Partial liquidations takes place when there is a contraction or reduction of a corporation’s business activities. Complete liquidations occur at the end of a corporation’s life cycle. Surprisingly, the IRS Code does not define what complete liquidation is. Instead, Treasury regulations indicate that a complete liquidation exists for tax purposes.

… when the corporation ceases to be a going concern, and its activities are merely for the purpose of winding up its affairs, paying its debts, and distributing any remaining balance to its shareholders.

Treasury Regulations

Notice that the regulations refer to a liquidation for tax purposes. This means that legal dissolution of a corporation under state law is not required for complete liquidation tax treatment. In fact, Revenue Ruling 54-518 notes that a transaction can result in a complete liquidation even if the corporation retains a nominal amount of assets to pay remaining debts and preserve its legal existence.

The corporation can liquidate in several ways:

  • Distribute assets directly to shareholders who may then sell them
  • Sell its assets and then distribute sale proceeds to shareholders in exchange for their stock
  • A parent corporation might liquidate a subsidiary corporation by selling all of its stock

All these transactions raise some interesting tax issues at both the corporate and shareholder levels.

Corporate Complete Liquidation

A complete liquidation occurs when a corporation ceases to be a going concern. This concept differs from a dissolution under state law because the corporation may solely to wind up affairs, pay debts, and distribute any remaining property to its shareholders, and continue operations.

Consider an situation, Person A, as sole shareholder, liquidates his/her Corp B, but continues business operations as a sole proprietorship. What is the “proper” tax treatment?

  1. Non-recognition treatment? Even though §351 provides non-recognition treatment upon corporation formation, treating the transfer of corporate assets back into his own hands as a tax-free event probably is not appropriate.
    • Such treatment would be inconsistent with the double-tax regime at subchapter C because it would create a tax-free bailout of corporate E&P.
    • Many liquidations involve the sale of a business followed by distribution of the cash proceeds to shareholders.
    • Distributions of cash do not lend themselves to non-recognition treatment because it is impossible to assign cash the appropriate carry-over basis that would defer the shareholders gain for recognition at a later time. 
  2. Dividend treatment? According to §301 and §316, this approach focuses on E&P, rather than shareholder’s connection to the capital investment.
    • The liquidation will terminate his ownership ventures, dividend treatment is inconsistent with §302, which treats a distribution and redemption of stock as a sale or exchange if the shareholder terminates or significantly reduces their interest in a corporation.
  3. Redemption treatment (§302)? Treated as a sale or exchange of stock, but ignored E&P.
    • This is not perfect, but we run out of options.

Finally Congress decided to treat complete liquidations as sales and exchanges, an approach that allows shareholders to avoid the double taxation of dividends, why?

  • The potential for double taxation of dividends was preventing the liquidation of many corporations because of the high tax costs and impose and thus was generating only minimal tax revenue.
  • Sale or exchange treatment is consistent with the entire theory of the Code
  • Sale or exchange treatment is the only method which can be easily administered

In summary, a complete liquidation, much like a qualified stock redemption, provides sale or exchange tax treatment to the shareholder. Congress allows:

  • Shareholders to receive capital gains treatment on distributed property
  • Corporations can receive either capital or ordinary tax treatment depending on the type of property distributed

However, the tax effects to the corporation can vary from those of redemption especially in the case of losses.

From a compliance perspective, a corporation must file form 966 to notify the IRS of its intent to completely liquidate. This form is due within 30 days after the shareholders commit to a liquidation.

General Rule

The corporate tax treatment of complete liquidations is governed by Code §336.

Except as otherwise provided in this section or section 337, which considers subsidiaries, more on that later, gain or loss shall be recognized to a liquidating corporation on the distribution of property in complete liquidation, as if such property were sold to the distributee at its fair market value. 


Similar to non-liquidating distributions, if any property distributed in the complete liquidation is subject to a liability or the shareholder assumes a liability of the corporation in connection with the distribution, the fair market value of such property shall be treated as not less than the amount of such liability. In other words, to calculate gain or loss, use the greater of the fair market value or the amount of the liability.

