ANSWER:

None, as Mr. Kelly owned 80% of the outstanding stock of the corporation immediately after the transfer of his property, and was therefore in control of the corporation.

REFERENCE:

Sec. 202 (c): "For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized. .

"(3) When (a) a person transfers any property, real, personal or mixed, to a corporation, and immediately after the transfer is in control of such corporation, or (b) two or more persons transfer any such property to a corporation, and immediately after the transfer are in control of such corporation, and the amounts of stock, securities, or both, received by such persons are in substantially the same proportion as their interests in the property before such transfer. For the purposes of this paragraph, a person is, or two or more persons are, in control of a corporation when owning at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation."

PROBLEM 29

Illustrating the Basis for Determining Gain or Loss on the Sale of Property Received in Exchange for Other Property in Case No Gain or Loss Was Recognized as a Result of the Exchange

FACTS:

Mr. Hiram H. Corby purchased eight thousand shares of Corby Steel Company Stock on April 1, 1912, for $50 per share. This stock was selling for $60 per share on March 1, 1913, and on June 10, 1921, at $90 per share. In connection with a reorganization of the company, Mr. Corby exchanged his entire holdings in the Corby Steel Company on June 10, 1921, for the same number of shares of the Northwestern Steel Company which shares were selling on the day of the exchange at $110 per share. On October 1, 1922, Mr. Corby sold one thousand

shares of Northwestern Steel Company stock thus received for $105 per share. Mr. Corby files his Federal income tax returns on the calendar-year basis.

QUESTION:

What profit or profits, if any, for tax purposes, did Mr. Corby derive from the above mentioned transactions and for what year or years are they to be reported?

ANSWER:

The exchange by Mr. Corby of his stock in the Corby Steel Company for stock in the Northwestern Steel Company, is one which reflects neither profit nor loss for tax purposes. (See Problem 27.) The stock of the Northwestern Steel Company simply takes the place of the stock of the Corby Steel Company The profit upon the sale of 1000 shares of Northwestern Steel Company stock in 1921, is therefore the same as if the same number of shares of Corby Steel Company stock previously owned by Mr. Corby had been sold. In this event, as the March 1, 1913, value was greater than cost, the profit is the difference between the selling price ($105 per share) and such March 1, 1913, value ($60 per share) or $45,000.

REFERENCES:

Sec. 202 (d) (1): "Where property is exchanged for other property and no gain or loss is recognized under the provisions of subdivision (c), the property received shall, for the purposes of this section, be treated as taking the place of the property exchanged therefor, except as provided in subdivision (e);

For section 202 (c) see Problems 26, 27 and 28, and for section 202 (e) see Problem 32.

PROBLEM 30

Illustrating the Computation of Taxable Gains on Property Compulsorily or Involuntarily Converted into Cash or its

Equivalent

FACTS:

The Pacific Oil Steamship Company, a domestic corporation, in

January, 1921, lost a 10,000-ton tanker by shipwreck. The original cost of the tanker to the Pacific Oil Steamship Company January 1, 1914, was $1,000,000, or $100 per ton. The tanker had depreciated at the rate of 3% per annum. The insurance received on the hull was $2,000,000. The ship was replaced during the year by a 10,000-ton tanker at a cost of $1,500,000, or $150 per ton.

QUESTION:

How should these transactions be reported for income-tax purposes? At what figure should the new vessel be carried on the books of the company to conform to proper income-tax procedure in the event of a subsequent sale?

Gain to be reported as gross income.. $1,210,000

Against this, however, there is to be allowed a deduction, since the Pacific Oil Steamship Company purchased during the current year a 10,000-ton tanker at a cost of $1,500,000, which is 75% of the proceeds of insurance received. Seventy-five per cent of the gain of $1,210,000 above stated, or $907,500, is deductible from gross income.

In other words 75% of the insurance collected is treated as taking the place of a like proportion of the vessel converted, and therefore reflecting no profit. The other 25% of the insurance collected is treated in the same manner as if a like proportion of the property converted had actually been sold for an amount equal to such 25% of the insurance collected, thus reflecting a profit of $302,500. Thus the property acquired

would be carried on the books of the company at a figure equal to 75% of the depreciated cost ($790,000) of the vessel lost or $592,500. The following entries on the books of the company would reflect the proper treatment in accordance with the foregoing:

To reduce the profit resulting from the conversion of the tanker by the amount of the deduction provided for in section 234 (a) (14) of the Revenue Act of 1921 and to adjust the value of the tanker acquired in accordance with the provisions of section 202 (d) (2) of the Revenue Act of 1921.

REFERENCES:

Sec. 202 (d) (2): "Where property is compulsorily or involuntarily converted into cash or its equivalent in the manner described in paragraph 12 of subdivision (a) of section 214 and paragraph (14) of subdivision (a) of section 234, and the taxpayer proceeds in good faith to expend or set aside the proceeds of such conversion in the form and in the manner therein provided, the property acquired shall, for the purpose of this section, be treated as taking the place of a like proportion of the property converted."

Sec. 234 (a) (14): "That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions; . . . (14) If property is compulsorily

or involuntarily converted into cash or its equivalent as a result of (A) its destruction in whole or in part, (B) theft or seizure, or (C) an exercise of the power of requisition or condemnation, or the threat or imminence thereof; and if the taxpayer proceeds forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, to expend the proceeds of such conversion in the acquisition of other property of a character similar or related in service or use to the property so converted, or in the acquisition of 80 per centum or more of the stock or shares of a corporation owning such other property, or in the establishment of a replacement fund, then there shall be allowed as a deduction such portion of the gain derived as the portion of the proceeds so expended bears to the entire proceeds. The provisions of this paragraph prescribing the conditions under which a deduction may be taken in respect of the proceeds or gains derived from the compulsory or involuntary conversion of property into cash or its equivalent, shall apply so far as may be practicable to the exemption or exclusion of such proceeds or gains from gross income under prior income, war-profits and excess-profits tax Acts."

NOTE: The procedure set forth under the Revenue Act of 1921 in paragraph 12 of subdivision (a) of section 214 and paragraph (14) of subdivision (a) of section 234 for the handling of "replacements" of the kind set forth in this problem is quite dissimilar from the practice employed by the Bureau of Internal Revenue under the Revenue Acts of 1917 and 1918. As a matter of fact, neither the Revenue Act of 1917 nor the Revenue Act of 1918 contained any express provisions for the elimination of profit resulting from the compulsory or involuntary conversion of property into cash or its equivalent. The Treasury Department, however, promulgated a rule for the elimination of such profit and the basis therefor was "replacement in kind," for the determination of which see Article 49 of Regulations 45 Revised. Congress, in enacting section 214 (a) (12) and section 234 (a) (14) of the Revenue Act of 1921, evidently intended to depart from the technical requirements of "replacement in kind." It is to be noted that the provisions of said sections 214 (a) (12) and 234 (a) (14) are retroactive to prior income, war-profits and excess-profits tax Acts as far as practicable.