Installment Obligations Received From Liquidating Corporations

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-209332-80]

RIN 1545-AB43

Installment Obligations Received From Liquidating Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Partial withdrawal of previous notice of proposed rulemaking;

Notice of proposed rulemaking.

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SUMMARY: This document withdraws portions of the notice of proposed

rulemaking published in the Federal Register (49 FR 1742) on January

13, 1984, and proposes new 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 would affect taxpayers who receive installment

obligations in exchange for their stock upon the complete liquidation

of a corporation.

DATES: Comments or requests for a public hearing must be received by

April 22, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209332-80), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered between the

hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209332-80), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC. Alternatively, taxpayers may submit comments

electronically via the internet by selecting the ``Tax Regs'' option on

the IRS Home Page, or by submitting comments directly to the IRS

internet site at http://www.irs.ustreas.gov/prod/tax__regs/

comments.html.

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. Proposed regulations under section 453(h) were

published in the Federal Register on January 13, 1984 (49 FR 1742).

Subsequently, section 453(h) was amended by the Tax Reform Act of 1986.

This document withdraws a portion of the regulations proposed on

January 13, 1984, at 49 FR 1742 and proposes new regulations under

section 453(h). The new proposed regulations are issued under the

authority contained in sections 453(j)(1), 453(k) and 7805 of the

Internal Revenue Code of 1986 (Code).

Explanation 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 respect

to 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 12-month

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

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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.

Interaction of Section 453(h) and Limitations on the Installment Method

Under section 453(k)(2), an installment obligation arising out of a

sale of stock or securities that are traded on an established

securities market does not qualify for installment method reporting.

Accordingly, 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 received by a shareholder from a liquidating corporation,

the stock of which is not publicly traded, arose from a sale by the

corporation of stock or securities that are traded on an established

securities market, then the obligation generally is a qualifying

installment obligation in the hands of the shareholder. An exception to

this rule applies to the extent the liquidating corporation is formed

or availed of for a principal purpose of avoiding limitations on the

availability of installment sale treatment through the use of a related

party. For example, the exception would apply if a shareholder

contributed a substantial amount of publicly traded stock to a

corporation shortly before or after the corporation adopted a plan of

liquidation and sold its assets, including the publicly traded stock,

for an installment obligation. Under the exception, the allocable

portion of the installment obligation is not a qualifying installment

obligation and, thus, is treated as a payment received in exchange for

the shareholder's stock. The IRS specifically requests comments on this

exception, which is contained in Sec. 1.453-11(c)(5) of these proposed

regulations.

Determination of Shareholder's Selling Price

All amounts distributed or treated as distributed incident to the

liquidation are included in the selling price of the shareholder's

stock in the liquidating corporation. This selling price includes the

issue price of a qualifying installment obligation that is distributed

in the liquidation. For this purpose, the issue price of a qualifying

installment obligation is equal to the sum of the adjusted issue price

of the obligation on the date of the distribution and the amount of any

qualified stated interest that has accrued prior to the distribution

but that is not payable until after the distribution. In this manner,

the accrued but unpaid qualified stated interest is treated as having

been received and taken into account by the liquidating corporation,

and then distributed by the corporation to the shareholder in exchange

for the shareholder's stock. The issue price is also used to compute

interest and original issue discount accruals for the shareholder.

Liquidating Distributions Received in More Than One Year

Generally, a shareholder that receives liquidating distributions in

more than one taxable year may recover the basis in the shareholder's

stock completely before recognizing any gain. This general rule is

inconsistent with installment method reporting, which requires that

basis be ratably recovered as payments are received. Therefore, if a

shareholder receives liquidating distributions in more than one taxable

year, and included in the distributions is an installment obligation

that qualifies for section 453(h) treatment, then upon completion of

the liquidation, basis must be reallocated among all property received,

or to be received, in all years. See section 453(h)(2). One method of

achieving this basis reallocation would be to require the shareholder

to file an amended return if the reallocation of basis would affect the

computation of gain recognized in an earlier year. An alternative

method 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 liquidating distributions been

known in the earlier year. This portion of the proposed regulations is

reserved and comments are specifically requested regarding these and

any other methods of accomplishing the basis reallocation.

