- 42 -
for depletion,25 and is characterized as a sale or exchange under
section 1231. The fair market value of the cut timber then
becomes the new basis of the timber (new basis) for all purposes
in the hands of the taxpayer. If the cut timber is then sold,
ordinary gain or loss is calculated as the difference between the
amount realized and the new basis.
As a result of its section 631(a) election, Johnco will
recognize its built-in capital gains under section 1231 as it
cuts timber. This recognition will occur independently of any
liquidation. Consequently, we conclude that a hypothetical
willing buyer of decedent's Johnco stock would take into account
Johnco's built-in capital gains, even if his plans were to hold
the assets and cut the timber on a sustainable yield basis. For
this reason, we hold that a valuation of decedent's Johnco stock
should take into account Johnco's built-in capital gains, but
only in an amount reflecting the rate at which they will be
recognized, measured as the net present value of the built-in
capital gains tax liability that will be incurred over time as
timber is cut.
We calculate the net present value of the built-in capital
gains tax liability by estimating Johnco's capital gains
25 Where only a portion of the timber is cut, basis is
allocated to cut and standing timber in proportion to timber
units. See sec. 612; sec. 1.612-1, Income Tax Regs. Units of
timber are ordinarily expressed in terms such as thousands of
board feet, log scale or cords, as appropriate. Timber quantity
is generally estimated upon acquisition and subsequently
increased as timber is acquired and decreased as units of timber
are cut and sold.
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