Code Section 368(a)(1)(E) generally allows a corporation to rejigger its debt and equity structure and then swap old interests for new interests with its stock and security holders, with no gain or loss to the current owners. A recent Legal Advice by Field Attorneys demonstrates an important limit to such E reorganization nonrecognition treatment.
To qualify for nonrecognition treatment, the old stock and securities that are exchanged for recapitalized stock and securities must have the same value. Kohler, TC Memo 2006-152. In the Legal Advice, the IRS determined that the stock surrendered by the stockholder had little or no value, and that the new stock issued in the reorganization did have value. Thus, nonrecognition treatment did not apply and the stockholder had to recognize gain on the transaction.
Thus, taxpayers need to keep in mind that an E reorganization is not an open door to any type of exchanges of stock and securities arising in a reorganization setting – an equal exchange of value requirement still applies (even though in many cases that is easily satisfied via a pro rata exchange of all existing equity and security interests for the newly issued interests).
Legal Advice Issued by Field Attorneys 20131601F