Scott Davison is the president and sole shareholder of Bluebird Corporation (stock basis of $270,000).Since 1988, Bluebird has imported fine Mexican pottery and sold it to large nurseries and hardware stores across the United States.On July 1, 2016, Bluebird transferred its entire pottery inventory to Davison in a transaction described by the parties as a sale.According to Davison and collaborated by the minutes of the corporation's board of directors, the inventory was "sold" to him for the sum of $1 million, the fair market value of the inventory (Bluebird's basis, $350,000).The terms of the sale provided that Davison would pay Bluebird the $1 million amount at some future date.This debt obligation was not evidenced by a promissory note, and, to date, Davison has made no payments (principal or interest) on the obligation. The inventory transfer was not reported on Bluebird's 2016 tax return, either as a sale or as a distribution.After the transfer of inventory to Davison, Bluebird had no remaining assets and ceased to conduct any business.

Upon an audit of Bluebird's 2016 tax return in 2017, the IRS asserted that the transfer of inventory to Davison constituted a liquidation of Bluebird and, as such, that the corporation recognized a gain on the liquidating distribution in the amount of $650,000 ($1 million value - $350,000 basis).Further, the IRS has assessed a tax due from Davison for his gain recognized in the purported liquidating distribution.Davison has contacted you regarding the IRS's determination.create a letter a memo for the tax file documenting your conclusions.

Research aids:

IRC 331 & 336.

Kennemer v. Comm., 38-1 USTC 9297, 21 AFTR 103, 96 F.2d 177 (CA-5, 1938).