allocated among assets in that class in proportion to their relative fair market values.

  • Comprehensive QSP and Section 338 Election Model (Pine & River):

    • Context: Pine purchases 100%100\% of River stock from unrelated sellers for $500,000\$500,000. River has $100,000\$100,000 of liabilities. River holds three assets: Cash (basis $50,000\$50,000, FMV $50,000\$50,000), Land (basis $100,000\$100,000, FMV $300,000\$300,000), and Equipment (basis $150,000\$150,000, FMV $250,000\$250,000). Total ADSP and total AGUB are both correctly computed as $600,000\$600,000 (\500,000 \text{ stock price} + \100,000 liabilities100,000 \text{ liabilities}).
    • Scenario A: No Section 338 Election:
      • River retains historical inside asset bases: Cash $50,000\$50,000, Land $100,000\$100,000, and Equipment $150,000\$150,000 (aggregate inside basis $300,000\$300,000).
      • Pine has an outside stock basis in River of $500,000\$500,000.
    • Scenario B: Timely Section 338(g) Election:
      • ADSP/AGUB Allocation:
        • Class I (Cash): Allocated $50,000\$50,000.
        • Remaining balance of $550,000\$550,000 ($600,000−$50,000\$600,000 - \$50,000) is allocated to Class V assets pro rata by FMV:
          • \text{Land Allocation} = \550,000 \times \frac{\300,000}{\$550,000} = \$300,000
          • \text{Equipment Allocation} = \550,000 \times \frac{\250,000}{\$550,000} = \$250,000
      • Deemed-Sale Gain Recognized by Old River:
        • Cash: $50,000−$50,000=$0\$50,000 - \$50,000 = \$0
        • Land: $300,000−$100,000=$200,000\$300,000 - \$100,000 = \$200,000
        • Equipment: $250,000−$150,000=$100,000\$250,000 - \$150,000 = \$100,000
        • Total corporate deemed-sale gain recognized = $300,000\$300,000.
      • New River Asset Bases: Cash $50,000\$50,000, Land $300,000\$300,000, and Equipment $250,000\$250,000.
    • Subsequent Complete Liquidation under Sections 332 and 337:
      • If River later liquidates into Pine, Pine takes carryover inside bases under Section 334(b)(1):
        • Following a § 338 Election: Pine takes bases of $50,000\$50,000 (cash), $300,000\$300,000 (land), and $250,000\$250,000 (equipment).
        • Without a § 338 Election: Pine takes carryover bases of $50,000\$50,000 (cash), $100,000\$100,000 (land), and $150,000\$150,000 (equipment).
      • Pine's $500,000\$500,000 stock basis is canceled and does not alter the asset bases.
    • Statutory and Regulatory Authorities: I.R.C. § 338(a), (b), (d), (g); Treas. Reg. § 1.338-6(a), (b); I.R.C. § 332(a); I.R.C. § 337(a); I.R.C. § 334(b)(1).

Corporate Reorganizations: Classifications, Boot, and Basis Rules

  • Overview of Reorganization Types under Section 368(a)(1):

    • Type A: Statutory merger or consolidation effected pursuant to state or federal law.
    • Type B: Acquisition of stock of target solely in exchange for voting stock of acquirer (or voting stock of acquirer's parent), provided acquirer has control of target under § 368(c) immediately after the exchange (80%80\% of voting power and 80%80\% of all nonvoting shares).
    • Type C: Acquisition of substantially all properties of target solely in exchange for voting stock of acquirer, followed by the mandatory liquidation of target.
    • Type D: Transfer of assets to a controlled corporation, encompassing acquisitive transactions or divisive transactions (spin-offs, split-offs, split-ups under Section 355).
    • Type E: Recapitalization reshuffling corporate capital structure (exchanges of stock for stock, bonds for stock, or bonds for bonds).
    • Type F: Mere change in identity, form, or place of organization of a single corporation.
    • Type G: Transfer of assets to another corporation in a Title 11 or similar bankruptcy or receivership proceeding.