A corporation will certainly incur cost in connection with the liquidation:

Ordinary and necessary business expenses
(such as legal and accounting services for drafting and implementing a liquidation plan,)
Deductible under §162
Selling expenses incurred in connection with the sale of property
(such as brokerage commissions and legal costs of title transfers)
Reduce the amount realized on the disposition

There are four exceptions to the general rule of gain or loss recognition. The first 2 exceptions are so-called anti-stuffing rules and the second 2 exceptions involve the liquidation of a subsidiary.

Anti-Stuffing Rules

Recall in the formation of corporation under §351, both shareholders and corporations receive exchange carryover basis in a transaction. But for any built-in gain or loss in the shareholders transferred property, whose carryover basis is reflected in both the shareholder stock basis but also in the corporation’s basis in the transferred property. It means the same built-in gain or loss can be duplicated among different tax payers.

The Treasury doesn’t mind if a gain is duplicated because it will lead to more tax revenue. However built-in loss property would be used by taxpayers to deduct the same loss twice, leading to less tax revenue for the government. This situation is also relevant in the case of liquidations.

  • Stuffing means shareholders were intentionally stuff a new corporation with loss property in a section 351 transaction.
  • Upon liquidation, these losses could be unstuffed, resulting in a loss recognized by the corporation and shareholder. 

Congress enacted §336(d) to disallow some or even all of the loss realized by a corporation and liquidating distributions of certain property. These Anti-Stuffing Rules were generally effective at limiting loss duplication upon complete liquidation. But soon it is discovered that loss duplication was still possible if the corporations simply sold built-in loss property in the normal course of business such as before a complete liquidation.

Built-in Loss Property in Formation vs Liquidation

In sum, the section §362(e)(2) rules limit the built-in loss transfer during corporate formation. Thereby limiting loss duplication and subsequent asset sales in the normal course of business.

In contrast, the Anti-Stuffing rules in §336(d) limit loss duplication in corporate complete liquidations. They serve as a safety net in limiting loss duplication, because the §362(e)(2) rules often address the issue first, through the stepdown and basis upon initial transfer to the corporation. But this is only true if there was in fact a built-in loss upon initial transfer.

Rule 1: Related-Party Losses

This rule applies even when the section 362(e)(2) rules do not apply, such as when property has a built-in gain upon initial transfer to the corporation.

No loss shall be recognized to a liquidating corporation on the distribution of any property to a related person (within the meaning of Â§267) if such distribution is not pro rata, or such property is disqualified property.


The definition of a Related-Party here is similar to the one used in the §318 Stock Attribution Rules except it includes any stock owned by siblings.

A corporation and shareholder are related if the shareholder owns, directly or indirectly, more than 50% in value of the corporation’s stock. 

A non-pro rata distribution exists when shareholders receive something other than their proportionate share.

Disqualified property is the property:

  1. Acquired by the liquidating corporation in the §351 exchange or contribution of capital
  2. during the five year period (ending on the date of the distribution).

Example: Person A owns 51% of Corp B. With in last five years, Person A contributed property with an adjusted basis of $35,000 and a fair market value of $3,000 to Corp B in an §351 transaction. In the current year, Corp B adopted a plan of complete liquidation and distributed the same property to Person A. At this time, the property had an adjusted basis of $13,000 and a fair market value of $2,500. What are the tax effects of the distribution for Corp B?

At the time of distribution
  Fair market value   $2500
- Adjusted basis     $13000
= Loss               $10500

Recall the General Rule states that gain or loss is recognized under §336, however §336(d)(1) says there is no loss recognized if the distribution is to a related party (defined as a 50% shareholder) unless:

  1. The distribution is pro-rata
  2. The property was not acquired in a section 351 exchange or capital contribution transaction during the last five years.

The property actually was acquired in a §351 transaction within the last five years. As a result, the requirements are not met, and Corp B is not able to recognize a loss in this particular transaction. 

Example: Corp A stock is owned by Person B (80%), and his mother C (20%). In a complete liquidation of the corporation, Corp A distributed land purchased two years ago for $630,000 to C. The property had a fair market value of $210,000 at the time of the distribution. Now, what are the tax effects of the distribution for Corp A?

