SCOTUS Reports

Tag: Stock Basis

  • American Water Works Co. v. Commissioner, 25 T.C. 903 (1956): Basis Reduction for Capital Distributions and Net Operating Losses in Consolidated Tax Returns

    25 T.C. 903 (1956)

    When corporations file consolidated tax returns, the basis of a parent company’s stock in a subsidiary must be reduced by capital distributions made by the subsidiary and by the amount of net operating losses of the subsidiary used in the consolidated returns, even if the stock was issued after the losses occurred.

    Summary

    The United States Tax Court addressed whether a parent company’s stock basis in its subsidiaries should be reduced by capital distributions and net operating losses when consolidated income tax returns were filed. The court held that the basis of the stock must be reduced by capital distributions made by the subsidiary to the parent company, both in years with and without consolidated returns. Furthermore, the basis of the stock must be reduced by the amount of the subsidiary’s net operating losses that were utilized in the consolidated returns, even if the parent acquired the stock after the losses occurred. The court emphasized the importance of adhering to Treasury regulations, which had the force of law due to the broad delegation of power to the Commissioner in the context of consolidated returns. The dissenting opinion argued that the basis of new stock acquired by the parent should not be reduced by prior net operating losses.

    Facts

    American Water Works Company, Inc. (the parent) filed consolidated income tax returns with several affiliated corporations. The parent sold stock in Texarkana Water Corporation and City Water Company of Chattanooga. The Commissioner determined deficiencies based on the parent’s failure to reduce the basis of the stock for capital distributions and net operating losses of the subsidiaries. Texarkana had made capital distributions to the parent in years with and without consolidated returns. Texarkana also had net operating losses in prior years, which were utilized in consolidated returns. Chattanooga had made capital distributions to the parent in years when consolidated returns were filed. Greenwich Water System, Inc. (an affiliate) sold stock in Cohasset Water Company, which had also made capital distributions to Greenwich and had net losses utilized in consolidated returns. The Commissioner adjusted the parent’s basis in subsidiaries’ stock, reducing the basis by the amount of capital distributions and net operating losses. The parent challenged the adjustments.

    Procedural History

    The Commissioner determined deficiencies in the parent company’s income tax for 1948 and 1949. The parent petitioned the U.S. Tax Court for redetermination. The cases, involving the deficiencies for 1948 and 1949, were consolidated. The Tax Court upheld the Commissioner’s determinations.

    Issue(s)

    1. Whether the basis of stock held by a member of an affiliated group of corporations should be reduced by capital distributions made by the issuing corporations to the parent corporation in years when consolidated income tax returns were filed, or also in years when no such returns were filed?

    2. Whether the basis of stock held by a member of an affiliated group of corporations should be reduced by the amount of net operating losses sustained by the issuing corporation and availed of in years when consolidated returns were filed, but before the shares of stock in question were issued?

    Holding

    1. Yes, the basis of the stock must be reduced by the total amount of capital distributions, made by the subsidiary to the parent, both in years when consolidated income tax returns were filed and in years when such returns were not filed, because the relevant Treasury regulations require such basis adjustments.

    2. Yes, the basis of the stock held by the parent must be reduced by the amount of net operating losses sustained by the subsidiary in the years when consolidated tax returns were filed, because the relevant Treasury regulations also require that adjustments be made for those losses, irrespective of when the stock was issued.

    Court’s Reasoning

    The court’s reasoning centered on interpreting the regulations governing consolidated returns, specifically Regulations 104. The court emphasized that the regulations had “legislative character” because of the broad delegation of power from Congress to the Commissioner. The court found no basis to deviate from the regulations. The regulations required the basis of stock to be adjusted in accordance with the Internal Revenue Code, which mandates basis reductions for distributions that are not dividends and for capital distributions. The court cited Internal Revenue Code § 113(b)(1)(D) which provides for basis reduction “for the amount of distributions previously made which… were tax-free or were applicable in reduction of basis.” The court also held that net operating losses of the subsidiary must reduce the basis of the parent’s stock because Regulation 104 § 23.34(c)(2) required an adjustment to the basis on account of the losses.

    The court distinguished between the basis rules for intercompany transactions during a consolidated return period and the sale of stock by the parent to an outside party. The capital distributions did not fall into the exception for intercompany transactions.

    The dissenting opinion argued that reducing the basis of stock acquired by the parent, by losses of the subsidiary that occurred prior to the parent owning the stock of the subsidiary, unjustly penalized the investor and did not align with the intent of the tax laws.

