Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 77-20

1977-1 C.B. 91

Section 61
Section 355
Section 356

IRS Headnote

Stock distribution; exchange for stock of less value. The excess of the fair market value of stock of a controlled corporation, distributed by the controlling corporation to one of its shareholders, over the fair market value of stock surrendered to the distributing corporation by the shareholder that represents payment for rent owed the shareholder by the distributing corporation is includible in the shareholder's gross income under section 61(a)(5).

Full Text

Rev. Rul. 77-20

Advice has been requested concerning the treatment of a distribution of stock otherwise qualifying for tax free treatment under section 355 of the Internal Revenue Code of 1954 under the circumstances described below in which the fair market value of the stock distributed is in excess of the fair market value of the stock of the distributing corporation surrendered in the transaction.

P corporation owned all of the stock of S corporation. For valid business reasons, P distributed all of the S stock to one of its shareholders, individual A, in exchange for all of the shares of P stock owned by A. The fair market value of the P stock surrendered was equal to 85 percent of the fair market value of the S stock received in the exchange. This difference in value represented a payment by P to A for rent owed by P to A in connection with property leased by A to P.

The distribution met the requirements of section 355 of the Code, including the active trade or business requirement, and the requirement that the transaction not be used as a device to distribute earnings and profits.

Section 355(a)(1) of the Code, provides, in part, that no gain or loss will be recognized to (and no amount will be includible in the income of) shareholders of a corporation upon the distribution by that corporation of all the stock of a corporation controlled by the distributing corporation whether or not the shareholder surrenders stock in the distributing corporation.

Section 356(f) of the Code states, in part, that for special rules for a transaction described in section 354 or 355 but which (1) results in a gift, see section 2501 and following, or (2) has the effect of the payment of compensation, see section 61(a)(1).

Section 61(a)(5) of the Code, in part, defines gross income to include rents.

Rev. Rul. 74-269, 1974-1 C.B. 87, holds that an exchange of newly issued preferred stock for all of the common stock of a corporation held by the corporation's majority shareholder pursuant to a plan of recapitalization qualifies as a reorganization under section 368(a)(1)(E) of the Code and that no gain or loss is recognized to the majority shareholder, under section 354, on the exchange of those shares of common stock equal in value to the value of the preferred stock received in exchange therefor. Rev. Rul. 74-269 states that to the extent the fair market value of either stock exceeds the other, the difference will be treated as having been used to make gifts, pay compensation, or satisfy obligations of any kind, or for whatever purpose the facts indicate.

Similarly, as in the instant case, the nonrecognition provisions of section 355 of the Code will not apply to stock received by a shareholder in a transaction described in that section to the extent that such stock represents the payment for something other than the stock surrendered in the exchange.

Accordingly, pursuant to section 355(a)(1) of the Code, no gain or loss will be recognized to, and no amount will be includible in the income of, A upon the receipt of shares of S stock equal in value to the shares of P stock surrendered therefor. However, the fair market value of the S stock in excess of the fair market value of the P stock exchanged therefor and received by A as rent will be includible in A's gross income pursuant to section 61(a)(5).