Deferring Gain on Reinvested Stock Sale Proceeds

Question:  I am selling stock of my corporation and reinvesting a portion of the sale proceeds in the purchasing entity. Is there a way to avoid reporting taxable gain on the reinvested proceeds?

Answer:  You must first identify the type of entity which will be acquiring your stock. If the purchasing entity is a corporation, the answer will depend on the amount of the stock of the purchasing entity you and potentially others will receive.

Generally speaking, contributions of cash or other property to a corporation in exchange for stock of the corporation will not constitute a taxable event if the transferors are in control of the corporation immediately following the contribution. For this purpose, control is defined as ownership of 80% or more of both the voting rights and the shares of all classes of the corporation’s stock. By contrast, a contribution of cash or property to a partnership or a limited liability company treated as a partnership will not be a taxable event. Unlike contributions to a corporate entity which require the transferors be in control to avoid gain recognition, contributions to a partnership or a limited liability company treated as a partnership are generally non-taxable events.

The tax deferral can be accomplished by structuring your transaction as a part sale and part contribution. That is, part of your stock can be sold for cash consideration and a part can be contributed to the purchasing entity in return for an ownership interest in such entity. For example, if you intend to have 25% of the consideration attributable to the sale of your stock by receiving an interest in the purchasing entity, you can contribute 25% of your stockhold interest in return for an ownership interest in the purchasing entity and sell the balance of your stock for cash.

From a tax perspective, if the purchasing entity is a corporation, the stock you receive from the purchasing corporation will be taxable if you and others receiving stock in the purchasing entity are not in control of the purchasing corporation. You and the other transferors must own 80% or more of the entity and the shares of all stock classes of the purchasing corporation. As a practical matter, this may be a difficult requirement to satisfy. If alternatively, the purchasing entity is a partnership or a limited liability company treated as a partnership, then the contribution of your stock to the purchasing entity will not be a taxable event, regardless of your percentage ownership of the purchasing entity. In this case, only the portion of the stock you sell for cash to the purchasing entity will be taxable to you.

If you are able to satisfy the requirements for tax deferral, you should be aware that your tax basis in the stock or other ownership interest in the purchasing entity will be the same as your basis in the stock you contribute to the purchasing entity. Upon a sale of your ownership interest in the purchasing entity, the deferred gain will become taxable to you.

For shareholders selling stock and reinvesting sale proceeds in the purchasing entity, paying tax on non-cash consideration is an undesirable circumstance. Careful planning can, in some cases, prevent this tax consequence.

 

The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want to be answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfnr.com.