    Practical Implications

    This case is a crucial reminder of how closely basis calculations are tied to corporate structure and the use of consolidated tax returns. Attorneys should understand that consolidated tax returns are governed by complex regulations that require careful attention to detail when computing basis. The decision highlights that the basis of stock in a subsidiary can be reduced by distributions made by the subsidiary, even if the distribution occurred in years when no consolidated tax returns were filed. It also illustrates that net operating losses of a subsidiary utilized in a consolidated return can impact the basis of the parent’s stock, even if acquired after the loss.

    This case reinforces the need to review all relevant regulations, including Regulations 104, to determine the proper basis of stock in situations where consolidated returns are filed. Failing to make these basis adjustments can result in unexpected tax liabilities. It also illustrates the complexity and potential for dispute in corporate tax matters, particularly when subsidiaries are involved, and consolidated returns are filed.

    Later cases applying or distinguishing this ruling would likely involve interpretations of the regulations regarding consolidated tax returns and basis adjustments, especially in scenarios involving capital distributions, net operating losses, and stock sales.

  • Edwards v. Commissioner, 19 T.C. 275 (1952): Basis of Stock After Debt Forgiveness

    19 T.C. 275 (1952)

    The basis of stock for calculating gain or loss is its original cost, even if the purchaser later experiences debt forgiveness from a loan used to acquire the stock, provided the debt forgiveness is a separate transaction.

    Summary

    Edwards purchased stock using borrowed funds, pledging the stock as collateral. Later, he withdrew the stock by providing other security and making payments. Subsequently, Edwards separately negotiated a compromise of the debt. He then sold the stock. The Tax Court held that the basis for determining gain or loss on the stock sale was the original cost of the stock. The debt compromise was a separate transaction and did not retroactively reduce the stock’s basis. This separation is crucial because the creditor was not the seller, and the stock could be sold independently of the debt.

    Facts

    Edward Edwards purchased 32,228 shares of Valvoline Oil Company stock from Paragon Refining Company for $6,433,157. To finance the purchase, he borrowed $6 million from two banks, securing the loans with the Valvoline stock and other securities as collateral. Over time, Edwards withdrew some Valvoline stock by providing other collateral or making payments on the loans. Years later, facing financial difficulties, Edwards negotiated settlements with the banks, paying a fraction of the outstanding debt in full satisfaction. Subsequently, in 1944, Edwards sold 31,329 shares of Valvoline stock.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Edwards’ income tax for 1944, arguing that the basis of the Valvoline stock should be reduced by the amount of debt forgiven by the banks. Edwards petitioned the Tax Court, contesting the Commissioner’s determination. The Tax Court ruled in favor of Edwards, holding that the stock’s basis was its original cost.

    Issue(s)

    Whether the compromise of an indebtedness, evidenced by two notes used to purchase stock, resulted in a reduction of the basis of that stock when the stock was later sold in a separate transaction.

    Holding

    No, because the debt forgiveness was a separate transaction from the original stock purchase, and the creditor was not the seller of the stock. Therefore, the basis of the stock is its original cost.

    Court’s Reasoning

    The Tax Court reasoned that the basis of property is its cost, as defined by Section 113(a) of the Internal Revenue Code. The court emphasized that Edwards purchased the stock from Paragon Refining Company, establishing the cost at $6,433,157. The subsequent loans from the banks were separate transactions. The court distinguished cases cited by the Commissioner, such as Hirsch and Killian, because those cases involved purchase money mortgages where the debt reduction was directly linked to the property’s declining value. In this case, the creditor was not the vendor, and the stock could be sold free and clear of the debt once other security was substituted. The court stated, “We think that it would be factitious to say that the cost of his stock, that is the basis of his title, was reduced by a subsequent and totally unrelated cancelation of an indebtedness.” The court emphasized that the ability to substitute collateral underscored the separation of the stock ownership from the debt obligation.

    Practical Implications

    This case clarifies that debt forgiveness does not automatically reduce the basis of an asset purchased with the borrowed funds, especially when the debt and the asset are treated separately. Attorneys should analyze whether the debt forgiveness is directly linked to a decline in the asset’s value (as in purchase money mortgage scenarios) or whether it’s a separate transaction. This case highlights the importance of distinguishing between purchase money obligations and separate loan agreements when determining the basis of assets for tax purposes. It confirms that cost basis is determined at the time of purchase and is not retroactively adjusted by subsequent, independent financial events.

