# Bulletin No. 1998–14

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- **Document type:** Agency decision

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Internal Revenue

bulletin

Bulletin No. 1998–14
April 6, 1998

HIGHLIGHTS
OF THIS ISSUE

These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

INCOME TAX
Rev. Rul. 98–18, page 22.

nized by a shareholder who receives, in exchange for the
shareholder’s stock, certain installment obligations that are
distributed upon the complete liquidation of a corporation.

Federal rates; adjusted federal rates; adjusted federal
long-term rate, and the long-term exempt rate. For
purposes of sections 1274, 1288, 382, and other sections
of the Code, tables set forth the rates for April 1998.

EXEMPT ORGANIZATIONS

T.D. 8760, page 4.
T.D. 8761, page 13.
REG–120882–97, page 25.
Final, temporary, and proposed regulations under section
368 of the Code provide guidance regarding satisfaction of
the continuity of interest and continuity of business enterprise requirements for corporate reorganizations. A public
hearing on the proposed regulations will be held on May 26,
1998.

T.D. 8762, page 15.
Final regulations under section 453 of the Code relate to
the use of the installment method to report the gain recog-

Finding Lists begin on page 32.
Index for January-March begins on page 34.

Department of the Treasury
Internal Revenue Service

Announcement 98–26, page 28.
A list is given of organizations now classified as private foundations.

ADMINISTRATIVE
REG–209373–81, page 26.
Proposed regulations under section 195 of the Code provide
rules and procedures for electing to amortize start-up expenditures. A public hearing will be held on June 2, 1998.

Mission of the Service
ucts and services; and perform in a manner warranting
the highest degree of public confidence in our integrity, efficiency, and fairness.

The purpose of the Internal Revenue Service is to collect
the proper amount of tax revenue at the least cost; serve
the public by continually improving the quality of our prod-

Statement of Principles
of Internal Revenue
Tax Administration
The Service also has the responsibility of applying and
administering the law in a reasonable, practical manner.
Issues should only be raised by examining officers when
they have merit, never arbitrarily or for trading purposes.
At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that
care be exercised not to raise an issue or to ask a court to
adopt a position inconsistent with an established Service
position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue
is determined by Congress.
With this in mind, it is the duty of the Service to carry out that
policy by correctly applying the laws enacted by Congress;
to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;
and to perform this work in a fair and impartial manner, with
neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It
should be conducted with as little delay as possible and
with great courtesy and considerateness. It should never
try to overreach, and should be reasonable within the
bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax devices and
fraud.

At the heart of administration is interpretation of the Code. It
is the responsibility of each person in the Service, charged
with the duty of interpreting the law, to try to find the true
meaning of the statutory provision and not to adopt a
strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only
when we ascertain and apply the true meaning of the statute.

2

Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold
on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.

Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking
and the disbarment and suspension list included in this part,
none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual basis
and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 42.—Low-Income
Housing Credit
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of April 1998. See Rev. Rul. 98–18, page 22.

Section 280G.—Golden
Parachute Payments
Federal short-term, mid-term, and long-term
rates are set forth for the month of April 1998. See
Rev. Rul. 98–18, page 22.

Section 368.—Definitions
Relating to Corporate
Reorganizations
26 CFR 1.368–1: Purpose and scope of exception of
reorganization exchanges.

T.D. 8760
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Continuity of Interest and
Continuity of Business
Enterprise
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations providing guidance regarding satisfaction of the continuity of
interest and continuity of business enterprise requirements for corporate reorganizations. The final regulations affect corporations and their shareholders.
DATES: These regulations are effective
January 28, 1998.
Applicability: These regulations apply
to transactions occurring after January 28,
1998, except that they do not apply to any
transaction occurring pursuant to a written agreement which is (subject to customary conditions) binding on January
28, 1998, and at all times thereafter.
FOR FURTHER INFORMATION CONTACT: Regarding §1.368–1(e) (continuity of interest), §§1.338–2 and 1.368–1(a)

April 6, 1998

and (b): Phoebe Bennett, (202) 622-7750
(not a toll-free number); regarding
§1.368–1(d) (continuity of business enterprise), §§1.368–1(a) and (b), and 1.368–
2(k): Marlene Peake Oppenheim, (202)
622-7750 (not a toll free number).
SUPPLEMENTARY INFORMATION:
Background
On December 23, 1996, the IRS published a notice of proposed rulemaking
(REG–252231–96 [1997–1 C.B. 800]) in
the Federal Register (61 F.R. 67512) relating to the continuity of interest (COI)
requirement (proposed COI regulations).
On January 3, 1997, the IRS published a
notice of proposed rulemaking (REG–
252233–96 [1997–1 C.B. 802]) in the
Federal Register (62 F.R. 36101) (proposed COBE regulations) relating to (1)
the continuity of business enterprise
(COBE) requirement; and (2) transfers of
acquired assets or stock following certain
otherwise qualifying reorganizations (remote continuity of interest). Many written comments were received in response
to these notices of proposed rulemaking.
A public hearing on both proposed regulations was held on May 7, 1997. After
consideration of all comments, the regulations proposed by REG–252231–96 and
REG–252233–96 are adopted as revised
by this Treasury decision, along with temporary regulations and proposed regulations cross-referencing the temporary regulations regarding COI published in T.D.
8761, page 13 of this Bulletin.
Explanation of Provisions
The Internal Revenue Code of 1986
provides general nonrecognition treatment
for reorganizations specifically described
in section 368. In addition to complying
with the statutory requirements and certain
other requirements, a transaction generally
must satisfy the continuity of interest requirement and the continuity of business
enterprise requirement.
A. Continuity of Interest
The purpose of the continuity of interest requirement is to prevent transactions
that resemble sales from qualifying for
nonrecognition of gain or loss available to

4

corporate reorganizations. The final regulations provide that the COI requirement
is satisfied if in substance a substantial
part of the value of the proprietary interest
in the target corporation (T) is preserved
in the reorganization. A proprietary interest in T is preserved if, in a potential reorganization, it is exchanged for a proprietary interest in the issuing corporation
(P), it is exchanged by the acquiring corporation for a direct interest in the T enterprise, or it otherwise continues as a
proprietary interest in T. The issuing corporation means the acquiring corporation
(as the term is used in section 368(a)), except that, in determining whether a reorganization qualifies as a triangular reorganization (as defined in §1.358–6(b)(2)),
the issuing corporation means the corporation in control of the acquiring corporation. However, a proprietary interest in T
is not preserved if, in connection with the
potential reorganization, it is acquired by
P for consideration other than P stock, or
P stock furnished in exchange for a proprietary interest in T in the potential reorganization is redeemed. All facts and circumstances must be considered in
determining whether, in substance, a proprietary interest in T is preserved.
Rationale for the COI regulations
The proposed and final regulations permit former T shareholders to sell P stock
received in a potential reorganization to
third parties without causing the reorganization to fail to satisfy the COI requirement. Some commentators have questioned whether the regulations are
consistent with existing authorities.
The COI requirement was applied first
to reorganization provisions that did not
specify that P exchange a proprietary interest in P for a proprietary interest in T.
Supreme Court cases imposed the COI requirement to further Congressional intent
that tax-free status be accorded only to
transactions where P exchanges a substantial proprietary interest in P for a proprietary interest in T held by the T shareholders rather than to transactions
resembling sales. See LeTulle v. Scofield,
308 U.S. 415 (1940); Helvering v. Minnesota Tea Co., 296 U.S. 378 (1935);
Pinellas Ice & Cold Storage Co. v. Com-

1998–14 I.R.B.

missioner, 287 U.S. 462 (1933). See also
Cortland Specialty Co. v. Commissioner,
60 F.2d 937 (2d Cir. 1932), cert. denied
288 U.S. 599 (1933).
None of the Supreme Court cases establishing the COI requirement addressed the
issue of whether sales by former T shareholders of P stock received in exchange
for T stock in the potential reorganization
cause the COI requirement to fail to be
satisfied. Since then, however, some
courts have premised decisions on the assumption that sales of P stock received in
exchange for T stock in the potential reorganization may cause the COI requirement to fail to be satisfied. McDonald’s
Restaurants of Illinois, Inc. v. Commissioner, 688 F.2d 520 (7th Cir. 1982);
Penrod v. Commissioner, 88 T.C. 1415
(1987); Heintz v. Commissioner, 25 T.C.
132 (1955), nonacq., 1958–2 C.B. 9; Estate of Elizabeth Christian v. Commissioner, 57 T.C.M. (CCH) 1231 (1989).
The apparent focus of these cases is on
whether the T shareholders intended on
the date of the potential reorganization to
sell their P stock and the degree, if any, to
which P facilitates the sale. Based on an
intensive inquiry into nearly identical
facts, some of these cases held that as a
result of the subsequent sale the potential
reorganization did not satisfy the COI requirement; others held that satisfaction of
the COI requirement was not adversely
affected by the subsequent sale. The IRS
and Treasury Department have concluded
that the law as reflected in these cases
does not further the principles of reorganization treatment and is difficult for both
taxpayers and the IRS to apply consistently.
Therefore, consistent with Congressional intent and the Supreme Court
precedent which distinguishes between
sales and reorganizations, the final regulations focus the COI requirement generally
on exchanges between the T shareholders
and P. Under this approach, sales of P
stock by former T shareholders generally
are disregarded.
The final regulations will greatly enhance administrability in this area by both
taxpayers and the government. The regulations will prevent “whipsaw” of the
government, such as where the former T
shareholders treat the transaction as a taxfree reorganization, and P later disavows
reorganization treatment to step up its

1998–14 I.R.B.

basis in the T assets based on the position
that sales of P stock by the former T
shareholders did not satisfy the COI requirement. See, e.g., McDonald’s Restaurants, supra. In addition, this approach
will prevent unilateral sales of P stock by
former majority T shareholders from adversely affecting the section 354 nonrecognition treatment expected by former
minority T shareholders.
Dispositions of T stock
The proposed COI regulations do not
specifically address the effect upon COI
of dispositions of T stock prior to a potential reorganization, but ask for comments
on that issue. The IRS and Treasury Department believe that issues concerning
the COI requirement raised by dispositions of T stock before a potential reorganization correspond to those raised by
subsequent dispositions of P stock furnished in exchange for T stock in the potential reorganization. As requested by
commentators, the final regulations apply
the rationale of the proposed COI regulations to transactions occurring both prior
to and after a potential reorganization.
Cf. J.E. Seagram Corp. v. Commissioner,
104 T.C. 75 (1995) (sales of T stock prior
to a potential reorganization do not affect
COI if not part of the plan of reorganization). The final regulations provide that,
for COI purposes, a mere disposition of T
stock prior to a potential reorganization to
persons not related to P is disregarded and
a mere disposition of P stock received in a
potential reorganization to persons not related to P is disregarded. But see §1.368–
1T(e)(1)(ii)(A) and (B).
In soliciting comments on the effect
upon COI of dispositions of T stock prior
to a potential reorganization, the preamble
to the proposed COI regulations specifically requests comments on King Enterprises, Inc. v. United States, 418 F.2d 511
(Ct. Cl. 1969) (COI requirement satisfied
where, pursuant to a plan, P acquires the T
stock for 51 percent P stock and 49 percent debt and cash, and T merges upstream into P), and Yoc Heating Corp. v.
Commissioner, 61 T.C. 168 (1973) (COI
requirement not satisfied where, pursuant
to a plan, P acquires 85 percent of the T
stock for cash and notes, and T merges
into P’s newly formed subsidiary with minority shareholders receiving cash). Consistent with these cases, where the step

