ID: A

Chapter 04 Answer Section

TRUE/FALSE 1. ANS: T PTS: 1 DIF: 1 REF: p. 4-3 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 2. ANS: F Realized gain is recognized to the extent of the boot received. However, losses are not recognized on the receipt of boot. PTS: 1 DIF: 1 REF: p. 4-4 NAT: AICPA FN-Reporting | AACSB Analytic 3. ANS: F Section 351 does not permit the recognition of realized losses. OBJ: 1 MSC: 2 min

PTS: 1 DIF: 1 REF: p. 4-4 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 4. ANS: F If a shareholder ends up with a realized loss, the receipt of the boot will not cause that loss to be recognized. The receipt of boot will only trigger a realized gain. PTS: 1 DIF: 1 REF: p. 4-4 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 5. ANS: T If a shareholder ends up with a realized loss, boot does not trigger gain or loss recognition. PTS: 1 DIF: 1 REF: p. 4-4 NAT: AICPA FN-Reporting | AACSB Analytic 6. ANS: T It is the lesser of and not the greater of. OBJ: 1 MSC: 2 min

PTS: 1 DIF: 1 REF: p. 4-4 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 7. ANS: T Allen recognizes $40,000 of capital gain. The gain on the transfer is limited to the boot received of $40,000; further, the gain is characterized by reference to the assets transferred, which are capital assets in Allens hands. PTS: NAT: 8. ANS: OBJ: MSC: 1 DIF: 1 REF: p. 4-4 OBJ: 1 AICPA FN-Reporting | AACSB Analytic MSC: 5 min T PTS: 1 DIF: 1 REF: p. 4-4 1 NAT: AICPA FN-Reporting | AACSB Analytic 2 min

ID: A 9. ANS: F Gain would not be recognized since an installment obligation is property under 351. PTS: 1 DIF: 1 REF: p. 4-4 | p. 4-5 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 10. ANS: T PTS: 1 DIF: 1 REF: p. 4-4 | p. 4-5 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 11. ANS: T PTS: 1 DIF: 1 REF: p. 4-5 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 12. ANS: T Securities (i.e., long-term debt), as well as other debt, constitute boot under 351. As a result, the receipt of securities can trigger the recognition of realized gain. PTS: 1 DIF: 1 REF: p. 4-5 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 13. ANS: T Realized gain will be recognized to the extent of the cash or fair market value of boot received. PTS: 1 DIF: 1 REF: p. 4-4 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 14. ANS: T Nonqualified preferred stock, as well as securities (i.e., long-term debt), constitute boot under 351. Nonqualified preferred stock possesses many of the attributes of debt. PTS: 1 DIF: 1 REF: p. 4-5 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 15. ANS: F The $20,000 long-term obligation of Blue Corporation constitutes boot. Thus, as to the realized gain of $10,000, Jill must recognize gain of $10,000, the lesser of the realized gain or boot received. PTS: 1 DIF: 1 REF: p. 4-5 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 16. ANS: F Unless the property contributed is relatively insignificant in value compared to the services performed by the transferor who contributes both, the entire contribution will be counted as being for property for purposes of the control requirement. PTS: 1 DIF: 1 REF: p. 4-7 | p. 4-8 | Example 10 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 17. ANS: T In spite of Ralphs momentary control, it will not suffice if such control is lost by a contractually binding prearranged agreement. PTS: 1 DIF: 1 REF: p. 4-7 NAT: AICPA FN-Reporting | AACSB Analytic 2 OBJ: 1 MSC: 5 min

ID: A 18. ANS: F Unless Sally is legally obligated to give the stock to her children, the fact that she had initial control is enough. PTS: 1 DIF: 1 REF: p. 4-7 | Example 8 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 19. ANS: F A person who performs services and also transfers some property can be treated as a member of the transferring group if the property value is not relatively small compared to the value of the stock to be received for services rendered. Although the person will be taxed on the value of the stock issued for services, he or she is not taxed on the value of the stock issued for the property. Further, by being a member of the control group, 351 treatment will not be lost for other persons who contribute property for stock. PTS: 1 DIF: 1 REF: p. 4-7 | p. 4-8 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 20. ANS: T As long as the 80% control requirement is met, there is no limit on the use of 351. PTS: 1 DIF: 1 REF: p. 4-9 | Example 13 OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 21. ANS: T PTS: 1 DIF: 1 REF: p. 4-9 OBJ: 2 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 22. ANS: T One dollar of tainted liabilities causes all liabilities to be treated as boot under 357(b). PTS: 1 DIF: 1 REF: Example 16 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 23. ANS: T PTS: 1 DIF: 1 REF: p. 4-10 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min 24. ANS: T The result is to preclude having a negative stock basis by compelling the transferor to recognize gain on the excess of the liabilities over the basis of the assets. PTS: 1 DIF: 1 REF: Example 17 NAT: AICPA FN-Reporting | AACSB Analytic 25. ANS: F Section 357(b) will predominate in this situation. PTS: 1 DIF: 1 REF: p. 4-11 NAT: AICPA FN-Reporting | AACSB Analytic OBJ: 2 MSC: 2 min