  • Alfred Decker & Cohn, Inc. v. Commissioner, 22 T.C. 132 (1954): Determining Basis of Stock Acquired with Option Restrictions

    Alfred Decker & Cohn, Inc. v. Commissioner, 22 T.C. 132 (1954)

    When a corporation acquires its own stock subject to a significant option that depresses its fair market value, the basis of that stock for later determining gain or loss is the remaining amount of the debt for which the stock was received, especially if the stock’s fair market value is not ascertainable due to the option.

    Summary

    Alfred Decker & Cohn, Inc. (petitioner) sought a redetermination of deficiencies in excess profits tax. The Tax Court addressed issues concerning the basis of treasury stock sold, the valuation of goodwill, borrowed invested capital, and accrued interest income. The court held that the basis of stock acquired subject to a 10-year option with nominal value was the remaining debt. It also determined the fair market value of goodwill and addressed the computation of borrowed invested capital and accrued interest income. The core issue revolved around determining the tax consequences of various transactions affecting the corporation’s invested capital.

    Facts

    In 1934, the petitioner acquired 24,000 shares of its own common stock in cancellation of Alfred Decker’s debt, which included paying Continental Bank $15,075 for 10,000 shares. As part of this deal, Raye Decker received a 10-year option to purchase these shares. In December 1943, Raye Decker exercised the option. The petitioner claimed the stock’s basis was $133,438.55, the remaining debt. The Commissioner argued for a basis of $29,075, based on an assigned fair market value at the time of acquisition. The key factual element was the existence of a 10-year option that significantly impacted the stock’s marketability.

    Procedural History

    The Commissioner determined deficiencies in the petitioner’s excess profits tax. The petitioner appealed to the Tax Court, contesting the Commissioner’s valuation of the stock basis and other aspects of invested capital. The Commissioner amended their answer, raising new issues, particularly concerning borrowed invested capital. The Tax Court reviewed the Commissioner’s determinations and the petitioner’s claims.

    Issue(s)

    1. Whether the basis of the 24,000 shares of treasury stock sold in 1943, which were acquired subject to a 10-year option, should be determined by the remaining debt owed by Alfred Decker or by an assigned fair market value at the time of acquisition.

    2. What was the fair market value of the goodwill acquired by the petitioner from its shareholders in 1919 for purposes of computing equity invested capital?

    3. Whether the petitioner’s borrowed invested capital should include debentures at their face value or at the par value of the preferred stock surrendered in exchange for the debentures.

    4. Whether the petitioner, an accrual basis taxpayer, must include in income interest due and payable on a note from its wholly-owned subsidiary, where there was a mutual agreement that no interest would be charged or paid until a future date.

    Holding

    1. No, because the stock was encumbered by a 10-year option rendering its fair market value unascertainable at the time of acquisition; therefore, the basis is the remaining debt.

    2. The fair market value of the goodwill was determined to be $1,000,000 based on the past earnings, business conditions, and prospective future earnings.

    3. Yes, the petitioner’s borrowed invested capital should be computed by including the debentures at their face value, as the transaction converted equity invested capital into borrowed capital without statutory prohibition.

    4. No, the petitioner is not required to accrue interest on the note as income, because there was a mutual understanding that no interest would be paid until a future date.

    Court’s Reasoning

    The court reasoned that because the 24,000 shares of stock were encumbered by a 10-year option held by Raye Decker, they had no ascertainable fair market value at the time they were received. Citing Gould Securities Co. v. United States, 96 F.2d 780, the court determined that the basis should be the remaining portion of Alfred Decker’s debt. The court noted, “Whether the fair market value of stock has been destroyed by an option will depend upon what kind of stock it is and upon the kind of option which has been granted and other relevant facts and circumstances of the particular case.” With respect to goodwill, the court relied on factors such as past earnings, business conditions, and prospective earnings. On the borrowed invested capital issue, the court distinguished cases involving interest and found no statutory prohibition against converting equity invested capital into borrowed capital. As for the accrued interest, the court cited Combs Lumber Co., 41 B.T.A. 839, stating, “When the right to receive an amount becomes fixed, the right accrues.”, and found that, due to a mutual agreement, the right to receive interest was not fixed.