5

transaction doctrine applies to link T
stock purchases with later acquisitions of
T, the final regulations provide that a proprietary interest in T is not preserved if, in
connection with the potential reorganization, it is acquired by P for consideration
other than P stock. Whether a stock acquisition is made in connection with a potential reorganization will be determined
based on the facts and circumstances of
each case. See generally §1.368–1(a).
This regulation does not address the effect, if any, of section 338 on corporate
transactions (except for conforming
changes to §1.338–2(c)(3)). See generally §1.338–2(c)(3) (certain tax effects of
a qualified stock purchase without a section 338 election on the post-acquisition
elimination of T).
Related person rule
The proposed COI regulations provide
that “[i]n determining whether [COI is satisfied], all facts and circumstances must
be considered, including any plan or
arrangement for the acquiring corporation
or its successor corporation (or a person
related to the acquiring corporation or its
successor corporation within the meaning
of section 707(b)(1) or 267(b) (without regard to section 267(e))) to redeem or acquire the consideration provided in the reorganization.” The final regulations
provide a more specific rule that a proprietary interest in T is not preserved if, in
connection with a potential reorganization, a person related (as defined below) to
P acquires, with consideration other than a
proprietary interest in P, T stock or P stock
furnished in exchange for a proprietary interest in T in the potential reorganization.
The IRS and Treasury Department believe, however, that certain related party
acquisitions preserve a proprietary interest
in T and therefore, the rule includes an exception to the related party rule. Under
this exception, a proprietary interest in T is
preserved to the extent those persons who
were the direct or indirect owners of T
prior to the potential reorganization maintain a direct or indirect proprietary interest in P. See, e.g., Rev. Rul. 84–30
(1984–1 C.B. 114).
Commentators stated that the proposed
COI regulations’ rule, which employs sections 707(b)(1) and 267(b) to define persons related to P, is too broad. In response, the final regulations adopt a

April 6, 1998

narrower related person definition which
has two components in order to address
two separate concerns.
First, the IRS and Treasury Department
were concerned that acquisitions of T or P
stock by a member of P’s affiliated group
were no different in substance from an acquisition or redemption by P, because of
the existence of various provisions in the
Code that permit members to transfer
funds to other members without significant tax consequences. Accordingly,
§1.368–1(e)(3)(i)(A) includes as related
persons corporations that are members of
the same affiliated group under section
1504, without regard to the exceptions in
section 1504(b).
Second, because the final regulations
take into account whether, in substance, P
has redeemed the stock it exchanged for T
stock in the potential reorganization, the
final regulations treat two corporations as
related persons if a purchase of the stock
of one corporation by another corporation
would be treated as a distribution in redemption of the stock of the first corporation under section 304(a)(2) (determined
without regard to §1.1502–80(b)).
Because the final regulations focus generally on the consideration P exchanges,
related persons do not include individual
or other noncorporate shareholders. Thus,
the IRS will no longer apply the holdings
of South Bay Corporation v. Commissioner, 345 F.2d 698 (2d Cir. 1965), and
Superior Coach of Florida, Inc. v. Commissioner, 80 T.C. 895 (1983), to transactions governed by these regulations.
T stock not acquired in connection with a
potential reorganization
Commentators requested clarification
of whether P must actually furnish stock
to T shareholders that own T stock which
was not acquired in connection with a potential reorganization. The final regulations provide that a proprietary interest in
T is preserved if it is exchanged by the acquiring corporation (which may or may
not also be P) for a direct interest in the T
enterprise, or otherwise continues as a
proprietary interest in T.
Redemptions of T stock or extraordinary
distributions with respect to T stock
In addition to the final regulations, the
IRS and Treasury Department are con-

April 6, 1998

temporaneously issuing temporary regulations and proposed regulations crossreferencing the temporary regulations
published in T.D. 8761 with the same effective date as these final regulations.
The temporary and proposed regulations
provide that a proprietary interest in T is
not preserved if, in connection with a potential reorganization, it is redeemed or
acquired by a person related to T, or to
the extent that, prior to and in connection
with a potential reorganization, an extraordinary distribution is made with respect to it.
Transactions following a qualified stock
purchase
As stated above, these final regulations
focus the COI requirement generally on
exchanges between the T shareholders
and P. Accordingly, the language of
§1.338–2(c)(3) is conformed to these
final COI regulations to treat the stock of
T acquired by the purchasing corporation
in the qualified stock purchase as though
it was not acquired in connection with the
transfer of the T assets.
Effect on other authorities
The IRS and Treasury Department continue to study the role of the COI requirement in section 368(a)(1)(D) reorganizations and section 355 transactions.
Therefore, these final COI regulations do
not apply to section 368(a)(1)(D) reorganizations and section 355 transactions.
See §1.355–2(c).
These COI regulations apply solely for
purposes of determining whether the COI
requirement is satisfied. No inference
should be drawn from any provision of
this regulation as to whether other reorganization requirements are satisfied, for
example, whether P has issued solely voting stock for purposes of section 368(a)(1)(B) or (C).
Effect on other documents
Rev. Proc. 77–37 (1977–2 C.B. 568)
and Rev. Proc. 86–42 (1986–2 C.B. 722)
will be modified to the extent inconsistent
with these regulations.
Rev. Rul. 66–23 (1966–1 C.B. 67) is
hereby obsoleted because it indicates that
a plan or arrangement in connection with
a potential reorganization for disposition

6

of stock to unrelated persons does not satisfy the COI requirement.
B. Continuity of Business Enterprise
The COBE requirement is fundamental
to the notion that tax-free reorganizations
merely readjust continuing interests in
property. In §1.368–1(d), as effective
prior to these final regulations, COBE
generally required the acquiring corporation to either continue a significant historic T business or use a significant portion of T’s historic business assets in a
business. However, a valid reorganization may qualify as tax-free even if the acquiring corporation does not directly
carry on the historic T business or use the
historic T assets in a business. See section 368(a)(2)(C). See also Rev. Rul. 68–
261 (1968–1 C.B. 147); Rev. Rul. 81–247
(1981–1 C.B. 87).
Consistent with the view that the acquiring corporation need not directly conduct the T business or use the T assets, the
final regulations provide rules under
which, in an otherwise qualifying corporate reorganization, the assets and the
businesses of the members of a qualified
group of corporations are treated as assets
and businesses of the issuing corporation.
Accordingly, in the final regulations,
COBE requires that the issuing corporation either continue T’s historic business
or use a significant portion of T’s historic
business assets in a business.
A qualified group is one or more chains
of corporations connected through stock
ownership with the issuing corporation,
but only if the issuing corporation owns
directly stock meeting the requirements of
section 368(c) in at least one of the corporations, and stock meeting the requirements of section 368(c) in each of the corporations is owned directly by one of the
other corporations.
The judicial continuity of interest doctrine historically included a concept commonly known as remote continuity of interest. Commonly viewed as arising out
of Groman v. Commissioner, 302 U.S. 82
(1937), and Helvering v. Bashford, 302
U.S. 454 (1938), remote continuity of interest focuses on the link between the T
shareholders and the former T business
assets following the reorganization. In
§1.368–1(d), as effective prior to these
final regulations, COBE focuses on the
continuation of T’s business, or the use of

1998–14 I.R.B.

T’s business assets, by the acquiring corporation. Section 1.368–1(d), as revised
herein, expands this concept by treating
the issuing corporation as conducting a T
business or owning T business assets if
these activities are conducted by a member of the qualified group or, in certain
cases, by a partnership that has a member
of the qualified group as a partner.
The proposed COBE regulations separately address COBE (§1.368–1(d)) and
remote continuity of interest (§1.368–
1(f)). The IRS and Treasury Department
believe the COBE requirements adequately address the issues raised in Groman and Bashford and their progeny.
Thus, these final regulations do not separately articulate rules addressing remote
continuity of interest.
Definition of the qualified group
The proposed COBE regulations define
the qualified group using a control test
based on section 368(c). The IRS and
Treasury Department received comments
suggesting the replacement of the section
368(c) definition of control by the affiliated group definition of control stated in
section 1504, without regard to section
1504(b). However, because section 368
generally determines control by reference
to section 368(c), the final regulations retain the approach of the proposed COBE
regulations.
Rules for aggregation of interests in
historic T assets and businesses held in
partnership solution
In determining whether COBE is satisfied, the proposed COBE regulations aggregate the interests of the members of a
qualified group. In addition, the proposed
COBE regulations attribute a business of
a partnership to a corporate transferor
partner if the partner has a sufficient
nexus with that partnership business.
However, the proposed COBE regulations
only consider the transferor partner’s interest in the partnership business, and do
not aggregate this interest with interests in
the partnership held by other members of
the qualified group.
In response to comments requesting a
partnership aggregation rule, the final
regulations, through a system of attribution, aggregate the interests in a partnership business held by all the members of a

1998–14 I.R.B.

qualified group. The final regulations
provide rules under which a corporate
partner may be treated as holding assets
of a business of a partnership. Additionally, P is treated as holding all the assets,
and conducting all the businesses of its
qualified group. Furthermore, in certain
circumstances, P will be treated as conducting a business of a partnership. Once
the relevant T businesses and T assets are
attributed to P, COBE is tested under the
general rule of the final COBE regulations. See §1.368–1(d)(1).
The proposed COBE regulations do not
discuss tiered partnerships. In response to
comments, the final regulations provide
guidance on this issue. See §1.368–
1(d)(5), Example 12.
C. Transfers of Assets or Stock to
Controlled Corporations as Part of a
Plan of Reorganization
The proposed COBE regulations are
limited in their application to COBE and
remote continuity of interest. The rules of
the proposed COBE regulations provide
that for certain reorganizations, transfers
of acquired assets or stock among members of the qualified group, and in certain
cases, transfers of acquired assets to partnerships, do not disqualify a transaction
from satisfying the COBE and remote
continuity of interest requirements. The
preamble to the proposed COBE regulations states that these rules do not address
any other issues concerning the qualification of a transaction as a reorganization.
Comments suggest that the proposed
COBE regulations are ambiguous as they
could be interpreted to mean that a transfer of stock or assets to a qualified group
member after an otherwise tax-free reorganization would be given independent
significance and the step transaction doctrine would not apply. Under such an interpretation, the potential reorganization
would not be recast as a taxable acquisition or another type of reorganization. To
eliminate this ambiguity, §1.368–1(a) of
the final regulations provides that, in determining whether a transaction qualifies
as a reorganization under section 368(a),
the transaction must be evaluated under
relevant provisions of law, including the
step transaction doctrine. Section 1.368–
1(d) of the final regulations is limited to a
discussion of the COBE requirement, and
does not address satisfaction of the ex-

7

plicit statutory requirements of a reorganization, which is the subject of §1.368–
2. However, §1.368–2(k) of the final
regulations does provide guidance in this
regard, extending the application of section 368(a)(2)(C) to certain successive
transfers.
Section 1.368–2(k) of the final regulations states that a transaction otherwise
qualifying under section 368(a)(1)(A), (B),
(C), or (G) (where the requirements of sections 354(b)(1)(A) and (B) are met) shall
not be disqualified by reason of the fact
that part or all of the acquired assets or
stock acquired in the transaction are transferred or successively transferred to one or
more corporations controlled in each transfer by the transferor corporation. Control
is defined under section 368(c). The final
regulations also provide a rule for transfers
of assets following a reorganization qualifying under section 368(a)(1)(A) by reason
of section 368(a)(2)(E). No inference is to
be drawn as to whether transactions not described in §1.368–2(k) otherwise qualify
as reorganizations.
The final regulations also provide that,
if a transaction otherwise qualifies as a reorganization, a corporation remains a
party to the reorganization even though
stock or assets acquired in the reorganization are transferred in a transaction described in §1.368–2(k). See §1.368–2(f).
Furthermore, if a transaction otherwise
qualifies as a reorganization, a corporation shall not cease to be a party to the reorganization solely because acquired assets are transferred to a partnership in
which the transferor is a partner if the
COBE requirement is satisfied.
Section 368(a)(1)(D), 368(a)(1)(F), and
355 transactions
The proposed COBE regulations, applying only to the COBE and remote continuity of interest requirements, are limited to transactions otherwise qualifying
for reorganization treatment under section
368(a)(1)(A), (B), (C), or (G) (where the
requirements of sections 354(b)(1)(A)
and (B) are met). The IRS and Treasury
Department received comments stating
that the final regulations should apply to
reorganizations qualifying under section
368(a)(1)(D) or (F) or to transactions
qualifying under section 355.
The final regulations do not limit the
application of §1.368–1(d) to the transac-