OBJ: 2 MSC: 2 min

ID: A 26. ANS: F The shareholders basis in the stock received is reduced by the amount of the liabilities on the property. PTS: 1 DIF: 1 REF: p. 4-9 OBJ: 2 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min 27. ANS: F When property contributed to a corporation in a 351 transaction has an aggregate basis in excess of its fair market value, the basis in the property is stepped down to its fair market value. Therefore, Geralds stock basis is $120,000 and Rusts basis in the equipment is $85,000. However, if Gerald and Rust both elect, Gerald could reduce his stock basis to its fair market value ($85,000), which would allow Rust to take a carryover basis in the property ($120,000). PTS: 1 DIF: 1 REF: Example 22 | Example 23 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min 28. ANS: T Carl will have a tax basis of $50,000 in his 50 shares in Eagle Corporation, but Ben will have a zero basis in his 50 shares. PTS: 1 DIF: 1 REF: p. 4-12 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 29. ANS: F Pine Corporation has a basis of $60,000 in the land it receives from Isabella. Isabella recognizes a gain of $20,000 on the transfer. Under 362, Pine Corporations basis in the land is equal to Isabellas basis of $40,000 plus the $20,000 gain Isabella recognizes on the transfer. PTS: 1 DIF: 1 REF: p. 4-12 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 30. ANS: T PTS: 1 DIF: 1 REF: Example 24 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min 31. ANS: F Tacking on of the old holding period is allowed only when the asset transferred is a capital or 1231 asset. PTS: 1 DIF: 1 REF: p. 4-16 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min 32. ANS: T PTS: 1 DIF: 1 REF: p. 4-16 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min 33. ANS: T PTS: 1 DIF: 1 REF: p. 4-16 OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min 34. ANS: F The recapture potential carries over to the corporation. PTS: 1 DIF: 1 REF: Example 26 NAT: AICPA FN-Reporting | AACSB Analytic OBJ: 3 MSC: 2 min

ID: A 35. ANS: T PTS: 1 DIF: 1 REF: p. 4-17 OBJ: 4 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 36. ANS: T PTS: 1 DIF: 1 REF: p. 4-17 OBJ: 4 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 37. ANS: T This is a classic capital contribution which has no tax consequences to the transferee corporation. PTS: 1 DIF: 1 REF: p. 4-16 OBJ: 4 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 38. ANS: T A contribution to the capital of a corporation produces neither gain nor loss to either the shareholder or the corporation. PTS: 1 DIF: 1 REF: p. 4-16 NAT: AICPA FN-Reporting | AACSB Analytic 39. ANS: F Not all debt need be so reclassified. PTS: 1 DIF: 1 REF: p. 4-19 NAT: AICPA FN-Reporting | AACSB Analytic 40. ANS: F This makes the debt look like equity. OBJ: 4 MSC: 2 min

OBJ: 5 MSC: 2 min

PTS: 1 DIF: 1 REF: p. 4-20 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 41. ANS: F Since being an investor is not regarded as a trade or business for this purpose, a nonbusiness bad debt is the result. PTS: 1 DIF: 1 REF: p. 4-21 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min 42. ANS: F Amy has a business bad debt deduction. She is a minority shareholder and, thus, under more compulsion to loan the corporation money to protect her job. In addition, her stock investment is low in comparison to her annual salary. PTS: 1 DIF: 1 REF: p. 4-21 | p. 4-22 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 43. ANS: T A transfer of the stock causes the loss of the 1244 trait. Only the original holder of the stock can take advantage of 1244. PTS: 1 DIF: 1 REF: Example 39 NAT: AICPA FN-Reporting | AACSB Analytic OBJ: 6 MSC: 2 min

