Rev. Rul. 88-39

1988-1 C.B. 299, 1988-21 I.R.B. 12.

                       Internal Revenue Service

                                 Revenue Ruling

                SALE TO EFFECTUATE POLICIES OF F.C.C.; ELECTIONS

                            Published: May 23, 1988

SECTION 1071. - GAIN FROM SALE OR EXCHANGE TO EFFECTUATE POLICIES OF F.C.C., 26 CFR 1.1071-2: Nature and effect of election

(Also Section 1033; 1.1033(a)-2.)

  Sale to effectuate policies of F.C.C.; elections. A taxpayer who elected on a timely filed return the provisions of section 1033 of the Code pursuant to section 1071(a) and subsequently was unable to acquire qualified replacement property within the time prescribed by section 1033(a) may not then elect on a return for a subsequent year to reduce the basis of other depreciable property pursuant to section 1071(a) and section 1.1071-3 of the regulations.

  A corporation was required by the Federal Communications Commission (FCC) to sell a broadcasting station in 1984. On its 1984 income tax return, the corporation elected under section 1071(a) to treat the sale as an involuntary conversion under section 1033. The corporation was unable to buy replacement property within the two- year period specified by section 1033. In 1986, the corporation sought to elect under section 1071(a) and regulation section 1.1071-3 to reduce the basis of depreciable property that it had owned immediately after the 1984 sale or had acquired in 1984.

  ISSUE. At issue is whether the corporation, which had elected involuntary conversion treatment under section 1071(a), but was unable to acquire replacement property, may subsequently elect to defer recognition of the gain on the broadcasting station's sale by reducing the basis of other property in accordance with section 1071(a).

  HOLDING. The Service has held that the corporation, having made an election to treat a sale as an involuntary conversion under section 1071, may not subsequently elect to reduce the basis of other depreciable property pursuant to section 1071(a) and regulation section 1.1071-3.

  ANALYSIS. The Service acknowledged that an election to reduce basis in property and an election to treat a sale or exchange as an involuntary conversion 'may be exercised independently of each other.' However, citing Cloutier v. United States, 709 F.2d 480 (7th Cir. 1983), and Rev. Rul. 79-277, 1979-2 C.B. 300, the Service concluded that 'in no event [may] the time of the reduction in basis be later than the end of the tax year in which the sale or exchange occurred.' Once either section 1071 election is made, the Service reasoned, it is 'binding as to the particular sale or exchange for the taxable year and all subsequent taxable years.'

                                     ISSUE

  If a taxpayer elected under section 1071(a) of the Internal Revenue Code to treat the sale of a broadcasting station as an involuntary conversion within the meaning of section 1033(a) but was unable to acquire replacement property, may the taxpayer subsequently elect to defer recognition of the gain on such sale by reducing the basis of other depreciable property in accordance with the regulations under section 1071(a)?

                                     FACTS

  The taxpayer, a domestic corporation, was required by the Federal Communications Commission (FCC) to sell a broadcasting station. The taxpayer received a certificate from the FCC stating that the sale was necessary to effectuate a change in policy of the FCC with respect to ownership or control of broadcasting stations.

  The taxpayer sold the station in 1984. When the taxpayer filed its federal income tax return for 1984, it attached a statement, in duplicate, electing under section 1071(a) of the Code to treat the sale as an involuntary conversion under section 1033. The statement was signed in the manner required by section 1.1071-4(a) of the Income Tax Regulations. The taxpayer also attached a copy of the certificate received from the FCC.

  Unable to find qualified replacement property, the taxpayer, in its 1986 return, sought to elect under section 1071(a) of the Code and section 1.1071-3 of the regulations to reduce the basis of depreciable property that it had owned immediately after the 1984 sale or had acquired in the year of sale.

                                LAW AND ANALYSIS

  Section 1071(a) of the Code provides that if the sale or exchange of property (including stock in a corporation) is certified by the FCC to be necessary or appropriate to effectuate a change in a policy of, or the adoption of a new policy by, the FCC with respect to the ownership and control of radio broadcasting stations, such sale or exchange, upon election by the taxpayer, shall be treated as an involuntary conversion within the meaning of section 1033.

  Further, section 1071(a) of the Code and section 1.1071-3(a)(1) of the regulations provide that the part of the gain, if any, on such sale or exchange to which section 1033 is not applied shall nevertheless not be recognized, if the taxpayer so elects, to the extent that that part of the gain is applied to reduce the basis for determining gain or loss on sale or exchange of property of a character subject to the allowance for depreciation under section 167 remaining in the hands of the taxpayer immediately after the sale or exchange, or acquired in the same tax year. Any election made by the taxpayer under section 1071 shall be made by a statement to that effect in the return for the tax year in which the sale or exchange takes place, and such election shall be binding for the tax year and all subsequent tax years.

