ships of the corporation type is the same as that for corporations. (See Chapter 1.) The securities in a new corporation or limited partnership, received in exchange, would be regarded as a distribution in kind and no tax would be imposed unless and until the securities were subsequently disposed of by the individual partners.33

83

[Former Procedure] The subject of exchanges and reorganizations under the 1918 law is treated at great length in Income Tax Procedure, 1921, in Chapters 14 and 15.

CHAPTER 18

INCOME FROM GAINS UPON SALE OR EXCHANGE OF PROPERTY-DETERMINING GAIN OR LOSS -BASIS AND COMPUTATION

Chapter 17 discusses the conditions under which a sale or exchange is deemed to be a closed transaction, the results of which must be accounted for in an income tax return. This chapter deals primarily with the basis for determining gain or loss-the "basis" referred to in the following section:

LAW. Section 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204, and the loss shall be the excess of such basis over the amount realized.

REGULATION. In general, the gain from the sale or other disposition of property is the excess of the amount realized therefrom over the cost or other basis provided in section 204 and articles 1591-1603, and the loss is the excess of such cost or other basis over the amount realized. Whether gain or loss from a sale or exchange shall be recognized, and if so, the extent to which it is to be recognized for the purpose of income taxation must be determined under the provisions of section 203 and articles 1571-1580.

The amount realized from the sale or other disposition of property is the sum of any money received plus the fair market value of the property (other than money) received. (Art. 1561.)

General

The problem of establishing a basis.-The establishment of a basis with which realizations are compared in order to determine gains and losses is complicated by the following circumstances which require departures from the simple rule of utilizing cost' as the basis: First, the absence of legal authority to levy a federal tax without apportionment upon income arising before March I, 1913, which makes it necessary to consider values at that date in cases where the property was acquired before that time; second, the desire to follow accepted accounting practice with reference to inventories, which often makes it necessary to recognize market valuations, rather than simple cost, when they are below cost; third, the desire, in the case of property transferred by gift, to tax appreciation accruing prior to the date of the gift, which makes it necessary to trace the value history of the property back of the date when acquired by the taxpayer,' and, fourth, the desire to tax the entire

1 The determination of March 1, 1913, value is treated in Chapter 19, while "capital gains and losses" are discussed in Chapter 21.

2 With adjustments, of course, for improvements or other capital outlay, for depreciation, depletion, etc.

In the case of bequests, devises, and inheritances which also are gifts, the basis is the value at date of acquisition. [See section 204 (a-5).]

appreciation when realization finally takes place in the case of the special exceptions, discussed in the preceding chapter, of exchanges where the property received in exchange is, for one reason or another, not considered sufficiently distinct from the property given in exchange to justify closing the transaction and imposing the tax at the time of exchange.

In this chapter the plan is followed of discussing first the general rule regarding the basis, which specifies cost or March 1, 1913 value, with the necessary adjustments to insure the integrity of the capital and to take account of capital deductions already allowed. In the second part of the chapter the specified exceptions to the general rule, designed to take care of inventoried goods, gifts, transfers in trust, bequests, devises, inheritances and property received in continuing transactions, are discussed in detail.

Changes made by 1926 law.-The "discovery" basis for depletion, formerly allowed to mines, oil and gas wells, is now allowed to mines only. The term "discovery" has been broadened to include minerals within an existing mine. The allowance for oil and gas depletion has been fixed, with certain modifications, at 271⁄2 per centum of the gross income from the property. This is an attempt to eliminate the difficult problem of oil and gas valuation where the basis was cost or value as at a particular date. However, a taxpayer may elect annually whether he wishes to determine depletion by this method or by computing depletion on the basis of cost or March 1, 1913 value. (For discussion see Chapter 38.)

Retroactive character of changes in basis.-The manner in which gains and losses are brought to account for income tax, under which the entire effect is exerted [except in so far as the treatment of net losses (see Chapter 34) and inventories (see Chapter 16) modify this statement] in the year when the transaction is closed, even though the history of the growth or decline in value has extended over a long period of years, results in a special problem of retroactive taxation. Thus a transaction begun in 1914 and closed in 1923 may result in a very different net income from a transaction begun in 1914 and closed in 1926, if a change is made in the law in 1926 with respect to the basis from which gain or loss

[Former Procedure] See Income Tax Procedure, 1921, pages 404 et seq; Income Tax Procedure, 1925, pages 678 et seq; and Income Tax Procedure, 1926, page 795.

is measured. Many reorganizations have, for example, taken place in recent years in order to establish the basis then permitted under the revenue law then in force, only to have that basis radically changed by the subsequent legislation. This raises very nice questions as to the legality and equity of legislation changing the basis, once established and utilized by taxpayers. While these questions remain undetermined, it will be well for taxpayers to remember that Congress at present feels at liberty to make such changes as it desires in the basis, effective with respect to transactions already carried through. In contemplating reorganizations to secure a favorable basis under the present law, the uncertain character of the advantages, subject as they are to modification at any time by Congress, should be constantly borne in mind.

Supreme Court decisions regarding basis for determining gain or loss.-The courts have consistently held, under both the 1909 and 1913 laws, that increases in the value of property, to be subject to the tax, must have occurred during the period when the law was effective. The 1916, 1917, 1918, 1921 and 1924 laws, specifically designate March 1, 1913, as the date from which appreciation, which is taxable when realized, shall be measured. The Supreme Court decisions bearing on the basis from which appreciation must be measured may be summarized as follows:

CASES UNDER THE 1909 LAW.-In Doyle v. Mitchell Brothers Co., 247 U. S. 179 (see also U. S. v. Guggenheim Exploration Co., 238 Fed. 231; and Baldwin Locomotive Works v. McCoach, 221 Fed. 59) where lands had appreciated in value at December 31, 1908, the court held that "when the act took effect, plaintiff's timber lands, with whatever value they then possessed, were a part of its capital Also to the same effect is Hays v. Gauley Mountain Coal Company (247 U. S. 189), decided by the Supreme Court on the same day. (See also U. S. v. C. C. C. & St. L. Ry. Co., 247 U. S. 195.) Revaluations as of January 1, 1909, however, are of interest only when there was a realization of such appreciation prior to February 28, 1913.

assets.

CASES UNDER THE 1913 LAW.-In Lynch v. Turrish (247 U. S. 221), the taxpayer received in cash double the par value of stock

For discussion of Supreme Court decisions affecting taxability of dividends in prior years from appreciation at March 1, 1913, see Chapter 26, and Income Tax Procedure, 1922, page 586, footnote 22.