                          115 T.C. No. 23



                      UNITED STATES TAX COURT



       ARCHIE L. AND LOUISE B. HONBARRIER, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


  HONBARRIER, INC., FORMERLY CENTRAL TRANSPORT, INC., SUCCESSOR
TO COLONIAL MOTOR FREIGHT LINE, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent.



     Docket Nos.   9053-97, 9054-97.   Filed September 29, 2000.


          H was the sole shareholder of P. P was engaged in
     the business of hauling packaged freight in trucks.
     Its trucking operations were terminated in 1988. By
     1990, P had sold its operating assets. P invested the
     proceeds from the sale of its operating assets in tax-
     exempt bonds and a municipal bond fund.

          C was a privately held trucking company that
     operated as a bulk carrier of chemicals. The majority
     of C’s stock was owned by H.

          On Dec. 31, 1993, P was merged into C. Pursuant
     to the merger, H received 17,840 shares of C stock for
     his P stock. The value of the 17,840 shares was
     determined to be equal to the net fair market value of
     P’s assets. P and H treated the merger as a tax-free
                              - 2 -

     reorganization within the meaning of sec. 368(a)(1)(A),
     I.R.C. R determined that the merger failed to meet the
     continuity of business enterprise requirement necessary
     to qualify as a tax-free reorganization within the
     meaning of sec. 368(a)(1)(A), I.R.C.

          Prior to the day of the merger, P’s assets
     consisted of tax-exempt bonds, a municipal bond fund,
     and $1,500 in cash. On the day of the merger, P
     liquidated one of its tax-exempt bonds and its
     municipal bond fund. As a result, P’s assets at the
     time of the merger consisted of $2,415,321 in cash,
     $4,849,146 in tax-exempt bonds, $37,800 in interest and
     dividends receivable, and $18,926 in money funds. At
     the time of the merger, C distributed $7 million to C’s
     shareholders. This distribution was made with checks
     totaling $2,450,854 and tax-exempt bonds worth
     $4,549,146 that had been acquired from P. Within 4
     months, C had disposed of the remaining tax-exempt bond
     that it had acquired from P in the merger.

          Held: In order for a merger to be a tax-free
     reorganization within the meaning of sec. 368(a)(1)(A),
     I.R.C., there must be continuity of the business
     enterprise of the acquired corporation. See sec.
     1.368-1(b), Income Tax Regs. Continuity of business
     enterprise requires that the acquiring corporation
     either continue the acquired corporation’s historic
     business or use a significant portion of the acquired
     corporation’s historic business assets in a business.
     See sec. 1.368-1(d)(2), Income Tax Regs. C did not
     continue P’s historic business or use a significant
     portion of P’s historic business assets in a business.
     Therefore, C did not satisfy the continuity of business
     enterprise requirement for a tax-free reorganization.
     As a result, H must recognize gain equal to excess of
     the fair market value of the property that he received
     for his P stock over his basis in his P stock.



     Frederick Brook Voght and Shane T. Hamilton, for

petitioners.

     Ross A. Rowley and Steven M. Webster, for respondent.
                               - 3 -

     RUWE, Judge:   Respondent determined a deficiency in Archie

L. and Louise B. Honbarrier’s Federal income tax for 1993 in the

amount of $2,090,149.   Respondent determined a deficiency in

Colonial Motor Freight Line, Inc.’s (Colonial) Federal income tax

for 1993 in the amount of $27,374.

     The sole issue for decision is whether the merger of

Colonial into Central Transport, Inc. (Central), on December 31,

1993, qualifies as a tax-free reorganization within the meaning

of section 368(a)(1)(A).1

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts, first supplemental stipulation of

facts, and the attached exhibits are incorporated herein by this

reference.   Mr. and Mrs. Honbarrier resided in High Point, North

Carolina, at the time they filed their petition.    At the time

Central filed its petition as successor to Colonial, its

principal place of business was High Point, North Carolina.

Colonial

     Colonial was incorporated in 1941.     Colonial was a trucking

company that operated as a common carrier of packaged freight.