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 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 owned subsidiaries). However, that exception does not apply to

liquidations under section 331.

The Internal Revenue Code provides for a different treatment in the

case of a liquidating distribution by an S corporation. 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).

Proposed Effective Date

The proposed regulations provide that this section will be

effective for distributions of qualifying installment obligations made

on or after the date final regulations are filed with the Federal

Register.

Special Analyses

It has been determined that this notice of proposed rulemaking 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, this

notice of proposed rulemaking will be submitted to the Chief Counsel

for Advocacy of the Small Business Administration for comment on its

impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any

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comments that are submitted timely (in the manner described in the

ADDRESSES portion of the preamble) to the IRS. All comments will be

available for public inspection and copying. A public hearing will be

scheduled if requested by any person who timely submits comments. If a

public hearing is scheduled, notice of the date, time and place for the

hearing will be published in the Federal Register.

Drafting Information

The principal author of these proposed 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.

Partial Withdrawal of Notice of Proposed Rulemaking

Accordingly, under the authority of 26 U.S.C. 7805, Sec. 1.453-2

(a), (b), (c), (d) and (f) in the notice of proposed rulemaking that

was published on January 13, 1984 (49 FR 1742) is withdrawn.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

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 * * *

Section 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:

Sec. 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 connection

with a liquidation that satisfies section 453(h)(1)(A) treats the

receipt of payments in respect to 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 Sec. 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 distribution (as determined under

Sec. 1.1275-1(b)) and the amount of any qualified stated interest (as

defined in Sec. 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 Sec. 1.446-2 (e.g., a debt instrument that has unstated

interest under section 483), the adjusted issue price of the qualifying

installment obligation is determined by reference to the issue price of

the qualifying installment obligation under Sec. 1.446-2(d)(1).

(B) Variable rate debt instrument. If the qualifying installment

obligation is a variable rate debt instrument (as defined in

Sec. 1.1275-5), the shareholder uses the equivalent fixed rate debt

instrument (within the meaning of Sec. 1.1275-5(e)(3)(ii)) constructed

for the qualifying installment obligation on 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 Sec. 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 as a liquidating distribution 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. 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 basis 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 10-year 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 semi-annual accrual period is used. Under Sec. 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

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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

Sec. 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 Secs. 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 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 section, qualifying installment obligation means an installment

obligation (other than an evidence of indebtedness described in

Sec. 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 to 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 sale 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. In the case of a liquidation

to which section 453(h)(1)(E) (relating to certain liquidating

subsidiary corporations) applies, a qualifying installment obligation

acquired in respect to a sale or exchange by the liquidating subsidiary

corporation will be treated as a qualifying installment obligation if

distributed by a controlling corporate shareholder (within the meaning

of section 368(c)) to a qualifying shareholder. The preceding sentence

is applied successively to each controlling corporate shareholder, if

any, above the first controlling corporate shareholder.

(ii) Examples. The provisions of this paragraph (c)(3) are

illustrated by the following examples:

Example 1. (i) A, an individual, owns all of the stock of T

corporation, a C corporation. T has an operating division and three

wholly-owned subsidiaries, X, Y, and Z. On February 1, 1998, T, Y,

and Z all adopt plans of complete liquidation.

(ii) On March 1, 1998, the following sales are made to unrelated

purchasers: T sells the assets of its operating division to B for

cash and an installment obligation. T sells the stock of X to C for

an installment obligation. Y sells all of its assets to D for an

installment obligation. Z sells all of its assets to E for cash. The

B, C, and D installment obligations bear adequate stated interest

and meet the requirements of section 453.

(iii) In June 1998, Y and Z completely liquidate, distributing

their respective assets (the D installment obligation and cash) to

T. In July 1998, T completely liquidates, distributing to A cash and

the installment obligations respectively issued by B, C, and D. The

liquidation of T is a liquidation to which section 453(h) applies

and the liquidations of Y and Z into T are liquidations to which

section 332 applies.