April 6, 1998

tions enumerated in section 368(a)(2)(C).
The COBE provisions in the final regulations apply to all reorganizations for
which COBE is relevant.
Section 1.368–2(k)(1) of the final regulations, however, is limited in its application to the transactions described in section 368(a)(2)(C), and does not apply in
determining whether a reorganization
qualifies under section 368(a)(1)(D), section 368(a)(1)(F), or section 355. The
IRS and Treasury Department believe that
further study is needed prior to extending
§1.368–2(k)(1) to one or more of these
provisions.
Effective Date
The amendments to these regulations
apply to transactions occurring after January 28, 1998, except that they do not
apply to any transaction occurring pursuant to a written agreement which is
(subject to customary conditions) binding
on January 28, 1998, and at all times
thereafter. Commentators requested that
the effective date be changed to allow
these regulations to apply to transactions
occurring on or before January 28, 1998.
The IRS and Treasury Department believe
that adopting an earlier effective date increases the likelihood that T, P, and each
of the former T shareholders would report
the transaction inconsistently (in some
cases using hindsight), and would reduce
administrability of the regulation. No inference should be drawn from any provision of this regulation as to application of
the COI or COBE requirements to transactions occurring on or before January 28,
1998.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and because
the regulation does not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue
Code, the notices of proposed rulemaking
preceding these regulations were submit-

April 6, 1998

ted to the Chief Counsel for Advocacy of
the Small Business Administration for
comment on their impact on small business.
Drafting Information
The principal authors of these regulations are Phoebe Bennett, regarding
§1.368–1(e) (continuity of interest), and
Marlene Peake Oppenheim, regarding
§1.368–1(d) (continuity of business enterprise) and §1.368–2(k), both of the Office
of the Assistant Chief Counsel (Corporate), IRS. However, other personnel
from the IRS and Treasury Department
participated in their development.
*

*

*

*

*

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805. * * *
Par. 2. Section 1.338-2 is amended:
1. By revising paragraph (c)(3)(ii).
2. In paragraph (c)(3)(iv) Example by
revising the first sentence of paragraph
(B).
The revisions read as follows:
§1.338–2 Miscellaneous issues under
section 338.
*

*

*

*

*

(c) * * *
(3) * * *
(ii) Continuity of interest. By virtue of
section 338, in determining whether the
continuity of interest requirement of
§1.368–1(b) and (e) is satisfied on the
transfer of assets from target to the transferee, the purchasing corporation’s target
stock acquired in the qualified stock purchase shall be treated as though it was not
acquired in connection with the transfer
of target assets.
*

*

*

*

*

(iv) Example. * * *
(B) Status of transfer as a reorganization. By virtue of section 338, for the

8

purpose of determining whether the continuity of interest requirement of §1.368–
1(b) is satisfied, P’s T stock acquired in
the qualified stock purchase shall be
treated as though it was not acquired in
connection with the transfer of T assets to
X. * * *
*

*

*

*

*

Par. 3. Section 1.368–1 is amended by:
1. Adding three sentences immediately
following the first sentence of paragraph
(a).
2. Removing the third sentence and
adding four sentences in its place to paragraph (b).
3. Removing paragraph (d)(1).
4. Redesignating paragraphs (d)(2),
(d)(3), and (d)(4) as paragraphs (d)(1),
(d)(2), and (d)(3), respectively.
5. Removing the first sentence of
newly designated paragraph (d)(1) and
adding two sentences in its place.
6. Adding new paragraph (d)(4).
7. Paragraph (d)(5) is amended by:
a. Adding two sentences to the end of
paragraph (d)(5) introductory text.
b. Removing the parentheses around
the numbers in the paragraph headings for
Example (1) through Example (5).
c. Adding Example 6 through Example
12.
8. Adding paragraph (e).
The additions and revisions read as follows:
§1.368–1 Purpose and scope of
exception of reorganization exchanges.
(a) * * * In determining whether a
transaction qualifies as a reorganization
under section 368(a), the transaction must
be evaluated under relevant provisions of
law, including the step transaction doctrine. But see §§1.368–2(f) and (k) and
1.338–2(c)(3). The preceding two sentences apply to transactions occurring
after January 28, 1998, except that they
do not apply to any transaction occurring
pursuant to a written agreement which is
binding on January 28, 1998, and at all
times thereafter. * * *
(b) * * * Requisite to a reorganization
under the Internal Revenue Code are a
continuity of the business enterprise
through the issuing corporation under the
modified corporate form as described in
paragraph (d) of this section, and (except

1998–14 I.R.B.

as provided in section 368(a)(1)(D)) a
continuity of interest as described in paragraph (e) of this section. (For rules regarding the continuity of interest requirement under section 355, see §1.355–2(c).)
For purposes of this section, the term issuing corporation means the acquiring
corporation (as that term is used in section
368(a)), except that, in determining
whether a reorganization qualifies as a triangular reorganization (as defined in
§1.358–6(b)(2)), the issuing corporation
means the corporation in control of the
acquiring corporation. The preceding
three sentences apply to transactions occurring after January 28, 1998, except that
they do not apply to any transaction occurring pursuant to a written agreement
which is binding on January 28, 1998, and
at all times thereafter. * * *
*

*

*

*

*

(d) Continuity of business enterprise—
(1) General rule. Continuity of business
enterprise (COBE) requires that the issuing corporation (P), as defined in paragraph (b) of this section, either continue
the target corporation’s (T’s) historic
business or use a significant portion of T’s
historic business assets in a business. The
preceding sentence applies to transactions
occurring after January 28, 1998, except
that it does not apply to any transaction
occurring pursuant to a written agreement
which is binding on January 28, 1998, and
at all times thereafter. * * *
*

*

*

*

*

(4) Acquired assets or stock held by
members of the qualified group or partnerships. The following rules apply in
determining whether the COBE requirement of paragraph (d)(1) of this section is
satisfied:
(i) Businesses and assets of members
of a qualified group. The issuing corporation is treated as holding all of the businesses and assets of all of the members of
the qualified group, as defined in paragraph (d)(4)(ii) of this section.
(ii) Qualified group. A qualified group
is one or more chains of corporations connected through stock ownership with the
issuing corporation, but only if the issuing
corporation owns directly stock meeting
the requirements of section 368(c) in at
least one other corporation, and stock
meeting the requirements of section

1998–14 I.R.B.

368(c) in each of the corporations (except
the issuing corporation) is owned directly
by one of the other corporations.
(iii) Partnerships—(A) Partnership
assets. Each partner of a partnership will
be treated as owning the T business assets
used in a business of the partnership in accordance with that partner’s interest in the
partnership.
(B) Partnership businesses. The issuing corporation will be treated as conducting a business of a partnership if —
(1) Members of the qualified group, in
the aggregate, own an interest in the partnership representing a significant interest
in that partnership business; or
(2) One or more members of the qualified group have active and substantial
management functions as a partner with
respect to that partnership business.
(C) Conduct of the historic T business
in a partnership. If a significant historic
T business is conducted in a partnership,
the fact that P is treated as conducting
such T business under paragraph (d)(4)(iii)(B) of this section tends to establish
the requisite continuity, but is not alone
sufficient.
(iv) Effective date. This paragraph
(d)(4) applies to transactions occurring
after January 28, 1998, except that it does
not apply to any transaction occurring
pursuant to a written agreement which is
binding on January 28, 1998, and at all
times thereafter.
(5) * * * All corporations have only
one class of stock outstanding. The preceding sentence and paragraph (d)(5) Example 6 through Example 12 apply to
transactions occurring after January 28,
1998, except that they do not apply to any
transaction occurring pursuant to a written agreement which is binding on January 28, 1998, and at all times thereafter.
*

*

*

*

*

Example 6. Use of a significant portion of T’s
historic business assets by the qualified group. (i)
Facts. T operates an auto parts distributorship. P
owns 80 percent of the stock of a holding company
(HC). HC owns 80 percent of the stock of ten subsidiaries, S–1 through S–10. S–1 through S–10 each
separately operate a full service gas station. Pursuant to a plan of reorganization, T merges into P
and the T shareholders receive solely P stock. As
part of the plan of reorganization, P transfers T’s assets to HC, which in turn transfers some of the T assets to each of the ten subsidiaries. No one subsidiary receives a significant portion of T’s historic
business assets. Each of the subsidiaries will use the

9

T assets in the operation of its full service gas station. No P subsidiary will be an auto parts distributor.
(ii) Continuity of business enterprise. Under
paragraph (d)(4)(i) of this section, P is treated as
conducting the ten gas station businesses of S–1
through S–10 and as holding the historic T assets
used in those businesses. P is treated as holding all
the assets and conducting the businesses of all of the
members of the qualified group, which includes S–1
through S–10 (paragraphs (d)(4)(i) and (ii) of this
section). No member of the qualified group continues T’s historic distributorship business. However,
subsidiaries S–1 through S–10 continue to use the
historic T assets in a business. Even though no one
corporation of the qualified group is using a significant portion of T’s historic business assets in a business, the COBE requirement of paragraph (d)(1) of
this section is satisfied because, in the aggregate, the
qualified group is using a significant portion of T’s
historic business assets in a business.
Example 7. Continuation of the historic T business in a partnership satisfies continuity of business
enterprise. (i) Facts. T manufactures ski boots. P
owns all of the stock of S–1. S–1 owns all of the
stock of S–2, and S–2 owns all of the stock of S–3.
T merges into P and the T shareholders receive consideration consisting of P stock and cash. The T ski
boot business is to be continued and expanded. In
anticipation of this expansion, P transfers all of the T
assets to S–1, S–1 transfers all of the T assets to S–2,
and S–2 transfers all of the T assets to S–3. S–3 and
X (an unrelated party) form a new partnership
(PRS). As part of the plan of reorganization, S–3
transfers all the T assets to PRS, and S–3, in its capacity as a partner, performs active and substantial
management functions for the PRS ski boot business, including making significant business decisions and regularly participating in the overall supervision, direction, and control of the employees of
the ski boot business. S–3 receives a 20 percent interest in PRS. X transfers cash in exchange for an
80 percent interest in PRS.
(ii) Continuity of business enterprise. Under
paragraph (d)(4)(iii)(B)(2) of this section, P is
treated as conducting T’s historic business because
S–3 performs active and substantial management
functions for the ski boot business in S–3’s capacity
as a partner. P is treated as holding all the assets and
conducting the businesses of all of the members of
the qualified group, which includes S–3 (paragraphs
(d)(4)(i) and (ii) of this section). The COBE requirement of paragraph (d)(1) of this section is satisfied.
Example 8. Continuation of the historic T business in a partnership does not satisfy continuity of
business enterprise. (i) Facts. The facts are the
same as Example 7 except that S–3 transfers the historic T business to PRS in exchange for a 1 percent
interest in PRS.
(ii) Continuity of business enterprise. Under
paragraph (d)(4)(iii)(B)(2) of this section, P is
treated as conducting T’s historic business because
S–3 performs active and substantial management
functions for the ski boot business in S–3’s capacity
as a partner. The fact that a significant historic T
business is conducted in PRS, and P is treated as
conducting such T business under (d)(4)(iii)(B)
tends to establish the requisite continuity, but is not
alone sufficient (paragraph (d)(4)(iii)(C) of this sec-