The company principally transported furniture manufactured in



     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code and income tax regulations in effect
for the year in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                                - 4 -

North Carolina.    Colonial hauled freight in conventional van

trailers pulled by highway tractors.

     Colonial held an operating authority granted by the

Interstate Commerce Commission (ICC) and an operating authority

granted by the State of North Carolina.    These authorities

granted Colonial contract and common carrier status between

specified points and places within the United States and North

Carolina for the transportation of packaged freight.

     When the trucking industry was deregulated at the Federal

level in the 1980's, Colonial was subjected to competition from

small individual truckers, with low overhead costs.    As a result,

Colonial’s ICC operating authority became worthless, and the

company experienced significant business reversals.

     Colonial operated at a loss in the late 1980's.    On its

Federal income tax returns2 for 1987 and 1988, Colonial reported

ordinary losses from trade or business activities as follows:

                  Year               Loss
                  1987           $1,291,408
                  1988            2,245,186
                    Total         3,536,594

     In 1988, as a result of its financial losses, Colonial

stopped hauling freight and began selling its operating assets.

By December 31, 1990, Colonial had sold all of its operating



     2
      Colonial elected S corporation status in 1985. At the end
of 1992, Colonial’s S corporation status was terminated pursuant
to sec. 1362(d)(3). Colonial was a C corporation in 1993.
                               - 5 -

assets, except for the ICC and North Carolina operating

authorities, for cash and cash equivalents.     On August 21, 1992,

Colonial sold its North Carolina authority for $5,000 but

retained its ICC authority.

     Colonial invested the proceeds from the sale of its

operating assets almost exclusively in tax-exempt bonds and a

municipal bond fund.   Colonial held 18 tax-exempt bonds, 16 of

which were purchased in 1990 and 1991, and 2 of which were

purchased in 1992.   One bond was redeemed in 1991, and three

bonds were redeemed in 1992 and 1993.     Colonial continued to hold

the remaining 14 bonds as of the end of 1993.

     As of October 31, 1993, 2 months prior to the merger,

Colonial held approximately $7.35 million in tax-exempt bonds and

a municipal bond fund and approximately $1,500 in cash.       On

December 31, 1993, Colonial liquidated one of its tax-exempt

bonds and its municipal bond fund.     The proceeds of this

liquidation together totaled more than $2,550,000.     As a result,

Colonial’s cash position increased significantly.

     Immediately prior to the merger of Colonial into Central on

December 31, 1993,3 Colonial’s assets and liabilities consisted

of the following:




     3
      The merger agreement provided that the merger would occur 1
second before midnight on Dec. 31, 1993.
                                      - 6 -

Assets                           Tax Basis                Fair Market Value
Cash                            $2,413,839                    $2,413,839
Tax-exempt bonds                 4,549,146                     4,549,146
Interest and dividends
 receivable                          37,800                         37,800
                                     1                              2
ICC authority                          -0-                            -0-
Alex Brown and Sons
  Account

     Cash                            1,482                          1,482
     Money funds                    18,926                         18,926
     Tax-exempt bonds              300,000                        300,000
  Total                          7,321,193                      7,321,193

Liabilities
Federal and State income
 tax payable                                                       (76,142)
  Total                                                          7,245,051
      1
        TheICC authority had no book value or tax basis.
      2
       Due to Federal deregulation of the trucking industry in the 1980's,
Colonial’s ICC operating authority became worthless.

      The only expenses incurred by Colonial in 1993, other than

Federal and State income taxes and the State intangible tax, were

professional fees of $900 and office supplies of $8,733.

      From 1985 to December 31, 1993, Mr. Honbarrier owned 100

percent of Colonial’s issued and outstanding shares.                  From 1988

through 1993, Mr. Honbarrier was the sole director of Colonial.

On December 31, 1993, Mr. Honbarrier’s Colonial stock (245

shares) had a tax basis of $291,506.

Central

      Central was incorporated under the laws of North Carolina in

1951.    From 1951 through 1997, Central was a trucking company
                               - 7 -

that operated as a bulk carrier of liquid and dry chemicals.4

Some of the chemicals that Central hauled were toxic.       Central

transported bulk chemicals in tanker trailers pulled by tractors.