(iv) Because T is in control of Y (within the meaning of section

368(c)), the D obligation acquired by Y is treated as acquired by T

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pursuant to section 453(h)(1)(E). A is a qualifying shareholder and

the installment obligations issued by B, C, and D are qualifying

installment obligations. Unless A elects otherwise, A reports the

transaction on the installment method as if the cash and installment

obligations had been received in an installment sale of the stock of

T corporation. Under section 453B(d), no gain or loss is recognized

by Y on the distribution of the D installment obligation to T. Under

sections 453B(a) and 336, T recognizes gain or loss on the

distribution of the B, C, and D installment obligations to A in

exchange for A's stock.

Example 2. (i) A, a cash-method individual taxpayer, owns all of

the stock of P corporation, a C corporation. P owns 30 percent of

the stock of Q corporation. The balance of the Q stock is owned by

unrelated individuals. On February 1, 1998, P adopts a plan of

complete liquidation and sells all of its property, other than its Q

stock, to B, an unrelated purchaser for cash and an installment

obligation bearing adequate stated interest. On March 1, 1998, Q

adopts a plan of complete liquidation and sells all of its property

to an unrelated purchaser, C, for cash and installment obligations.

Q immediately distributes the cash and installment obligations to

its shareholders in completion of its liquidation. Promptly

thereafter, P liquidates, distributing to A cash, the B installment

obligation, and a C installment obligation that P received in the

liquidation of Q.

(ii) In the hands of A, the B installment obligation is a

qualifying installment obligation. In the hands of P, the C

installment obligation was a qualifying installment obligation.

However, in the hands of A, the C installment obligation is not

treated as a qualifying installment obligation because P owned only

30 percent of the stock of Q. Because P did not own the requisite 80

percent stock interest in Q, P was not a controlling corporate

shareholder of Q (within the meaning of section 368(c)) immediately

before the liquidation. Therefore, section 453(h)(1)(E) does not

apply. Thus, in the hands of A, the C obligation is considered to be

a third-party note (not a purchaser's evidence of indebtedness) and

is treated as a payment to A in the year of distribution.

Accordingly, for 1998, A reports as payment the cash and the fair

market value of the C obligation distributed to A in the liquidation

of P.

(iii) Because P held 30 percent of the stock of Q, section

453B(d) is inapplicable to P. Under sections 453B(a) and 336,

accordingly, Q recognizes gain or loss on the distribution of the C

obligation. P also recognizes gain or loss on the distribution of

the B and C installment obligations to A in exchange for A's stock.

See sections 453B and 336.

(4) Installment obligations attributable to certain sales of

inventory--(i) In general. An installment obligation acquired by a

corporation in a liquidation that satisfies section 453(h)(1)(A) in

respect to a broken lot of inventory is not a qualifying installment

obligation. If an installment obligation is acquired in respect to a

broken lot of inventory and other assets, only the portion of the

installment obligation acquired in respect to the broken lot of

inventory is not a qualifying installment obligation. The portion of

the installment obligation attributable to other assets is a qualifying

installment obligation. For purposes of this section, the term broken

lot of inventory means inventory property that is sold or exchanged

other than in bulk to one person in one transaction involving

substantially all of the inventory property attributable to a trade or

business of the corporation. See paragraph (c)(4)(ii) of this section

for rules for determining what portion of an installment obligation is

not a qualifying installment obligation.

(ii) Rules for determining nonqualifying portion of an installment

obligation. If a broken lot of inventory is sold to a purchaser

together with other corporate assets for consideration consisting of an

installment obligation and either cash, other property, the assumption

of (or taking property subject to) corporate liabilities by the

purchaser, or some combination thereof, the installment obligation is

treated as having been acquired in respect to a broken lot of inventory

only to the extent that the fair market value of the broken lot of

inventory exceeds the sum of unsecured liabilities assumed by the

purchaser, secured liabilities which encumber the broken lot of

inventory and are assumed by the purchaser or to which the broken lot

of inventory is subject, and the sum of the cash and fair market value

of other property received. This rule applies solely for the purpose of

determining the portion of the installment obligation (if any) that is

attributable to the broken lot of inventory.