ID: A MULTIPLE CHOICE 1. ANS: D Walts realized gain of $325,000 is recognized to the extent of the $25,000 of boot received. PTS: 1 DIF: 1 REF: p. 4-3 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 2. ANS: D A long-term note is treated as boot. Thus, Eve is taxed on the value of the note received. PTS: 1 DIF: 1 REF: p. 4-4 | p. 4-5 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 3. ANS: B The exchange is taxable because Bob did not hold 80% control in Dove after the transfer. PTS: 1 DIF: 1 REF: Example 5 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 4. ANS: D Tom has no recognized gain; George recognizes ordinary income of $10,000 representing the stock received for services rendered. Swan Corporation has a basis of $40,000 in the machinery and $20,000 in the land. George has a basis of $30,000 in the stock [$20,000 (basis of machinery) + $10,000 (income from services rendered)]. PTS: 1 DIF: 1 REF: Example 3 | Example 10 | Example 24 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 5. ANS: C The transfer does not qualify under 351 as Ann has only a 1/3 interest in Brown Corporation. PTS: 1 DIF: 1 REF: Example 13 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 6. ANS: C Indigo Corporation has a basis of $360,000 in the inventory [$360,000 (Kevins basis) + $0 (gain recognized by Kevin)]. The $25,000 value of Nicoles services must be capitalized as an organizational expenditure. PTS: 1 DIF: 1 REF: p. 4-12 | p. 4-15 | Example 20 | Example 25 | Figure 4.2 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 7. ANS: E Tara has a recognized gain of $10,000 that is the amount of the boot she is treated as having received. Thus, her basis in the Black Corporation stock is $240,000 [$240,000 (basis of the property given up) $10,000 (boot received) + $10,000 (gain recognized)]. Black Corporations basis in the property is $250,000 [$240,000 (Taras basis in the property) + $10,000 (gain recognized by Tara)]. In terms of the $10,000 boot, 357(b) taints all liabilities even though some are supported by a bona fide business purpose. PTS: 1 OBJ: 2 MSC: 10 min DIF: 2 REF: p. 4-9 | p. 4-10 NAT: AICPA FN-Measurement | AACSB Analytic

ID: A 8. ANS: D Under 357(c), Tim recognizes gain to the extent liabilities (mortgage payable of $135,000) exceed the basis of all assets transferred [$110,000 (building) + $20,000 (cash)]. Wren Corporations basis in the building is $115,000 [$110,000 (Tims basis) + $5,000 (gain recognized by Tim)]. PTS: 1 DIF: 2 REF: p. 4-9 to 4-12 OBJ: 1 | 2 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 9. ANS: A As a result of the transfer, Mary receives boot of $5,000 (fair market value of the automobile) and has additional gain of $5,000 (excess of the mortgage over the basis of the building). Since the sum of these amounts is less than the realized gain of $75,000, $10,000 is recognized under 351. White Corporations basis in the building is $25,000 [$15,000 (Marys basis in the building) + $10,000 (Marys recognized gain)]. PTS: 1 DIF: 2 REF: p. 4-4 | p. 4-9 to 4-12 OBJ: 1 | 2 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 10. ANS: A An installment obligation qualifies as property under 351. Thus, Kim recognizes no gain on the transfer. Cardinal has a basis of $30,000 in the installment obligation. PTS: 1 DIF: 1 REF: p. 4-4 | p. 4-12 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 11. ANS: D Sarah has no recognized gain and Emily recognizes income of $20,000 representing the stock received for services rendered. Red Corporation has a basis of $80,000 in the computers and $40,000 in the real estate. Emily has a basis of $60,000 in the stock [$40,000 (basis of real estate) + $20,000 (income recognized from services rendered)]. PTS: 1 DIF: 2 REF: Example 3 | Example 10 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 12. ANS: D Wade has no recognized gain on the transfer and Paul recognizes income of $10,000 representing the stock received for services rendered. Swan Corporation has a basis of $40,000 in the machinery and $20,000 in the land. Paul has a basis of $30,000 in the stock in Swan Corporation [$20,000 (basis of land) + $10,000 (income recognized from services rendered)]. PTS: 1 OBJ: 1 | 3 MSC: 10 min DIF: 2 REF: Example 3 | Example 10 NAT: AICPA FN-Measurement | AACSB Analytic