     Central held operating authorities issued by the ICC,

various States, and Canada.   These authorities granted Central

contract and common carrier status for the transportation of bulk

chemicals, including liquid or dry toxic chemicals, in tanker

trailers between points and places within the United States,

various States, and Canada.   Central faced minimal competition

because of the expensive equipment required to engage in the

tanker trucking business.

     Central was an S corporation.5    Central was highly

successful in its bulk chemical hauling business, realizing net

ordinary income from 1991 through 1996 as follows:

               Year                     Amount
               1991                   $2,399,057
               1992                    2,321,825
               1993                    3,242,161
               1994                    8,239,741
               1995                    7,043,522
               1996                    6,046,232
                 Total                29,292,538




     4
      Central sold substantially all its operating assets and the
right to operate under the name of Central Transport, Inc., in
1997. After the sale, Central ceased its motor carrier
operations and changed its name to Honbarrier, Inc.
     5
      An S corporation generally pays no income tax. Rather, the
corporate income is taxed to the shareholders on a pro rata
basis. See sec. 1366.
                               - 8 -

     The yearend balances in Central’s accumulated adjustments

account6 reported on Central’s Federal income tax returns for the

years 1991 through 1996 show undistributed earnings as follows:

                Year              Account Balance
                1991                $8,378,797
                1992                 9,893,868
                1993                10,693,387
                1994                 7,333,838
                1995                 6,449,973
                1996                 6,592,738

     On several occasions, Charles L. Odom, a certified public

accountant and Mr. Honbarrier’s tax and financial adviser,

recommended that Central make distributions to shareholders if

such funds were not needed in Central’s business.    In a

memorandum to attorney Charles Lynch, dated November 5, 1993, Mr.

Odom stated:   “Central has $10 million in undistributed S Corp

earnings and would like [to] make a significant distribution to

shareholders, but needs its capital for expansion and replacement

of aging equipment.”

     Unlike Colonial, Central did not invest in tax-exempt bonds.

Central held passive investments in the form of short-term liquid

investments, such as certificates of deposit, because it needed

cash and cash equivalents to operate its business.    As of yearend

1991 through yearend 1996, Central held cash and short-term

investments in the following amounts:


     6
      The accumulated adjustments account reflects undistributed
earnings of Central on which Central’s shareholders had paid tax.
See sec. 1368.
                                - 9 -

                Yearend               Amount
                  1991              $5,621,829
                  1992               5,688,948
                  1993              11,924,102
                  1994              10,658,199
                  1995               9,363,012
                  1996              11,999,759

     For its taxable years 1991 through 1996, Central declared

distributions to its shareholders as follows:

               Year                       Amount
               1991                        -0-
               1992                     $1,000,000
               1993                      7,000,000
               1994                      7,540,000
               1995                      8,333,838
               1996                      6,449,974
                 Total                  30,323,812

     Both Central and Colonial had a long history of operating

debt free, in accordance with Mr. Honbarrier’s conservative

business policy of avoiding debt.    Central never incurred either

long-term or short-term debt.

     Central pursued a 5-year capital expansion program for

updating equipment.   From 1993 through 1996, Central made

expenditures on property and equipment as follows:

               Year                     Expenditure
               1993                     $8,481,534
               1994                      5,764,211
               1995                      6,600,730
               1996                      4,806,384
                 Total                  25,652,859

The majority of these expenditures were for power units (i.e.,

tractors) and stainless steel tankers.      These expenditures were

made on a debt-free basis from Central’s available funds.
                                - 10 -

     From 1982 through 1997, all of Central’s stock was owned by

Mr. and Mrs. Honbarrier and their children, Gary L. Honbarrier

and Linda Embler.   During the same period, Central had only four

directors, consisting of Mr. and Mrs. Honbarrier and their two

children.

Merger of Colonial into Central

     On December 31, 1993, Colonial merged into Central in

accordance with the laws of North Carolina.    Central was the

surviving corporation.     Prior to the merger, Mr. Odom requested

that Mr. Lynch research the income tax implications of a merger.