(iii) Example. The following example illustrates the provisions of

this paragraph (c)(4). In this example, assume that all obligations

bear adequate stated interest within the meaning of section 1274(c)(2)

and that the fair market value of each nonqualifying installment

obligation equals its face amount.

The example is as follows:

Example. (i) P corporation has three operating divisions, X, Y,

and Z, each engaged in a separate trade or business, and a minor

amount of investment assets. On July 1, 1998, P adopts a plan of

complete liquidation that meets the criteria of section

453(h)(1)(A). The following sales are promptly made to purchasers

unrelated to P: P sells all of the assets of the X division

(including all of the inventory property) to B for $30,000 cash and

installment obligations totalling $200,000. P sells substantially

all of the inventory property of the Y division to C for a $100,000

installment obligation, and sells all of the other assets of the Y

division (excluding cash but including installment receivables

previously acquired in the ordinary course of the business of the Y

division) to D for a $170,000 installment obligation. P sells \1/3\

of the inventory property of the Z division to E for $100,000 cash,

\1/3\ of the inventory property of the Z division to F for a

$100,000 installment obligation, and all of the other assets of the

Z division (including the remaining \1/3\ of the inventory property

worth $100,000) to G for $60,000 cash, a $240,000 installment

obligation, and the assumption by G of the liabilities of the Z

division. The liabilities assumed by G, which are unsecured

liabilities and liabilities encumbering the inventory property

acquired by G, aggregate $30,000. Thus, the total purchase price G

pays is $330,000.

(ii) P immediately completes its liquidation, distributing the

cash and installment obligations, which otherwise meet the

requirements of section 453, to A, an individual cash-method

taxpayer who is its sole shareholder. In 1999, G makes a payment to

A of $100,000 (exclusive of interest) on the $240,000 installment

obligation.

(iii) In the hands of A, the installment obligations issued by

B, C, and D are qualifying installment obligations because they were

timely acquired by P in a sale or exchange of its assets. In

addition, the installment obligation issued by C is a qualifying

installment obligation because it arose from a sale to one person in

one transaction of substantially all of the inventory property of

the trade or business engaged in by the Y division.

(iv) The installment obligation issued by F is not a qualifying

installment obligation because it is in respect to a broken lot of

inventory. A portion of the installment obligation issued by G is a

qualifying installment obligation and a portion is not a qualifying

installment obligation, determined as follows: G purchased part of

the inventory property (with a fair market value of $100,000) and

all of the other assets of the Z division by paying cash ($60,000),

issuing an installment obligation ($240,000), and assuming

liabilities of the Z division ($30,000). The assumed liabilities

($30,000) and cash ($60,000) are attributed first to the inventory

property. Therefore, only $10,000 of the $240,000 installment

obligation is attributed to inventory property. Accordingly, in the

hands of A, the G installment obligation is a qualifying installment

obligation to the extent of $230,000, but is not a qualifying

installment obligation to the extent of the $10,000 attributable to

the inventory property.

(v) In the 1998 liquidation of P, A receives a liquidating

distribution as follows:

------------------------------------------------------------------------

Qualifying Cash and

Item installment other

obligations property

------------------------------------------------------------------------

cash............................................ ........... $190,000

B note.......................................... $200,000 .........

C note.......................................... 100,000 .........

D note.......................................... 170,000 .........

F note.......................................... ........... 100,000

[[Page 3249]]

G note \1\...................................... 230,000 10,000

-----------------------

Total..................................... 700,000 300,000

------------------------------------------------------------------------

\1\ Face amount $240,000.

(vi) Assume that A's adjusted tax basis in the stock of P is

$100,000. Under the installment method, A's selling price and the

contract price are both $1 million, the gross profit is $900,000

(selling price of $1 million less adjusted tax basis of $100,000),

and the gross profit ratio is 90 percent (gross profit of $900,000

divided by the contract price of $1 million). Accordingly, in 1998,

A reports gain of $270,000 (90 percent of $300,000 payment in cash

and other property). A's adjusted tax basis in each of the

qualifying installment obligations is an amount equal to 10 percent

of the obligation's respective face amount. A's adjusted tax basis

in the F note, a nonqualifying installment obligation, is $100,000,

i.e., the fair market value of the note when received by A. A's

adjusted tax basis in the G note, a mixed obligation, is $33,000 (10

percent of the $230,000 qualifying installment obligation portion of

the note, plus the $10,000 nonqualifying portion of the note).

