Do you plan to realize a capital loss on liquidation? Better hurry because change is in the air – Capital Gains Tax


Incurring economic losses is rarely a good thing. On the other hand, harvesting a capital loss in the same tax period that an unrelated capital gain is recognized has its advantages – the loss can be used as a deduction to reduce the tax liability arising from the gain. in capital.1 While this statement is generally true for all types of losses, this article will focus on capital losses incurred by a corporation from the sale of shares of a subsidiary.

In general, a company can deduct losses incurred on the sale or exchange of fixed assets.2 These capital losses can only be used as a reduction of capital gains such as those recognized on the disposal of shares of subsidiaries.3 Therefore, a company that incurs an accounting loss due to a decline in the value of the shares of a subsidiary may recognize the loss by selling the shares of the subsidiary. Where the sale of the subsidiary is not possible due to the absence of a buyer, the shareholder may realize the loss following the complete liquidation of the subsidiary where the tax consequences of the liquidation are governed by the Code § 331.

Unfortunately, not all liquidations have their tax consequences governed by Code §331. Where 80% or more of the shares of the company in liquidation are held by a single shareholder company, the tax consequences of a full liquidation are governed by Code §332. Under Code §332, no gain or loss is recognized on the full liquidation of the subsidiary. However, corporate shareholders took the position that some steps could be taken to intentionally shut down Code §332 and bring Code §331 back into play.

Over the years, courts have allowed intentional circumvention of Code §332, rejecting IRS counterarguments. However, proposed legislation at the end of 2021 suggests that Congress may now seek to end this planning opportunity in order to increase revenue.


Code §331 Liquidation or Code §332 Liquidation?

From a corporate law perspective, a complete liquidation of a company generally involves the liquidation of the activities of the company in liquidation, the payment of creditors and the distribution of remaining assets to shareholders. From a tax perspective, however, the final step in a full liquidation – the distribution of remaining assets – is not treated as an ordinary dividend distribution. Instead, Code §331 generally provides that amounts received by a shareholder as part of a distribution that is part of a full liquidation of a corporation are treated as full payment in exchange for giving up shares. In other words, Code §331 creates a fiction, under which liquidation is treated as the transfer of the shares of the liquidating company by its shareholders to the liquidating company in exchange for the assets of the liquidating company. An exchange of property (including stock) generally results in the recognition of a gain or loss under Code §1001(c). Therefore, under Code §§331 and 1001, the deemed exchange of shares of the company in liquidation triggers the recognition of a gain or loss.4

Unlike Code §331, Code §332 provides that no gain or loss is recognized by a company that is a shareholder upon the full liquidation of a subsidiary, provided certain conditions are met.5 While this is a desirable outcome when there is an embedded gain in the actions, the non-recognition treatment produces an unfavorable outcome when there is an embedded loss in the actions. If no loss is recognized for tax purposes, no loss can be used to offset taxable capital gains.

The §332 code is not written as an optional provision. Therefore, a simple reading of the section would suggest that a taxpayer does not have the right to choose whether the section applies. However, Code §332 only applies to a liquidation if several conditions are met. If any of the conditions are not met, Code §331 governs the tax treatment of the liquidation.

The first condition requires that 80% or more of the voting rights and the value of all the shares of the company in liquidation be held by the parent company receiving the property. In addition, the required level of ownership must exist at all times, from the date of adoption of the liquidation plan until receipt of all assets.6 This 80% ownership requirement is actually the differentiating factor between Code §332 and Code §331, since all other conditions that apply to Code §332 also apply to Code §

Since the 80% ownership requirement can be controlled by a shareholder, a single parent company can prevent the application of the Code §332 by disposing of sufficient shares of the subsidiary in liquidation before the adoption of the liquidation plan . When there are at least two shareholders and the parent company owns less than 80% of the company in liquidation, both shareholders can adopt a liquidation plan. This liquidation would be outside the scope of Code §332 and instead trigger the recognition of losses under Code §331.8

The Granite Trust case

In Granite Trust Co. v. United States, 9 the IRS failed to challenge the effect of an assignment of shares of a wholly-owned subsidiary immediately prior to the adoption of a plan of liquidation.

The taxpayer owned 100% of a subsidiary. Over the course of several years, the value of the subsidiary’s shares fell significantly. Wishing to ensure recognition of the loss upon a purported liquidation of the subsidiary and to avoid non-recognition treatment, the taxpayer sold or otherwise transferred enough shares to reduce his ownership interest in the subsidiary to less than 80%. The transferee was a friendly party to the taxpayer and was well aware of the situation of the subsidiary and of the taxpayer’s intention to have the subsidiary liquidated. It is fair to say that the transferee acted as an accommodating party to the taxpayer, allowing the taxpayer to recognize a capital loss.

The IRS challenged the application of Code’s predecessor §331. She argued that the sale of shares should be ignored in light of the doctrine of step transactions. Under this doctrine, a series of transactions can be reduced to mere steps of a single integrated transaction for income tax purposes because each individual step is meaningless or unnecessary. to achieve the end result.ten Here, the IRS argued that the end result was the complete liquidation of a wholly owned subsidiary of the taxpayer. The sale of shares that preceded the adoption of the liquidation plan had no other purpose than to move the applicable tax law provision from the predecessor of Code §332 to the predecessor of Code §331. Therefore, it should be ignored. Additionally, the IRS argued that the sale should be ignored because it was transitory and meaningless, within the meaning of Gregory v. Helvering. 11


1. Subject to certain conditions being met. See Code §1211 and the regulations promulgated thereunder.

2. Code §1211(a).

3. Code §1221 allows the loss to offset the gain, provided the stock is not held by the taxpayer primarily for sale in the ordinary course of trade or business.

4. Note that a gain or loss may be recognized by the shareholder on the deemed sale of the shares of the subsidiary and possibly by the subsidiary in liquidation on the deemed sale of its assets to the shareholder.

5.See Code §332(b) and the regulations promulgated thereunder for the terms of Code §332(a).

6. Code §§332(b)(1) and 1504(a)(2)

7. The other conditions of application of the §332 Code are beyond the scope of this article.

8. Provided the underlying conditions of Code §331 are met.

9.238 F.2d 670 (1956).

10. See, for example, King Enterprises, Inc. v. U.S., 418 F.2d 511, 516 (Cl. Ct. 1969)

11. 293 US 465 (1935).

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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