At the time of distribution
  Fair market value   $210000
- Adjusted basis      $630000
= Realized loss       $420000

Recognized loss       $0

None of the realized loss is recognized. Because C is deemed to own B’s share, thus 100% of Corp A, also distribution is not pro rata.

Example: Corp A stock is held equally by two brothers. Four years ago, the shareholders transfer property with an adjusted basis of $180,000 and a fair market value of $220,000 to Corp A as a contribution to capital. In the current year, pursuant to a liquidation plan, the property is distributed proportionately to the brothers. At the time of the distribution, the property was worth $62,000. What are the tax effects of the distribution for Corp A?

At the time of distribution
  Fair market value    $62000
- Adjusted basis      $180000
= Realized loss       $118000

Recognized loss       $0

None of the realized loss is recognized. Because both brothers own 100 percent of Corp A, directly and indirectly. And the distribution also consists of disqualified property.

Rule 2: Built-in Losses

The second Anti-Stuffing Rule denies loss recognition on sales and liquidating distributions of property that was contributed to the corporation with a built-in loss shortly before liquidation. More specifically, this loss disallowance rule applies if two conditions are met:

  1. First, the built-in loss property was acquired by the corporation in a §351 exchange or contribution of capital transaction.
  2. Second, the property acquisition was part of a plan, where the principal goal was to recognize a loss on the property by the liquidating corporation.

The IRS will assume that tax avoidance was the primary motive if the built-in loss property was transferred within two years of adopting a liquidation plan.

The built-in loss limitation rules of §362(e)(2) already stepped down the basis of built-in lost property transfer to the corporation in an §351 transaction. 

The built-in loss disallowance rule for liquidations §336(d)(2), only applies to the extent a built-in loss was not already eliminated upon initial transfer to the corporation. This can occur:

  • When property had a built-in gain upon initial contribution, or
  • When the corporation and shareholder jointly elect to reduce the shareholder’s basis in the stock instead of the corporation’s basis on the property.

Any loss attributed to normal decline in value after initial transfer to the corporation is not subject to the built-in loss limitations.


Example: Person A and B are related, equal shareholders in Corp C. Last year, they each transferred property to Corp C under §351. Person A transferred:

  • Land with adjusted basis of $500,000 and a fair market value of $300,000
  • Furniture with an adjusted basis of $90,000 and fair market value of $350,000

Person B transferred:

  • Investments with an adjusted basis of $253,000 and fair market value of $510,000

This year, Corp C adopted a liquidation plan, sold its assets, and distributed the proceeds pro rata. The only loss realized was on the land, which had decreased in value to $275,000 when it was sold. The land was never used in the business. What are the tax effects of the land sale?

So this particular problem is focused on the sale of the land. The land was acquired within two years of a plan of liquidation, a tax avoidance purpose is assumed. There was no business purpose for the use of the land either, as it was never used in the actual business.

For the land:

At the time of distribution
  Fair market value   $275000
- Adjusted basis      $500000
= Realized loss       $225000

At the time of contribution
  Fair market value   $300000
- Adjusted basis      $500000
= Realized loss       $200000

Also note that total property transferred did not have a net built-in loss upon initial transfer to the corporation. In fact there was a net built-in gain of $60,000.

Person A
At the time of distribution
  Fair market value   $650000
- Adjusted basis      $590000
= Realized gain       $60000

So the §362(e)(2) basis stepdown rule for loss property and carry over basis situations doesn’t already address the issue. Thus, the built-in loss disallowance rule disallows this $200,000 initial loss.

While the related party Anti-Stuffing Rules are going to prevent the initial $200,000 of loss from being recognized, the additional $225,000 – $200,000 = $25,000 of loss attributed to the sale and thus a normal decline in value is allowed to be recognized.

Example: Last year, Corp A acquired assets from Person B under §351:

  • Land with an adjusted basis of $500,000 and a fair market value $410,000
    • The land was acquired to serve as collateral on a bank loan
  • Furniture with an adjusted basis of $200,000 and a fair market value of $300,000

This year, Corp A adopted a liquidation plan and distributed the land (worth $330,000 at that time) to Person C (a 43% shareholder). What are the tax effects to Corp A on the distribution of the land?