(vii) In respect to the $100,000 payment received from G in

1999, $10,000 is treated as the recovery of the adjusted tax basis

of the nonqualifying portion of the G installment obligation and

$9,000 (10 percent of $90,000) is treated as the recovery of the

adjusted tax basis of the portion of the note that is a qualifying

installment obligation. The remaining $81,000 (90 percent of

$90,000) is reported as gain from the sale of A's stock.

(5) Installment obligations attributable to sales of certain

property--(i) In general. An installment obligation acquired by a

liquidating corporation, to the extent attributable to the sale of

property described in paragraph (c)(5)(ii) of this section, is not a

qualifying obligation if the corporation is formed or availed of for a

principal purpose of avoiding section 453(b)(2)(A) (relating to dealer

dispositions), section 453(i) (relating to sales of property subject to

recapture), or section 453(k) (relating to dispositions under a

revolving credit plan and sales of stock or securities traded on an

established securities market) through the use of a party bearing a

relationship, either directly or indirectly, described in section

267(b) to any shareholder of the corporation.

(ii) Covered property. Property is described in this paragraph

(c)(5)(ii) if, within 12 months before or after the adoption of the

plan of liquidation, the property was owned by any shareholder and--

(A) The shareholder regularly sold or otherwise disposed of

personal property of the same type on the installment plan or the

property is real property that the shareholder held for sale to

customers in the ordinary course of a trade or business (provided the

property is not described in section 453(l) (2)(relating to certain

exceptions to the definition of dealer dispositions));

(B) The sale of the property by the shareholder would result in

recapture income (within the meaning of section 453(i)(2)), but only if

the amount of recapture is equal to or greater than 50 percent of the

property's fair market value on the date of the sale by the

corporation;

(C) The property is stock or securities that are traded on an

established securities market; or

(D) The sale of the property by the shareholder would have been

under a revolving credit plan.

(iii) Safe harbor. Paragraph (c)(5)(i) of this section will not

apply to the liquidation of a corporation if, on the date the plan of

complete liquidation is adopted and thereafter, less than 15 percent of

the fair market value of the corporation's assets is attributable to

property described in paragraph (c)(5)(ii) of this section.

(iv) Example. The provisions of this paragraph (c)(5) are

illustrated by the following example:

Example. Ten percent of the fair market value of the assets of T

is attributable to stock and securities traded on an established

securities market. T owns no other assets described in paragraph

(c)(5)(ii) of this section. T, after adopting a plan of complete

liquidation, sells all of its stock and securities holdings to C

corporation in exchange for an installment obligation bearing

adequate stated interest, sells all of its other assets to B

corporation for cash, and distributes the cash and installment

obligation to its sole shareholder, A, in a complete liquidation

that satisfies section 453(h)(1)(A). Because the C installment

obligation arose from a sale of publicly traded stock and

securities, T cannot report the gain on the sale under the

installment method pursuant to section 453(k)(2). In the hands of A,

however, the C installment obligation is treated as having arisen

out of a sale of the stock of T corporation. In addition, the

general rule of paragraph (c)(5)(i) of this section does not apply,

even if a principal purpose of the liquidation was the avoidance of

section 453(k)(2), because the fair market value of the publicly

traded stock and securities is less than 15 percent of the total

fair market value of T's assets. Accordingly, section 453(k)(2) does

not apply to A, and A may use the installment method to report the

gain recognized on the payments it receives in respect to the

obligation.

(d) Liquidating distributions received in more than one taxable

year. [Reserved]

(e) Effective date. This section is applicable for distributions of

qualifying installment obligations made on or after the date final

regulations are filed with the Federal Register.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 97-1522 Filed 1-21-97; 8:45 am]

BILLING CODE 4830-01-P