Recently a client contacted me, alerting me that his closely-held corporation was seeking to sell all of its assets. He was planning to sell the assets of the corporation, close up shop and retire to Hawaii. Hearing his plans reminded me (once again!), as a tax lawyer, that I had made a poor career choice so many years ago. It also reminded me of the last time I was on vacation, also many, many years ago.

My client’s understandable concern was that the corporation would be subject to tax on the gain from the sale of assets. He was aware of recent media attention devoted to abusive tax shelters, and was wondering if any opportunities remained for purchasing tax losses to offset against his anticipated tax liability.

Gimme Shelter

This made me think back on the various prohibitions to trading in net operating losses and other tax benefits. This also made me reflect back on the big waves on the north shore of Maui. In thinking about both topics, I had difficulty focusing on the prohibitions to trafficking in losses, such as Section 269 (disallowing deductions and other tax benefits when tax avoidance is the principal purpose for the acquisition), Section 382 (disallowing loss carry-overs where a corporation's stock changes hands by purchase), and the application of the SRLY rules. See Treas. Reg. Sec. 1.1502-1(f)(1), limiting my client’s ability to possibly reach his tax goal. As a practical matter, one possible method of achieving the tax result my client was hoping might be to approach the issue in reverse fashion, having a loss corporation, or a corporation with high basis assets and low value assets, acquire my client’s company.

Many businesses offer such structures. One such company is Preservation Capital LLC, a firm that specializes in leveraged acquisitions of closely-held corporations following an asset sale as a bridge to the divide between asset and stock sales.  Following an asset sale to an unrelated third party, Preservation Capital will acquire all issued and outstanding stock of the seller corporation. The two transactions are not connected, thus precluding a step transaction analysis. Preservation Capital acquires the stock, the remaining equity, and the accompanying liabilities subject to appropriate due diligence.

Such a structured transaction offered my client the potential for meeting his goals, so he was off to the beach. But this is really only part one. Part two involves the company, which doesn't die.

Following the acquisition, Preservation Capital positions the acquired company into a new line of business providing a long-term economic purpose in profit-seeking ventures, such as real estate, technology start-ups and equity funds. The restructured corporation becomes an investment holding company with a continuing business purpose without dissolving or merging the purchased entity for a long period of time.

Field of Dreams

A likely candidate for this kind of transaction is a family-owned corporation, or a corporation that has realized a significant gain from the divestment of its assets. Occasionally S corporations may qualify. Preservation Capital, like most other companies in this space, specializes in stock acquisitions, though the nature of the asset transaction is open. Corporations from a wide range of industries take advantage of these kinds of opportunities, including real estate, manufacturing/service, technology, media, retail and wholesale, energy and telecommunications.

For example, after a domestic corporation sells its assets with a market value of $10 million (zero tax basis), the corporation would be subject to a liability of $4 million (using a tax effected 40% federal and state tax rate). The selling corporation nets $6 million after tax, which the corporation can dividend to its shareholders. As an alternative, an acquirer like Preservation Capital can acquire the corporation for $8 million, providing a higher return to the shareholders. With the acquisition of the target corporation’s capital stock, Preservation Capital assumes all liabilities of the target corporation.

Orient Express

Although these transactions are designed primarily for meat and potatoes C corporation gain, there's a foreign application too. Foreign owners in U.S. real property often create U.S. corporations to hold their U.S. real property investments. This may be an office building that has sold and appreciated to the point where the seller has realized a significant gain above its basis. This provides estate planning and wealth transfer opportunities in addition to tax planning in connection with the sale of an asset.

The foreign owner has an incentive to try to purge the corporation of its U.S. Real Property Holding Corporation status. Again, enter an intermediary like Preservation Capital. In a typical transaction, they may be able to introduce a domestically-based purchaser to acquire the U.S. Corporation from the foreign investor after the U.S. Corporation has sold its real property. The object of that second transaction is to obviate the company's U.S. Property Holding Corporation status.

More information about Preservation Capital is available by contacting Thomas Myers (tamyers@prescap.com) or Arlene Chew (arlenechew@prescap.com). More information concerning high and low tides, beach house rentals, discount surf boards and wet suits may be obtained from my client.

The Great Escape Or, Life Is A Beach, by Mark A. Muntean, Vol. 13, No. 9, M&A Tax Report (April 2005), p. 3.