  Section 1.1071-2(a) of the regulations states:

    (1) A taxpayer entitled to the benefits of section 1071 in respect of a sale or exchange of property may elect -

    (i) To treat such sale or exchange as an involuntary conversion under the provisions of section 1033; or

    (ii) To treat such sale or exchange as an involuntary conversion under the provisions of section 1033, and in addition elect to reduce the basis of property, in accordance with the regulations prescribed in [section] 1.1071-3, by all or part of the gain that would otherwise be recognized under section 1033; or

    (iii) To reduce the basis of property, in accordance with the regulations prescribed in [section] 1.1071-3, by all or part of the gain realized upon the sale or exchange.

  Section 1.1071-2(a)(2) of the regulations states that the effect of section 1.1071-2(a)(1) is, in general, to grant the taxpayer an election to treat the proceeds of the sale or exchange as the proceeds of an involuntary conversion subject to the provisions of section 1033 of the Code, and a further election to reduce the basis of certain property owned by the taxpayer by the amount of the gain realized upon the sale or exchange to the extent of the portion of the proceeds which is not treated as the proceeds of an involuntary conversion.

  Section 1.1071-3(a)(1) of the regulations provides that the election to reduce basis under section 1071 of the Code applies only with respect to the cost or other basis of property that is of a character subject to the allowance for depreciation under section 167, and is either in the hands of the taxpayer at the time of the sale or exchange or acquired by the taxpayer in the same taxable year as the year of the sale or exchange.

  Section 1.1071-4(a) of the regulations provides that an election under section 1071 of the Code to reduce the basis of property and an election under such section to treat the sale or exchange as an involuntary conversion under section 1033 may be exercised independently of each other. An election under section 1071 must be filed with the return for the tax year in which the sale or exchange occurs. Where practicable, the certificate of the FCC should be filed with the election.

  Section 1033(a) of the Code provides that if property is involuntarily converted into money and the taxpayer, during the period specified, purchases other property similar or related in service or use to the property so converted, then at the election of the taxpayer the gain shall be recognized only to the extent that the amount realized upon such conversion exceeds the cost of such other property. As a general rule the converted property must be replaced before the expiration of two years after the cost of the first tax year in which any part of the gain upon the conversion is realized.

  In Cloutier v. United States, 709 F.2d 480 (7th Cir. 1983), the court held that an election pursuant to section 1071 of the Code may not be made on an amended federal income tax return. The Internal Revenue Service agrees with this holding. See Rev. Rul. 79-277, 1979- 2 C.B. 300. However, in dicta, the Cloutier opinion indicates that a taxpayer who makes a valid election under section 1071 to defer the recognition of gain under section 1033 but is unable to find suitable replacement property can change its election and instead defer the recognition of gain by reducing the basis of depreciable property in accordance with section 1.1071-3 of the regulations. 709 F.2d at 484- 85. The Service disagrees with this conclusion. This revenue ruling explains the Service's position that a taxpayer cannot make a subsequent election to reduce basis.

  Section 1071 of the Code provides two methods by which a taxpayer may defer the gain resulting from the sale or exchange of property if such sale or exchange is appropriately certified by the FCC. First, the taxpayer may treat the sale or exchange as an involuntary conversion under section 1033 and determine the amount of gain to be recognized under the provisions of section 1033, as modified by section 1071, together with the regulations prescribed under such sections. Second, the taxpayer may elect to defer the gain by reducing the basis of qualified depreciable property by the amount of such gain. Section 1071(a) and the regulations thereunder provide, however, that such other property must be in the hands of the taxpayer immediately after the sale or exchange, or acquired in the same tax year. In addition, the regulations state that in the case of property in the hands of the taxpayer, the time of reduction of the basis is the date of the sale or exchange; in all other cases the time of reduction of the basis is the date of acquisition. See section 1.1071-3(a)(1). Thus, in no event could the time of the reduction in basis be later than the end of the tax year in which the sale or exchange occurred.

  Section 1071(a) of the Code and the regulations thereunder further provide that an election under that section is binding for the tax year of the sale or exchange and all subsequent tax years. The regulations thereunder state that the alternative elections under section 1071 to reduce the basis of property or to treat the sale or exchange as an involuntary conversion under section 1033 may be exercised independently of each other. Section 1.1071-4(a) of the regulations. The legislative history of section 112(m) of the Internal Revenue Code of 1939 (the predecessor of section 1071) indicates that the alternative elections are 'separate and distinct elections which may be exercised independently of each other. However, either election once made is binding as to the particular sale or exchange for the taxable year and all subsequent taxable years.' H.R. Conf. Rep. No. 1079, 78th Cong., 2d Sess. 50 (1944), 1944 C.B. 1059, 1066.