April 6, 1998

tion). The COBE requirement of paragraph (d)(1) of
this section is not satisfied.
Example 9. Continuation of the T historic business in a partnership satisfies continuity of business
enterprise. (i) Facts. The facts are the same as Example 7 except that S–3 transfers the historic T business to PRS in exchange for a 331⁄3 percent interest
in PRS, and no member of P’s qualified group performs active and substantial management functions
for the ski boot business operated in PRS.
(ii) Continuity of business enterprise. Under
paragraph (d)(4)(iii)(B)(1) of this section, P is
treated as conducting T’s historic business because
S–3 owns an interest in the partnership representing
a significant interest in that partnership business. P
is treated as holding all the assets and conducting the
businesses of all of the members of the qualified
group, which includes S–3 (paragraphs (d)(4)(i) and
(ii) of this section). The COBE requirement of paragraph (d)(1) of this section is satisfied.
Example 10. Use of T’s historic business assets
in a partnership business. (i) Facts. T is a fabric
distributor. P owns all of the stock of S–1. T merges
into P and the T shareholders receive solely P stock.
S–1 and X (an unrelated party) own interests in a
partnership (PRS). As part of the plan of reorganization, P transfers all of the T assets to S–1, and S–1
transfers all the T assets to PRS, increasing S–1’s
percentage interest in PRS from 5 to 331⁄3 percent.
After the transfer, X owns the remaining 662⁄3 percent interest in PRS. Almost all of the T assets consist of T’s large inventory of fabric, which PRS uses
to manufacture sportswear. All of the T assets are
used in the sportswear business. No member of P’s
qualified group performs active and substantial
management functions for the sportswear business
operated in PRS.
(ii) Continuity of business enterprise. Under
paragraph (d)(4)(iii)(A) of this section, S–1 is
treated as owning 331⁄3 percent of the T assets used in
the PRS sportswear manufacturing business. Under
paragraph (d)(4)(iii)(B)(1) of this section, P is
treated as conducting the sportswear manufacturing
business because S–1 owns an interest in the partnership representing a significant interest in that
partnership business. P is treated as holding all the
assets and conducting the businesses of all of the
members of the qualified group, which includes S–1
(paragraphs (d)(4)(i) and (ii) of this section). The
COBE requirement of paragraph (d)(1) of this section is satisfied.
Example 11. Aggregation of partnership interests among members of the qualified group: use of
T’s historic business assets in a partnership business. (i) Facts. The facts are the same as Example
10, except that S–1 transfers all the T assets to PRS,
and P and X each transfer cash to PRS in exchange
for partnership interests. After the transfers, P owns
11 percent, S–1 owns 221⁄3 percent, and X owns 662⁄3
percent of PRS.
(ii) Continuity of business enterprise. Under
paragraph (d)(4)(iii)(B)(1) of this section, P is
treated as conducting the sportswear manufacturing
business because members of the qualified group, in
the aggregate, own an interest in the partnership representing a significant interest in that business. P is
treated as owning 11 percent of the assets directly,
and S–1 is treated as owning 221⁄3 percent of the assets, used in the PRS sportswear business (paragraph

April 6, 1998

(d)(4)(iii)(A) of this section). P is treated as holding
all the assets of all of the members of the qualified
group, which includes S–1, and thus in the aggregate, P is treated as owning 331⁄3 of the T assets
(paragraph (d)(4)(i) and (ii) of this section). The
COBE requirement of paragraph (d)(1) of this section is satisfied because P is treated as using a significant portion of T’s historic business assets in its
sportswear manufacturing business.
Example 12. Tiered partnerships: use of T’s historic business assets in a partnership business. (i)
Facts. T owns and manages a commercial office
building in state Z. Pursuant to a plan of reorganization, T merges into P, solely in exchange for P stock,
which is distributed to the T shareholders. P transfers all of the T assets to a partnership, PRS–1,
which owns and operates television stations nationwide. After the transfer, P owns a 50 percent interest
in PRS–1. P does not have active and substantial
management functions as a partner with respect to
the PRS–1 business. X, not a member of P’s qualified group, owns the remaining 50 percent interest in
PRS–1. PRS–1, in an effort to expand its state Z
television operation, enters into a joint venture with
U, an unrelated party. As part of the plan of reorganization, PRS–1 transfers all the T assets and its
state Z television station to PRS–2, in exchange for a
75 percent partnership interest. U contributes cash
to PRS–2 in exchange for a 25 percent partnership
interest and oversees the management of the state Z
television operation. PRS–1 does not actively and
substantially manage PRS–2’s business. PRS–2’s
state Z operations are moved into the acquired T office building. All of the assets that P acquired from
T are used in PRS–2’s business.
(ii) Continuity of business enterprise. Under
paragraph (d)(4)(iii)(A) of this section, PRS–1 is
treated as owning 75 percent of the T assets used in
PRS–2’s business. P, in turn, is treated as owning 50
percent of PRS–1’s interest the T assets. Thus, P is
treated as owning 371⁄2 percent (50 percent ⫻ 75 percent) of the T assets used in the PRS-2 business.
Under paragraph (d)(4)(iii)(B)(1) of this section, P is
treated as conducting PRS–2’s business, the operation of the state Z television station, and under paragraph (d)(4)(iii)(A) of this section, P is treated as
using 371⁄2 percent of the historic T business assets in
that business. The COBE requirement of paragraph
(d)(1) of this section is satisfied because P is treated
as using a significant portion of T’s historic business
assets in its television business.

(e) Continuity of interest—(1) General
rule. (i) The purpose of the continuity of
interest requirement is to prevent transactions that resemble sales from qualifying
for nonrecognition of gain or loss available to corporate reorganizations. Continuity of interest requires that in substance
a substantial part of the value of the proprietary interests in the target corporation
be preserved in the reorganization. A proprietary interest in the target corporation is
preserved if, in a potential reorganization,
it is exchanged for a proprietary interest in
the issuing corporation (as defined in para-

10

graph (b) of this section), it is exchanged
by the acquiring corporation for a direct
interest in the target corporation enterprise, or it otherwise continues as a proprietary interest in the target corporation.
However, a proprietary interest in the target corporation is not preserved if, in connection with the potential reorganization,
it is acquired by the issuing corporation
for consideration other than stock of the
issuing corporation, or stock of the issuing
corporation furnished in exchange for a
proprietary interest in the target corporation in the potential reorganization is redeemed. All facts and circumstances must
be considered in determining whether, in
substance, a proprietary interest in the target corporation is preserved. For purposes
of the continuity of interest requirement, a
mere disposition of stock of the target corporation prior to a potential reorganization
to persons not related (as defined in paragraph (e)(3) of this section determined
without regard to paragraph (e)(3)(i)(A) of
this section) to the target corporation or to
persons not related (as defined in paragraph (e)(3) of this section) to the issuing
corporation is disregarded and a mere disposition of stock of the issuing corporation
received in a potential reorganization to
persons not related (as defined in paragraph (e)(3) of this section) to the issuing
corporation is disregarded.
(ii) [Reserved] For further guidance
see §1.368–1T(e)(1)(ii)(A) and (B).
(2) Related person acquisitions. (i) A
proprietary interest in the target corporation is not preserved if, in connection with
a potential reorganization, a person related (as defined in paragraph (e)(3) of
this section) to the issuing corporation acquires, with consideration other than a
proprietary interest in the issuing corporation, stock of the target corporation or
stock of the issuing corporation furnished
in exchange for a proprietary interest in
the target corporation in the potential reorganization, except to the extent those
persons who were the direct or indirect
owners of the target corporation prior to
the potential reorganization maintain a direct or indirect proprietary interest in the
issuing corporation.
(ii) [Reserved] For further guidance
see §1.368–1T(e)(2)(ii).
(3) Definition of related person—(i)
In general. For purposes of this para-

1998–14 I.R.B.

graph (e), two corporations are related
persons if either—
(A) The corporations are members of
the same affiliated group as defined in
section 1504 (determined without regard
to section 1504(b)); or
(B) A purchase of the stock of one corporation by another corporation would be
treated as a distribution in redemption of
the stock of the first corporation under
section 304(a)(2) (determined without regard to §1.1502-80(b)).
(ii) Special rules. The following rules
apply solely for purposes of this paragraph (e)(3):
(A) A corporation will be treated as related to another corporation if such relationship exists immediately before or immediately after the acquisition of the
stock involved.
(B) A corporation, other than the target
corporation or a person related (as defined
in paragraph (e)(3) of this section determined without regard to paragraph
(e)(3)(i)(A) of this section) to the target
corporation, will be treated as related to
the issuing corporation if the relationship
is created in connection with the potential
reorganization.
(4) Acquisitions by partnerships. For
purposes of this paragraph (e), each partner of a partnership will be treated as
owning or acquiring any stock owned or
acquired, as the case may be, by the partnership in accordance with that partner’s
interest in the partnership. If a partner is
treated as acquiring any stock by reason
of the application of this paragraph (e)(4),
the partner is also treated as having furnished its share of any consideration furnished by the partnership to acquire the
stock in accordance with that partner’s interest in the partnership.
(5) Successors and predecessors. For
purposes of this paragraph (e), any reference to the issuing corporation or the target corporation includes a reference to
any successor or predecessor of such corporation, except that the target corporation is not treated as a predecessor of the
issuing corporation and the issuing corporation is not treated as a successor of the
target corporation.
(6) Examples. For purposes of the examples in this paragraph (e)(6), P is the issuing corporation, T is the target corporation, S is a wholly owned subsidiary of P,
all corporations have only one class of

1998–14 I.R.B.

stock outstanding, A and B are individuals, PRS is a partnership, all reorganization requirements other than the continuity of interest requirement are satisfied,
and the transaction is not otherwise subject to recharacterization. The following
examples illustrate the application of this
paragraph (e):
Example 1. Sale of stock to third party. (i) Sale
of issuing corporation stock after merger. A owns
all of the stock of T. T merges into P. In the merger,
A receives P stock having a fair market value of
$50x and cash of $50x. Immediately after the
merger, and pursuant to a preexisting binding contract, A sells all of the P stock received by A in the
merger to B. Assume that there are no facts and circumstances indicating that the cash used by B to
purchase A’s P stock was in substance exchanged by
P for T stock. Under paragraphs (e)(1) and (2) of
this section, the sale to B is disregarded because B is
not a person related to P within the meaning of paragraph (e)(3) of this section. Thus, the transaction
satisfies the continuity of interest requirement because 50 percent of A’s T stock was exchanged for P
stock, preserving a substantial part of the value of
the proprietary interest in T.
(ii) Sale of target corporation stock before
merger. The facts are the same as paragraph (i) of
this Example 1, except that B buys A’s T stock prior
to the merger of T into P and then exchanges the T
stock for P stock having a fair market value of $50x
and cash of $50x. The sale by A is disregarded. The
continuity of interest requirement is satisfied because B’s T stock was exchanged for P stock, preserving a substantial part of the value of the proprietary interest in T.
Example 2. Relationship created in connection
with potential reorganization. A owns all of the
stock of T. X, a corporation which owns 60 percent
of the P stock and none of the T stock, buys A’s T
stock for cash prior to the merger of T into P. X exchanges the T stock solely for P stock in the merger
which, when combined with X’s prior ownership of
P stock, constitutes 80 percent of the stock of P. X is
a person related to P under paragraphs (e)(3)(i)(A)
and (ii)(B) of this section, because X becomes affiliated with P in the merger. The continuity of interest
requirement is not satisfied, because X acquired a
proprietary interest in T for consideration other than
P stock, and a substantial part of the value of the
proprietary interest in T is not preserved. See paragraph (e)(2) of this section.
Example 3. Participation by issuing corporation
in post-merger sale. A owns 80 percent of the T
stock and none of the P stock, which is widely held.
T merges into P. In the merger, A receives P stock.
In addition, A obtains rights pursuant to an arrangement with P to have P register the P stock under the
Securities Act of 1933, as amended. P registers A’s
stock, and A sells the stock shortly after the merger.
No person who purchased the P stock from A is a
person related to P within the meaning of paragraph
(e)(3) of this section. Under paragraphs (e)(1) and
(2) of this section, the sale of the P stock by A is disregarded because no person who purchased the P
stock from A is a person related to P within the
meaning of paragraph (e)(3) of this section. The