On November 5, 1993, 7 weeks before the merger, Mr. Odom made the

following handwritten notes:

     ALH Oks merger of Col. & Central, payout to Cen.
     shareholders

     - if tax free
     - need bus. purpose

     On November 11, 1993, after researching the matter, Mr.

Lynch sent Mr. Odom a memorandum identifying the following

possible business reasons for the merger:    (1) Obtaining

Colonial’s ICC operating rights to expand Central’s business; (2)

reducing and simplifying operating procedures and expenses by

utilizing Central’s existing staff and facilities; (3) reducing

administrative expenses due to projected increased revenue

without increasing overhead expenses; and (4) use of Colonial’s
                               - 11 -

cash to permit Central to expand and capitalize on the operating

rights acquired from Colonial.

       In a letter dated November 12, 1993, Mr. Odom forwarded a

copy of Mr. Lynch’s memorandum to Mr. Honbarrier and stated the

following:

       Since Colonial has no intention of returning to the
       transportation industry, its intangible assets (ICC
       Authority), which would be lost on liquidation, could
       benefit another company within that industry. It seems
       to me that a merger could benefit both Central and
       Colonial. Central would be acquiring valuable rights
       for current and future use, as well as a substantial
       addition to its working capital. Colonial would no
       longer be required to maintain records and manage its
       investments, file separate income tax returns and
       whatever other administrative duties are now required.

       On November 16, 1993, Mr. Honbarrier telephoned Mr. Odom to

tell him to proceed with the merger.    Mr. Honbarrier’s approval

of the merger was forwarded to Mr. Lynch by Mr. Odom on the same

day.

       On December 22, 1993, Colonial and Central entered into an

Agreement and Plan of Merger of Colonial with and into Central

(Merger Agreement) providing for a merger of Colonial into

Central to occur 1 second before midnight on December 31, 1993.

On December 22, 1993, the shareholders and directors of Central

unanimously approved the merger.    The directors and shareholders’

written consent provided, in part, as follows:

       WHEREAS, Colonial Motor Freight Line, Incorporated, has
       certain Interstate Commerce Commission operating
       authorities which the Corporation wishes to acquire for
       current and future use as well as Colonial’s
                                     - 12 -

      substantial working capital in order to permit it to
      make use of Colonial’s ICC authority;

      As previously stated, Colonial’s ICC operating authority had

no value, and Central never used the ICC operating authority

acquired from Colonial in the merger.           Central never operated as

a packaged-freight carrier.

      For purposes of the merger, Mr. Odom determined that the

premerger value of Central’s stock was $417.45 per share.                He

then determined that the net asset value of Colonial, which was

being acquired by Central, was $7,442,6607 and that the number of

Central shares necessary to compensate Mr. Honbarrier for his

Colonial stock was 17,840 shares.           Pursuant to the merger, Mr.

Honbarrier’s 245 shares of Colonial stock were exchanged for

17,840 shares of Central stock.           The merger changed Central’s

shareholder ownership as follows:
                   Before Merger:                After Merger:
                   Shares   Percent Ownership    Shares    Percent Ownership
Mr. Honbarrier     65,484        72.0396         83,324         76.6268
Mrs. Honbarrier       300         0.3300            300          0.2760
Gary L. Honbarrier 12,558        13.8152         12,558         11.5486
Linda Embler       12,558        13.8152         12,558         11.5486
  Total            90,900       100.0000        108,740        100.0000

      On December 22, 1993, the board of directors of Central also

declared a $7 million distribution payable to its shareholders on

December 31, 1993.       The shareholder distribution was allocated on

a pro rata basis among the shareholders based on their stock


      7
      This figure includes $175,000 for Colonial’s ICC operating
authority. As we previously found, the ICC operating authority
had no value and should not have been included in Colonial’s net
asset value.
                                - 13 -

ownership in Central on December 22, 1993.    The amounts to be

distributed to the various shareholders were as follows:

     Shareholder            Allocable Amount of Distribution
     Mr. Honbarrier                   $5,042,772
     Mrs. Honbarrier                      23,102
     Gary L. Honbarrier                  967,063
     Linda Embler                        967,063
       Total                           7,000,000

     With the exception of the amount allocable to Mr.

