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discharge of the liability that arose as the result of the lawsuit.
We find no discernible distinction between the situation herein and
the situations discussed in Fahey v. Commissioner, supra, or Hudson
v. Commissioner, supra. In each case, the debtor made payment to
the creditor or an assignee of the original creditor in exchange
for the extinguishment of the claim. Whether the claim is reduced
to judgment before payment is not relevant; ultimately the debtor
receives nothing in the form of property or property rights which
can later be transferred. Consequently, we hold that the
settlement of the lawsuit between the S corporations and Xerox does
not constitute a sale or exchange and hence capital gain treatment
is not warranted.
Petitioners argue that the so-called Arrowsmith doctrine
requires us to apply capital gain treatment to the settlement claim
regardless of whether a sale or exchange occurred. We disagree.
In Arrowsmith v. Commissioner, 344 U.S. 6 (1952), the Supreme Court
held that the characterization of a transaction may require
examination of prior, related transactions. In Arrowsmith, the
taxpayer-shareholders reported as capital gain the gain realized on
the liquidation of their corporation. Subsequently, a judgment was
rendered against the former corporation, and the shareholders, as
transferees of the corporation's assets, paid the judgment. The
Supreme Court held that the payment of the judgment resulted in a
capital (rather than ordinary) loss because the judgment was
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