11

transaction satisfies the continuity of interest requirement because A’s T stock was exchanged for P
stock, preserving a substantial part of the value of
the proprietary interest in T.
Example 4. Redemptions and purchases by issuing corporation or related persons. (i) Redemption
by issuing corporation. A owns 100 percent of the
stock of T and none of the stock of P. T merges into
S. In the merger, A receives P stock. In connection
with the merger, P redeems all of the P stock received
by A in the merger for cash. The continuity of interest
requirement is not satisfied, because, in connection
with the merger, P redeemed the stock exchanged for
a proprietary interest in T, and a substantial part of the
value of the proprietary interest in T is not preserved.
See paragraph (e)(1) of this section.
(ii) Purchase of target corporation stock by issuing corporation. The facts are the same as paragraph
(i) of this Example 4, except that, instead of P redeeming its stock, prior to and in connection with the
merger of T into S, P purchases 90 percent of the T
stock from A for cash. The continuity of interest requirement is not satisfied, because in connection with
the merger, P acquired a proprietary interest in T for
consideration other than P stock, and a substantial
part of the value of the proprietary interest in T is not
preserved. See paragraph (e)(1) of this section.
However, see §1.338–2(c)(3) (which may change the
result in this case by providing that, by virtue of section 338, continuity of interest is satisfied for certain
parties after a qualified stock purchase).
(iii) Purchase of issuing corporation stock by
person related to issuing corporation. The facts are
the same as paragraph (i) of this Example 4, except
that, instead of P redeeming its stock, S buys all of
the P stock received by A in the merger for cash. S
is a person related to P under paragraphs (e)(3)(i)(A)
and (B) of this section. The continuity of interest requirement is not satisfied, because S acquired P
stock issued in the merger, and a substantial part of
the value of the proprietary interest in T is not preserved. See paragraph (e)(2) of this section.
Example 5. Redemption in substance by issuing
corporation. A owns 100 percent of the stock of T
and none of the stock of P. T merges into P. In the
merger, A receives P stock. In connection with the
merger, B buys all of the P stock received by A in the
merger for cash. Shortly thereafter, in connection
with the merger, P redeems the stock held by B for
cash. Based on all the facts and circumstances, P in
substance has exchanged solely cash for T stock in
the merger. The continuity of interest requirement is
not satisfied, because in substance P redeemed the
stock exchanged for a proprietary interest in T, and a
substantial part of the value of the proprietary interest in T is not preserved. See paragraph (e)(1) of
this section.
Example 6. Purchase of issuing corporation
stock through partnership. A owns 100 percent of
the stock of T and none of the stock of P. S is an 85
percent partner in PRS. The other 15 percent of PRS
is owned by unrelated persons. T merges into P. In
the merger, A receives P stock. In connection with
the merger, PRS purchases all of the P stock received by A in the merger for cash. Under paragraph
(e)(4) of this section, S, as an 85 percent partner of
PRS, is treated as having acquired 85 percent of the
P stock exchanged for A’s T stock in the merger, and
as having furnished 85 percent of the cash paid by
PRS to acquire the P stock. S is a person related to P

April 6, 1998

under paragraphs (e)(3)(i)(A) and (B) of this section.
The continuity of interest requirement is not satisfied, because S is treated as acquiring 85 percent of
the P stock issued in the merger, and a substantial
part of the value of the proprietary interest in T is not
preserved. See paragraph (e)(2) of this section.
Example 7. Exchange by acquiring corporation
for direct interest. A owns 30 percent of the stock of
T. P owns 70 percent of the stock of T, which was
not acquired by P in connection with the acquisition
of T’s assets. T merges into P. A receives cash in the
merger. The continuity of interest requirement is
satisfied, because P’s 70 percent proprietary interest
in T is exchanged by P for a direct interest in the assets of the target corporation enterprise.
Example 8. Effect of general stock repurchase
program. T merges into P, a corporation whose
stock is widely held and publicly traded and that has
one class of common stock outstanding. In the
merger, T shareholders receive common stock of P.
Immediately after the merger, P repurchases a small
percentage of its common stock in the open market
as part of its ongoing stock repurchase program.
The repurchase program was not created or modified in connection with the acquisition of T. Continuity of interest is satisfied, because based on all of
the facts and circumstances, the redemption of a
small percentage of the P stock does not affect the T
shareholders’ proprietary interest in T, because it
was not in connection with the merger, and the value
of the proprietary interest in T is preserved. See
paragraph (e)(1) of this section.
Example 9. Maintenance of direct or indirect interest in issuing corporation. X, a corporation,
owns all of the stock of each of corporations P and
Z. Z owns all of the stock of T. T merges into P. Z
receives P stock in the merger. Immediately thereafter and in connection with the merger, Z distributes the P stock received in the merger to X. X is a
person related to P under paragraph (e)(3)(i)(A) of
this section. The continuity of interest requirement
is satisfied, because X was an indirect owner of T
prior to the merger who maintains a direct or indirect
proprietary interest in P, preserving a substantial part
of the value of the proprietary interest in T. See
paragraph (e)(2) of this section.

(7) Effective date. This paragraph (e)
applies to transactions occurring after
January 28, 1998, except that it does not
apply to any transaction occurring pursuant to a written agreement which is
binding on January 28, 1998, and at all
times thereafter.
Par. 4. Section 1.368–2 is amended by:
1. Removing the second sentence of
paragraph (a) and adding two sentences in
its place.
2. Removing the second sentence of
paragraph (f) and adding four sentences in
its place.
3. Removing the second sentence in
paragraph (j)(1).
4. Revising paragraph (j)(3)(ii).
5. Revising the first sentence in paragraph (j)(3)(iii).

April 6, 1998

6. Adding paragraph (j)(3)(iv).
7. Removing paragraph (j)(4).
8. Redesignating paragraphs (j)(5),
(j)(6), and (j)(7) as (j)(4), (j)(5), and
(j)(6), respectively.
9. Removing the parentheses around
the numbers in the paragraph headings for
Example (1) through Example (9) in
newly designated paragraph (j)(6).
10. Adding paragraph (k).
The additions and revisions read as follows:
§1.368–2 Definition of terms.
(a) * * * The term does not embrace
the mere purchase by one corporation of
the properties of another corporation. The
preceding sentence applies to transactions
occurring after January 28, 1998, except
that it does not apply to any transaction
occurring pursuant to a written agreement
which is binding on January 28, 1998, and
at all times thereafter. * * *
*

*

*

*

*

(f) * * * If a transaction otherwise
qualifies as a reorganization, a corporation
remains a party to the reorganization even
though stock or assets acquired in the reorganization are transferred in a transaction
described in paragraph (k) of this section.
If a transaction otherwise qualifies as a reorganization, a corporation shall not cease
to be a party to the reorganization solely
by reason of the fact that part or all of the
assets acquired in the reorganization are
transferred to a partnership in which the
transferor is a partner if the continuity of
business enterprise requirement is satisfied. See §1.368–1(d). The preceding
three sentences apply to transactions occurring after January 28, 1998, except that
they do not apply to any transaction occurring pursuant to a written agreement
which is binding on January 28, 1998, and
at all times thereafter. * * *
*

*

*

*

*

(j) * * *
(3) * * *
(ii) Except as provided in paragraph
(k)(2) of this section, the controlling corporation must control the surviving corporation immediately after the transaction.
(iii) After the transaction, except as
provided in paragraph (k)(2) of this section, the surviving corporation must hold
substantially all of its own properties and

12

substantially all of the properties of the
merged corporation (other than stock of
the controlling corporation distributed in
the transaction). * * *
(iv) Paragraphs (j)(3)(ii) and (iii) of
this section apply to transactions occurring after January 28, 1998, except that
they do not apply to any transaction occurring pursuant to a written agreement
which is binding on January 28, 1998, and
at all times thereafter.
*

*

*

*

*

(k) Transfer of assets or stock in section 368(a)(1)(A), (B), (C), or (G) reorganizations—(1) General rule for transfers
to controlled corporations. Except as
otherwise provided in this section, a
transaction otherwise qualifying under
section 368(a)(1)(A), (B), (C), or (G)
(where the requirements of sections
354(b)(1)(A) and (B) are met) shall not be
disqualified by reason of the fact that part
or all of the acquired assets or stock acquired in the transaction are transferred or
successively transferred to one or more
corporations controlled in each transfer
by the transferor corporation. Control is
defined under section 368(c).
(2) Transfers following a reverse triangular merger. A transaction qualifying
under section 368(a)(1)(A) by reason of
the application of section 368(a)(2)(E) is
not disqualified by reason of the fact that
part or all of the stock of the surviving
corporation is transferred or successively
transferred to one or more corporations
controlled in each transfer by the transferor corporation, or because part or all of
the assets of the surviving corporation or
the merged corporation are transferred or
successively transferred to one or more
corporations controlled in each transfer
by the transferor corporation.
(3) Examples. The following examples illustrate the application of this paragraph (k). P is the issuing corporation and
T is the target corporation. P has only one
class of stock outstanding. The examples
are as follows:
Example 1. Transfers of acquired assets to controlled corporations. (i) Facts. T operates a bakery
which supplies delectable pastries and cookies to
local retail stores. The acquiring corporate group
produces a variety of baked goods for nationwide
distribution. P owns 80 percent of the stock of S–1.
Pursuant to a plan of reorganization, T transfers all
of its assets to S–1 solely in exchange for P stock,
which T distributes to its shareholders. S–1 owns 80

1998–14 I.R.B.

percent of the stock of S–2; S–2 owns 80 percent of
the stock of S–, which also makes and supplies pastries and cookies. Pursuant to the plan of reorganization, S–1 transfers the T assets to S–2; S–2 transfers the T assets to S–3.
(ii) Analysis. Under this paragraph (k), the transaction, otherwise qualifying as a reorganization
under section 368(a)(1)(C), is not disqualified by
reason of the fact of the successive transfers of all of
the acquired assets from S–1 to S–2, and from S–2
to S–3 because in each transfer, the transferee corporation is controlled by the transferor corporation.
Control is defined under section 368(c).
Example 2. Transfers of acquired stock to controlled corporations. (i) Facts. The facts are the
same as Example 1 except that S–1 acquires all of the
T stock rather than the T assets, and as part of the plan
of reorganization, S–1 transfers all of the T stock to
S–2, and S–2 transfers all of the T stock to S–3.
(ii) Analysis. Under this paragraph (k), the transaction, otherwise qualifying as a reorganization
under section 368(a)(1)(B), is not disqualified by
reason of the fact of the successive transfers of all of
S–2, and from S–2 to S–3 because in each transfer,
the transferee corporation is controlled by the transferor corporation.
Example 3. Transfers of acquired stock to partnerships. (i) Facts. The facts are the same as in Example 2. However, as part of the plan of reorganization, S–2 and S–3 form a new partnership, PRS.
Immediately thereafter, S–3 transfers all of the T
stock to PRS in exchange for an 80 percent partnership interest, and S–2 transfers cash to PRS in exchange for a 20 percent partnership interest.
(ii) Analysis. This paragraph (k) describes the
successive transfer of the T stock to S–3, but does
not describe S–3’s transfer of the T stock to PRS.
Therefore, the characterization of this transaction
must be determined under the relevant provisions of
law, including the step transaction doctrine. See
§1.368–1(a). The transaction fails to meet the control requirement of a reorganization described in
section 368(a)(1)(B) because immediately after the
acquisition of the T stock, the acquiring corporation
does not have control of T.

(4) This paragraph (k) applies to transactions occurring after January 28, 1998,
except that it does not apply to any transaction occurring pursuant to a written
agreement which is binding on January
28, 1998, and at all times thereafter.
Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
Approved January 12, 1998.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
January 23, 1998, 12:15 p.m., and published in the
issue of the Federal Register for January 28, 1998,
63 F.R. 4174)

1998–14 I.R.B.