    Practical Implications

    This case clarifies how to determine the basis of assets, particularly stock, when significant restrictions, such as options, affect their fair market value. It emphasizes that the existence and terms of an option can render stock’s fair market value unascertainable. It provides guidance on valuing goodwill based on various economic factors. Furthermore, it confirms that taxpayers can convert equity into debt for excess profits tax purposes, absent specific statutory prohibitions. The case reinforces the principle that for accrual basis taxpayers, income accrues when the right to receive it becomes fixed, highlighting the importance of mutual agreements between parties.

  • Foster v. Commissioner, 9 T.C. 930 (1947): Determining Stock Basis After Corporate Restructuring

    9 T.C. 930 (1947)

    When a shareholder makes capital contributions or surrenders stock to a corporation to enhance its financial position, the cost basis of the stock sold includes the cost of common stock transferred to another party to procure working capital, plus the portion of the cost of preferred shares surrendered that was not deductible as a loss at the time of surrender.

    Summary

    William H. Foster, the controlling stockholder of Foster Machine Co., transferred common shares to Greenleaf to secure working capital for the corporation. He also surrendered preferred shares, some of which were canceled and the rest resold to Greenleaf. When Foster later sold his remaining common stock, a dispute arose concerning the basis of the stock for tax purposes. The Tax Court held that Foster’s basis included the cost of the common stock transferred to Greenleaf, plus the portion of the cost of the surrendered preferred stock that was not initially deductible as a loss. This decision emphasizes that actions taken to improve a corporation’s financial health can impact the basis of a shareholder’s stock.

    Facts

    William H. Foster owned a controlling interest in Foster Machine Co. To improve the company’s financial position, Foster entered into agreements with Carl D. Greenleaf. In 1922 Foster agreed to transfer 2,180 shares of common stock to Greenleaf in return for Greenleaf’s association with the company as a director and his contribution of working capital to the company. By 1927, Foster transferred 1,050 shares of common stock to Greenleaf. Foster also granted Greenleaf an option to purchase 1,130 shares of common stock which Greenleaf exercised in 1929. In 1935, Foster surrendered 1,848 shares of preferred stock to the company, 1,048 of which were canceled, and 800 were resold to Greenleaf.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in William H. Foster’s and L. Mae Foster’s income tax for 1940. The estate of William H. Foster petitioned the Tax Court for a redetermination, arguing that there was an overpayment of taxes. The central issue was the correct calculation of the basis of the stock sold in 1940.

    Issue(s)

    Whether the basis of stock sold in 1940 should include (1) the cost of common stock transferred to an individual to procure working capital for the corporation, and (2) the cost of preferred stock surrendered to the corporation, a portion of which was then resold to that same individual.

    Holding

    Yes, because a payment by a stockholder to the corporation, made to protect and enhance his existing investment and prevent its loss, is a capital contribution, rather than a deductible loss, and should be added to the basis of his stock.

    Court’s Reasoning

    The Tax Court determined that Foster’s actions were aimed at improving the financial standing of Foster Machine Co. rather than generating an immediate profit. The court referenced First National Bank in Wichita v. Commissioner, 46 Fed. (2d) 283 stating that payments made to protect and enhance a shareholder’s existing investment are capital contributions and should be added to the basis of his stock. The court also considered Commissioner v. Burdick, 59 Fed. (2d) 395, and Julius C. Miller, 45 B.T.A. 292, regarding the surrender of stock. The court determined that Greenleaf was not merely purchasing stock from Foster, but was investing in the business. Therefore, Foster was never in a position to make a contribution of $218,000 to the capital of the corporation. The court found that the cost of the surrendered preferred stock, which was not deductible as a loss, should be included in the basis of the common shares because it enhanced the value of those shares. The court reasoned that the enhancement in the value of the 2,232.5 shares he then owned was $82,513.20. “This part of the cost of the surrendered preferred stock, which was not allowable as a loss deduction because it inured to the benefit of his own common stock, properly becomes a part of the basis of these common shares to be taken into consideration on their final disposition.”

    Practical Implications

    This case clarifies how contributions to a corporation and stock surrenders can affect a shareholder’s stock basis for tax purposes. It illustrates that actions taken to improve a corporation’s financial health are treated as capital contributions rather than deductible losses. Attorneys and accountants should carefully analyze transactions where shareholders contribute capital or surrender stock, as these actions can have long-term implications for determining capital gains or losses when the stock is eventually sold. This ruling impacts how similar cases should be analyzed, changing legal practice in this area, and has implications for businesses involved in corporate restructuring.