ID: A 13. ANS: A Rick has a realized gain of $60,000 determined as follows. Amount realized Fair market value of the stock in Warbler Corporation Cash received Liability transferred Less: Basis of property transferred Realized gain

$225,000 75,000 30,000

$330,000 (270,000) $ 60,000

Because recognized gain cannot exceed the lesser of the realized gain ($60,000) or the boot received ($75,000), the recognized gain is $60,000. Ricks basis in the Warbler Corporation stock is $225,000 [$270,000 (basis of property transferred) $75,000 (boot received) $30,000 (liability transferred) + $60,000 (gain recognized)]. Warbler Corporations basis in the property transferred is $330,000 [$270,000 (basis in the property transferred) + $60,000 (gain recognized)]. PTS: 1 DIF: 3 REF: p. 4-4 | p. 4-11 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 14. ANS: D The fact that the stock was not in proportion to the value of the property transferred (choice a.) does not prevent 351 from applying. Since 351 applies and no boot was received, Tony does not recognize a gain (choice b.). His basis in the stock is $35,000 plus $5,000, the basis of the stock implicitly gifted by Sarah to Tony (not $50,000 as in choice c.). PTS: 1 DIF: 2 REF: p. 4-4 | p. 4-11 | Example 7 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 15. ANS: B This fact pattern comes within the scope of 351. As such, Hunter does not recognize the realized loss of $30,000 (choice a.). Although cash was involved, it was given and not received by Warren (choice c.). Only boot received triggers gain recognition under 351. Tan Corporation has a basis of $180,000 in the equipment transferred by Hunter ($210,000 carryover basis reduced by the $30,000 built-in loss) and $15,000 in the land (not $45,000 as in choice d.) transferred by Warren. PTS: 1 DIF: 2 REF: p. 4-3 | p. 4-4 | p. 4-12 | Example 22 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 16. ANS: D Erica has a recognized gain of $200,000 which is the amount of the boot she is treated as having received through her receipt of the securities in Robin Corporation. The basis of the land to Robin would be equal to the basis Erica had in the land, $100,000, plus the gain recognized by Erica, $200,000, or $300,000. PTS: 1 OBJ: 1 | 3 MSC: 10 min DIF: 2 REF: p. 4-5 | p. 4-11 | p. 4-12 NAT: AICPA FN-Measurement | AACSB Analytic

ID: A 17. ANS: D This is a taxable exchange because Kathleen did not meet the 80% control requirement of 351. Thus, Mockingbird Corporation will have a basis of $180,000 in the equipment and land; Kathleen has a recognized loss of $12,000 on the equipment and a recognized gain of $36,000 on the land; and she has a basis of $280,000 in the Mockingbird Corporation stock she receives. PTS: 1 DIF: 2 REF: p. 4-9 | p. 4-12 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 18. ANS: C Dawn has a basis of $10,000 in the stock in the newly formed corporation [$105,000 (basis in the assets transferred to the corporation) $95,000 (liabilities assumed by the corporation)]. Because the trade accounts payable give rise to a deduction, they are not considered to be liabilities for purposes of 357(c); thus, liabilities do not exceed basis. In addition, the cash basis payables are not considered in the computation of Dawns stock basis. Dawn has no gain on the transfer, and the basis of the assets to the corporation is $105,000. PTS: 1 DIF: 3 REF: p. 4-10 | p. 4-11 OBJ: 1 | 2 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 19. ANS: E The mortgage on the land exceeds Carls basis in the land by $30,000. This amount would be recognized gain under 357(c). In addition, the note payable to Carl does not qualify for nonrecognition under 351; thus, Carl would have additional gain of $40,000. Amount realized: Stock Note Release of mortgage Less: Basis of land Realized gain Recognized gain ($30,000 + $40,000)

$ 20,000 40,000 100,000 $160,000 (70,000) $ 90,000 $ 70,000

Cardinal Corporation will have a basis of $140,000 in the land [$70,000 (Carls basis in the land) + $70,000 (gain recognized by Carl with respect to the transfer of the land)]. PTS: 1 DIF: 3 REF: p. 4-4 | p. 4-10 OBJ: 1 | 2 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 20. ANS: E Kirby will not recognize gain on the transfer. Helen will have income of $20,000, the value of the services she rendered to the corporation. Red Corporation will have a basis of $40,000 in the property it acquired from Helen. Red Corporation will not have a business deduction of $20,000. Instead, it must capitalize the $20,000 as an organizational expense. PTS: 1 DIF: 2 REF: Example 25 NAT: AICPA FN-Measurement | AACSB Analytic OBJ: 1 | 3 MSC: 10 min