26 CFR 1.368–1T: Purpose and scope of exception
of reorganization exchanges (temporary).

T.D. 8761

tential reorganization, an extraordinary
distribution is made with respect to it.
Background

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Continuity of Interest
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations.
SUMMARY: This document contains
temporary regulations providing guidance
regarding satisfaction of the continuity of
interest requirement for corporate reorganizations. The temporary regulations affect corporations and their shareholders.
Final regulations published in T.D. 8760,
page 4 of this Bulletin, also provide guidance regarding satisfaction of the continuity of interest requirement for corporate
reorganizations. These temporary regulations amplify the final regulations. The
text of these temporary regulations also
serves as the text of proposed regulations
published in REG–120882–97, page 25 of
this Bulletin.
DATES: These regulations are effective
January 28, 1998.
Applicability: These regulations apply
to transactions occurring after January 28,
1998, except that they do not apply to any
transaction occurring pursuant to a written agreement which is (subject to customary conditions) binding on January
28, 1998, and at all times thereafter.
FOR FURTHER INFORMATION CONTACT: Phoebe Bennett, (202) 622-7750
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
This document contains amendments to
the Income Tax Regulations (26 CFR part
1) under section 368. These temporary
regulations provide that, in determining
whether the continuity of interest requirement for corporate reorganizations is satisfied with respect to a potential reorganization, a proprietary interest in the target
corporation is not preserved if, in connection with a potential reorganization, it is
redeemed or acquired by a person related
to the target corporation, or to the extent
that, prior to and in connection with a po-

13

On December 23, 1996, the IRS published a notice of proposed rulemaking
(REG–252231–96 [1997–1 C.B. 800]) in
the Federal Register (61 F.R. 67512) relating to the continuity of interest requirement. Many written comments were received in response to this notice of
proposed rulemaking. A public hearing
on the proposed regulations was held on
May 7, 1997. After consideration of all
comments, the regulations proposed by
REG–252231–96 are adopted as final regulations, and published in T.D. 8760.
These temporary regulations supplement
the final regulations.
Explanation of Provisions
Final regulations published in T.D.
8760 provide that in determining whether
the continuity of interest (COI) requirement for corporate reorganizations is satisfied, dispositions of stock of the target
corporation (T) by a T shareholder generally are not taken into account.
Redemptions of T Stock or Extraordinary
Distributions with Respect to T Stock
Commentators requested guidance on
the circumstances under which a redemption by T of its stock would adversely affect satisfaction of the COI requirement.
Some commentators suggested that the
IRS and Treasury Department adopt an
approach that would identify either the issuing corporation (P) or T as the source of
the funds for the redemption. If, in connection with an acquisition of T, the facts
and circumstances indicate that P did not
directly or indirectly furnish funds used
by T to redeem T shareholders, these
commentators suggested that satisfaction
of the COI requirement should not be adversely affected. In many transactions,
however, such a tracing approach would
be extremely difficult to administer. For
example, if P acquired the assets, rather
than the stock, of T or if T redeemed stock
for a note, it would be unclear in many
circumstances whether in substance T or
P assets were used to fund the redemption
or to repay the note.
Another commentator suggested that
redemptions by T in connection with a

April 6, 1998

potential reorganization should adversely
affect satisfaction of the COI requirement
because the effect on COI is the same as if
P had furnished the redemption consideration in the transaction. The temporary
regulations generally adopt this approach
because it reflects that T and P will be
combined economically and because of
the difficulties of administering a tracing
approach, as previously described.
Treatment of stock redeemed by T as
proprietary interests that are not preserved
in the reorganization also accords the
same tax result to transactions that reach
the same result by different steps. For example, T could merge into P for a combination of consideration, of which 30 percent is P stock and 70 percent is a P
promissory note. Conversely, T could
issue its promissory note to redeem 70
percent of the T stock and then P would
assume the T note in the merger, in which
the remaining T shareholders receive
solely P stock. From the perspective of P,
T, and the T shareholders, these two transactions are substantively identical, and the
COI requirement is not satisfied in the first
transaction. The temporary regulations
provide that the second transaction likewise does not satisfy the COI requirement.
In addition, this approach corresponds
with the rule of the final regulations that a
proprietary interest in T is not preserved if,
in connection with the potential reorganization, P stock furnished in exchange for a
proprietary interest in T in the potential reorganization is redeemed. Because the
final regulations do not inquire, in the case
of a subsequent P redemption, whether the
source of consideration furnished in the
redemption was former T assets or historic
P assets, the temporary regulations similarly do not make an inquiry in the case of
a prior T redemption. Instead, for purposes of the COI requirement, the temporary regulations treat T and P as a combined economic enterprise. In an asset
acquisition, this approach avoids the difficult process of identifying the source of
payments as between T and P.
Commentators have suggested that this
approach is inconsistent with authorities
which hold that redemptions of stock of
the target corporation with assets of the
target corporation do not violate the
solely-for-voting-stock requirement applicable to section 368(a)(1)(B) reorganizations. See, e.g., Rev. Rul. 55–440

April 6, 1998

(1955–2 C.B. 226). None of these authorities address the effect on continuity of interest of such redemptions. For the reasons stated above, the temporary
regulations take such redemptions into account for continuity purposes.
The temporary regulations provide that
a proprietary interest in T is not preserved
if, in connection with a potential reorganization, it is redeemed or to the extent that,
prior to and in connection with a potential
reorganization, an extraordinary distribution is made with respect to it. An extraordinary distribution with respect to T
stock, followed by a sale of the remaining
T stock to P, has the same effect on the
value of the proprietary interest in T as a
pro rata redemption by T followed by a
sale of the outstanding T stock to P.
The temporary regulations do not provide guidance on the determination of
whether a distribution will be treated as
an extraordinary distribution, except that
the rules of section 1059 do not apply for
this purpose. The IRS and Treasury Department invite comments on whether the
regulations should provide more specific
guidance in this area.
A section 355 distribution of controlled
corporation stock by T will preserve a
proprietary interest in T, except to the extent that the T shareholders receive other
property or money to which section
356(a) applies or the distribution is extraordinary in amount and is a distribution of
property or money to which section
356(b) applies.
Related Person Rule
In determining whether the COI requirement is satisfied, dispositions of T
stock to persons that are not related to T
or P are disregarded. The final regulations provide that a proprietary interest in
T is not preserved if, in connection with a
potential reorganization, a person related
to P acquires, with consideration other
than a proprietary interest in P, T stock or
P stock furnished in exchange for a proprietary interest in T in the potential reorganization. Consistent with the final regulations, the temporary regulations
provide that a proprietary interest in T is
not preserved if, prior to and in connection with a potential reorganization, a person related to T acquires T stock with
consideration other than T stock or P
stock.

14

Definition of Related Person of T
The final regulations include as related
persons any corporation that is a member
of the affiliated group, within the meaning
of section 1504, of which P is a member,
and any corporation whose purchase of P
stock would be treated as a redemption of
that stock under section 304(a)(2). The
section 1504 test was adopted because the
IRS and Treasury Department were concerned that acquisitions of T stock or P
stock by P affiliated corporations were no
different in substance than acquisitions or
redemptions by P. This concern does not
generally extend to members of T’s affiliated group that are not also considered related to T under section 304(a)(2) because
such corporations are T shareholders participating in the potential reorganization
along with the other shareholders of the
target corporation. The temporary regulations treat two corporations as related persons if a purchase of the stock of one corporation by another corporation would be
treated as a distribution in redemption of
the stock of the first corporation under
section 304(a)(2) (determined without regard to §1.1502–80(b)).
Effect on Other Authorities
These COI regulations apply solely for
purposes of determining whether the COI
requirement is satisfied. No inference
should be drawn from any provision of
this regulation as to whether other reorganization requirements are satisfied, or as
to the characterization of a related transaction. See, e.g., §1.301–1(l).
Effect on Other Documents
Rev. Proc. 77–37 (1977–2 C.B. 568)
and Rev. Proc. 86–42 (1986–2 C.B. 722)
will be modified to the extent inconsistent
with these temporary regulations.
Effective Date
These regulations apply to transactions
occurring after January 28, 1998, except
that they do not apply to any transaction
occurring pursuant to a written agreement
which is (subject to customary conditions) binding on January 28, 1998, and at
all times thereafter.
Special Analyses
It has been determined that these temporary regulations are not a significant

1998–14 I.R.B.

regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these temporary regulations and,
because the temporary regulations do not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue
Code, these regulations will be submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small business.
Drafting Information
The principal author of these regulations is Phoebe Bennett of the Office of
the Assistant Chief Counsel (Corporate),
IRS. However, other personnel from the
IRS and Treasury Department participated in their development.
*

*

*

*

*

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805. * * *
Par. 2. Section 1.368–1T is added to
read as follows:
§1.368–T Purpose and scope of exception
of reorganization exchanges (temporary).
(a) through (e)(1)(i) [Reserved] For
further guidance see §1.368–1(a) through
(e)(1)(i).
(e)(1)(ii)(A) General rule. A proprietary interest in the target corporation
(other than one held by the acquiring corporation) is not preserved if, prior to and
in connection with a potential reorganization, it is redeemed or to the extent that,
prior to and in connection with a potential
reorganization, an extraordinary distribution is made with respect to it. The determination of whether a distribution with
respect to stock of the target corporation
is an extraordinary distribution for pur-

1998–14 I.R.B.

poses of this paragraph (e)(1)(ii) will be
made on the basis of all of the facts and
circumstances, but the treatment of the
distribution under section 1059 (relating
to extraordinary dividends) will not be
taken into account.
(B) Exception. Paragraph (e)(1)(ii)(A)
of this section does not apply to a distribution of stock by the target corporation to
which section 355(a) (or so much of section 356 as relates to section 355) applies,
except to the extent that—
(1) The target corporation shareholders
receive other property or money to which
section 356(a) applies; or
(2) The distribution is extraordinary in
amount and is a distribution of property or
money to which section 356(b) applies.
(2)(i) [Reserved] For further guidance, see §1.368–1(e)(2)(i).
(ii) A proprietary interest in the target
corporation is not preserved if, prior to
and in connection with a potential reorganization, a person related (as defined in
§1.368–1(e)(3) determined without regard to §1.368–1(e)(3)(i)(A)) to the target
corporation acquires stock of the target
corporation, with consideration other than
stock of either the target corporation or
the issuing corporation.
(e)(3) through (e)(6) Example 9. [Reserved] For further guidance, see §1.3681(e)(3) through (e)(6) Example 9.
(e)(6) Example 10. Acquisition of target corporation stock before merger. (i) Redemption by target
corporation. A owns 85 percent and B owns 15 percent of the stock of T. The fair market value of T is
$100x. Neither A nor B own stock of P. Prior to and
in connection with the merger of T into P, T redeems
A’s T stock for $85x and issues to A its promissory
note in exchange for the stock. At the time of the
merger T has a value of $15x, after giving effect to
the redemption of its stock. In the merger, B receives solely P stock. The continuity of interest requirement is not satisfied because T redeemed A’s
stock, and a substantial part of the value of the proprietary interest in T is not preserved. See paragraph
(e)(1)(ii)(A) of this section.
(ii) Purchase by person related to target corporation. The facts are the same as paragraph (i) of
this Example 10, except that X, T’s wholly owned
subsidiary, acquires A’s T stock prior to and in connection with the merger for cash of $85x. Under
paragraph (e)(2)(ii) of this section and §1.368–
1(e)(3)(i)(B), X’s acquisition of A’s T stock is an acquisition by a related person. The continuity of interest requirement is not satisfied, because X acquired T stock, for consideration other than P stock,
and a substantial part of the value of the proprietary
interest in T is not preserved. See paragraph
(e)(2)(ii) of this section.
Example 11. Extraordinary distribution before
merger. A owns all of the stock of T. The fair mar-

15

ket value of T is $100x. Prior to and in connection
with the merger of T into P, T pays A an extraordinary distribution of an $85x note. T merges into P,
and A receives solely P stock. P assumes T’s obligation on the note. The continuity of interest requirement is not satisfied, because T paid A an extraordinary distribution, and a substantial part of the value
of the proprietary interest in T is not preserved. See
paragraph (e)(1)(ii)(A) of this section.

