No gain on the extension of a prepaid forward contract.

• Author: Borghino, Jeff

Under Regs. Sec. 1.61-6(a), a taxpayer must include in gross income any gain realized on the sale or exchange of property, unless it is excluded by another provision. The specific rules for determining the amount of gain from a sale or exchange of property are contained in Sec. 1001; however, special Code provisions provide for sale or exchange treatment when Sec. 1001 does not apply (e.g., Sec. 1259). In a recent case, Estate of McKelvey, 148 T.C. No. 13 (2017), the Tax Court determined whether Sec. 1001 and Sec. 1259 applied. This item summarizes the current law and discusses the facts and analysis in McKelvey.

The facts

Andrew McKelvey was the founder and former CEO of Monster Worldwide Inc., known for its job-search website, Monster.com. As the founder of Monster, he held some Monster stock with a zero basis.

On Sept. 11, 2007, McKelvey entered into a variable prepaid forward contract with Bank of America (BofA) relating to 1,765,188 of his Monster shares. On that date, Monster stock closed at S32.91. Under the contract, McKelvey received $50,943,578 (i.e., approximately 88% of the value, based on the closing price, or $28.86 per share) upfront from BofA in exchange for agreeing to deliver a contingent amount of the underlying shares to BofA over the course of 10 settlement dates in September 2008.

The settlement dates were each allocated an average of 176,519 underlying shares. The number of underlying shares that McKelvey would be required to deliver on each settlement date was contingent on the closing price of Monster stock on that date. The terms of the contract specified that on each settlement date, McKelvey would be required to deliver:

1. If the price of Monster stock closed on that date at $30,461 (the floor) or less, all of the allocated underlying shares;

2. If the closing price of Monster stock on the settlement date was greater than the floor but less than or equal to $40.58 (the cap), a number of shares equal to the product of (a) 176,519 (or, on two settlement dates, 176,518) and (b) a fraction with a numerator of $30,461 and the denominator of the closing price on the settlement date; and

3. If the price of Monster stock closed higher than the cap, a number of shares equal to the product of (a) 176,519 (or 176,518) and (b) a fraction with a numerator of the floor price plus the closing price on the settlement date, minus the cap price, and a denominator of the closing price.

   McKelvey could elect to deliver instead of the required shares an equivalent amount of cash. He also pledged 1,765,188 Monster shares to BofA to secure his obligations, but he could substitute other collateral with BofA's approval.

   On July 24, 2008, less than two months before the settlement dates commenced, McKelvey paid BofA $3,477,950 to extend the settlement dates until February 2010 (i.e., approximately 17 months), with all other...