  The last sentence discussing this issue in the conference committee report is particularly relevant. It states:

    An election to reduce the basis of property remaining in the hands of the taxpayer may not be made with respect to any portion of the proceeds of the sale or exchange used to establish a replacement fund pursuant to an election to have the benefits of section 112(f) [the predecessor of section 1033] even though the entire amount of such fund is not subsequently expended in the acquisition of property similar or related in service or use to the property disposed of.

H.R. Conf. Rep. No. 1079 at 50, 1944 C.B. at 1066.

  Thus, Congress intended that if a taxpayer elected to treat a sale or exchange as an involuntary conversion and it was necessary to establish a replacement fund because the property could not be replaced immediately, then any unexpended portions of the fund could not be subsequently used to reduce the basis of property remaining in the hands of the taxpayer. Section 1033 of the Code no longer requires the use of a replacement fund. This does not, however, diminish the significance of the legislative intent to prohibit the consecutive use of section 1033 and the basis reduction provisions of section 1071 on the same proceeds from a qualifying sale or exchange. Such a conclusion is supported by the regulations, which, as noted above, require that the reduction in basis take place no later than the end of the tax year in which the sale or exchange occurs.

  An example in section 1.1071-2(c) of the regulations illustrates how a taxpayer, with respect to a single transaction, can avail itself of the two elections provided under section 1071 of the Code. In the example, unlike the facts presented by this revenue ruling, the taxpayer acquired qualified replacement property under section 1033 prior to filing its return for the taxable year in which the sale or exchange eligible for FCC certification took place. The example demonstrates how, on the return for the taxable year in which the sale or exchange takes place, the taxpayer may allocate the sale or exchange proceeds between section 1033 replacement property and basis reduction under section 1.1071-3 of the regulations.

  In addition, with respect to a single transaction, a taxpayer may also use a combination of the two elections provided in section 1071 of the Code, even though the taxpayer does not acquire replacement property under section 1033 of the Code prior to filing its return for the tax year in which the sale or exchange took place. On this return, the taxpayer may both elect to reduce the basis of assets by a specified amount of the gain realized on the sale or exchange and also elect to treat the sales proceeds, less the amount of gain so specified, as the proceeds of an involuntary conversion. By acquiring qualifying replacement property within the time period prescribed by section 1033(a)(2), the taxpayer may then avoid recognition of some or all of the part of the gain that was realized on the sale or exchange and that was not applied to reduce basis. No further basis reduction is then available for the amount that was so treated as the proceeds of an involuntary conversion but that was not used to purchase replacement property within the time period prescribed by section 1033(a)(2). See section 1.1033(a)-2(c)(2) for regulations applicable to the remaining portion of the sales proceeds.

  If a taxpayer, however, makes both elections provided for in section 1.1071- 2(a)1(ii) of the regulations, then the elections must be made on its return for the tax year in which the property is sold or exchanged, and the taxpayer must specify in those elections the amount that is subject to each. Even though the taxpayer cannot determine until the end of the 2-year replacement period the amount of gain that section 1033 of the Code requires to be recognized rather than deferred, specification of the amount subject to each of the elections may not be postponed until that time. That is, a taxpayer that makes both elections under section 1071 must make the elections on its return for the tax year of the sale or exchange, must identify in that return the amounts subject to each election, and may not defer until the end of the replacement period the specification of those amounts. A taxpayer attempting to defer that specification would be attempting to elect, with respect to the same proceeds, both involuntary conversion treatment and basis reduction. This would be contrary to the congressional intent that these are separate and independent elections.

                                    HOLDING

  If a taxpayer elected on a timely filed return the provisions of section 1033 of the Code pursuant to section 1071(a) and subsequently was unable to acquire qualified replacement property within the time prescribed by section 1033(a), the taxpayer may not then elect on a return for a subsequent year to reduce the basis of other depreciable property pursuant to section 1071(a) and section 1.1071-3 of the regulations. In addition, under Cloutier and Rev. Rul. 79-277, such an election to reduce basis cannot be made on an amended return for the tax year in which the sale or exchange took place.

                              DRAFTING INFORMATION

  The principal author of this revenue ruling is Robert N. Deitz of the Corporation Tax Division. For further information regarding this revenue ruling, contact Mr. Deitz on (202) 377-9589 (not a toll- free call).

Rev. Rul. 88-39, 1988-1 C.B. 299, 1988-21 I.R.B. 12.