Rev. Rul. 66-280

Advice has been requested concerning the proper treatment for Federal income tax purposes of payments received by A , an individual, on a mortgage note distributed to him in complete liquidation of X , his wholly owned corporation, where the obligor on the note is Y corporation. The note calls for payment in pro rata installments and is a capital asset in A's hands.

The 4-percent second mortgage note of 30 x dollars face value was distributed to A in a complete liquidation of X corporation under section 331 of the Internal Revenue Code of 1954. The note had been given to X corporation by Y corporation in part payment for assets it had purchased from X corporation. The fair market value of the assets conveyed to Y corporation. was equal to the cash and face value of the second mortgage note received by X corporation. The fair market value of the second mortgage note on the day it was distributed to A on complete liquidation of X corporation was 25 x dollars. Under section 334(a) of the Code, the basis of the note in A's hands would be 25 x dollars, its fair market value at the time of distribution.

The payment of interest to A on the note is includible under section 61(a) of the Code. There will also be gain realized on the principal element of each installment equal to a percentage, determined by the number of installments, of the difference between the fair market value of the note when received by A and its face value. The note here calls for payment in ten installments. The gain on each installment can be derived by substitution in the following formula:

Gain (0.5 x ) = Amount received applied to principal (3 x ) x Face value of note (30 x )-Fair market value of note at time of distribution to A (25 x )/Face at time of distribution to A (25 x )/ value of note (30 x )

The character of the gain A receives on the pro rata installment payments on the note, an evidence of indebtedness of a corporation, is determined under section 1232 of the Code. Section 1232(a)(1) of the Code provides that amounts received by the holder of an evidence of indebtedness, which is capital asset in the hands of the holder and which is issued by any corporation, on retirement thereof, shall be considered as amounts received in exchange therefor.

Since X corporation in this situation paid the equivalent of the full face value of the note in other property no original issue discount as defined by section 1232(b) of the Code is involved here. Therefore, since the note is a capital asset in A's hands, the gain on the principal element of each installment payment made to A on the note would be considered capital gain subject to the provisions and limitations of subchapter P, chapter 1 of the Code.

Accordingly, when A receives payments on the mortgage note, in addition to the interest income, capital gain will be realized, determined by the above formula, subject to the provisions and limitations of subchapter P, chapter 1 of the Code.

Whether any original issue discount exists in transactions of the type described above depends upon all of the facts and circumstances in each case.