The Effect of Rescission Still Unclear

Currently, the following inquiry is unanswered in the tax code and in regulations to the tax code: whether a transaction purporting to unwind or rescind an earlier transaction will be given effect as if neither transaction occurred for federal income tax purposes? 

Recently, the IRS announced that it planned to release guidance in this area.  Currently, Rev. Rul. 80-85 provides the bulk of guidance on the topic.  For the original sale to be disregarded, these two conditions have to be met: 1) the parties to the transaction must be returned to the “status quo ante,” and 2) the restoration must be accomplished within the same taxable year as the original transaction. “Status quo ante” is the term used to express the requirement that the rescission places the seller and the buyer at the end of the taxable year of sale in the same positions as they were prior to the sale. 

As the IRS applied Rev. Rul. 80-85 in a series of private letter rulings, these rulings clarified that hindsight as to the tax consequences of the original transaction is not a bar to successful rescission relief. Furthermore, it still remains unclear how the status quo ante requirement applies in various situations.  Practitioners are hopeful that the IRS will clear up this area soon with new guidance. 

See Thomas J. Gallagher, United States: The Income Tax Rescission Doctrine–The Code’s “Etch-A-Sketch” Tax Planning Tool, Mondaq, Mar. 12, 2013.