P, T, and X are domestic corporations, and both T and X operate a trade or business. Individuals A and K, who are unrelated to P, own 85% and 15% of T, respectively, while P owns all of the stock of X. T’s aggregate adjusted basis in its property exceeds the sum of its liabilities plus the liabilities to which its property is subject.
P purchases all of A’s T stock for cash in a qualified stock purchase and does not make a section 338(g) election with respect to that acquisition. Shortly after the acquisition date, and as part of the same plan, T merges under applicable state law into X in a transaction that — but for the continuity-of-interest requirement — would satisfy section 368(a)(1)(A). In the merger all of T’s assets are transferred to X, and P and K receive X stock in exchange for their T stock. P intends to retain the X stock indefinitely.
Under Treas. Reg. § 1.338-3(d), P’s recently purchased T stock is treated as transferred to X in connection with the merger. Because that deemed transfer is respected, P is treated as making a qualified stock purchase of T and the merger is not recharacterized in a way that defeats P’s cost basis in the T assets that come to rest in X. At the ending point, P owns more than 85% of X (its original 100% plus the X stock received for its purchased T stock) and K owns less than 15% of X, with X holding all of T’s assets and liabilities.
P’s cash purchase of A’s 85% block is a qualified stock purchase of T; the state-law merger of T into X happens shortly afterward as part of the same overall plan.
P deliberately does not elect under section 338(g), so there is no deemed asset sale by T on the acquisition date and T’s historic asset basis is preserved into the merger.
The regulation treats P’s recently purchased T stock as transferred to X in the merger, so P is still treated as having made a QSP of T rather than a disqualified acquisition.
After the merger P owns more than 85% of X and K owns less than 15%, and X holds all of T’s assets and liabilities as the surviving corporation.
