Taxpayer evidently is publicly held, but has a large shareholder. Taxpayer apparently has NOLs that it wants to protect from a section 382 limitation upon a change of ownership, and it also wants to sell common stock in private placements. Evidently the amount of stock it would sell would trigger an ownership change, absent some modification of the normal rules.

Solution: The large common shareholder is willing to convert to pure preferred stock, which is disregarded for purposes of the ownership change calculations. However, that shareholder does not want to completely miss out on upside growth, which it would because pure preferred cannot participate. Therefore, the shareholder exchanges its common stock for pure preferred stock and warrants to purchase common stock. Then the investors will buy common stock for cash from Taxpayer.

Taxpayer had to represent that it was more likely than not that the warrants would not be exercised. Also the shareholder receiving the warrants had to be willing to forego any management or shareholder voting rights.

The benefit of removing a common shareholder from the ownership calculation is this: Reg. section 1.382-3(j)(3) contains a modification of the public roup segregation rule, which has the effect of ignoring part of an ownership change upon sales of stock by the loss corporation for cash. The way the exemption works is that it grows as the percentage ownership of "direct public groups" grows. Evidently by eliminating the one shareholder who was willing to exchange its common for preferred and warrants, the direct public groups of the Taxpayer grew in relative ownership of Taxpayer, and that increased the part of the cash issuances of stock that could be ignored for ownership change purposes.

The IRS did not rule on aspects of the exchange that would affect the exchanging shareholder.