Honbarrier, all of the declared distributions were paid by check

on December 31, 1993.     Central made the $5,042,772 distribution

to Mr. Honbarrier in two parts.    The first part was paid via a

$493,626 check drawn on Central’s account on December 31, 1993.

Thus, the cash distributions made to Mr. Honbarrier and the other

shareholders on December 31, 1993, totaled $2,450,854.8    The

second part of the distribution to Mr. Honbarrier was made on

January 3, 1994, and consisted of $4,549,146 in tax-exempt

bonds.9   The tax-exempt bonds distributed to Mr. Honbarrier on

January 3, 1994, were the same bonds acquired by Central from

Colonial in the merger.

     For Federal income tax purposes, petitioners treated the

merger as a tax-free reorganization within the meaning of section

368(a)(1)(A) and treated the $7 million distribution as a


     8
      The cash and cash equivalents that Central received from
Colonial on Dec. 31, 1993, totaled $2,472,047.
     9
      The parties have stipulated that Mr. Honbarrier was in
actual or constructive receipt of his entire $5,042,772 share of
the distribution at the close of 1993.
                               - 14 -

payment of previously taxed income reflected in Central’s

accumulated adjustments account.

                               OPINION

     As a general rule, any gain recognized on the sale or

exchange of property is taxable.   However, the Internal Revenue

Code provides that certain transactions may occur in such a way

that ownership interests are exchanged, yet no taxable event is

deemed to have taken place.    One instance where nonrecognition is

provided involves corporate reorganizations that come within the

provisions of section 368.    The income tax regulations explain

the rationale behind the reorganization provisions as follows:

     Under the general rule, upon the exchange of property,
     gain or loss must be accounted for if the new property
     differs in a material particular, either in kind or in
     extent, from the old property. The purpose of the
     reorganization provisions of the Code is to except from
     the general rule certain specifically described
     exchanges incident to such readjustments of corporate
     structures made in one of the particular ways specified
     in the Code, as are required by business exigencies and
     which effect only a readjustment of continuing interest
     in property under modified corporate forms. Requisite
     to a reorganization under the Code are a continuity of
     the business enterprise under the modified corporate
     form, and (except as provided in section 368(a)(1)(D))
     a continuity of interest therein on the part of those
     persons who, directly or indirectly, were the owners of
     the enterprise prior to the reorganization. * * * [Sec.
     1.368-1(b), Income Tax Regs.]

     Shareholders generally do not recognize gain or loss when

stock in a corporation that is a party to a reorganization is,

pursuant to a plan of reorganization, exchanged solely for stock

in another corporation that is a party to the reorganization.
                               - 15 -

See sec. 354(a)(1).    Section 368(a)(1)(A) defines a

reorganization as “a statutory merger or consolidation”.    A

statutory merger or consolidation is one effected pursuant to the

corporate laws of the United States, a State, a territory, or the

District of Columbia.    See sec. 1.368-2(b)(1), Income Tax Regs.

The merger of Colonial into Central meets this literal

requirement.    Petitioners argue that they are entitled to tax-

free treatment under the Code because the merger was a complete

and valid transaction for State law purposes.

     It has long been held that qualification as a merger under

State law is not, by itself, sufficient to qualify as a

reorganization under section 368(a)(1)(A).    Courts have

interpreted section 368 as imposing three additional requirements

for a merger to be treated as a reorganization under section

368(a)(1)(A).    These are: (1) Business purpose; (2)continuity of

business enterprise; and (3) continuity of interest.    See Gregory

v. Helvering, 293 U.S. 465 (1935); Wortham Mach. Co. v. United

States, 521 F.2d 160 (10th Cir. 1975); Cortland Specialty Co. v.

Commissioner, 60 F.2d 937 (2d Cir. 1932); Atlas Tool Co. v.

Commissioner, 70 T.C. 86, 100 (1978), affd. 614 F.2d 860 (3d Cir.

