4-1

Chapter 4 Solutions Corporations: Organization & Capital Structure (2012) 26. a. b. $7,000 ordinary gain.

updated: August 8, 2011

$30,000 [$30,000 (basis of inventory) + $7,000 (gain recognized) $7,000 (boot received)]. $37,000 [$30,000 (basis of inventory) + $7,000 (gain recognized)]. John recognizes gain of $9,000 (the amount of cash received). The gain is ordinary income because of the 1245 depreciation recapture provisions. John has a basis of $55,000 in the Pine Corporation stock, computed as follows: $55,000 (basis in the equipment) + $9,000 (gain recognized) $9,000 (boot received). Pine Corporation has a basis of $64,000 in the equipment, computed as follows: $55,000 (basis of the equipment to John) + $9,000 (gain recognized by John). Lucy has no recognized gain or loss. A secret process is property for purposes of 351. Lucy has a basis of $25,000 in the Pine Corporation stock. Pine Corporation has a basis of $25,000 in the secret process. Sylvia has no gain or loss on the transfer. Sylvia has a basis of $30,000 in the Pine Corporation stock.

c. d.

e.

f.

g. h. i. j. k.

pp. 4-3 to 4-13 and Figures 4.1 and 4.2 27. a. b. c. d. e. f. g. $0. $180,000. $140,000. $0. $264,000. $120,000 (basis in the equipment) and $4,000 (basis in the patent). The answers would not change. There is no requirement that the transferors receive the same type of stock. Further, both common stock and most preferred stock qualify as stock. However, if Gail received nonqualified preferred stock, her realized gain would be recognized because this type of preferred stock is treated as boot. The answers would not change. There is no requirement that the transferors be individuals.

h.

Example 2 and Figures 4.1 and 4.2

4-2

30.

Were Barbaras and Alices transfers part of an integrated transaction? Was there an agreement between Barbara and Alice regarding the transfers? Because Alice is Barbaras daughter, can her stock be attributed to Barbara in computing her stock ownership?

p. 4-6 31. The general rule under 351 also applies to transfers to an existing corporation. In this situation, Jaime has a taxable gain of $510,000 ($600,000 $90,000). The exchange will not qualify under 351 because Jaime does not have 80% control immediately following the transfer. Jaime has a basis of $600,000 in the stock, and Hummingbird Corporation has a basis of $600,000 in the property. Example 13 a. Ann does not recognize a gain. Bob recognizes ordinary income of $15,000, the value of the services he rendered to the corporation. Bob does not recognize gain on the transfer of property to the corporation. Examples 3 and 12 Ann has a basis of $150,000 in her stock, while Bob has a basis of $45,000 in his stock [$30,000 (basis in property transferred) + $15,000 (income recognized)]. Figure 4.1 Robin Corporation has a basis of $150,000 in the property Ann transferred and a basis of $30,000 in property Bob transferred. Robin Corporation capitalizes $15,000 as organizational expenditures. Figure 4.2 and Example 25

32.

b.

c.

33.

To be a member of the control group and aid in qualifying all transferors under the 80% test, a person contributing services must transfer property having more than a relatively small value in relation to the services performed. Stock issued for property of relatively small value compared with the value of the stock to be received for services rendered by the person transferring such property will not be treated as issued in return for property. The value of property transferred by Bob is less than 10% of the value of the services he provided. Bob will probably not qualify as a member of the control group. If Bob does not qualify as a member of the control group, Anns transfer will also not qualify as she transferred property for only 70% of the stock. Therefore, both Ann and Bob would recognize gain/income on the exchanges. Robins basis in the property transferred by Ann and Bob will be $420,000 and $15,000, respectively. Examples 10 and 11 In addition to her cash salary of $30,000, Kim has ordinary income of $10,000 [10 (shares of stock in Azure Corporation) $1,000 (value of each share)]. Azure Corporation has a 162 deduction totaling $40,000 ($30,000 cash + $10,000 stock). Example 24 a. The transaction is fully taxable because Rhonda, the sole transferor of property, does not have control immediately after the transaction. Therefore, all of the realized gain is recognized. Amount realizedstock Less: Adjusted basis of property transferred Realized gain Recognized gain Example 13 b. With the change, Rhonda is trying to avoid recognizing the $185,000 gain. The plan involves Rachel becoming a transferor of property along with Rhonda so that together they would meet the 80% control test. However, this plan will not be successful as Rachels interest cannot be countedthe value of the stock she would receive is relatively small compared to the value of the stock she already owns. In addition, $200,000 (15,000) $185,000 $185,000

