Tax Code 362 Case Study

Pboulder
March 2, 2010
Tax Code 362 Research Case

Question: Can the sole owner of a corporation successfully avoid taxes on the liquidation of appreciated assets by contributing depreciated property to the corporation, selling the property soon thereafter, and then waiting two years before adopting the plan to liquidate?
Facts:
J is an individual who solely owns Average Corporation
Average Corporation’s assets have appreciated in value despite low profitability
J will contribute depreciated property to Average, then sell it soon after to an unrelated party
He will then wait two years and one month before adopting a plan to liquidate Average Corp
Average will distribute the appreciated property to J
J’s plan is to use the capital loss carryover from the property he contributed to offset the gain on the distribution
Analysis:
According to code section 362(c) (2) (a), property that is transferred to a corporation as contributed capital, to which section 351 applies (no gain/loss recognition if property is transferred solely for stock), and the aggregate basis of the property exceeds its aggregate value immediately after the transaction, then the transferee corporation’s basis in the property can not exceed the fair market value of the property.
When this section is applied, with respect to 351, the depreciated property transferred to Average Corporation has a basis equal to fair market value of the property on the transfer date. When Average sells the property soon after the transfer at fair market value no loss will be realized. Therefore, J’s plan will not succeed as there will be no capital loss available to carry over and offset the gain on the liquidation of Average Corporation’s appreciated assets, two years after the sale was
made. Code section 362 (e) (2) (c) provides a way for J’s plan to potentially work. The transferee and transferor can make a joint election to reduce the transferor’s basis in the stock received from the property contributed to its fair market value. J’s basis in the stock would be equal to the fair market value of the property at the date of the transfer. The application of this code section makes it unnecessary for Average Corporation’s basis in the depreciated property to be reduced. Both parties would be required to attach the election to their tax returns for the taxable year when the transaction occurred. When Average sells the property soon after at fair market value, a capital loss will be realized, making it possible to offset the gain on liquidation of the appreciated assets, so long as there were no other capital gains prior to or during the two years waited before adopting the plan to liquidate.

A subsection of code 336 proves J’s plan to be unacceptable by stating that the contribution made can not be apart of any type of plan whose purpose is to recognize a loss by the liquidating corporation with respect to such property in connection with the liquidation. This illegitimates the property transferred by J because a case can be made that his intent was to purposefully create a loss to avoid taxation on the appreciated property. The property must not be sold before the liquidation is begun.

Conclusion: J’s plan will not succeed because the IRS code has provisions inhibiting corporations from creating losses when trying to avoid taxes. If Average waits to liquidate, the property will be considered acquired solely for loss recognition. No loss can be recognized or carried over and the taxes on the gain will have to be paid.