  • Judicial Requirements and Exceptions:

    • Reorganizations must have a bona fide plan of reorganization and a valid business purpose.
    • Continuity of Interest (COI) and Continuity of Business Enterprise (COBE): Required for corporate reorganizations generally. However, under Treas. Reg. § 1.368-1(b), Type E recapitalizations and Type F mere changes are specifically exempt from both the COI and COBE doctrines.
    • Step-Transaction Doctrine: Steps in an integrated plan may be collapsed to evaluate compliance with statutory reorganization definitions.

  • Shareholder-Level Reorganization Rules (§§ 354, 356, 358):

    • General Nonrecognition (§ 354(a)(1)): No gain or loss is recognized if stock or securities in a party to a reorganization are exchanged solely for stock or securities in such corporation or another corporate party to the reorganization.
    • Receipt of Boot (§ 356(a)(1)): When nonqualifying property (cash or other property) is received in addition to stock:
      • Realized Gain=(FMV of Stock Received+Boot Received)−Adjusted Stock Basis\text{Realized Gain} = (\text{FMV of Stock Received} + \text{Boot Received}) - \text{Adjusted Stock Basis}
      • Recognized Gain=min⁡(Realized Gain,Boot Received)\text{Recognized Gain} = \min(\text{Realized Gain}, \text{Boot Received})
    • Dividend Effect (§ 356(a)(2)): If an exchange has the effect of a dividend distribution, recognized gain is treated as dividend income to the extent of the shareholder's ratable share of accumulated E&P\text{E\&P}; any excess recognized gain is treated as capital gain.
    • Loss Disallowance (§ 356(c)): Under Section 356(c), no loss may be recognized in an exchange occurring pursuant to a reorganization, even if boot is received.
    • Shareholder Basis in New Stock (§ 358(a)(1)):
      • New Stock Basis=Old Stock Basis−Cash/Boot Received+Gain Recognized−Loss Recognized (if any)\text{New Stock Basis} = \text{Old Stock Basis} - \text{Cash/Boot Received} + \text{Gain Recognized} - \text{Loss Recognized (if any)}
      • Basis in boot property received under § 358(a)(2) is its fair market value.
      • Preserved Deferred Gain/Loss=FMV of New Stock−New Stock Basis\text{Preserved Deferred Gain/Loss} = \text{FMV of New Stock} - \text{New Stock Basis}

  • Comparative Reorganization Calculations:

