## Facts

- Joseph V. Rafferty and his wife owned and controlled Rafferty Brown Steel Co., Inc. (Massachusetts) (RBS), Rafferty Brown Steel Co., Inc. of Connecticut (RBS Conn.), and Teragram Realty Co., Inc. (Teragram).
- In 1960, RBS transferred its Longmeadow, Massachusetts real estate to newly formed Teragram in exchange for all Teragram stock; Teragram leased the property back to RBS under a long-term lease for fixed annual rent.
- In 1962, the taxpayers organized RBS Conn., which operated in Waterbury, Connecticut; from 1962 to 1965, RBS Conn. leased Waterbury real estate from an unrelated lessor.
- In 1965, Teragram purchased unimproved Waterbury property, constructed a plant, and leased it to RBS Conn. under a long-term lease.
- Teragram had no office or employees; Rafferty served as its president and treasurer; Teragram kept separate books and filed separate tax returns.
- From 1960 through 1965, Teragram’s income consisted entirely of rent paid by RBS and RBS Conn.
- The taxpayers received a distribution of all Teragram stock and reported it as qualifying for tax-free treatment under IRC § 355; the IRS treated the distribution as a taxable dividend.

## Issues

1. Whether Teragram’s ownership and long-term leasing of real estate to related operating corporations constituted the “active conduct of a trade or business” under IRC § 355(b).
2. Whether the distribution of Teragram stock therefore qualified for nonrecognition under IRC § 355 or was taxable to the shareholders as a dividend.

## Decision

- The First Circuit affirmed the Tax Court.
- The court held that Teragram was not engaged in the “active conduct of a trade or business” within IRC § 355(b).
- Because the § 355(b) active-business requirement was not met, the stock distribution did not qualify under § 355 and was taxable as a dividend.

## Legal Principles

- To satisfy IRC § 355(b), a corporation must conduct business activity that is qualitatively distinguishable from passive investment activity and is supported by objective indicia of operations.
- Mere ownership of income-producing property and collection of fixed rent—especially under long-term leases to related companies—generally resembles passive investment rather than an active trade or business.
- Minimal corporate activity (e.g., collecting rent, paying taxes, maintaining records) without employees, salaries, or operational functions weighs against finding an active trade or business for § 355 purposes.

## Conclusion

The distribution of Teragram’s stock was taxable as a dividend because Teragram’s real-estate holding and leasing activities to affiliated operating companies lacked the entrepreneurial and operational characteristics required for an “active trade or business” under IRC § 355(b).


Rafferty v. Commissioner, 452 F.2d 767 (1st Cir. 1971)