ID: A 21. ANS: C Gull Corporation has a basis of $50,000 in the property it received from Kay. Kay has income of $10,000 on the exchange. Gull Corporation deducts the $10,000 as a business expense. PTS: 1 DIF: 2 REF: Example 24 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 22. ANS: D Earl will not recognize gain on the transfer. Mary will have income of $120,000, the value of the services she will render to Crow. Crow will have a business deduction of $120,000. PTS: 1 DIF: 2 REF: Example 24 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 23. ANS: B Both Jane and Walt are protected by 351 and have no income to recognize (choices a., c., and d.). The depreciation recapture rules do not apply to Walt because he does not recognize income from the transaction. PTS: 1 DIF: 2 REF: p. 4-16 | Example 2 | Example 3 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 24. ANS: E The transfer comes under 351; thus, Leonard has no recognized gain and no depreciation to recapture. However, when Green Corporation later disposes of the equipment in a taxable transaction, it must take into account the 1245 recapture potential originating with Leonard. The basis of the equipment to Green is $40,000. PTS: 1 DIF: 2 REF: Example 26 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 25. ANS: D PTS: 1 DIF: 1 REF: Example 28 OBJ: 4 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 26. ANS: C The payment will be treated as a payment on the debt. The interest will be ordinary income to Thomas and produce a deduction to Grouse Corporation. PTS: 1 DIF: 1 REF: Example 29 OBJ: 5 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 27. ANS: A Adam will have a taxable dividend of $50,000. Camel will not be permitted a deduction for the $50,000 payment because dividends are not deductible by the distributing corporation. PTS: 1 DIF: 1 REF: p. 4-18 NAT: AICPA FN-Measurement | AACSB Analytic 28. ANS: C Corporate shareholders can only have business bad debts. PTS: 1 DIF: 1 REF: p. 4-21 NAT: AICPA FN-Reporting | AACSB Analytic OBJ: 5 MSC: 5 min

OBJ: 6 MSC: 5 min

10

ID: A 29. ANS: D Lime Corporation can support its debt-equity ratio by stressing the fair market value of its assets. The shareholders also have avoided pro rata holding of debt. Thus, the loans should not be reclassified as equity. PTS: 1 DIF: 2 REF: p. 4-26 | p. 4-27 | Example 37 | Example 38 OBJ: 6 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 30. ANS: B PTS: 1 DIF: 2 REF: Example 32 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 31. ANS: B For purposes of 1244 treatment, the basis in the stock is $35,000. When the stock is sold for $25,000, only $10,000 qualifies as an ordinary loss; the remaining $5,000 loss is a capital loss. PTS: 1 OBJ: 6 MSC: 5 min PROBLEM 1. ANS: Based on the facts provided, the transaction will be taxable to all persons involved. Section 351 treatment will be lost if stock is transferred to persons who did not contribute property, causing those who did to lack control immediately after the exchange. However, if a person performs services for the corporation in exchange for stock and also transfers some property, he or she may be treated as a member of the transferring group although the value of the stock issued for services is taxed. PTS: 1 DIF: 2 REF: Example 9 OBJ: 1 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 2. ANS: Julio has a taxable gain of $1.7 million. Although 351 also applies to transfers of property to existing corporations, Julio did not receive at least an 80% stock ownership. Thus, the transaction is a taxable exchange. Julio has a $1.8 million basis in his stock, and Lime Corporation has a basis of $1.8 million in the property it received. PTS: 1 DIF: 1 REF: Example 13 OBJ: 1 | 3 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 3. ANS: Robert recognizes a gain of $550,000 on the transfer [$700,000 (value of the stock received) $150,000 (basis in the property)]. The transfer does not qualify under 351. Although Robert originally owned 100% of Redbird Corporation, Robert only owns 60% of Redbird Corporation after the transfer [2,000 (shares originally owned) 1,200 (shares transferred to Brittany and Julie) + 1,000 (shares acquired in the transfer), or 1,800 shares out of a total of 3,000 shares]. [The ownership of the shares held by Brittany and Julie cannot be counted because the attribution rules of 318 (discussed in Chapter 6) do not apply to a 351 transfer.] PTS: 1 DIF: 2 REF: Example 13 NAT: AICPA FN-Reporting | AACSB Analytic OBJ: 1 MSC: 5 min DIF: 2 REF: p. 4-23 | Example 32 NAT: AICPA FN-Measurement | AACSB Analytic