(f) Effective date. This section applies
to transactions occurring after January 28,
1998, except that it does not apply to any
transaction occurring pursuant to a written agreement which is (subject to customary conditions) binding on January
28, 1998, and at all times thereafter.
Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
Approved January 12, 1998.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
January 23, 1998, 12:15 p.m., and published in the
issue of the Federal Register for January 28, 1998,
63 F.R. 4183)

Section 382.—Limitation on Net
Operating Loss Carryforwards
and Certain Built-In Losses
Following Ownership Change
The adjusted federal long-term rate is set forth
for the month of April 1998. See Rev. Rul. 98–18,
page 22.

Section 412.—Minimum Funding
Standards
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of April 1998. See Rev. Rul. 98–18, page 22.

Section 453.—Installment
Method
26 CFR 1.453–11: Installment obligations received
from a liquidation corporation.

T.D. 8762
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1

April 6, 1998

Installment Obligations Received
From Liquidating Corporations
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the use of the
installment method to report the gain recognized by a shareholder who receives, in
exchange for the shareholder’s stock, certain installment obligations that are distributed upon the complete liquidation of
a corporation. Changes to the applicable
tax law were made by the Installment
Sales Revision Act of 1980 and the Tax
Reform Act of 1986. These regulations
affect taxpayers who receive installment
obligations in exchange for their stock
upon the complete liquidation of a corporation.
DATES: This regulation is effective January 28, 1998.
For dates of applicability, see §1.453–
11(e) of these regulations.
FOR FURTHER INFORMATION CONTACT: George F. Wright, (202) 622-4950
(not a toll-free number).
SUPPLEMENTARY INFORMATION
Background
Section 453(h), relating to the tax treatment of installment obligations received
by a shareholder from a liquidating corporation, was added to the Internal Revenue
Code of 1954 by the Installment Sales Revision Act of 1980, Public Law 96–471,
94 Stat. 2247, 2250. Proposed regulations under section 453(h) were published
in the Federal Register for January 13,
1984 (49 F.R. 1742). Subsequently, section 453(h) was amended as part of the
Tax Reform Act of 1986, Public Law 99514, 100 Stat. 2085, 2274, pursuant to
which both C and S corporations became
subject to tax upon making liquidating
distributions of installment obligations to
shareholders. The Technical and Miscellaneous Revenue Act of 1988, Public Law
100–647, 102 Stat. 3342, 3403, added
section 453B(h), which provides that no
gain or loss is recognized by S corporations with respect to certain liquidating
distributions of installment obligations.
The regulations proposed on January 13,

April 6, 1998

1984 (49 F.R. 1742), were withdrawn by
the notice of proposed rulemaking published on January 22, 1997 (62 F.R.
3244), except for paragraph (e) relating to
liquidating distributions received in more
than one taxable year, and paragraph (g)
containing the effective date provision.
The notice of proposed rulemaking published in the Federal Register for January 22, 1997, reserved paragraph (d) for
liquidating distributions received in more
than one taxable year. Written comments
responding to this notice were received.
No public hearing was held because no
hearing was requested. After consideration of all comments received, the proposed regulations are adopted as revised
by this Treasury decision.
Explanation of Provisions
A. Overview of Provisions
Prior to the Installment Sales Revision
Act of 1980, a shareholder recognized
gain or loss on receipt of an installment
obligation that was distributed by a liquidating corporation in exchange for the
shareholder’s stock. Gain could not be reported under the installment sale provisions of section 453 as payments were received on the obligation distributed by the
corporation in the liquidation.
As enacted by the Installment Sales Revision Act of 1980 and amended by the
Tax Reform Act of 1986, section 453(h)
provides a different treatment for certain
installment obligations that are distributed
in a complete liquidation to which section
331 applies. Under section 453(h), a
shareholder that does not elect out of the
installment method treats the payments
under the obligation, rather than the
obligation itself, as consideration received in exchange for the stock. The
shareholder then takes into account the income from the payments under the obligation using the installment method. In
this manner, the shareholder generally is
treated as if the shareholder sold the
shareholder’s stock to an unrelated purchaser on the installment method.
This treatment under section 453(h) applies generally to installment obligations
received by a shareholder (in exchange
for the shareholder’s stock) in a complete
liquidation to which section 331 applies if
(a) the installment obligations are qualifying installment obligations, i.e., the installment obligations are acquired in re-

16

spect of a sale or exchange of property by
the corporation during the 12-month period beginning on the date a plan of complete liquidation is adopted, and (b) the
liquidation is completed within that 12month period. However, an installment
obligation acquired in a sale or exchange
of inventory, stock in trade, or property
held for sale in the ordinary course of
business qualifies for this treatment only
if the obligation arises from a single bulk
sale of substantially all of such property
attributable to a trade or business of the
corporation. If an installment obligation
arises from both a sale or exchange of inventory, etc., that does not comply with
the requirements of the preceding sentence and a sale or exchange of other assets, the portion of the installment obligation that is attributable to the sale or
exchange of other assets is a qualifying
installment obligation.
B. Discussion of Comments
Interaction of section 453(h) and
limitations on the installment method
The regulations provide that, if the stock
of a liquidating corporation is traded on an
established securities market, an installment obligation received by a shareholder
from that corporation as a liquidating distribution is not a qualifying installment
obligation and does not qualify for installment reporting, regardless of whether the
requirements of section 453(h) are otherwise satisfied. However, if an installment
obligation is received by a shareholder
from a liquidating corporation whose stock
is not publicly traded, and the obligation
arose from a sale by the corporation of
stock or securities that are traded on an established market, then the obligation generally is a qualifying installment obligation
in the hands of the transferor. An exception to the above rule applies if the liquidating corporation is formed or availed of
for a principal purpose of avoiding limitations on the availability of installment sales
treatment, such as section 453(k), through
the use of a related party.
One commentator suggested that the
anti-abuse rule directed at cases in which
there is a principal purpose to avoid section 453(k) is not necessary. The commentator suggests that the effect of a contribution of publicly-traded stock to a
nonpublicly-traded corporation, followed

1998–14 I.R.B.

by the sale of the publicly-traded stock for
an installment obligation and the liquidation of the nonpublicly-traded corporation, is the creation of two levels of tax
because the liquidating corporation must
recognize gain on the distribution of the
installment obligation. Accordingly, the
commentator does not believe that the
transaction offers any tax avoidance opportunities that warrant a specific antiabuse rule.
The anti-abuse rule is directed at circumvention of the prohibition in section
453(k) against the use of the installment
method for a sale of publicly-traded securities. It is designed to prevent a shareholder from indirectly entering into such a
sale on the installment method when the
shareholder could not have done so
through a direct sale. Accordingly, the
anti-abuse rule has been retained.
Liquidating distributions received in
more than one year
Under §1.453–2(e) proposed on January 13, 1984, if liquidating distributions,
including qualifying installment obligations, are received in more than one taxable year, a shareholder must file an
amended return if the reallocation of basis
required under section 453(h)(2) affects
the computation of gain recognized in an
earlier year. If the shareholder has transferred the installment obligation to a person whose basis in the obligation is determined by reference to the shareholder’s
basis, then the transferee generally is
required to reallocate basis and, if necessary, file an amended return. The proposed effective date applied to distributions of qualifying installment obligations
made after March 31, 1980.
In the preamble to the 1997 proposed
regulations, the IRS and Treasury Department suggested that an alternative to the
amended return requirement would be to
require the shareholder to recognize in the
current year the additional amount of gain
that would have been recognized in the
earlier year had the total amount of the
liquidating distributions been known in
the earlier year. Comments were requested regarding these and any other
methods of accomplishing the basis reallocation. Proposed §1.453–11(d) relating
to liquidating distributions received in
more than one taxable year was reserved.
One commentator questioned whether

1998–14 I.R.B.

amended returns were necessary and
noted that the alternative method discussed in the preamble is simpler and less
burdensome for taxpayers. The commentator then suggested an ordering rule as
another method of achieving the intended
purpose. Under the proposed ordering
rule, basis first would be allocated to assets other than installment obligations distributed in the liquidation with the remainder allocated to the installment
obligations. The commentator acknowledged that it might not be appropriate to
implement this approach by regulation
without amending the statute.
The proposed ordering rule does not
satisfy the basis reallocation requirement
of section 453(h)(2) and would require
complex provisions to implement it. Accordingly, the suggested approach is not
adopted in the final regulations.
The purpose underlying section 453(h)(2) is to ensure that gain is recognized in
the appropriate year when liquidating distributions are received in more than one
taxable year. The IRS and Treasury Department believe that this purpose can be
substantially fulfilled without imposing
the burden of filing amended returns. Accordingly, the final regulations incorporate
a current-year recognition rule. Under the
current-year recognition rule, a shareholder is required to recognize in the current year the additional amount of gain
that would have been recognized in the
earlier year had the total amount of the liquidating distributions been known in the
earlier year. In allocating basis to calculate the gain to be reported in the first year
in which a liquidating distribution is received, a shareholder is required to reasonably estimate the anticipated aggregate
distributions. For this purpose, the shareholder must take into account distributions
and other events occurring up to the time
at which the return for the first taxable
year is filed. Section §1.453–2(e) of the
1984 proposal is adopted as revised by
this Treasury decision. The effective date
provision in §1.453–2(g) of the proposal is
not adopted.
Recognition of gain or loss to the
distributing corporation under section
453B
Under section 453B, the disposition of
an installment obligation generally results
in the recognition of gain or loss to the

17

transferor. Thus, in accordance with sections 453B and 336, a C corporation generally recognizes gain or loss upon the
distribution of an installment obligation to
a shareholder in exchange for the shareholder’s stock, including complete liquidations covered by section 453(h). Section 453B(d) provides an exception to this
general rule if the installment obligation
is distributed in a liquidation to which
section 337(a) applies (regarding certain
complete liquidations of 80 percent or
more owned subsidiaries). However, that
exception does not apply to liquidations
under section 331.
In the case of a liquidating distribution
by an S corporation, however, section
453B(h) provides that if an S corporation
distributes an installment obligation in exchange for a shareholder’s stock, and payments under the obligation are treated as
consideration for the stock pursuant to
section 453(h)(1), then the distribution
generally is not treated as a disposition of
the obligation by the S corporation. Thus,
except for purposes of sections 1374 and
1375 (relating to certain built-in gains and
passive investment income), the S corporation does not recognize gain or loss on
the distribution of the installment obligation to a shareholder in a complete liquidation covered by section 453(h). One commentator believed that it is inequitable to
allow a shareholder to recognize gain on
the installment basis while the liquidating
C corporation has immediate recognition
upon distribution of an obligation. As an
alternative, the commentator suggested
that the corporation’s tax liability arising
from the distribution of an obligation carry
over to the shareholders and be taken into
account by them as payments are received
on the obligation. The suggested approach would be inconsistent with the
statutory provisions of sections 336 and
453B and, accordingly, is not adopted in
the final regulations.
Another commentator requested that
the regulations provide relief from a
bunching of income that occurs for shareholders receiving liquidating distributions
from S corporations. The bunching can
occur, for example, by virtue of the interrelationship of the S corporation and installment sale provisions if, in the year in
which assets are sold, an S corporation receives a payment on an installment obligation arising from the sale before the cor-

