Background

The distributing corporation (“Distributing”) is a publicly traded domestic corporation and the parent of an affiliated group of corporations that file a consolidated return for US federal income tax purposes. Distributing owns interests in DRE 1, DRE 2, and DRE 3, all of which are entities that are treated as disregarded for US federal income tax purposes. DRE 1 was previously a corporation, but converted to a limited liability company and was deemed to liquidate (“Conversion 1”) prior to the transactions described in the PLR. DRE 1 owns all of the interests in DRE 4, DRE 5, and DRE 6, all of which are entities that are treated as disregarded for US federal income tax purposes. DRE 6 was previously a corporation but converted to a limited liability company and was deemed to liquidate (“Conversion 2”) prior to the transactions described in the PLR. DRE 3 owns all of the interests in DRE 7, DRE 8, DRE 9, and DRE 10, all of which are entities that are treated as disregarded for US federal income tax purposes. DRE 6 owns all of the interests in DRE 11, an entity that is treated as disregarded for US federal income tax purposes. DRE 6 and DRE 11 own all of the interests in DRE 12, an entity that is treated as disregarded for US federal income tax purposes (although DRE 12 has two owners, both of its owners are disregarded subsidiaries of Distributing for US federal income tax purposes, and therefore, Distributing is treated as the sole regarded owner of DRE 12 for US federal income tax purposes).

Distributing, directly and indirectly, conducts Business A, which has had gross receipts and operating expenses representing the active conduct of a trade or business for each of the past five years. DRE 4, DRE 8, DRE 9, and DRE 10 conduct Business B, which has had gross receipts and operating expenses representing the active conduct of a trade or business for each of the past five years. 

Through disregarded entities, DRE 4 indirectly owns a general partner interest and a limited partner interest (representing a percentage ownership greater than 20% but less than 33.3%) in PRS 1, an entity that is treated as a partnership for US federal income tax purposes. DRE 4 also indirectly owns through disregarded entities a general partner interest and a limited partner interest (representing a percentage ownership greater than 20% but less than 33.3%) in PRS 2, an entity that is treated as a partnership for US federal income tax purposes. Through disregarded entities, PRS 1 and PRS 2 indirectly own all of the issued and outstanding stock of corporations that have elected to be taxed as Real Estate Investment Trusts (REITs) for US federal income tax purposes. The REITs, through a series of disregarded entities, indirectly own assets that are used in Business B.

Directly and through disregarded entities, DRE 11 and DRE 12 own a general partner interest (a percentage ownership greater than 20% but less than 33.3%) in PRS 3, an entity that is treated as a partnership for US federal income tax purposes. PRS 3 owns assets that are used in Business B.

For what were represented to be valid business reasons, Distributing plans to engage in a series of transactions to separate Business A from Business B. Distributing formed a new wholly-owned subsidiary (“Controlled”) with two classes of stock (Class A and Class B) that have different voting rights but identical economic rights. Subsequent to Controlled’s formation, Distributing will contribute cash to Controlled, as well as all of its interests in DRE 2, DRE 4, DRE 5, DRE 7, DRE 8, DRE 9, DRE 10, DRE 11, and DRE 12, in exchange for Controlled stock (“Contribution”) (note that from a legal perspective, the interests in some of these DREs will be distributed to Distributing by the intermediate DREs prior to the Contribution). After the Contribution, Distributing will distribute the stock of Controlled to its shareholders (“Distribution”), generally on a pro-rata basis, except that Distributing shareholders may elect to receive Class B stock of Controlled rather than Class A stock, and that cash may be distributed in lieu of fractional shares. After the Distribution, Distributing and Controlled will have separate boards of directors, except for one overlapping board member. Distributing and Controlled will also enter into certain continuing agreements after the Distribution. Distributing is in discussions with an unrelated third party regarding entering into one or more agreements pursuant to which, immediately after the Distribution, the third party would exchange its interests in a disregarded entity in exchange for a percentage of Controlled’s Class A stock.

Distributing made all of the representations that are included in Section 3 of the Appendix to Rev. Proc. 2017-52 (which outlines the pilot program that was introduced for the expanded scope of letter rulings available for questions concerning stock distributions of a controlled corporation under section 355), with the exception of a few instances where alternative representations were provided or instances where representations were not applicable to the Distribution. With respect to DRE 1 and DRE 6, representations were made that the assets of each that Distributing will contribute to Controlled will represent less than 30% of the gross fair market value of the assets of each entity prior to Conversions 1 and 2.

Rulings

With respect to Distributing and Controlled, the IRS ruled that the Contribution and Distribution will together constitute a reorganization within the meaning of section 368(a)(1)(D), that neither Distributing nor Controlled will recognize gain or loss on the Contribution, and that Distributing will not recognize gain or loss on the Distribution. The IRS also ruled that Controlled will take a carryover basis and holding period in each asset received in the Contribution and that the earnings and profits will be allocated between Distributing and Controlled in accordance with section 312(h). Additionally, Distributing’s contribution to Controlled of assets held by DRE 1 and DRE 6 following Conversions 1 and 2 should not preclude either Conversion 1 or 2 from qualifying as a complete liquidation within the meaning of section 332.

The IRS also made certain rulings with respect to the shareholders of Distributing, including that they will not recognize gain or loss upon receipt of Controlled stock and that each shareholder’s holding period in the Controlled stock received will include the holding period of the Distributing stock, provided that such Distributing stock is held as a capital asset on the date of the Distribution. The aggregate basis of the Distributing stock and Controlled stock in the hands of each shareholder immediately after the Distribution will equal the aggregate basis of the Distributing stock held by such shareholder immediately before the Distribution, allocated between the Distributing stock and the Controlled stock in proportion to their respective fair market values immediately following the Distribution. These rulings do not take into account any potential consequences to the shareholders under section 897, which deals with dispositions of investments in United States real property.

The IRS noted that it did not determine whether the Distribution (i) satisfies the business purpose requirement of Treas. Reg. §1.355-2(b); (ii) is used principally as a device for the distribution of the earnings and profits of Distributing, Controlled, or both within the meaning of Treas. Reg. §1.355-2(d); or (iii) is part of a plan or a series of related transactions pursuant to which a 50% or greater interest in Distributing or Controlled will be acquired within the meaning of Treas. Reg. §1.355-7.

Conclusion

The PLR continues the IRS’s series of rulings on the qualification of transactions under section 355, with this particular PLR also considering whether transactions undertaken as part of section 368(a)(1)(D)/section 355 spin-off would prevent a prior transaction from qualifying under section 332. Taxpayers often are concerned whether transactions that take place close in time and are undertaken pursuant to the same plan will be integrated. At least in this fact pattern, the IRS concluded that no integration was required.