1980).   Following judicial precedent, the regulations also

require that there be a business purpose for the transaction,

continuity of business enterprise, and continuity of interest, in

order for a merger to qualify as a reorganization under section
                               - 16 -

368(a)(1)(A).    See sec. 1.368-1(b), Income Tax Regs.; T.D. 7745,

1981-1 C.B. 134.    Failure to comply with any one of these

requirements will preclude treatment as a tax-free reorganization

within the meaning of section 368(a)(1)(A).

       Respondent argues that the merger failed to meet the

continuity of business enterprise requirement necessary to

qualify the merger as a tax-free reorganization within the

meaning of section 368(a)(1)(A).10   The continuity of business

enterprise requirement was first expressed in Cortland Specialty

Co. v. Commissioner, supra.    See Laure v. Commissioner, 653 F.2d

253, 258 (6th Cir. 1981).    This requirement is now embodied in

section 1.368-1(b), Income Tax Regs., and described in paragraph

(d) of the same section.    These regulations are based on an

interpretation of judicial precedents which articulate the

continuity of business enterprise doctrine.    See T.D. 7745, 1981-

1 C.B. 134.    The basic concept behind the continuity of business

enterprise requirement is that the receipt of a new ownership

interest in an entity that retains none of the business

attributes of the shareholder’s former corporation is more

closely akin to a sale or liquidation than to a mere adjustment

in the form of ownership.    See Laure v. Commissioner, supra at

258.


       10
      Respondent also argues that the merger did not have any
business purpose. Because we hold that the merger did not
satisfy the continuity of business enterprise requirement, we
need not address respondent’s alternative argument.
                               - 17 -

     Under the income tax regulations, a transaction constitutes

a tax-free reorganization only if there is “a continuity of the

business enterprise under the modified corporate form”.    Sec.

1.368-1(b), Income Tax Regs.   Continuity of business enterprise

requires that the acquiring corporation either continue the

acquired corporation’s historic business or use a significant

portion of the acquired corporation’s historic business assets in

a business.   See sec. 1.368-1(d)(2), Income Tax Regs.   In

essence, the acquiring corporation must retain a link to the

business enterprise of the acquired corporation by continuing the

acquired corporation’s business or by using the acquired

corporation’s business assets in a business.    See Berry Petroleum

Co. v. Commissioner, 104 T.C. 584, 635-636 (1995), affd. 142 F.3d

442 (9th Cir. 1998).   In this case, as explained below, we find

that Central neither continued Colonial’s historic business nor

used a significant portion of Colonial’s historic business assets

in Central’s business operations.

     1.   Continuation of Acquired Corporation’s Historic Business

     In general, a corporation’s historic business is the

business it has conducted most recently.   See sec. 1.368-

1(d)(3)(iii), Income Tax Regs.   Petitioners contend that there is

a continuity of Colonial’s trucking business because Central is

also in the trucking business.   We disagree.
                                - 18 -

     Colonial terminated its business of hauling packaged freight

in 1988.11    It then began selling its operating assets.   From

1988 forward, Colonial had no customers.    By the end of 1990,

Colonial had essentially disposed of its trucking operation

assets for cash and cash equivalents.    The only trucking assets

Colonial retained were its ICC and North Carolina operating

authorities.    The ICC operating authority had become worthless,

and Colonial sold its North Carolina operating authority in 1992

for $5,000.    For 3 years prior to the merger, Colonial’s assets

consisted principally of tax-exempt bonds and a municipal bond

fund.12    During the 3-year period prior to the merger, Colonial

held 18 tax-exempt bonds, 16 of which were purchased in 1990 and

1991, and 2 of which were purchased in 1992.    One bond was

redeemed in 1991, and three bonds were redeemed in 1992 and 1993.

Colonial continued to hold the remaining 14 bonds as of the end

of 1993.

