REVENUE RULE 90-7

1990-1 C.B. 153, 1990-5 I.R.B. 10.

Internal Revenue Service
Revenue Ruling

EXCHANGE OF INVESTMENT TRUST CERTIFICATES FOR TRUST ASSETS: GAIN OR LOSS RECOGNITION

Published: January 29, 1990

Section 1001. - Determination of Amount of and Recognition of Gain or Loss, 26 CFR 1.1001-1: Computation of gain or loss.
Exchange of investment trust certificates for trust assets: gain or loss recognition. A certificate holder in an investment trust that has a single class of ownership interests and a fixed portfolio of stocks does not recognize gain or loss when the certificates are exchanged for a proportionate share of each of the trust's assets. Rev. Rul. 68-633 revoked

ISSUE

If a taxpayer holds certificates in an investment arrangement classified as a trust for federal tax purposes under section 301.7701-4(c) of the Procedure and Administration Regulations, does the taxpayer realize gain or loss upon exchanging the certificates for a proportionate share of each of the trust's assets?

FACTS

TR is an arrangement created under a trust instrument and classified as a trust under section 301.7701-4(c) of the Procedure and Administration Regulations. TR holds a fixed portfolio consisting of common stock in 15 different corporations. Interests in TR are represented by certificates.

Under the terms of the trust instrument, the trustee collects dividends paid on the common stock being held by TR and distributes the entire amount (less an amount deposited in a reserve for administrative expenses) to the various certificate holders. Certificate holders have an undivided interest in the trust assets and share equally in any income or loss realized with respect to such assets. Certificate holders also have the right to exchange their certificates for proportionate amounts of the stocks held by TR.

In 1982, A, an individual, paid 200x dollars to TR in exchange for 100 certificates issued by TR. A exercised the exchange right in 1987, when the value of A's share of TR's assets was 300x dollars. In return for surrendering all 100 trust certificates, A received a proportionate amount of the stock held by TR in each of the 15 corporations, 1x dollars of cash as A's proportionate share of the reserve for administrative expenses, and 4x dollars of cash in lieu of fractional shares of stock. The 4x dollars of cash that A received in lieu of fractional shares was funded from the other certificate holders' shares of the reserve for administrative expenses. The total value of the stock and cash A received was 300x dollars.

LAW AND ANALYSIS

Section 1001(a) of the Internal Revenue Code provides that the gain from the sale or other disposition of property shall be the excess of the amount realized over the adjusted basis provided in section 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in section 1011 for determining loss over the amount realized.

Section 1001(b) of the Code provides that the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.

Section 1001(c) of the Code provides that, except as otherwise provided in subtitle A, the entire amount of the gain or loss, determined under section 1001(a), on the sale or exchange of property shall be recognized.

Section 1.1001-1(a) of the Income tax Regulations provides that gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or extent, is treated as income or as loss sustained.

Rev. Rul. 56-437, 1956-2 C.B. 507, concludes that there is no sale or exchange when a joint tenancy in the stock of a corporation is severed in a partition action. A division of stock among parties having undivided ownership interests in the stock is a nontaxable transaction for federal income tax purposes.

Sections 673 through 679 of the Code set forth the rules for determining when a grantor or other taxpayer is treated as the owner of an entire trust, section 671 and the regulations thereunder require the grantor to take into account in computing the grantor's tax liability, all of the trust's items of income, deduction, and credit as though the trust had not been in existence during the period the grantor is treated as the owner. Section 1.671-3(a)(1) of the regulations.

Rev. Rul. 84-10, 1984-1 C.B. 155, considers mortgage pools created by the Federal National Mortgage Association (FNMA) pursuant to a trust agreement. Each pool consists of residential mortgages transferred to FNMA by a single mortgage lender in exchange for trust certificates. The trust certificates represent fractional undivided interests in the mortgage loans, pool proceeds, mortgaged property acquired by foreclosure that has not been withdrawn from the pool, and FNMA's obligation to supplement the pool proceeds in certain events. Rev. Rul. 84-10 concludes that each pool is classified as a trust and that each certificate holder is treated as the owner of an undivided interest in the entire trust under section 671 of the Code.

When a grantor is treated as the owner of an entire trust, the grantor is considered to be the owner of the trust assets for federal income tax purposes. Rev. Rul. 85-13, 1985-1 C.B. 184.

Under the terms of TR's trust instrument, A's certificates represented an undivided interest in TR's assets and any income or loss realized on them. Therefore, like a certificate holder in the mortgage pool described in Rev. Rul. 84-10, A was an owner of an undivided interest in all of TR under section 671 of the Code. As an owner of an undivided interest in all of TR under section 671, A was considered an owner of an undivided interest in all of TR's assets for federal income tax purposes. Rev. Rul. 85-13. Thus, when A exchanged the certificates, A went from being a co-owner of all TR's stock to being sole owner of a proportionate share of that stock. A realized no gain or loss because like a partition of stock among co- owners, the exchange effected no material difference in A's position. Rev. Rul. 56-437.

A also received 4x dollars of cash in lieu of fractional shares of the stock held by TR. A realized and must recognize gain or loss measured by the difference between the amount of cash received and the adjusted basis in the fractional shares as determined under section 1011 of the Code. A recognized no gain or loss on the receipt of A's 1x dollar share of the reserve for administrative expenses.

Rev. Rul. 68-633, 1968-2 C.B. 329, considers the conversion of shares in an investment trust into the underlying stock held by the trust. That transaction does not materially differ from the one between A and TR. Rev. Rul. 68-633 concludes that the transaction results in the recognition of gain or loss. Rev. Rul. 68-633 is inconsistent with the position of the Internal Revenue Service that the holder of the undivided interest in the investment trust owns an undivided interest in the trust assets for federal income tax purposes so that after the exchange the holder is in essentially the same position as before the exchange. Accordingly, Rev. Rul. 68-633 is revoked.

HOLDING

A does not realize gain or loss upon exchanging certificates in TR for a proportionate share of the stock held by TR. However gain or loss is realized and recognized to the extent cash received in lieu of fractional shares exceeds (or falls short of) A's adjusted basis in the fractional shares.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 68-633 is revoked.

PROSPECTIVE APPLICATION

Pursuant to the authority granted by section 7805(b) of the Code, the holding of this ruling will not be applied adversely to a taxpayer if the exchange of trust certificates for trust assets occurred before January 29, 1990. Any gain or loss reported pursuant to Rev. Rul. 68-633 must be reflected in corresponding adjustments to the basis of the trust assets received, pursuant to section 1.1016-6 of the Income Tax Regulations.

DRAFTING INFORMATION

The principal author of this revenue ruling is Marshall D. Feiring, formerly of the Office of distant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact David Edquist on (202) 343-8459 (not a toll-free call).

Rev. Rul. 90-7, 1990-1 C.B. 153, 1990-5 I.R.B. 10.