Rev. Rul. 83-65
1983-1 C.B. 10.
Internal Revenue Service
Revenue Ruling
INVESTMENT CREDIT RECAPTURE; TRANSFER OF ASSETS TO NEW CORPORATION
Published: April 18, 1983
SECTION 47. - -CERTAIN DISPOSITIONS, ETC., OF SECTION 38 PROPERTY, 26 CFR 1.47-3: Exceptions to the application of s1.47-1
Investment credit recapture; transfer of assets to new corporation. The Service will no longer apply Rev. Rul. 76-514 in view of the decision in Loewen v. Commissioner. Rev. Rul. 76-514 revoked.
ISSUE
Will the Internal Revenue Service continue to apply Rev. Rul. 76-514, 1976-2 C.B. 11, in view of the decision of the Tax Court in Loewen v. Commissioner, 76 T.C. 90 (1981), page 5, this Bulletin?
FACTS
Rev. Rul. 76-514 deals with investment tax credit ("ITC") recapture. In Rev. Rul. 76-514 a taxpayer incorporated a sole proprietorship dental practice. The taxpayer exchanged the dental and office equipment for stock in the corporation. The taxpayer leased the building that housed the practice to the corporation on an annual basis. Certain items of the dental and office equipment that had qualified for the ITC were transferred prior to the close of the useful life given the assets in computing the ITC under section 38 of the Internal Revenue Code. Following the transfer, the taxpayer was in control of the corporation and retained and used the transferred property in the incorporated dental practice. The revenue ruling concludes that since the value of the building was 30 percent of the total value of all the assets used in the business, substantially all the assets necessary to operate the business had not been transferred to the corporation as required by section 1.47- 3(f)(1)(ii)(c) of the Income Tax Regulations. Consequently, the transaction was not a mere change in the form of conducting the trade or business under section 47(b) and was subject to the ITC recapture rules.
In Loewen the taxpayers incorporated their unincorporated farming and cattle- feeding business. The taxpayers exchanged all their grain inventories, cattle, movable machinery, and equipment for all the stock issued by the corporation. These assets had an aggregate fair market value of approximately $1,200,000. The taxpayers also assigned to the corporation year-to-year oral leases to lands that were owned by others but were used by the taxpayers in their business. The taxpayers did not transfer to the corporation real property that they owned in fee simple and used in the business. Instead of transferring the title to the real property, the taxpayers orally leased it to the corporation under a year-to-year lease. This property consisted of farmland, numerous fixtures necessary to the business, and a house in which the taxpayers resided. The real property had a fair market value of approximately $1,000,000. Some of the items of machinery and equipment that had qualified for the ITC were transferred to the corporation prior to the close of the useful life used for computing the ITC. Following the transfer, the corporation continued to operate the same farming and cattle-feeding business that the taxpayers formerly had operated as individuals. The Commissioner of Internal Revenue argued that substantially all the assets necessary to operate the business had not been transferred to the corporation because the taxpayers had not transferred title to the real property on which the farm was located. The Tax Court disagreed, and held that the lease of the land to the corporation, along with the transfer of the other assets necessary to operate the farm, was sufficient to satisfy section 1.47-3(f)(1)(ii)(c) of the regulations.
LAW AND ANALYSIS
Section 47(a)91) of the Code provides that if during any tax year any property is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the useful life that was taken into account in computing the ITC under section 38, then the tax for the tax year shall be increased by an amount equal to the aggregate decrease in the ITC allowed under section 38 for all prior tax years that would have resulted solely from substituting, in determining qualified investment, for such useful life the actual useful life of the property.
Section 47(b) of the Code provides that property shall not be treated as ceasing to be section 38 property with respect to the taxpayer by reason of a mere change in the form of conducting the trade or business so long as the property is retained in the trade or business as section 38 property and the taxpayer retains a substantial interest in the trade or business.
Section 1.47-3(f)(1)(ii) of the regulations provides the following four mandatory criteria for determining whether, under section 47(b) of the Code, there has been a mere change in the form of conducting the trade or business:
(a) the section 38 property is retained as section 38 property in the same trade or business;
(b) the transferor of the section 38 property retains a substantial interest in the trade or business;
(c) substantially all of the assets (whether or not section 38 property) necessary to operate the trade or business are transferred to the transferee to whom the section 38 property is transferred; and
(d) the basis of the section 38 property in the hands of the transferee is determined in whole or in part by reference to the basis of the section 38 property in the hands of the transferor.
The taxpayers in both Rev. Rul. 76-514 and Loewen satisfied criteria (a), (b), and (d) in section 1.47-3(f)(1)(ii) of the regulations. The issue addressed in both situations was whether substantially all the assets necessary to operate the business had been transferred to the corporation as required by criterion (c).
The legislative history of section 47 of the Code indicates that its purpose is to prevent a quick turnover of assets in an effort by a taxpayer to obtain multiple tax credits. See H.R.Rep. No. 1447, 87th Cong., 2d Sess. 13 (1962), 1962-3 C.B. 405, 417. By recognizing that a mere change in the legal form of conducting a business may give rise to a technical disposition of section 38 property when no actual turnover has occurred, the "mere change in form" exception in section 47(b) is consistent with the purpose of the recapture rules. Section 47(b) sets forth only two requirements in connection with the mere change in form exception: (1) the property must be retained in the same trade or business and continue to qualify as section 38 property; (2) the taxpayer must retain a substantial interest in the trade or business. The "substantially all" requirement of section 1.47-3(f)(1)(ii)(c) of the regulations stems from the legislative history, which provides that the mere change in form exception applies only to cases where the properties of a trade or business are transferred. See H.R.Rep. No. 1447, 87th Cong., 2d Sess. A-15 (1962), 1962-3 C.B. 513. This history indicates that the mere change in form exception is intended to apply only in situations in which the trade or business remains substantially intact after the change in form occurs. The properties, including the section 38 property, must continue to be used not only in the same trade or business, but a trade or business that uses the same general assets. Compare Ramm v. Commissioner, 72 T.C. 671 (1979), in which the court held that the continued use of a subchapter § corporation's section 38 property in a ranching activity following liquidation by the former shareholders of the corporation did not fall within the mere change in form exception because the shareholders operated independently of each other and the assets of the former corporation were no longer collectively employed.
In both Rev. Rul. 76-514 and Loewen the taxpayers continued to own and operate the business and they employed the same assets. Although the corporations leased, rather than owned, major properties of the old businesses, in each case the difference between the old and new business was one of form rather than substance. The taxpayers owned both the leased properties and the corporations, and their incomes depended on the continued use of the leased properties by the corporations. Thus, the financial realities of each case guaranteed that the corporations would continue to have access to the leased property. Under these circumstances, it is now the Service's position that the requirement in section 1.47-3(f)(1)(ii)(c) of the regulations has been satisfied.
HOLDING
The Internal Revenue Service acquiesces in the decision of the Tax Court in Loewen and will no longer apply Rev. Rul. 76-514.
EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 76-514 is revoked.
Rev. Rul. 83-65, 1983-1 C.B. 10.