Overlooked RRA provision offers substantial tax deferral opportunity.

• Author: Midler, Robert A.
• Position: Revenue Reconciliation Act of 1993

Some tax practitioners may not be aware that the Revenue Reconciliation Act of 1993 (RRA) added Sec. 1044 to the Code allowing individuals and corporations to defer, within limits, the gain they would otherwise be required to recognize on the sale of publicly traded securities--either stock or debt instruments. Sec. 1044 may have been overlooked because it was originally intended to be part of the empowerment zones portion of the bill. Because many practitioners do not have a client base that would use the incentives for locating within economically disadvantaged areas, they may not have had occasion to review all of its provisions. As enacted, however, Sec. 1044 is included as part of the RRA's investment incentives. On closer inspection, new Sec. 1044 may provide significant tax benefits to a broad cross section of clients.

To obtain the tax deferral benefit of Sec. 1044, the entire proceeds from the sale of publicly traded securities must be invested in an entity known as a specialized small business investment company (SSBIC). SSBICs are special-purpose venture capital firms authorized by the Small Business Administration to invest in small businesses owned by members of minority groups and economically disadvantaged individuals.

The Small Business Administration has announced that 103 SSBICs were in existence as of Oct. 1, 1993.

Qualified investors can elect to roll over, without payment of any current tax, the capital gain from publicly traded securities sold on or after Aug. 10, 1993. A security is considered publicly traded if it is a stock or debt instrument (such as a bond) that trades on an established securities market. The important factor to keep in mind is timing: The rollover of the entire sale proceeds must occur within 60 days from the sale of the securities. Once the 60-day period lapses, so do the tax benefits.

Not all taxpayers may elect to roll over their gain from the sale of publicly traded securities into an SSBIC. The RRA limits this benefit to individuals and C corporations. Other entities (including partnerships, S corporations, trusts and estates) are not eligible.

If the entire proceeds of publicly traded securities are rolled over into an SSBIC, the gain is deferred--not excluded--because the basis in the SSBIC stock or partnership interest must be reduced by the amount of the gain that would otherwise be recognized. Eventually, when an investor sells his interest in the SSBIC, any gain will be recognized and...