Question

Amy and Ben plan to organize X Corporation to engage in the construction business. Amy will contribute a truck with a basis of $50,000 and a fair market value of $150,000 and a power shovel with a basis of $125,000 and a fair market value of $100,000 in exchange for 20 shares of voting common stock. Ben will contribute $100,000 in cash and undeveloped land, previously held as an investment, having a basis of $20,000 and a fair market value of $150,000, in exchange for 100 shares of $1,000 par value nonvoting preferred stock with an 8% dividend preference and 12 shares of voting common stock. The fair market value of the preferred stock is $100,000. What are the tax consequences to Amy, Ben and X Corporation as a result of formation of the corporation? Specifically, how much, if any, gain must each recognize; what is the basis to each shareholder in the stock received; and what is the corporation's basis in the assets received by it?

Answer 1

solution :

Amy – 20 shares of voting common stock

Property Contributed	AB	FMV
Truck	$50,000	$150,000
Power Shovel	$125,000	$100,000
Aggregate AB/FMV	$175,000	$250,000

Ben –    100 shares of $1,000 par value nonvoting preferred stock with 8% dividend                                          preference.

                12 shares of voting common stock

Property Contributed	AB	FMV
Cash	$100,000	$100,000
Undeveloped land	$20,000	$150,000
Aggregate AB/FMV	$120,000	$250,000

learning notes :

Before determining the tax consequences to the shareholders and the corporation, we must first determine whether § 351(a) applies. If § 351(a) applies, no gain or loss is recognized by a taxpayer who transfers property to a corporation in exchange for stock of that corporation; however, if the requirements of § 351(a) are not met (or avoided), incorporation will constitute a taxable exchange under § 1001(a), (c), since the transferor's change of status from the owner of an asset to the owner of share of a corporation that owns the asset is a realization event. Burnet v. Commonwealth Improvement Co., 287 U.S. 415 (1932).

Tax consequences to Amy –

Tax Consequences to Amy
Property Transferred	Truck	Shovel
Realization Event (§ 1001)	Yes	Yes
Amount Realized (§ 1001(b))	$150,000	$100,000	FMV of Stock Received
Adjusted Basis	$ 50,000	$125,000
Realized Gain/Loss (§ 1001(a))	$ 50,000	($ 25,000)
Recognized?	$0	$0	§ 351(a)
Amy's Basis in Stock	$175,000	§ 358; Treas. Reg. § 1.358-1(a)
Corp.'s Basis in SWT	$50,000		§ 362(a)(1)
Y Corp.'s Basis in LWT		$125,000	§ 362(a)(1)

NOTES :

1. there is no § 362(e)(2) issue here, because immediately after the transaction the corporation's aggregate adjusted basis in the assets transferred ($175,000) would not exceed the aggregate fair market value of those assets ($250,000).

2. Under § 358(a)(1), "[t]he basis of the property permitted to be received under [§ 351] without the recognition of gain or loss shall be the same as that of the property exchanged."

• "The basis of property permitted to be received . . . without recognition of gain or loss," is stock. See § 351(a) ("solely in exchange for stock").
• The fair market value of each share of common stock is $12,500 ($250,000/20).

3. Since Amy exchanged two properties – the truck and the shovel – and since § 358(a)(1) says "[t]he basis of the property permitted to be received . . . shall be the same as that of the property exchanged," could we not say that Amy exchanged the truck with a fair market value of $150,000 and basis of $50,000 for 12 shares of common stock with an aggregate basis of $50,000[1] and exchanged the shovel with a fair market value of $100,000 basis of $125,000 for 8 shares of common stock with an aggregate basis of $125,000? No. Why? Treas. Reg. § 1.358-1(a).

• Treas. Reg. § 1.358-1(a) – "In the case of an exchange to which section 351 . . . applies in which . . . only non recognition property is received, the basis of all the stock . . . received in the exchange shall be the same as the basis of all property exchanged therefore." (emphasis added).
• Thus, § 358(a)(1) read in conjunction with Treas. Reg. § 1.358-1(a) says that Amy exchanged the truck and the power shovel with an aggregate basis of $175,000 for 20 shares of common stock with an aggregate basis of $175,000 ($8750 per share).  

4. Under § 1223(1), Amy should take a tacked holding period in the stock, and on a sale the stock should be treated as held for the period of the transferred property only if the truck and the power shovel were either capital assets (which they are not) or § 1231 gain property.

               

Tax consequences to Ben –

• § 351(a) applies because the preferred stock is not "nonqualified preferred stock" within the meaning of § 351(g)(2).
• For purposes of § 351, "property" includes cash. Rev. Rul. 69-357, 1969-1 C.B. 101.

• · Treas. Reg. § 1.358-2(b)(2) – "If in an exchange to which § 351 . . . applies property is transferred to a corporation and the transferor receives stock . . . of more than one class . . . , then the basis of the property transferred (as adjusted under § 1.358-1) shall be allocated among all of the stock . . . received in proportion to the fair market values of the stock of each class. . . . "

• · Ben takes an "exchanged basis" in the stock received. §§ 358(a), 7701(a)(44). Pursuant to § 358(b)(1) and Treas. Reg. § 1.358-2(b)(2), Ben’s basis in the property transferred, i.e., the cash and land, must be allocated among all of the stock received in proportion to the fair market values of the common and preferred stock. Thus, Ben’s basis in the common stock is $72,000 ($120,000 x ($150,000/$250,000)), and his basis in the preferred stock is $48,000($120,000 x ($100,000/$250,000)).

• · Under § 1223(1), Ben should take a tacked holding period in both the common and preferred stock.

Tax consequences to the corporation –

• § 1032 provides nonrecognition treatment to a corporation when it issues its stock in exchange for property or services and regardless of whether the person to whom the stock is issued is accorded nonrecognition under § 351.

• · Under §§ 362(a)(1), 7701(a)(43), the corporation takes a "transferred basis" in the property

• When a shareholder exchanges more than one item of property solely for stock in a § 351 transfer, the corporation's basis in each item of property is the same as it was in the hands of the shareholder. Thus, the aggregate basis is not reallocated among the properties

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