Using an installment sale to defer shareholder gain on a liquidation.

• Author: Ellentuck, Albert B.

Facts: Smith Partnership owns 100% of Sheepcorp. The partnership's basis in the corporation is $100,000. George Smith owns a 60% general partnership interest in Smith Partnership; his nephew, Stanley Smith, owns a 40% limited partnership interest. Sheepcorp has been winding down its operations for several years; its only remaining assets are the small building in which its offices are located and the land that surrounds it. Sheepcorp purchased the land and building several years ago for $520,000. The corporation's basis in the property is $495,750; its current fair market value (FMV) is $500,750. Depreciation on the building was computed using the straight-line method; therefore, no portion of any gain on the disposition of the property would be treated as ordinary income. There is no mortgage on the building. George and Stanley disagree over what the corporation should do with the remaining property. Stanley feels it will begin to increase in value soon. However, George feels the value of the property will either remain constant or decline slightly. Because of their disagreement and because Sheepcorp is no longer actively engaged in a business, George and Stanley have decided to liquidate the corporation. Stanley would like to purchase the property, but does not have sufficient cash at this time. He has offered to purchase the property for $500,750 ($150,750 in cash plus a note for $350,000). George is willing to allow the corporation to sell the property to Stanley only if the tax consequences of such a sale would not be any more severe than a sale to an outside party. Issue: How can the transaction be structured to allow Stanley to purchase the land without any adverse tax consequences?

Analysis

The tax adviser could recommend that the corporation be liquidated. As part of the plan of liquidation, the land could be sold to Stanley in an installment sale. A corporation must recognize in the year of liquidation all gain on installment obligations, including obligations arising from sales during the liquidation period. However, in this instance, the amount of gain the corporation will have to recognize is only $5,000 ($500,750 - $495,750), with a resulting tax liability of $750 (15% rate). Therefore, the corporation's net proceeds from the sale will be $500,000 ($150,750 cash-$750 tax + $350,000 installment note).

Shareholders who acquire a corporation's preliquidation installment obligations (those acquired by the corporation prior to the...