## Facts

- Granite Trust Company, a Massachusetts bank, formed Granite Trust Building Corporation in 1928 to own and finance the bank’s office building; the bank initially acquired all of the subsidiary’s stock.
- Banking regulators repeatedly criticized the carrying value of the subsidiary stock, pressing for write-downs.
- By 1943, the bank planned to have the subsidiary sell the real estate to the bank at fair value and then liquidate the subsidiary, which would produce a substantial loss on the bank’s subsidiary stock.
- Section 112(b)(6) of the 1939 Internal Revenue Code required nonrecognition of gain or loss on liquidation if the parent owned at least 80% of the subsidiary’s stock throughout the liquidation; Granite Trust sought to avoid this nonrecognition rule to recognize its loss.
- On December 6, 1943, Granite Trust sold 20.5% (1,025 shares) of the subsidiary’s common stock to an unrelated tenant, Howard D. Johnson Company, for $65.50 per share.
- With the bank’s ownership reduced to 79.5%, the subsidiary’s shareholders approved liquidation on December 10, 1943; the bank also made minor additional transfers (sales to individuals and a small charitable gift).
- The purchasers and charitable donee received legal title without side agreements, and the shares were subject to ordinary incidents of ownership (e.g., creditor claims, estate inclusion).
- The subsidiary liquidated on December 17, 1943; Granite Trust claimed a deductible loss based on its reduced ownership and liquidation proceeds.
- The Commissioner disallowed the loss by treating the transfers as disregarded for purposes of § 112(b)(6), and the district court entered judgment for the United States.

## Issues

1. Whether bona fide, tax-motivated sales and gifts of subsidiary stock to unrelated parties immediately before liquidation must be disregarded so that § 112(b)(6) nonrecognition applies.
2. Whether a parent that actually reduces its ownership below the 80% threshold before liquidation may recognize a loss on the subsidiary’s liquidation.

## Decision

- The First Circuit reversed the district court.
- The court held the pre-liquidation transfers were bona fide and effective for § 112(b)(6) ownership testing.
- Because Granite Trust owned less than 80% of the subsidiary’s stock at the relevant times, § 112(b)(6) nonrecognition did not apply.
- The bank’s loss on liquidation was therefore recognizable, entitling it (per stipulation) to recover the tax overpayment plus interest.

## Legal Principles

- When a nonrecognition statute uses a mechanical ownership threshold (here, at least 80% ownership “throughout” liquidation), the test turns on actual ownership at the relevant times.
- Tax motivation alone does not permit disregarding transactions; transfers may be respected if they are real, unconditional, and confer genuine legal and economic incidents of ownership on the transferees.
- The government may not treat bona fide stock transfers as ineffective under a general “substance over form” theory absent evidence of sham, reversionary arrangements, or retained ownership benefits inconsistent with the transfers’ legal effect.
- A parent corporation may recognize gain or loss on liquidation when it validly falls below the statutory ownership threshold that would otherwise trigger liquidation nonrecognition.

## Conclusion

The court held that Granite Trust’s genuine, unconditional transfers of subsidiary stock to unrelated parties reduced its ownership below 80% before liquidation, preventing § 112(b)(6) nonrecognition and allowing the bank to recognize its liquidation loss.


Granite Tr. Co. v. United States, 238 F.2d 670 (1st Cir. 1956)