     Colonial stopped hauling freight approximately 5 years prior

to the merger, had essentially sold all of its operating assets 3

years prior to the merger, and for 3 years prior to the merger

kept most of its assets in tax-exempt bonds and a municipal bond


     11
      Colonial principally transported furniture manufactured in
North Carolina.
     12
      The passive income from these money management activities
caused Colonial to lose its S corporation status at the end of
its 1992 tax year pursuant to sec. 1362(d)(3). For the taxable
year 1993, Colonial was a C corporation and Central was an S
corporation.
                                - 19 -

fund.     We conclude that Colonial had abandoned its trucking

business well before the merger.13    Colonial’s most recent

business type activity was acquiring and holding tax-exempt bonds

and a municipal bond fund.     This was Colonial’s historic business

at the time of the merger for purposes of determining whether

there was a continuity of business enterprise.     See, e.g., Abegg

v. Commissioner, 50 T.C. 145 (1968), affd. 429 F.2d 1209 (2d Cir.

1970).14

     As of October 31, 1993, 2 months prior to the merger,

Colonial held approximately $7.35 million in tax-exempt bonds and

a municipal bond fund and approximately $1,500 in cash.     On

December 31, 1993, Colonial liquidated one of those bonds and its

municipal bond fund for more than $2,550,000.     As a result,

Colonial’s cash position increased significantly.

     The fair market value of the tax-exempt bonds held directly



     13
      We also note: (1) The type of trucking business conducted
by Central involving hauling solid and liquid (and sometimes
toxic) chemicals in expensive tanker trailers was different from
the operations previously conducted by Colonial; (2) Central
never operated as a packaged-freight carrier; and (3) Central
never used the ICC operating authority acquired from Colonial in
the merger.
     14
      We recognize that investment activity is not a trade or
business for some purposes. See Commissioner v. Groetzinger, 480
U.S. 23 (1987). However, investment activity has been recognized
as a historic business for purposes of the continuity of business
enterprise doctrine. See Abegg v. Commissioner, 50 T.C. 145
(1968), affd. 429 F.2d 1209 (2d Cir. 1970); see also T.D. 7745,
1981-1 C.B. 134, 139 (Investment operations may constitute a
historic business if the investment assets were not acquired as
part of a plan of reorganization).
                                 - 20 -

by Colonial totaled $4,549,146 just before the merger on December

31, 1993.   Three days after the merger, Central distributed these

same tax-exempt bonds to Mr. Honbarrier.15    This distribution

occurred on January 3, 1994.16    The last tax-exempt bond acquired

by Central in the merger was worth $300,000 and held in the Alex

Brown and Sons account.    This bond was liquidated by Central 4

months after the merger.    Unlike Colonial, Central did not invest

in tax-exempt bonds.   Central placed its money in short-term

liquid investments, such as certificates of deposit because it

needed cash and cash equivalents to operate its business.    Thus,

we conclude that Central did not continue Colonial’s business of

holding tax-exempt bonds and municipal bond funds.

     2.   Significant Use of Acquired Corporation’s Business
          Assets

     Continuity of business enterprise can also be satisfied if

the acquiring corporation uses a significant portion of the

acquired corporation’s historic business assets in a business.

See sec. 1.368-1(d)(4)(i), Income Tax Regs.    A corporation’s

historic business assets are the assets used in its historic


     15
      On Dec. 31, 1993, the date of the merger, Central made
$2,450,854 in cash distributions to Mr. Honbarrier and other
shareholders of Central.
     16
      The merger was effective on Dec. 31, 1993, at 1 second
before midnight. Dec. 31, 1993, fell on a Friday, and the tax-
exempt bonds totaling $4,549,146 were distributed to Mr.
Honbarrier on Jan. 3, 1994, which fell on a Monday. Mr.
Honbarrier testified that the bonds could not be signed over to
him until the bank opened on Monday, Jan. 3, 1994, even though
the merger was effective on Friday, Dec. 31, 1993.
                                - 21 -

business.   See sec. 1.368-1(d)(4)(ii), Income Tax Regs.   Business

assets may include stock and securities.    See id.   In general,

the determination of the portion of the corporation’s assets

considered “significant” is based on the relative importance of

the assets to the operation of the business.    See sec. 1.368-

1(d)(4)(iii), Income Tax Regs.    However, all other facts and

circumstances, such as the net fair market value of those assets,

will be considered.   See id.