34.

35.

4-3

Rachels contribution would be made primarily to qualify Rhonda for 351 treatment. p. 4-28 c. The following alternatives would enable Rhonda to avoid gain recognition: Rhonda can transfer property that has not appreciated in value. For example, if she were to contribute $200,000 of cash to Peach, Rhonda would not recognize gain on the transaction. Rachel could contribute property of an amount that is not small relative to the value of the stock already owned. By doing so, she would be considered a transferor of property along with Rhonda, and together, they would have control. As a result, Rhonda would avoid gain recognition. p. 4-24

36.

Natalie recognizes no gain on the transfer. The problem concerns the application of 357(c) since liabilities would exceed basis in the assets if the trade payables are considered. Accounts payable of a cash basis taxpayer that give rise to a deduction when paid are not included as liabilities for purposes of applying 357(c). Consequently, the liabilities (notes payable of $360,000) do not exceed the basis of the assets transferred ($450,000). Natalie has a basis of $90,000 in the stock in Brown Corporation [$450,000 (basis in the assets transferred to Brown Corporation) $360,000 (liabilities assumed by Brown Corporation)]. Brown Corporation has a basis of $450,000 in the assets received from Natalie. pp. 4-10, 4-11, and Figures 4.1 and 4.2

37.

Did the exchange four years ago qualify as a nontaxable exchange under 1031? What basis did Gene acquire in the land? What basis will Gene have in the Bronze Corporation stock? Does Gene have control in Bronze? How are the mortgages on the land treated for tax purposes? Will the second mortgage be treated as boot under 357(b)? What basis will Bronze Corporation have in the land?

pp. 4-2, 4-11, and 4-12 38. Because the two liabilities on the land exceed its basis, 357(c) triggers gain of $50,000 to David [$250,000 (liabilities) $200,000 (basis)]. However, since $100,000 of the borrowed funds were used personally by David and the debt was assumed by the corporation, 357(b) causes all the liabilities to be boot. As 357(b) predominates when both 357(b) and 357(c) apply, David recognizes gain on the transfer of $250,000 and his basis in the White Corporation stock is $200,000 [$200,000 (basis in the land) $250,000 (liabilities assumed by White Corporation) + $250,000 (gain recognized)]. White Corporation has no gain or loss on the transfer and its basis in the land is $450,000 [$200,000 (basis to David) + $250,000 (gain recognized)]. pp. 4-9 to 4-11 and Figures 4.1 and 4.2 39. a. Michaels transfer of property to Peach Corporation is subject to 351. Therefore, the $30,000 realized loss ($260,000 $290,000) is not recognized.

4-4

b. c.

Michaels basis in the Peach stock is $290,000. Note that Michaels basis exceeds the $260,000 value of his stock. Thus, a $30,000 built-in loss exists with respect to his stock. Because the aggregate basis of the assets transferred to Peach exceeds their fair market value, the basis of the loss assets must be stepped down. After the step down, the aggregate basis of the assets will equal their fair market value. The basis of each of the assets is as follows: inventory, $60,000; delivery vehicles, $125,000; shelving, $75,000.