    • Mia Case (Stock and Cash Boot): Target stock (basis $100,000\$100,000) exchanged for Acquirer voting stock (FMV $120,000\$120,000) plus $30,000\$30,000 cash. No dividend effect.
      • Total Consideration (Amount Realized)=$120,000+$30,000=$150,000\text{Total Consideration (Amount Realized)} = \$120,000 + \$30,000 = \$150,000
      • Realized Gain=$150,000−$100,000=$50,000\text{Realized Gain} = \$150,000 - \$100,000 = \$50,000
      • Recognized Gain=min⁡($50,000,$30,000)=$30,000 long-term capital gain\text{Recognized Gain} = \min(\$50,000, \$30,000) = \$30,000 \text{ long-term capital gain}
      • \text{Basis in New Stock} = \$100,000 - \$30,000 \text{ (cash)} + \30,000 \text{ (gain recognized)} = \100,000100,000
      • \text{Preserved Deferred Gain} = \120,000 \text{ (FMV)} - \100,000 (basis)=$20,000100,000 \text{ (basis)} = \$20,000
      • Authorities: I.R.C. § 354(a)(1); I.R.C. § 356(a); I.R.C. § 358(a)(1); I.R.C. § 1222(3).
    • Comparative Gain vs. Loss Study (Cases A & B): Each shareholder receives Acquirer stock worth $100,000\$100,000 plus $20,000\$20,000 cash (Amount Realized = $120,000\$120,000). No dividend effect.
      • Case A (Old Stock Basis $70,000\$70,000):
        • Realized Gain=$120,000−$70,000=$50,000\text{Realized Gain} = \$120,000 - \$70,000 = \$50,000
        • Recognized Gain=min⁡($50,000,$20,000)=$20,000 long-term capital gain\text{Recognized Gain} = \min(\$50,000, \$20,000) = \$20,000 \text{ long-term capital gain}
        • New Stock Basis=$70,000−$20,000+$20,000=$70,000\text{New Stock Basis} = \$70,000 - \$20,000 + \$20,000 = \$70,000
        • Deferred Gain Preserved=$100,000−$70,000=$30,000\text{Deferred Gain Preserved} = \$100,000 - \$70,000 = \$30,000
      • Case B (Old Stock Basis $140,000\$140,000):
        • Realized Loss=$120,000−$140,000=−$20,000\text{Realized Loss} = \$120,000 - \$140,000 = -\$20,000
        • Recognized Loss=$0 (disallowed under §356(c))\text{Recognized Loss} = \$0 \text{ (disallowed under \S 356(c))}
        • New Stock Basis=$140,000−$20,000 (cash)+$0=$120,000\text{New Stock Basis} = \$140,000 - \$20,000 \text{ (cash)} + \$0 = \$120,000
        • \text{Deferred Loss Preserved} = \100,000 \text{ (FMV)} - \120,000 (basis)=−$20,000120,000 \text{ (basis)} = -\$20,000
      • Operational Distinction: Cash boot triggers recognition of realized gain up to boot received, but cash boot cannot trigger recognition of realized loss in a reorganization exchange.
      • Authorities: I.R.C. § 354(a)(1); I.R.C. § 356(a), (c); I.R.C. § 358(a)(1); I.R.C. § 1222(3).
    • Debt Securities and Excess Principal as Boot (Omar Case): Omar exchanges Target debt securities (principal $100,000\$100,000, basis $70,000\$70,000) for Acquirer debt securities (principal $120,000\$120,000, FMV $120,000\$120,000). Excess principal is $20,000\$20,000, with a fair market value of $20,000\$20,000.
      • Excess Principal Rule (§ 354(a)(2)(A) & § 356(d)(2)(B)): When securities are received with a principal amount exceeding the principal amount of securities surrendered, the fair market value of the excess principal constitutes other property (boot).
      • Realized Gain=$120,000−$70,000=$50,000\text{Realized Gain} = \$120,000 - \$70,000 = \$50,000
      • \text{Recognized Gain} = \min(\text{Realized Gain } \50,000, \text{Boot FMV } \20,000)=$20,00020,000) = \$20,000
      • Deferred Gain=$50,000−$20,000=$30,000\text{Deferred Gain} = \$50,000 - \$20,000 = \$30,000
      • Basis Verification: Qualifying securities take a basis of $70,000−$20,000+$20,000=$70,000\$70,000 - \$20,000 + \$20,000 = \$70,000. The boot portion takes an FMV basis of $20,000\$20,000. Aggregate basis in the received debt securities is $90,000\$90,000, preserving $120,000−$90,000=$30,000\$120,000 - \$90,000 = \$30,000 of deferred gain.
      • Authorities: I.R.C. § 354(a)(1), (a)(2)(A); I.R.C. § 356(a)(1), (d)(2)(B); I.R.C. § 358(a); Treas. Reg. § 1.356-3(a).

Corporate-Level Reorganization Rules under Section 361, Section 1032, and Section 362(b)

  • Target Corporation Consequences under Section 361:

    • Exchange Nonrecognition (§ 361(a)): A target corporation recognizes no gain or loss on the exchange of property solely for stock or securities in another corporate party to the reorganization.
    • Receipt and Distribution of Boot (§ 361(b)(1)): If the target receives boot in addition to qualifying stock:
      • Distributed Boot (§ 361(b)(1)(A)): If the target distributes all boot received to its shareholders pursuant to the plan of reorganization, the target recognizes no gain on the exchange.
      • Retained Boot (§ 361(b)(1)(B)): If the target retains any boot, it recognizes gain up to the amount of cash and FMV of other property retained.
    • Target Distributions to Shareholders (§ 361(c)):
      • Target recognizes no gain or loss on distributing "qualified property" (stock, stock rights, or obligations of a corporate party to the reorganization).
      • Target recognizes gain on the distribution of appreciated nonqualified property (boot) under Section 361(c)(2)(A) as if sold at fair market value.

