Related Party Transactions counted as ordinary income
In general, gains from Related Party (Section 1239) Transactions of depreciable or amortizable property is ordinary income, and does not fall under the 1231 rules where net 1231 gains are treated as capital income.
A recent IRS case illustrates the regulation: The issue in this case was whether income received by taxpayer’s S corporation in a Section 351 transaction with its subsidiary should be classified as ordinary income under IRC Sec. 1239, which treats gain from the sale of depreciable property between related taxpayers as ordinary income rather than as capital gain. [ Editor’s Note: The ‘depreciable property’ in this case was an amortizable Section 197 intangible (goodwill), which under Reg. 1.197-2(g)(8) is Section 1245 property, with IRC Sec. 1239 applying to any gain recognized upon its sale or exchange between related persons.] The Tax Court noted that two corporations are related persons under IRC Sec. 1239 if the parent owns more than 50% of the (1) total combined voting power of all classes of the subsidiary’s stock entitled to vote, or (2) the total value of all shares of the subsidiary’s stock. Since both tests were met, the Tax Court held that the $9.4 million gain from the transaction should have been reported as flow-through ordinary income. Gary Fish , TC Memo 2013-270 (Tax Ct.).