Assets Inventory Delivery vehicles Shelving

Michaels Adjusted Basis $ 60,000 150,000 80,000 $290,000 Unadjusted Tax Basis $ 60,000 150,000 80,000 $290,000 $30,000 = $25,000

Built-in Gain/(Loss) FMV $ 90,000 100,000 70,000 $260,000 $30,000 (50,000) (10,000) ($30,000) Adjusted Tax Basis $ 60,000 125,000 75,000 $260,000

Assets Inventory Delivery vehicles Shelving

Adjustment $ 0 (25,000)* (5,000)** ($30,000)

*$50,000 $60,000 **$10,000 $60,000 d.

$30,000

$5,000

If Michael plans to hold his stock for a substantial period of time, he and Peach may elect to allow Peach to take a carryover basis in the assets received. If they so elect, Michael will reduce his stock basis to $260,000 [$290,000 (stock basis under 358) $30,000 (built-in loss)]. To Peachs advantage, its basis in the assets would be as follows: inventory, $60,000; delivery vehicles, $150,000; shelving $80,000. The election has no effect on the application of 351 on the formation of Peach.

Examples 22 and 23 41. a. Sara does not recognize gain on the transfer. Jane has income of $15,000, the value of the services she renders to Wren Corporation. Wren Corporation has a basis of $25,000 in the property it acquires from Sara and a basis of $10,000 in the property it acquires from Jane. It has a $15,000 business deduction under 162 for the value of the services Jane renders.

b.

Example 24

4-5

42.

a. b.

Jane has income of $15,000 for the value of the services rendered. Wren Corporation has a basis of $10,000 in the property it acquires from Jane. It must capitalize the $15,000 as an organizational expense.

Example 25 44. a. RetailMart Corporation does not recognize any income from the receipt of land, building, and cash. The transfer is viewed as a capital contribution and not taxed pursuant to 118. RetailMart has a zero basis in the land and building. RetailMart Corporation must apply $800,000 of the cash received against the renovation costs, resulting in a zero basis in the building; $300,000 of the cash received is applied against the cost of the inventory, resulting in an inventory basis of zero. The $400,000 excess of the cash received reduces the basis of other property held by RetailMart. The reduction is made in the following order: Depreciable property. Property subject to amortization. Property subject to depletion. All remaining property.

b. c.

d.

pp. 4-16, 4-17, and Example 28 47. a. b. Sam has an ordinary loss of $50,000 and a long-term capital loss of $40,000. Example 31 Kara has a long-term capital loss of $40,000. Only the original holder of 1244 stock qualifies for ordinary loss treatment. p. 4-23 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 July 28, 2011 Mr. Mike Sanders 10 Hunt Wood Drive Hadley, PA 16130 Dear Mr. Sanders: In response to your question with respect to stock you held in a corporation that qualified as a small business corporation under 1244, our conclusion is based on the facts you provided us. Any change in facts may cause our conclusion to be inaccurate. Your brother, Paul, gave you the stock a few months after he purchased it for $40,000 three years ago. You sold the stock this year for $25,000. You may deduct the difference between your basis and the selling price of the stock. When property is given to another, there is a carryover of basis from the donor to the donee. Thus, your basis in the stock is the $40,000 basis your brother, Paul, had in the stock. Consequently, a longterm capital loss of $15,000 results from the sale of the stock. Because you were not the original

48.

4-6

holder of the stock, the special rules of 1244 do not apply. These rules would allow you to take an ordinary (rather than capital) loss deduction on the sale. Should you need more information or need to clarify our conclusion, do not hesitate to contact me. Sincerely yours, Suzy Smith, CPA Partner TAX FILE MEMORANDUM July 19, 2011 FROM: Suzy Smith SUBJECT: Mike Sanders

Today I talked to Mike Sanders with respect to his sale of stock which was issued to his brother, Paul, pursuant to 1244. Paul paid $40,000 for the stock three years ago and gave the stock to his brother, Mike, a few months after he acquired it. Mike sold the stock in the current tax year for $25,000. At issue: May a donee of stock in a corporation that qualified as a small business corporation under 1244 take an ordinary loss deduction pursuant to 1244? Conclusion: No. Only the original holder of 1244 stock qualifies for ordinary loss treatment. p. 4-23