Rev. Rul. 84-50: Shareholder Tax in Corporate Liquidations

IRS Revenue Ruling 84-50 provides guidance for shareholders receiving property from a corporation undergoing a complete liquidation. This ruling clarifies the tax treatment of such distributions. It establishes how a shareholder must calculate their gain or loss and determines the tax basis of the property they receive.

The Transaction Covered

Revenue Ruling 84-50 addresses a scenario where a corporation distributes property to a shareholder as part of a complete liquidation. A complete liquidation is the process where a corporation ceases its business operations, settles its debts, and distributes its remaining assets to its shareholders. The ruling applies when the distributed property has appreciated, meaning its current fair market value is higher than the value at which the corporation holds it on its books.

The transaction involves the shareholder surrendering their stock in the corporation in exchange for the distributed assets. This exchange is the event that triggers the tax consequences outlined in the ruling. The guidance is designed to ensure that the appreciation in the value of the corporate assets is properly accounted for at the shareholder level when the corporation is dissolved.

Shareholder Tax Consequences

Under Internal Revenue Code Section 331, when a shareholder receives property in a complete corporate liquidation, they must recognize a gain or loss as if they sold their stock. The gain or loss is the fair market value (FMV) of the property received minus the shareholder’s adjusted basis in the surrendered stock. Fair market value is the price the property would sell for on the open market. A shareholder’s adjusted basis is what they originally paid for the stock, plus any capital contributions, and less any returns of capital.

For example, if a shareholder receives property with an FMV of $100,000 and their adjusted basis in the stock was $20,000, they would recognize an $80,000 gain. This gain is considered a capital gain, subject to tax rates based on how long the shareholder held the stock.

Basis of the Received Property

A separate but related consequence of the liquidating distribution is the determination of the shareholder’s tax basis in the newly acquired property. Under the rules associated with Internal Revenue Code Section 334, the shareholder’s basis in the property received is its fair market value at the time of the distribution. This is a departure from many other types of property transfers where the basis might carry over from the previous owner.

If the shareholder later sells the property, this FMV-based figure will be used to calculate their gain or loss on that subsequent sale. For instance, if the property received had an FMV of $100,000 on the distribution date, the shareholder’s new basis is $100,000. If they sell it a year later for $110,000, they will have a taxable gain of $10,000.