Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 75-39

1975-1 C.B. 272

Sec. 1232

IRS Headnote

Original issue discount; debentures exchanged for common and preferred stock. No amount is includible in the income of debenture holders, under section 1232(a)(2)(A) or (a)(2)(B) of the Code, as a result of the exchange of their debentures for common or preferred stock in a recapitalization qualifying as a reorganization under section 368(a)(1)(E).

Full Text

Rev. Rul. 75-39

Advice has been requested regarding the Federal income tax consequences of an exchange of certain debt instruments for stock under the circumstances described below.

In 1970 the X corporation, in order to effectuate a recapitalization, exchanged shares of its preferred and common stock for certain of its outstanding debt instruments that qualified as securities under section 354 of the Internal Revenue Code of 1954. Some of the debt instruments were issued subsequent to May 27, 1969, while others were issued prior to May 27, 1969, and after December 31, 1954, at an original issue discount. In the case of some debenture holders, the fair market value of the stock received in the exchange exceeded the basis of the debt instruments. In other cases the fair market value of such stock did not exceed the basis of the debt instruments.

The recapitalization qualified as a reorganization within the meaning of section 368(a)(1)(E) of the Code. X corporation was a party to the reorganization within the meaning of section 368(b).

The specific question presented is whether the original issue discount should be recognized by the debt instrument holders at the time of exchange of such instruments for the stock notwithstanding the provisions of section 354(a)(1) of the Code.

Section 354(a)(1) of the Code provides that no gain or loss shall be recognized if stock or securities in a corporation that is a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

Section 1232(b)(1) of the Code provides that original issue discount means the difference between the issue price and the stated redemption price at maturity.

Section 1232(a)(2)(A) of the Code provides, in part, that in the case of a gain realized on the sale or exchange of certain debt obligations issued at a discount after May 27, 1969, and held by the taxpayer for more than six months, the amount of the gain will be considered capital gain rather than ordinary income. If at the time of original issue there was an intention to call the debt instruments before maturity, any gain realized on the sale or exchange thereof which does not exceed an amount equal to the original issue discount reduced by the portion of original issue discount previously includible in income will be considered as ordinary income rather than capital gain.

Section 1232(a)(2)(B) of the Code provides, in part, that in the case of a gain realized on the sale or exchange of certain debt obligations issued at a discount after December 31, 1954, and on or before May 27, 1969, held by the taxpayer for more than six months, the amount of gain equal to a specified portion of such discount will be considered as ordinary income rather than capital gain.

Notwithstanding that the term "realized" is used in section 1232 of the Code, the section has been interpreted to apply only to recognized gain. See Rev. Rul. 60-37, 1960-1 C.B. 309.

Accordingly, since no gain or loss will be recognized on the exchange by virtue of section 354 of the Code, no amount is includible in the income of the debenture holders who exchanged their debt instruments for common and/or preferred stock by reason of section 1232(a)(2)(A) or section 1232(a)(2)(B). Where no gain is realized on the exchange, the holder's basis in the stock received will be the same as his basis in the debt instruments surrendered under section 358. With respect to the bonds issued after May 27, 1969, see also section 1232(a)(3) which requires that original issue discount be ratably included in the income of the holder prior to the sale or exchange of the bond.