Rev. Rul. 77-190

Advice has been requested whether, under the circumstances described below, a liquidating corporation's sale of mortgage servicing rights qualifies for nonrecognition treatment under section 337 of the Internal Revenue Code of 1954.

X, a corporation engaged in the mortgage banking business that was not a collapsible corporation as defined in section 341(b) of the Code, sold all of its assets to Y, a commercial banking corporation, for 400x dollars and distributed the entire proceeds to its shareholders in complete liquidation pursuant to the terms of section 337. In connection with and as part of the sale, Y paid X 47x dollars for the rights of X to service real estate mortgage contracts. At the time these contracts were sold, no services had been performed by X and thus no income had been earned by X with respect to these contracts.

Section 337(a) of the Code provides, in general, that if a corporation adopts a plan of complete liquidation and, within a 12-month period beginning on the date of the adoption of the plan, all of the assets of the corporation are distributed in complete liquidation, less those retained to meet claims, then no gain or loss will be recognized to such corporation from the sale or exchange by it of property within such 12-month period.

Section 337(b) of the Code provides that with certain exceptions the term property for purposes of section 337(a) does not include inventory property, property held for sale to customers in the ordinary course of a corporation's trade or business, or installment obligations.

Section 1.337-3 of the Income Tax Regulations also defines the term property as used in section 337(a) of the Code by stating what the term property does not include. However, section 1.337-3 states, in part, that with the exceptions listed therein, the term propery includes all assets owned by a corporation. None of the exceptions listed are relevant to the facts under consideration herein.

At issue here, as in the case of John T. Stewart III Trust, 63 T.C. 682 (1975), acq., page 1 of this Bulletin, is whether the sale of the rights to service real estate mortgage contracts by X constituted a sale of property within the meaning of section 337(b) of the Code, thereby qualifying the gain realied for nonrecognition treatment under section 337(a).

The Commissioner argued in Stewart that these rights did not constitute property for purposes of section 337 of the Code on the theory that section 337 was not intended to result in nonrecognition on all sales and exchanges of property, specifically those sales or exchanges that would result in the conversion of ordinary income into capital gain. Alternatively, it was argued by the Service that even if there had been a sale of property within the meaning of section 337, assignment of income principles would require such amounts to be taxable as ordinary income under section 61.

The United States Tax Court in Stewart held that mortgage servicing rights were property under section 337 of the Code. In so holding, the court indicated that only those types of property expressly excluded by section 337(b) would fall outside of the definition of the term property as used in section 337. The court specifically rejected any contention that the term property for purposes of section 337 was synonymous with the term capital asset contained in section 1221.

Based on the Tax Court's rationale in Stewart, the Internal Revenue Service now agrees that the term property as used in section 337 of the Code includes all assets of a corporation except the specific statutory exceptions in section 337(b) which are not relevant in this case. Also, in accord with Stewart, the Service agrees that the term property as used in section 337 is not limited to capital assets as defined in section 1221.

In addition, the Service believes the Tax Court was correct in holding that no assignment of income was involved in Stewart. The transaction involved the sale of what must be regarded as contractual rights to perform services in the future. Because the services under these contracts had not been performed and no income therefrom had been earned prior to the sale of these contractual rights, pursuant to section 337 of the Code, no assignment of income occurred. See Midland-Ross Corporation v. United States, 485 F. 2d 110 (6th Cir. 1973). But see Rev. Rul. 57-482, 1957-2 C.B. 49 (need for reserve for bad debts was eliminated on liquidation), Rev. Rul. 59-120, 1959-1 C.B. 74 (income earned prior to liquidation), and Rev. Rul. 61-214, 1961-2 C.B. 60 (sale of previously deducted items) which illustrate liquidations under section 337 where recognition treatment at the corporate level occurs as a result of application of the assignment of income doctrine or the tax benefit doctrine.

The instant situation is distinguishable from those cases which would have required X to recognize ordinary income rather than capital gain had the sale of the mortgage servicing rights not been part of a liquidation under section 337 of the Code. See, for example, United States v. Eidson, 310 F.2d 111 (5th Cir. 1962). Those cases involved the question of the characterization of gain admittedly recognized by the corporation, whereas the issue in a liquidation sale under section 337 is whether gain that is realized by a liquidating corporation is entitled to nonrecognition treatment by virtue of that section.

Moreover, since the mortgage servicing rights in this case and in Stewart could have been distributed in liquidation without the recognition of income by X, the result reached herein and in Stewart maintains the parity of tax consequences which obtains whether the liquidating corporation sells the assets itself, pursuant to the terms of section 337, or distributes them in kind to the shareholders for sale.

Accordingly, the 47x dollars received by X, in payment for the rights to service real estate mortgage contracts, is subject to the nonrecognition provisions of section 337 of the Code and is not ordinary income to X under section 61.