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ISSUES
(1) Are the liabilities assumed by S in the sec 351 exchange described below liabilities for purposes of secs 357(c)(1) and 358(d)?
(2) Once assumed by S, how will the liabilities in the sec 351 exchange described below be treated?
FACTS
Corporation P is an accrual basis, calendar-year corporation engaged in various ongoing businesses, one of which includes the operation of a manufacturing plant (the Manufacturing Business). The plant is located on land purchased by P many years before. The land was not contaminated by any hazardous waste when P purchased it. However, as a result of plant operations, certain environmental liabilities, such as potential soil and groundwater remediation, are now associated with the land.
In Year 1, for bona fide business purposes, P engages in an exchange to which sec 351 of the Internal Revenue Code applies by transferring substantially all of the assets associated with the Manufacturing Business, including the manufacturing plant and the land on which the plant is located, to a newly formed corporation, S, in exchange for all of the stock of S and for S's assumption of the liabilities associated with the Manufacturing Business, including the environmental liabilities associated with the land. P has no plan or intention to dispose of (or have S issue) any S stock. S is an accrual basis, calendar-year taxpayer.
P did not undertake any environmental remediation efforts in connection with the land transferred to S before the transfer and did not deduct or capitalize any amount with respect to the contingent environmental liabilities associated with the transferred land.
In Year 3, S undertakes soil and groundwater remediation efforts relating to the land transferred in the sec 351 exchange and incurs costs (within the meaning of the economic performance rules of sec 461(h)) as a result of those remediation efforts. Of the total amount of costs incurred, a portion would have constituted ordinary and necessary business expenses that are deductible under sec 162 and the remaining portion would have constituted capital expenditures under sec 263 if there had not been a sec 351 exchange and the costs for remediation efforts had been incurred by P. See Rev. Rul. 94-38, 1994-1 C.B. 35 (discussing the treatment of certain environmental remediation costs).
LAW AND ANALYSIS