So notice that Corp A actually had a business purpose for acquiring the land that is it was going to serve as collateral on a loan. Also the land was not distributed to related party because Person C owns less than 50%. Thus the Anti-Stuffing Rules do not apply here and the entire loss can be recognized. 

So how much loss is there?

  Fair market value   $330000
- Adjusted basis      $500000
= Realized loss       $170000

Note that, because there was no net built-in loss when the two properties were initially transferred under §351, §362(e)(2) rules don’t apply here, thus they didn’t address the issue. In other words when you add up all the properties fair market value there was actually a net built-in gain not a loss.

  Fair market value   $710000
- Adjusted basis      $700000
= Realized gain        $10000

Shareholder Tax Treatment

The shareholder-level tax treatment of complete liquidations is governed by §331.

Amounts received by a shareholder in a distribution in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock.


In other words, sale or exchange treatment applies, where the gain or loss recognized by the shareholder is determined as the difference between the fair market value of the assets received from the corporation and the adjusted basis of the stock surrendered to the corporation.

Recognized gain/loss = Fair market value of assets - Adjusted basis of the stock

The fair market value of property received that is encumbered by a liability is reduced by the amount of the liability. It is also assumed that the shareholder will pay such liabilities, and thus, shareholder obtains a full fair market value basis in the property under §334(a).

Like always, any gain or loss on the liquidation receives capital character treatment if the stock was a capital asset to the shareholder. However, the timing of gain or loss recognition can be a little complex, because it is common for a corporation to liquidate over multiple tax years. §346(a) defines a complete liquidation to include a series of distributions occurring over time, so long as they are all still pursuant to a liquidation plan, which is quite similar to the Step Transaction doctrine.

How do the corporate-level tax effects affect shareholders? Specifically, insofar as a corporation pays tax on the gain recognized due to a complete liquidation, the net proceeds available for distribution to shareholders is reduced.

Reduction in the amount distributed
⟹ reduce the amount realized by shareholders
⟹ reduce shareholders realized gain

Installment Obligations

Other complexities arise when a liquidating corporation sells assets for installment obligations and then distributes the debt obligations to shareholders in complete liquidation.

In such cases, shareholders are permitted to use the installment method under Â§453 to defer a portion of any gain that is attributable to the installment obligations. 

Essentially, payments received by shareholders are treated as if they were received in exchange for their stock, where their stock basis is required to be allocated between:

  1. The obligations and
  2. The other assets received in the liquidation

To qualify for the installment method, obligations must have been acquired by the corporation in a sale or exchange of property within a 12-month period, beginning on the date a liquidation plan was adopted, and the liquidation must be completed within that 12-month period.

Installment obligations (arising from the sale of inventory or other dealer property) are eligible if the obligation results from a bulk sale, which refers to a sale to one person in one transaction and involves substantially all of the property attributable to a trade or business. 

The installment method is not available if the stock of the liquidating corporation is publicly traded or if the shareholder elects out of the method.


Example: Person A own two lots of Corp B, representing a combined 10% interest.

  • Lot 1: In January of year one, he had bought 300 shares for $20,000.
  • Lot 2: In August of year two, he bought 200 shares for $32,500.

In a complete liquidation, Person A received a $75,000 cash distribution at the end of year two in exchange for all of his shares. Corp B had $620,000 of E&P before the distribution. What are the tax effects of the distribution for Person A?

Person A in effect is receiving $150 per share of stock.

Lot 1:
Received         300 * $150 = $45000
Adjusted basis                $20000
Long term capital gain        $25000

Lot 2:
Received         200 * $150 = $30000
Adjusted basis                $32500
Short term capital loss        $2500

Example: Person A owned 100 shares (with basis $30,000) of stock in Corp B. During the current year, Corp B completely liquidated and distributed the following to Person A:

  • $40,000 cash
  • Land worth $600,000 subject to a $300,000 mortgage
    • Person A will assume the mortgage

What does Person A’s basis in the land received?