  • Jones v. Commissioner, 4 T.C. 854 (1945): Determining Taxable Distribution in Partial Liquidation vs. Capital Gain

    4 T.C. 854

    When a corporation redeems its stock with the intent to cancel and retire it, the distribution to the shareholder is considered a partial liquidation and is taxed as ordinary income, not as a capital gain from a sale, regardless of the terminology used in the transaction documents.

    Summary

    George F. Jones contested a tax deficiency, arguing that the proceeds from the redemption of his stock in Billings Dental Supply Co. should be taxed as capital gains from a sale, not as ordinary income from a partial liquidation. Jones sold his shares back to Billings, which subsequently canceled the stock. The Tax Court held that because Billings intended to retire the stock, the transaction constituted a partial liquidation under Section 115(c) of the Internal Revenue Code, and the gain was taxable as ordinary income. The court emphasized that the corporation’s intent, not the terminology used by the parties, determines the nature of the distribution for tax purposes. The court also addressed the basis of stock acquired as a stock dividend, affirming the necessity of basis allocation.

    Facts

    Petitioner George F. Jones owned stock in Billings Dental Supply Co. (Billings).
    In 1940, Billings decided to sell its supply business and reorganize, reducing its capital stock.
    Jones, desiring to withdraw from the company due to the sale, agreed to sell his 331 shares back to Billings.
    The agreement referred to a “sale” and “purchase” of stock at $110 per share.
    Billings acquired 486 shares in total from various stockholders at the same time, including Jones’s shares.
    Billings canceled 411 of these shares, including all of Jones’s, and reissued 75 shares.
    At a special meeting, stockholders approved the “purchase and retirement” of these shares.
    Jones argued he sold his stock and should be taxed at capital gains rates.

    Procedural History

    George F. Jones petitioned the United States Tax Court contesting a deficiency in income tax for the calendar year 1940 as determined by the Commissioner of Internal Revenue.

    Issue(s)

    1. Whether the gain realized by petitioner from the disposition of his corporate stock is taxable under Section 115(c) of the Internal Revenue Code as a distribution in partial liquidation, or under Section 117 as a gain from the sale of capital assets.
    2. Whether the basis of stock acquired as a stock dividend, part of which was redeemed in a prior year and taxed as an ordinary dividend, should be fully included in the basis of remaining shares when calculating gain upon a later disposition.

    Holding

    1. Yes, the gain is taxable as a distribution in partial liquidation because the corporation intended to cancel and retire the stock, making Section 115(c) applicable, regardless of the “sale” terminology used.
    2. No, the basis of the stock redeemed in the prior year should not be included. The basis of stock acquired as a stock dividend must be allocated between the original stock and the dividend stock, and the basis of shares already disposed of cannot be retroactively added to remaining shares.

    Court’s Reasoning

    The court reasoned that the terminology of “sale” and “purchase” is not determinative; the crucial factor is the corporation’s intent. Citing Kena, Inc., the court stated, “The use by the parties of the terms ‘purchase’ and ‘sale’ does not determine the character of the transaction.”

    The court emphasized that Section 115(i) defines partial liquidation as “a distribution by a corporation in complete cancellation or redemption of a part of its stock.” The intent of the corporation to cancel and retire the stock is the controlling factor, citing Hammans v. Commissioner and Cohen Trust v. Commissioner.

    The minutes of the stockholders’ meeting explicitly stated the “purchase and retirement” of the stock, indicating the corporation’s intent to cancel the shares. The court found no evidence that Billings intended to hold the stock as treasury stock for resale.

    Regarding the stock basis issue, the court referred to Section 113(a)(19) of the Internal Revenue Code, which mandates the allocation of basis between old stock and new stock acquired as a stock dividend. The court rejected the petitioner’s argument that because the 1932 redemption was treated as an ordinary dividend, the basis of those shares should be added to the remaining shares. The court clarified that the purpose of Section 113(a)(19) is to ensure fair tax recovery of the original cost basis, and the Commissioner correctly applied the allocated basis.

    Practical Implications

    Jones v. Commissioner clarifies that the tax treatment of stock redemptions hinges on the corporation’s intent to retire the stock, not merely the language used in transaction documents. This case emphasizes the importance of examining the substance over the form of corporate transactions for tax purposes.
    For legal practitioners, this case serves as a reminder that when advising clients on stock redemptions, it is critical to ascertain and document the corporation’s intent regarding the redeemed shares. If the intent is retirement, partial liquidation treatment under Section 115(c) is likely to apply, leading to ordinary income tax rates. This case also reinforces the principle of basis allocation for stock dividends, impacting how gains are calculated on subsequent stock dispositions. Later cases and IRS rulings continue to apply the principle that corporate intent dictates the classification of stock redemptions, making Jones a foundational case in this area of tax law.