11

ID: A 4. ANS: Ashley would have a taxable gain of $650,000 on the transfer. She does not have the requisite 80% control. The transfer by the two shareholders will not qualify the transfer for 351 treatment because the primary purpose of the transfer was to qualify under this section. Should the transfer of property by the two shareholders have a value equal to or in excess of 10% of the fair market value of the stock owned by them after the transfer, the transfer would qualify. PTS: 1 DIF: 2 REF: p. 4-6 | p. 4-7 | p. 4-25 | Example 13 OBJ: 1 | 7 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 5. ANS: Both 357(b) and (c) come into play. Because the land is subject to liabilities in excess of basis, Trudy has a recognized gain of $310,000 pursuant to 357(c). Section 357(b) also applies because Trudy borrowed the $10,000 shortly before incorporating and used the money for personal purposes. Section 357(b) causes all the liabilities ($460,000) to be tainted and treated as boot. Under 357(b), Trudys realized gain of $650,000 [$800,000 (value of the stock received and release of mortgages) $150,000 (basis in the land)] is recognized to the extent of the boot of $460,000. When 357(b) and (c) both apply to the same transfer, 357(b) predominates. Thus, Trudy has a recognized gain of $460,000 on the transfer. Oak Corporation has a basis of $610,000 in the land, computed as follows: $150,000 (carryover basis from Trudy) + $460,000 (gain recognized by Trudy). Trudy has a $150,000 basis in her stock, computed as follows: $150,000 (basis in the land) + $460,000 (gain recognized) $460,000 (liabilities assumed by Oak Corporation). PTS: 1 DIF: 3 REF: p. 4-9 to 4-12 OBJ: 1 | 2 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 6. ANS: a. Nancy recognizes no gain. Due to the boot he receives, Guy recognizes $50,000 of gain. Rod has ordinary income of $50,000 for the services he performs. b. Guys basis in the Goldfinch stock is $120,000 [$120,000 (basis in the land and building) + $50,000 (gain recognized) $50,000 (boot received)]. Goldfinch Corporations basis in the inventory is $90,000. Its basis in the land and building is $170,000 [$120,000 (Guys basis) + $50,000 (gain recognized by Guy)]. Rods basis in the Goldfinch stock is $50,000. DIF: 2 REF: p. 4-4 | p. 4-5 | p. 4-11 | p. 4-12 | Figure 4.1 | Figure 4.2 NAT: AICPA FN-Measurement | AACSB Analytic

c.

d.

PTS: 1 OBJ: 1 | 3 MSC: 10 min

12

ID: A 7. ANS: a. Initially it seems as if the liabilities of $500,000 [$110,000 (trade accounts payable) + $390,000 (bank loan)] exceed the basis of the assets so as to make 357(c) apply. However, for this purpose the trade accounts payable are not counted since they originate from a cash basis taxpayer and would give rise to a deduction. Thus, Sean has no recognized gain. b. c. $10,000 [$400,000 (basis in the assets) $390,000 (bank loan assumed by Aqua Corporation)]. $400,000 (Seans basis in the assets).

PTS: 1 DIF: 2 REF: Figure 4.1 | Figure 4.2 OBJ: 2 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 8. ANS: a. Section 351 applies to these transfers as Irvs stock can be counted in satisfying the control requirement. The property Irv transfers has more than nominal value in comparison to the services rendered. (The property has a value of at least 10% of the value of the services.) Consequently, Barry has no recognized gain. His basis in the Swift Corporation stock is $400,000 [$100,000 (cash) + $300,000 (basis of property transferred) + $0 (gain recognized)]. b. Irv has no recognized gain or loss on the property transfer due to 351. However, he has ordinary income of $50,000 as to the services he renders. He has a basis in the Swift Corporation stock of $560,000 [$510,000 (basis in the land and building) + $50,000 (income recognized related to services rendered)]. Swift Corporation has a compensation deduction of $50,000. Swifts basis in the equipment is $300,000. However, the basis in the land and building must be reduced from $510,000 to $450,000 (their fair market value) because of the $60,000 built-in loss.

c.

