Replacement Property Disposition after ESOP Sale Results in Recognition of Deferred Gain.

• Author: Fiore, Nicholas J.

Taxpayer T is a shareholder of Company A, a closely held domestic C corporation. A maintains an employee stock ownership plan (ESOP) that satisfies the requirements of Sec. 4975(e)(7). A has one class of common stock that constitutes employer securities under Sec. 409(1). T did not receive the shares in a distribution from a plan described in Sec. 401(a), or a transfer pursuant to an option or other right to acquire stock to which Sec. 83,422 or 423 applied. T sells all of the A shares to the A ESOP and reinvests the sale's proceeds in qualified replacement property (QRP) (as defined in Sec. 1042(c)(4)), within 12 months of the sale date. T makes a timely election under Sec. 1042(a) to defer gain recognized on the sale of qualified securities to the ESOP. Under Sec. 1042(d), the basis of the QRP is reduced to reflect the deferred gain on the sale. After the Sec. 1042 election, T contributes the QRP to a partnership in exchange for a partnership interest.

Analysis

Sec. 1042(a) provides that a taxpayer or executor may sometimes elect not to recognize long-term capital gain on the sale of "qualified securities" to an ESOP (as defined in Sec. 4975(e)(7)) or eligible worker-owned cooperative, if the taxpayer purchases QRP (within the replacement period of Sec. 1042(c)(3)) and satisfies Sec. 1042(b) and Temp. Regs. Sec. 1.10421T.

A qualified securities sale meets Sec. 1042(b) requirements if: (1) the qualified securities are sold to an ESOP (as defined in Sec. 4975(e)(7)) or an eligible worker-owned cooperative; (2) the plan or cooperative owns (after application of Sec. 318(a)(4)), immediately after the sale, at least 30% of (a) each class of outstanding stock of the corporation (other than stock described in Sec. 1504(a)(4)) that issued the securities or (b) the total value of all the corporation's outstanding stock (other than stock described in Sec. 1504(a)(4)); (3) the taxpayer files with the Secretary a verified written statement of the employer whose employees are covered by the ESOP or an authorized officer of the cooperative, consenting to the application of Sets. 4978 and 4979A for such employer or cooperative; and (4) the taxpayer's holding period for the qualified securities is at least three years (determined as of the time of the sale).

Sec. 1042(c)(1) provides that qualified securities are employer securities (as defined in Sec. 409(1)), issued by a domestic C corporation with no stock outstanding that is readily tradable on an...