  • Big Wolf Corp. v. Commissioner, 2 T.C. 751 (1943): Applying the Average Cost Rule to Stock Basis After Recapitalization

    2 T.C. 751 (1943)

    When shares of stock are exchanged in a recapitalization and the new shares cannot be specifically identified with particular blocks of old shares, the average cost rule should be used to determine the basis of the new shares.

    Summary

    Big Wolf Corporation disputed a deficiency assessed by the Commissioner of Internal Revenue regarding personal holding company surtax and penalties. The core issue was whether the corporation realized a capital gain upon receiving liquidating dividends in 1938 from Santa Clara Lumber Co. The corporation’s stock in Santa Clara had been acquired through contributions from its principal stockholder, Meigs, who had previously exchanged old shares for new shares in a 1916 recapitalization. Because the specific old shares could not be traced to the new shares, the court held that the average cost rule should be applied to calculate the stock’s basis, potentially impacting the determination of a capital gain and the assessed deficiency.

    Facts

    Big Wolf Corporation received liquidating dividends from Santa Clara stock in 1938.

    All 2,064 shares of Santa Clara stock held by Big Wolf were acquired via contributions from its principal stockholder, Ferris G. Meigs, between 1924 and 1930.

    Meigs’ cost basis for the 2,064 shares totaled $589,774.77, acquired at different times and prices before being contributed to Big Wolf.

    In 1916, Santa Clara underwent a recapitalization where Meigs exchanged 2,595 old shares for 2,076 new shares and cash.

    Santa Clara made capital distributions on the 2,064 shares held by Big Wolf from 1925 to 1937, totaling $217,603.38.

    Procedural History

    The Commissioner determined a deficiency in Big Wolf’s personal holding company surtax for 1938 and imposed a 25% penalty.

    Big Wolf petitioned the Tax Court, contesting the deficiency and penalty.

    The Commissioner argued the new shares were identifiable with the old shares, allowing for specific allocation of distributions.

    Issue(s)

    1. Whether the Commissioner was justified in treating the new shares of Santa Clara stock as specifically identifiable with particular blocks of the old shares when calculating capital gains from liquidating dividends.

    Holding

    1. No, because there was no practical way to specifically identify which new shares corresponded to which old shares after the 1916 recapitalization, the “average cost rule” should be applied to determine the basis.

    Court’s Reasoning

    The court emphasized the commingling of shares during the 1916 recapitalization, where Meigs surrendered 2,595 old shares evidenced by eleven certificates and received 2,076 new shares evidenced by four certificates. This made identification impossible. The court noted that “certificates are not the only means of identification, but none other is here suggested or relied on.”

    The court distinguished this case from situations involving reorganizations with a second company, highlighting that this case involved a mere recapitalization.

    The court cited with approval the decision in Arrott v. Commissioner, 136 F.2d 449, which supported using the average cost rule when specific identification is impossible. As the Arrott court observed, “The old shares all have the same exchange value for the new ones no matter what they cost the taxpayer. He gets as much new stock for the share for which he paid $ 80 as he does for the share for which he paid $ 120. The old shares lose their identity when traded for the new…”

    The court concluded that applying the average cost rule, where the total cost of all shares is divided by the total number of shares, was the most reasonable approach. The court stated, “the aggregate cost of the eleven blocks of old shares persists and carries over as the basis for the new shares, but on the present facts there is no means of matching the cost of the eleven separate original blocks or certificates with the four new blocks of shares or certificates.”

    Practical Implications

    This case provides a practical rule for determining the basis of stock acquired in a recapitalization when specific identification of old shares to new shares is not possible.

    The ruling emphasizes the importance of accurate record-keeping and the ability to trace stock transactions for tax purposes. When records are incomplete or tracing is impossible due to the nature of the transaction (e.g., a commingling of shares), the average cost rule offers a reasonable alternative.

    The case clarifies that the Commissioner’s allocation of cost does not automatically establish identification; the factual circumstances determine whether specific identification is feasible.

    Later cases have cited Big Wolf to support the application of the average cost rule in similar situations involving stock reorganizations and distributions where specific identification is not possible.