Avoiding ordinary income on the sale or exchange of depreciable property to a corporation.

• Author: Ellentuck, Albert B.

Under Sec. 1239(a), gains recognized on sales or exchanges between related persons are treated as ordinary income if the buyer will be able to depreciate the property. For this purpose, Sec. 1239(b), (c) and (d) define "related persons" as: (1) a person and a corporation or a partnership, if the person owns (directly or indirectly) more than 50% of the stock's value or more than 50% of the partnership's capital or profits interest; (2) two corporations that are members of a controlled group, as defined in Sec. 267(f); (3) a corporation and a partnership, if the same persons own more than 50% of the stock's value and more than 50% of the partnership's capital or profits interest; (4) two S corporations, or an S corporation and a C corporation, if the same persons own more than 50% of the value of each corporation's stock; (5) a taxpayer and a trust in which the taxpayer (or spouse) is a beneficiary (unless it is a remote contingent beneficial interest); (6) an executor of an estate and a beneficiary of the estate, except for sales or exchanges to satisfy, pecuniary (dollar amount) bequests; or (7) an employer, or a person related to the employer, and a welfare benefit fund controlled by the employer or the related person.

The more-than-50% test is based on the value of the stock owned, rather than on voting control. Constructive ownership rules apply, except that an individual will not be deemed to own the stock of his or her partner, under Sec. 1239(c)(2).

Applying the Rules

These rules apply to property that can be depreciated by the buyer, even if the seller could not depreciate the asset; see Rev. Rul. 60-302. The gain will be ordinary income, even if the purchaser chooses not to depreciate the asset or elects to use an alternative method of expensing (e.g., amortization); see Twentieth Century-Fox Film Corp., 45 TC 137 (1965), aff'd, 372 F2d 281 (2d Cir. 1967) and Kegs. Sec. 1.1239-1(a). If a sale or exchange includes depreciable and non-depreciable property, the gain is allocated between the properties; only the gain allocable to the depreciable property results in ordinary income.

The determination that parties are related is made based on the relationship at a certain time, depending on who sells the property. If a corporation is the seller, the parties are deemed related for Sec. 1239 purposes if they are related either immediately before or after the sale. If an individual sells the property, the determination is made immediately...