Can a Completed Transaction be Reversed?

It is not uncommon to do something and then in hindsight decide you made a mistake and wish you could un-do or rescind what you had done. Sometimes you may be able to, but what are the tax consequences of reversing a completed transaction? As an example, suppose that in January you sold a house you owned and had previously rented to your daughter who had just finished college. You expected that she would get a job and live in the house. She paid you with a combination of cash and a promissory note secured by the house. A few months later your daughter is offered her dream job but the job is in Europe so now she has no use for the house. If she transfers the house back to you and you tear up the note and give her back her cash down payment, can you just ignore the sale as though it never happened? Or, is the return of the house to you considered a payment on the note causing you to recognize all of your tax gain? Does the tax law permit a transaction to be rescinded without tax consequences?

In 1980, the IRS issued a favorable ruling, Rev. Rul. 80-58, on rescissions that occur within the same tax year as the original transaction. In the ruling, the taxpayer sold land to another party in February with the proviso that if the buyer could not get the land re-zoned within nine months, the buyer could give the land back to the seller and the seller would return the buyer’s payment. When the buyer returned the property and the seller refunded the purchase price in October of the same year, the IRS ruled that the seller did not have to recognize gain from the sale. However, under an alternative set of facts, if the rescission does not occur until the following year, the seller does have to recognize his gain in the year of sale. Thus, un-doing the transaction within the same tax year was critical.

The IRS continues to periodically cite this revenue ruling in other rulings. Most recently, in PLR 201008033, a company had sold the stock of a subsidiary to another one of its affiliates. After the sale was completed, the parties were advised that the sale would create adverse tax consequences. They asked the IRS for a private ruling saying they could rescind the sale and restore the parties to their original positions and avoid the adverse tax consequences. The IRS ruled as requested, citing as authority Rev. Rul. 80-58. While this private ruling cannot be relied on as authority by other taxpayers, it is helpful to know that the IRS was willing to recognize a same-year rescission even where the taxpayer admitted that the only reason for rescinding the original transaction was to avoid undesired tax consequences. To use a golf analogy, sometimes you get a mulligan.