Can We Have a Do-Over? Rescinding Transactions for Federal Tax Purposes

Tax Section of the State Bar of Arizona

Can We Have a Do-Over? Rescinding Transactions for Federal Tax Purposes

In certain circumstances, taxpayers can rescind a transaction for federal tax purposes and avoid recognizing gain or loss or other unfavorable tax consequences as a result of the original transaction. This ability to get a "do-over" for federal tax purposes has been used by taxpayers in a myriad of ways to avoid recognizing adverse or unexpected tax consequences from a completed transaction. For example, taxpayers have successfully rescinded various transactions in order to:

(i) avoid the recognition of gain or loss on the sale of real property;
(ii) unwind the revocation of a corporation's Subchapter S election;
(iii) prevent a merger from being treated as a complete liquidation; and
(iv) revoke a Section 83(b) election.

In light of the obvious benefits to both clients and practitioners of getting a "do-over" for federal tax purposes, this article briefly summarizes the Internal Revenue Service's ("IRS") position on rescission and the instances in which the IRS has acquiesced to a re­scission for federal tax purposes.

Neither the Internal Revenue Code (the "IRC") nor the Treasury Regulations address whether unwind­ing or rescinding a transaction will be given effect for tax purposes, such that the rescinded transaction will be treated as a tax nul­lity. However, in Revenue Ruling ("Rev. Rul.") 80-58, 1980-1 C.B. 181, the IRS directly addressed this issue, formulating the following general rules:

(I) if a transaction is rescinded within the same tax year and the parties to the transaction are restored to their original positions, the rescission will be given retroactive effect for tax purposes and the parties will he treated as though the origi­nal transaction never occurred; and
(ii) if a transaction is rescinded after the close of the tax year in which the transaction occurred, the rescission will not be given retroactive effect and will be treated as a separate taxable event.


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