  • Acquiring Corporation Treatment under Section 1032 and Section 362(b):

    • Issuance of Acquirer Stock (§ 1032(a)): The acquiring corporation recognizes no gain or loss on the receipt of money or other property in exchange for its own stock (including treasury stock).
    • Transfer of Appreciated Boot Property: If the acquirer transfers non-stock property (such as investment assets) as boot to acquire target assets, Section 1032 does not apply to the transferred boot; the acquirer recognizes gain under Section 1001.
    • Acquirer Basis in Target Assets (§ 362(b)):
      • Acquirer Basis in Acquired Assets=Target’s Historical Basis+Gain Recognized by Target on Transfer\text{Acquirer Basis in Acquired Assets} = \text{Target's Historical Basis} + \text{Gain Recognized by Target on Transfer}
      • Any gain recognized by the acquirer on transferring its own appreciated boot property does not increase the carryover basis of the acquired target assets.

  • Comprehensive Asset Reorganization Model (Spruce & Elm):

    • Transaction: Spruce acquires all Elm assets (aggregate basis $280,000\$280,000, FMV $450,000\$450,000) in a qualifying asset reorganization. Spruce transfers its own voting common stock (FMV $400,000\$400,000) and an investment parcel (FMV $50,000\$50,000, Spruce basis $30,000\$30,000). Elm immediately distributes all Spruce stock and the parcel to its shareholders pursuant to the plan.
    • Step 1: Elm's Realized and Recognized Exchange Gain:
      • \text{Elm Realized Gain} = (\400,000 \text{ stock} + \50,000 \text{ parcel}) - \280,000 \text{ basis} = \170,000170,000
      • Under § 361(b)(1)(A), because Elm distributes all boot pursuant to the plan, Elm recognizes $0\$0 exchange gain.
    • Step 2: Spruce's Consideration Recognition:
      • Under § 1032(a), Spruce recognizes $0\$0 gain on issuing its own voting common stock.
      • Spruce recognizes gain on transferring its appreciated investment parcel under § 1001: $50,000−$30,000=$20,000\$50,000 - \$30,000 = \$20,000.
    • Step 3: Elm's Basis in Received Property:
      • Under § 358(a)(2), Elm takes a fair market value basis in the boot parcel: $50,000\$50,000.
      • Under § 358(a)(1), Elm’s basis in Spruce stock is: \$280,000 - \$50,000 \text{ (boot)} + \0 \text{ (gain)} = \230,000230,000.
    • Step 4: Elm's Immediate Distribution to Shareholders:
      • Spruce stock is qualified property under § 361(c)(2)(B), so Elm recognizes $0\$0 gain on distributing it.
      • The parcel is nonqualified property, but because Elm's basis in the parcel ($50,000\$50,000) equals its FMV ($50,000\$50,000), Elm recognizes $0\$0 gain on its distribution under § 361(c)(2)(A).
    • Step 5: Spruce's Basis in Acquired Elm Assets:
      • Under § 362(b), Spruce takes Elm’s carryover basis of $280,000\$280,000 plus gain recognized by the transferor Elm ($0\$0), resulting in an aggregate asset basis of $280,000\$280,000.
      • Spruce's separate $20,000\$20,000 gain on its parcel is not gain recognized by Elm on the transferred assets and does not adjust asset basis.
    • Step 6: Corporate Deferral Reconciliation:
      • The acquired Elm assets retain \450,000 \text{ (FMV)} - \280,000 (basis)=$170,000280,000 \text{ (basis)} = \$170,000 of deferred appreciation inside Spruce.
    • Statutory Authorities: I.R.C. § 361(a), (b)(1), (c); I.R.C. § 1032(a); Treas. Reg. § 1.1032-1(a), (d); I.R.C. § 1001(a)–(c); I.R.C. § 358(a), (f); I.R.C. § 362(b).