Joshua Blank (Wachtell) has an interesting paper arguing that we do away with the continuity of interest doctrine for corporate tax reorganizations. His argument that the continuity of interest doctrine has no teeth is fairly persuasive, but I am less sure that making nonrecognition treatment explicitly elective is such a great idea. In the alternative, we could make the continuity of interest test an economic test rather than a formal test (which would make it harder to evade the test through hedging or through taking securities like redeemable preferred stock.)
The hard question, which I don't really have a good handle on, is exactly when, from a policy perspective, it is important to call something a sale (and thus a realization event) versus a reorg (merely shifting money from one pocket to another). There is some sort of subsidy at work here, but it may just be a subsidy for legal and investment banking fees.
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