IRS Revenue Ruling 79-235 (Rev. Rul. 79-235)
Internal Revenue Service (I.R.S.)
Revenue Ruling (Rev. Rul.)
COLLAPSIBLE CORPORATIONS; HOLDING PERIOD; PROPERTY ACQUIRED BY EXCHANGE
26 CFR 1.341-4: Limitations on application of section.
Collapsible corporations; holding period; property acquired by exchange. A shopping center received by a corporation in a transaction qualifying under section 1031(a) of the Code in exchange for a shopping center constructed by the corporation takes the date of completion of construction of the shopping center that was exchanged for purposes of section 341(d)(3).
For purposes of applying section 341(d)(3) of the Internal Revenue Code, does the property received in a nontaxable exchange take the date of completion of construction of the property exchanged?
In January 1971 X corporation was formed to construct and operate a commercial shopping center. Construction of shopping center A was completed in March 1972. In November 1977 shopping center A was exchanged for shopping center B, a property owned by an unrelated corporation on which construction was completed in May 1976, and on which no further construction was performed. That transaction qualified for nonrecognition of gain or loss under section 1031(a) of the Code. In December 1978 X adopted a plan of liquidation and completely liquidated. Upon the liquidation the shareholders of X received shopping center B, the fair market value of which exceeded the adjusted basis of the X stock held by the shareholders.
LAW AND ANALYSIS
The applicable sections of the Code and Income Tax Regulations thereunder are 341(a), 341(b)(1), 341(b)(2)(C), 341(d)(3), 1031, 1.341-2, 1.341-4(d), and 1.1031(d)-1, relating to collapsible corporations and the nontaxable exchange of property.
Section 341(a) of the Code provides that gain from a distribution in partial or complete liquidation of a collapsible corporation, which distribution is treated as in part or full payment in exchange for stock, to the extent that it would be considered as gain from the sale or exchange of a capital asset held for more than 1 year will, except as otherwise provided, be considered as ordinary income.
Under section 341(b) the term 'collapsible corporation' means a corporation formed or availed of principally for the manufacture, construction, or production of property, for the purchase of property which (in the hands of the corporation) is property described in section 341(b)(3), or for the holding of stock in a corporation so formed or availed of, with a view to the sale or exchange of stock by its shareholders (whether in liquidation or otherwise), or a distribution to its shareholders, before the realization by the corporation manufacturing, constructing, producing, or purchasing the property of a substantial part of the taxable income to be derived from such property, and the realization by such shareholders of gain attributable to such property.
Under section 341(b)(2)(C) of the Code, a corporation will be deemed to have manufactured, constructed, produced, or purchased property, if it holds property having a basis determined, in whole or in part, by reference to the cost of property manufactured, constructed, produced, or purchased by the corporation.
Section 1.341-2(a)(5) of the regulations provides that if a corporation were to exchange property constructed by it for property of like kind constructed by another person, and such exchange qualifies under section 1031(a), then the corporation would be deemed to have constructed the property received by it in the exchange, since the basis of the property received by it in the exchange would, under section 1031(d), be determined by reference to the basis of the property constructed by the corporation.
Section 341(d)(3) of the Code states that in the case of gain realized by a shareholder with respect to his stock in a collapsible corporation, section 341(a) shall not apply to gain realized after the expiration of 3 years following the completion of such manufacture, construction, production, or purchase.
Pursuant to section 341(b)(2)(C) of the Code and section 1.341(a)(5) of the regulations, X is considered to have constructed shopping center B for purposes of the 'collapsible corporation' definition contained in section 341(b), since the basis of shopping center B in the hands of X is determined by reference to the cost of shopping center A that X constructed.
The 3-year period in section 341(d)(3) was imposed by Congress as an arbitrary time limit beyond which gain realized will not be subject to treatment under section 341(a) on the theory that a corporation will not be a collapsible corporation if the shareholders do not realize their gain until after 3 years following completion of manufacture, construction, production, or purchase by the corporation. S. Rep. No. 2375, 81st Cong., 2d Sess. 90 (1950), 1950-2 C.B. 483, and H.R. Rep. No. 2319, 81st Cong., 2d Sess. 99 (1950), 1950-2 C.B. 380. In the instant situation, the gain realized by the X shareholders upon the receipt of shopping center B was realized more than 3 years following completion of construction by X of shopping center A, during which time no construction activities were engaged in by X with regard to shopping center B. See Rev. Rul. 57-491, 1957-2 C.B. 232, which holds that, where a partnership transferred property to a corporation in exchange for stock in a transaction in which no gain or loss was recognized under section 351 of the Code, the time that the partnership held the property is taken into account for purposes of the 3-year rule of section 341(d)(3).
In view of the above, shopping center B will take the date of completion of construction of shopping center A and, therefore, section 341(d)(3) of the Code is satisfied, and the gain realized by the X shareholders is not subject to section 341(a).
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