April 6, 1998

poration liquidates. The commentator
suggested that the regulations allow a
shareholder first to apply the basis in the
stock against the initial payment received,
with any remaining basis allocated to any
additional payments to be received. Since
the bunching of income results from the
successive application of section 453(c) at
the corporate and shareholder levels and
no statutory exception for shareholders of
S corporations is provided, this issue cannot be appropriately addressed in these
final regulations.
Incorporation of guidance on section
338(h)(10) elections
Three commentators suggested that the
regulations be expanded to address the
use of the installment method to the sale
of stock of a corporation with respect to
which an election under section
338(h)(10) has been made. This issue
does not arise under section 453(h) and is
beyond the scope of these regulations.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and because
the regulations do not impose a collection
of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter
6) does not apply. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding
these regulations was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal author of these regulations is George F. Wright of the Office of
Assistant Chief Counsel (Income Tax and
Accounting). However, other personnel
from the IRS and Treasury Department
participated in their development.
*

*

*

*

*

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:

April 6, 1998

PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
§1.453–11 also issued under 26 U.S.C.
453(j)(1) and (k). * * *
Par. 2. Section 1.453–11 is added to
read as follows:
§1.453–11 Installment obligations
received from a liquidating corporation.
(a) In general—(1) Overview. Except
as provided in section 453(h)(1)(C) (relating to installment sales of depreciable
property to certain closely related persons), a qualifying shareholder (as defined in paragraph (b) of this section) who
receives a qualifying installment obligation (as defined in paragraph (c) of this
section) in a liquidation that satisfies section 453(h)(1)(A) treats the receipt of
payments in respect of the obligation,
rather than the receipt of the obligation itself, as a receipt of payment for the shareholder’s stock. The shareholder reports
the payments received on the installment
method unless the shareholder elects otherwise in accordance with §15a.453–1(d)
of this chapter.
(2)
Coordination with other
provisions—(i) Deemed sale of stock for
installment obligation. Except as specifically provided in section 453(h)(1)(C), a
qualifying shareholder treats a qualifying
installment obligation, for all purposes of
the Internal Revenue Code, as if the obligation is received by the shareholder from
the person issuing the obligation in exchange for the shareholder’s stock in the
liquidating corporation. For example, if
the stock of a corporation that is liquidating is traded on an established securities
market, an installment obligation distributed to a shareholder of the corporation in
exchange for the shareholder’s stock does
not qualify for installment reporting pursuant to section 453(k)(2).
(ii) Special rules to account for the
qualifying installment obligation—(A)
Issue price. A qualifying installment
obligation is treated by a qualifying shareholder as newly issued on the date of the
distribution. The issue price of the qualifying installment obligation on that date is
equal to the sum of the adjusted issue
price of the obligation on the date of the

18

distribution (as determined under
§1.1275–1(b)) and the amount of any
qualified stated interest (as defined in
§1.1273–1(c)) that has accrued prior to
the distribution but that is not payable
until after the distribution. For purposes
of the preceding sentence, if the qualifying installment obligation is subject to
§1.446–2 (e.g., a debt instrument that has
unstated interest under section 483), the
adjusted issue price of the obligation is
determined under §1.446–2(c) and (d).
(B) Variable rate debt instrument. If
the qualifying installment obligation is a
variable rate debt instrument (as defined
in §1.1275–5), the shareholder uses the
equivalent fixed rate debt instrument
(within the meaning of §1.1275–5(e)(3)(ii)) constructed for the qualifying installment obligation as of the date the
obligation was issued to the liquidating
corporation to determine the accruals of
original issue discount, if any, and interest
on the obligation.
(3) Liquidating distributions treated as
selling price. All amounts distributed or
treated as distributed to a qualifying
shareholder incident to the liquidation, including cash, the issue price of qualifying
installment obligations as determined
under paragraph (a)(2)(ii)(A) of this section, and the fair market value of other
property (including obligations that are
not qualifying installment obligations) are
considered as having been received by the
shareholder as the selling price (as defined in §15a.453–1(b)(2)(ii) of this chapter) for the shareholder’s stock in the liquidating corporation. For the proper
method of reporting liquidating distributions received in more than one taxable
year of a shareholder, see paragraph (d) of
this section. An election not to report on
the installment method an installment
obligation received in the liquidation applies to all distributions received in the
liquidation.
(4) Assumption of corporate liability by
shareholders. For purposes of this section, if in the course of a liquidation a
shareholder assumes secured or unsecured
liabilities of the liquidating corporation, or
receives property from the corporation
subject to such liabilities (including any
tax liabilities incurred by the corporation
on the distribution), the amount of the liabilities is added to the shareholder’s basis
in the stock of the liquidating corporation.

1998–14 I.R.B.

These additions to basis do not affect the
shareholder ’s holding period for the
stock. These liabilities do not reduce the
amounts received in computing the selling price.
(5) Examples. The provisions of this
paragraph (a) are illustrated by the following examples. Except as otherwise provided, assume in each example that A, an
individual who is a calendar-year taxpayer,
owns all of the stock of T corporation. A’s
adjusted tax basis in that stock is $100,000.
On February 1, 1998, T, an accrual method
taxpayer, adopts a plan of complete liquidation that satisfies section 453(h)(1)(A)
and immediately sells all of its assets to unrelated B corporation in a single transaction. The examples are as follows:
Example 1. (i) The stated purchase price for T’s
assets is $3,500,000. In consideration for the sale, B
makes a down payment of $500,000 and issues a 10year installment obligation with a stated principal
amount of $3,000,000. The obligation provides for
interest payments of $150,000 on January 31 of each
year, with the total principal amount due at maturity.
(ii) Assume that for purposes of section 1274, the
test rate on February 1, 1998, is 8 percent, compounded semi-annually. Also assume that a semiannual accrual period is used. Under §1.1274–2, the
issue price of the obligation on February 1, 1998, is
$2,368,450. Accordingly, the obligation has
$631,550 of original issue discount ($3,000,000 –
$2,368,450). Between February 1 and July 31,
$19,738 of original issue discount and $75,000 of
qualified stated interest accrue with respect to the
obligation and are taken into account by T.
(iii) On July 31, 1998, T distributes the installment obligation to A in exchange for A’s stock. No
other property is ever distributed to A. On January
31, 1999, A receives the first annual payment of
$150,000 from B.
(iv) When the obligation is distributed to A on
July 31, 1998, it is treated as if the obligation is received by A in an installment sale of shares directly
to B on that date. Under §1.1275–1(b), the adjusted
issue price of the obligation on that date is
$2,388,188 (original issue price of $2,368,450 plus
accrued original issue discount of $19,738). Accordingly, the issue price of the obligation under
paragraph (a)(2)(ii)(A) of this section is $2,463,188,
the sum of the adjusted issue price of the obligation
on that date ($2,388,188) and the amount of accrued
but unpaid qualified stated interest ($75,000).
(v) The selling price and contract price of A’s
stock in T is $2,463,188, and the gross profit is
$2,363,188 ($2,463,188 selling price less A’s adjusted tax basis of $100,000). A’s gross profit ratio
is thus 96 percent (gross profit of $2,363,188 divided by total contract price of $2,463,188).
(vi) Under §§1.446–2(e)(1) and 1.1275–2(a),
$98,527 of the $150,000 payment is treated as a payment of the interest and original issue discount that
accrued on the obligation from July 31, 1998, to January 31, 1999 ($75,000 of qualified stated interest
and $23,527 of original issue discount). The balance
of the payment ($51,473) is treated as a payment of

1998–14 I.R.B.

principal. A’s gain recognized in 1999 is $49,414
(96 percent of $51,473).
Example 2. (i) T owns Blackacre, unimproved
real property, with an adjusted tax basis of $700,000.
Blackacre is subject to a mortgage (underlying mortgage) of $1,100,000. A is not personally liable on
the underlying mortgage and the T shares held by A
are not encumbered by the underlying mortgage.
The other assets of T consist of $400,000 of cash
and $600,000 of accounts receivable attributable to
sales of inventory in the ordinary course of business.
The unsecured liabilities of T total $900,000.
(ii) On February 1, 1998, T adopts a plan of complete liquidation complying with section
453(h)(1)(A), and promptly sells Blackacre to B for
a 4-year mortgage note (bearing adequate stated interest and otherwise meeting all of the requirements
of section 453) in the face amount of $4 million.
Under the agreement between T and B, T (or its successor) is to continue to make principal and interest
payments on the underlying mortgage. Immediately
thereafter, T completes its liquidation by distributing
to A its remaining cash of $400,000 (after payment
of T’s tax liabilities), accounts receivable of
$600,000, and the $4 million B note. A assumes T’s
$900,000 of unsecured liabilities and receives the
distributed property subject to the obligation to
make payments on the $1,100,000 underlying mortgage. A receives no payments from B on the B note
during 1998.
(iii) Unless A elects otherwise, the transaction is
reported by A on the installment method. The selling price is $5 million (cash of $400,000, accounts
receivable of $600,000, and the B note of $4 million). The total contract price also is $5 million. A’s
adjusted tax basis in the T shares, initially $100,000,
is increased by the $900,000 of unsecured T liabilities assumed by A and by the obligation (subject to
which A takes the distributed property) to make payments on the $1,100,000 underlying mortgage on
Blackacre, for an aggregate adjusted tax basis of
$2,100,000. Accordingly, the gross profit is
$2,900,000 (selling price of $5 million less aggregate adjusted tax basis of $2,100,000). The gross
profit ratio is 58 percent (gross profit of $2,900,000
divided by the total contract price of $5 million).
The 1998 payments to A are $1 million ($400,000
cash plus $600,000 receivables) and A recognizes
gain in 1998 of $580,000 (58 percent of $1 million).
(iv) In 1999, A receives payment from B on the B
note of $1 million (exclusive of interest). A’s gain
recognized in 1999 is $580,000 (58 percent of $1
million).

(b) Qualifying shareholder. For purposes of this section, qualifying shareholder means a shareholder to which,
with respect to the liquidating distribution, section 331 applies. For example, a
creditor that receives a distribution from a
liquidating corporation, in exchange for
the creditor’s claim, is not a qualifying
shareholder as a result of that distribution
regardless of whether the liquidation satisfies section 453(h)(1)(A).
(c) Qualifying installment obligation—
(1) In general. For purposes of this sec-

19

tion, qualifying installment obligation
means an installment obligation (other
than an evidence of indebtedness described in §15a.453–1(e) of this chapter,
relating to obligations that are payable on
demand or are readily tradable) acquired
in a sale or exchange of corporate assets
by a liquidating corporation during the
12-month period beginning on the date
the plan of liquidation is adopted. See
paragraph (c)(4) of this section for an exception for installment obligations acquired in respect of certain sales of inventory. Also see paragraph (c)(5) of this
section for an exception for installment
obligations attributable to sales of certain
property that do not generally qualify for
installment method treatment.
(2) Corporate assets. Except as provided in section 453(h)(1)(C), in paragraph (c)(4) of this section (relating to
certain sales of inventory), and in paragraph (c)(5) of this section (relating to
certain tax avoidance transactions), the
nature of the assets sold by, and the tax
consequences to, the selling corporation
do not affect whether an installment
obligation is a qualifying installment
obligation. Thus, for example, the fact
that the fair market value of an asset is
less than the adjusted basis of that asset
in the hands of the corporation; or that
the sale of an asset will subject the corporation to depreciation recapture (e.g.,
under section 1245 or section 1250); or
that the assets of a trade or business sold
by the corporation for an installment
obligation include depreciable property,
certain marketable securities, accounts
receivable, installment obligations, or
cash; or that the distribution of assets to
the shareholder is or is not taxable to the
corporation under sections 336 and 453B,
does not affect whether installment obligations received in exchange for those assets are treated as qualifying installment
obligations by the shareholder. However,
an obligation received by the corporation
in exchange for cash, in a transaction unrelated to a sale or exchange of noncash
assets by the corporation, is not treated as
a qualifying installment obligation.
(3) Installment obligations distributed
in liquidations described in section
453(h)(1)(E)—(i) In general

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A02e29c919ce660c9. Public record. Not legal advice.