Debt instruments in reorganizations.

• Author: Laffie, Lesli S.
• Position: From The IRS

According to Rev. Rul. 2004-78, debt instruments issued by an acquirer in a reorganization in exchange for target securities can qualify for tax-free treatment under Sec. 354, in certain circumstances.

The IRS stated in the ruling that, even if the debt instruments are held for less than five years, they can still qualify if they represent a continuation of the security holder's investment in the target in substantially the same form.

Facts: In the ruling, a target issued debt instruments on Jan. 1, 2004, with a stated maturity date of Jan. 1, 2016. On the issue date, the instruments provided for a market rate of interest and were securities under Sec. 354.

The target has one class of common stock outstanding. On Jan. 1, 2014, under state law, the target would merge into the acquirer in an A reorganization. The target's shareholders would exchange their common stock for that of the acquirer.

Also, the target's security holders would exchange their securities for acquirer debt instruments with identical terms, including the maturity date. The only difference would be the interest rate (e.g., to reflect differences in creditworthiness between the target and the acquirer). The modification of the interest rate is a significant modification under Regs. Sec. 1.1001-3.

Holding: Under Sec. 354, no gain or loss is recognized if a...