Recall that §334 provides that, if property is received in a complete liquidation, and if gain or loss is recognized on the receipt of that property, the basis of the property in the distributee hands will be the fair market value of the property at the time of the distribution.

  Fair market value         $600000
+ Cash                       $40000
- Liability                 $300000
- Adjusted basis             $30000
= Gain                      $310000

So because he recognizes a gain, Â§334 will apply. And his basis in the land will be the fair market value, i.e. $600000.

Parent-Subsidiary Liquidations

When a parent corporation, a type of shareholder, liquidates a controlled subsidiary corporation, there are exceptions to the recognition standard that go beyond the Anti-Stuffing Rules. Upon liquidation, the assets of a controlled subsidiary are distributed to its parent corporation. Immediately after the distribution, the assets remain in a corporate entity albeit in a different one. It is a mere change in legal ownership, it does not make tax policy sense to impose tax in this situation.

Parent Tax Effects

Congress implemented a non-recognition provision for the parent with §332, which is written as an exception to §331. In particular, §332 provides that a parent corporation does not recognize a gain or loss on the receipt of property in complete liquidation of an 80% or more subsidiary, if three conditions are satisfied:

  1. First, the parent must possess at least 80% of the total voting power of the subsidiary stock, AND at least 80% of the total value of the subsidiary stock from the date the liquidation plan was adopted, AND at all times thereafter until the liquidation is complete.
    • If the parent fails these control requirements at any time, non-recognition treatment does not apply to any distribution.
  2. Second, the subsidiary must distribute to its parent all of its property and complete cancellation or redemption of all of its stock within the taxable year, OR within three years from the close of the tax year in which the first distribution occurred.
  3. Third, the subsidiary must be solvent.

If these three conditions are met, non-recognition of gains and losses by the parent is required.

The parent also generally takes exchanged basis in assets. The asset basis may differ from stock basis. Not to worry though, because as a nontaxable exchange, the gain or loss on any basis difference is not recognized. Parent receives tacked holding period in assets received. Parent also inherits other tax attributes of the subsidiary including:

  1. Its net operating loss carry over
  2. Capital loss carry over
  3. E&P

§332 only applies to the controlling parent corporation. Minority interest shareholders are subject to the general rules in §331, which requires gain or loss recognition and a complete liquidation.

Subsidiary Tax Effects

 The subsidiary is the corporation that is liquidating. Recall that §336 requires the liquidating corporation to recognize gain or loss on distributions of property in complete liquidation, but with the exception in §337, which provides that a liquidating subsidiary does not recognize gain or loss on distributions or property to its parent in a complete liquidation.

≥ 80% distributeeThe non-recognition rule only applies to distributions of property from the liquidating subsidiary to the parent corporation.
≤ 20% distributeeAny distributions to minority interest shareholders are treated as distributions in a non liquidating redemption.


Example: Corp A owns all of the stock of its subsidiary, Corp B, with a basis of $500,000 (purchased the stock 17 years ago), In the current year, Corp A liquidates Corp B under §332 and obtains assets worth $225,000. At the time of the liquidation, Corp B had a basis of $92,000 in the assets, and E&P of $61,000. What are the tax effects of the parent-subsidiary liquidation?

Recall under §332, that there’s no gain or loss recognition on the receipt of property in complete liquidation, if 3 conditions are met. In our example, all 3 conditions are met, so Corp A will recognize no gain or loss on the transaction. In addition, Corp A will receive an exchange or carry-over basis in the assets received for $92,000.

For the subsidiary Corp B, §337 provides no gain or loss recognition on distribution to a parent in complete liquidation. E&P of Corp B will carry over to Corp A.

Example: Corp A has a basis of of $460,000 in stock of Corp B, a 93% subsidiary. Corp A purchased the stock 11 years ago. In the current year, Corp A liquidates Corp B and obtains assets worth $570,00 that had a basis to Corp B of $720,000. Determine Corp A (the parent)’s basis in the assets received from Corp B (the subsidiary), in the liquidating distribution.

Recall that property received by a parent in complete liquidation of its subsidiary, under §332, has the same basis the property had in the hands of the subsidiary, in other words, there’s a $720,000 exchange for carryover basis.

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