PTS: 1 DIF: 2 REF: p. 4-7 | p. 4-8 | p. 4-12 | p. 4-13 | Example 10 | Examples 20 to 22 | Example 24 OBJ: 1 | 3 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 15 min 9. ANS: a. None, as these are contributions to the capital of a corporation by a nonshareholder. b. Zero basis in the land and $700,000 basis in the new plant. The cost of the plant ($1,200,000) must be reduced by the cash ($500,000) received from Union County. DIF: 1 REF: p. 4-16 | p. 4-17 | Example 28 NAT: AICPA FN-Measurement | AACSB Analytic

PTS: 1 OBJ: 4 MSC: 5 min

13

ID: A 10. ANS: Orange Corporation will not have income on the transfers from Lark City or Ann. However, its basis in the donated land is zero. In addition, Orange must reduce its basis in the purchased land and building from $500,000 to $400,000. The basis of any property acquired with money received from a nonshareholder during a 12-month period beginning on the day the contribution is received is reduced by the amount of the contribution. Orange will have a basis of $70,000 in the equipment it receives from Ann. Finally, the transfer, which is a capital contribution by Ann, increases her stock basis in Orange by $70,000. PTS: 1 DIF: 1 REF: p. 4-16 | p. 4-17 | Example 28 OBJ: 4 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 5 min 11. ANS: Payments on the notes will probably be treated as dividends for tax purposes. The debt instruments have too many features of stock. The debt does not bear a legitimate rate of interest, and the debt is proportionate to the stock holdings of Jane, Eve, and Fred. Merlin Corporation has substantial current taxable income indicating an attempt to withdraw earnings in the form of principal and interest payments on debt obligations rather than as dividends. PTS: 1 DIF: 2 REF: p. 4-18 | p. 4-19 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min 12. ANS: If the stock is 1244 stock, Linda has an ordinary loss on the worthless stock. Otherwise, her $20,000 stock investment is a capital loss. The IRS could argue thin capitalization to make the long-term debt equity, and thus, a capital loss. Also, it could contend that both the long-term debt (regardless of whether it can be deemed hybrid stock) and the $40,000 open account are nonbusiness bad debts and, therefore, short term capital losses. Linda would counter with the argument that the $40,000 open account is a business bad debt because the primary motive in loaning money to the corporation was to protect her employment. Although the loan is more than her annual salary, she is paid the salary continuously. Thus, in that context, the salary is more than the investment. Further, she only works for the corporation. PTS: 1 DIF: 2 REF: p. 4-21 | p. 4-22 | Example 30 OBJ: 6 NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min 13. ANS: Joe should sell the stock. He will have a $40,000 ordinary loss deduction in the current year. Joe must remain the original holder of the stock to qualify under 1244 for ordinary loss treatment. If Joe gives the stock to Jake, Jake will have a basis of $15,000 in the stock and, thus, will have no loss deduction. A carryover basis for gifts applies unless fair market value of the property is less on the date of the gift and the property is sold at a loss. PTS: 1 OBJ: 6 | 7 MSC: 10 min DIF: 2 REF: p. 4-23 | Example 31 NAT: AICPA FN-Measurement | AACSB Analytic

14

ID: A 14. ANS: a. For 1244 purposes, Donnas basis in her Egret Corporation stock is $250,000, while her regular income tax basis is $300,000. In the 2005 sale for $100,000, her $50,000 loss results in the following treatment: $25,000 under 1244 (ordinary) and $25,000 not under 1244 (capital). When the rest of the stock becomes worthless in 2011, her $150,000 loss is given the following treatment: $100,000 ordinary and $50,000 capital. Although the 1244 loss potential is $125,000 (one-half of $250,000), only $100,000 can be ordinary in any one year. b. Walter has a $100,000 capital loss, as he does not qualify for 1244 treatment. DIF: 2 REF: p. 4-23 | Example 31 | Example 32 NAT: AICPA FN-Measurement | AACSB Analytic

PTS: 1 OBJ: 6 MSC: 5 min ESSAY

1. ANS: Realized gain or loss is not recognized in a 351 transaction when a taxpayers economic status has not changed. This provision reflects the principle that gain should not be recognized when a taxpayers investment has not substantively changed. When a business is incorporated, the owners economic status remains the same; only the form of the investment has changed. Gain deferral is also justified under the wherewithal to pay concept discussed in Chapter 1. This concept recognizes that if the shareholder receives solely stock in the exchange, he or she is hardly in a position to pay a tax on any realized gain. Finally, 351 was enacted because Congress believed that taxes should not be triggered on the incorporation of a business. Otherwise tax consequences could impede the exercise of sound business judgment (e.g., choice of corporate form of doing business). PTS: 1 DIF: 2 REF: p. 4-3 NAT: AICPA FN-Reporting | AACSB Analytic OBJ: 1 MSC: 10 min