     Colonial’s historic business assets were its tax-exempt

bonds and municipal bond fund.    It was never intended that

Colonial’s tax-exempt bonds and municipal bond fund be held by

Central and, after the merger, Central did not use those assets

in its business.   On the day of the merger, Colonial liquidated a

tax-exempt bond and its municipal bond fund for more than $2.5

million in cash.   On the same day, Central made a cash

distribution to Central’s shareholders in the total amount of

$2,450,854.17   Three days after the merger, tax-exempt bonds

totaling $4,549,146 that had been held by Colonial were


     17
      Both the merger and distribution were authorized on Dec.
22, 1993, and both transactions occurred on Dec. 31, 1993. We
are not convinced that Central would have made a $7 million
dividend absent the merger with Colonial in light of Central’s
needs for expansion and replacement of aging equipment and
Central’s practice of not borrowing money. Indeed, Central’s
yearend balances in its accumulated adjustments account (the
undistributed earnings on which tax has been paid by Central’s
shareholders) for 1991 and 1992 were $8,378,797 and $9,893,868,
respectively. Yet, Central made no distributions to shareholders
in 1991 and distributed only $1 million in 1992.
                               - 22 -

distributed to Mr. Honbarrier.18   The remaining tax-exempt bond,

valued at $300,000, which was held in an account with Alex Brown

and Sons, was liquidated 4 months later.

     As a result of the transactions surrounding the merger, all

of Colonial’s investments in tax-exempt bonds and the municipal

bond fund were disposed of and Colonial ceased to exist.    We find

that Central did not use a significant portion of Colonial’s

historic business assets in a business.

     3.   Conclusion

     Central did not continue either Colonial’s historic business

or use a significant portion of Colonial’s historic business

assets in a business.    As a result, Central did not satisfy the

continuity of business enterprise requirement.    See sec. 1.368-

1(b), Income Tax Regs.

     We hold that the merger of Colonial into Central was not a

tax-free reorganization within the meaning of section

368(a)(1)(A).    Because this merger did not qualify as a

reorganization under section 368(a)(1)(A), Mr. Honbarrier’s

exchange of Colonial stock for valuable consideration was a

taxable event.    Colonial’s assets had a net fair market value of



     18
      The merger was not effective until 1 second before
midnight on Dec. 31, 1993. As a result, ownership in Colonial’s
assets could not pass to Central until then. However, on Dec.
27, 1993, Central instructed the financial institutions holding
Colonial’s bonds valued at $4,549,146 that those bonds were to be
transferred to Mr. Honbarrier effective Jan. 3, 1994. On Jan. 3,
1994, they were transferred to Mr. Honbarrier.
                                 - 23 -

$7,245,05119 at the time Colonial was merged into Central.

Petitioners acknowledge that Mr. Honbarrier received full fair

market value for his stock in Colonial.20     Mr. Honbarrier must

therefore recognize capital gain of $6,953,545, which is equal to

the excess of the fair market value of assets he received for his

Colonial stock ($7,245,051) over his basis ($291,506).21

     In the notice of deficiency to Colonial, respondent

determined that Colonial had a gain on the sale or exchange of

its assets in the merger transaction.     However, respondent now

agrees that Colonial did not realize any gain because the fair

market value of its assets equaled its tax basis in those assets.



                                      Decision will be entered under

                                 Rule 155 in docket No. 9053-97.

                                      Decision will be entered for

                                 petitioner in docket No. 9054-97.


     19
          $7,321,193 - $76,142 (tax liability) = $7,245,051
     20
      Mr. Honbarrier was provided with 17,840 shares of Central
stock, which petitioners determined had a value equal to the net
asset value of Colonial. In their brief, petitioners state: “At
the time of the merger, Mr. Honbarrier’s 245 shares of Colonial
stock were converted into 17,840 shares of Central stock, which
were equivalent in value to his Colonial shares.”
     21
      On brief, respondent proposes several substance-over-form
arguments. In light of our conclusion that the statutory merger
of Colonial into Central fails the continuity of business
enterprise requirement under sec. 1.368-1(b), Income Tax Regs.,
and therefore does not qualify as a tax-free reorganization
within the meaning of sec. 368(a)(1)(A), we need not decide or
address respondent’s various substance-over-form scenarios.