15

ID: A 2. ANS: To the extent that 351 causes a realized gain or loss to go unrecognized, the deferral continues until the shareholder disposes of the stock received in a taxable transaction. To ensure that postponed gain or loss ultimately will be recognized, the basis rules are utilized. Stock received in a 351 transaction is given a substituted basis. The stocks basis is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange and decreased by boot received. The basis of property received by the corporation is determined under a carryover basis rule that provides a basis equal to the basis in the hands of the transferor increased by the amount of any gain recognized by the transferor-shareholder. However, an adjustment to the corporations basis in property received or the shareholders stock basis may be required when loss property is contributed to a corporation in a 351 transaction. In the event a shareholder transfers property with an aggregate adjusted basis in excess of its fair market value, 362(e)(2) generally requires the corporation to step down the carryover basis amount for the property by the amount of the net built-in loss. However, if the shareholder and the corporation elect, the reduction can instead be taken against the shareholders stock basis. PTS: 1 DIF: 2 REF: p. 4-11 to 4-14 OBJ: 1 | 3 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 10 min 3. ANS: Generally when another party assumes a liability in a property transaction, the party no longer responsible for the debt is treated as having received cash or boot. This is consistent with the rule dealing with like-kind exchanges under 1031. However, when the acquiring corporation assumes a liability in a 351 transaction, 357(a) provides that the transfer does not result in boot to the transferor-shareholder for gain recognition purposes. To do so could trigger gain to the property transferor if the corporation assumed a mortgage on the transfer of encumbered property, which could, in turn, discourage the use of the corporate form of business. The general rule of 357(a) has two exceptions: (1) 357(b) provides that if the principal purpose of the assumption of the liabilities is to avoid tax or if there is no bona fide business purpose behind the exchange, the liabilities are treated as boot; and (2) 357(c) provides that if the sum of the liabilities exceeds the adjusted basis of the properties transferred, the excess is taxable gain. PTS: 1 OBJ: 2 MSC: 10 min DIF: 1 REF: p. 4-9 to 4-11 NAT: AICPA FN-Reporting | AACSB Analytic

16

ID: A 4. ANS: Significant tax differences exist between debt and equity in the capital structure. Interest payments on debt are deductible by the corporation while dividend payments on stock are not. Loan repayments of debt are not taxable to investors unless the repayments exceed basis; however, a shareholders nonliquidating receipt of property from a corporation cannot be tax-free as long as the corporation has earnings and profits. Dividend income on equity holdings is taxed to individual investors at the preferential capital gains rates while interest income on debt is taxed at the higher ordinary income tax rates.

PTS: 1 DIF: 1 REF: p. 4-18 | p. 4-19 OBJ: 5 NAT: AICPA FN-Reporting | AACSB Analytic MSC: 10 min 5. ANS: a. Stock that is not 1244 stock. If stock is a capital asset, losses from its worthlessness results in capital loss treatment as of the last day of the taxable year in which the stock becomes worthless. No deduction is allowed for a mere decline in value. A loss on partial worthlessness may be recognized if the stock is sold in a taxable transaction. b. Stock that is 1244 stock. Section 1244 provides ordinary (rather than capital) loss treatment on the sale or worthlessness. The amount of ordinary loss treatment is limited in any one year to $50,000 ($100,000 on a joint return). If the loss exceeds the amount allowed as ordinary, the excess is a capital loss. Corporate bond. If a bond is a capital asset, losses result in capital treatment as of the last day of the taxable year in which the bond becomes worthless. No deduction is allowed for a mere decline in value. A loss on partial worthlessness may be recognized if the bond is sold in a taxable transaction. An uncollectible loan made to a corporation. An uncollectible loan is treated either as a business bad debt or a nonbusiness bad debt. Business bad debts are ordinary losses while nonbusiness bad debts are short-term capital losses. For individuals lending money to a corporation in their capacity as an investor, bad debts are classified as nonbusiness. If a loan is made in a capacity that qualifies as a trade or business, business bad debt treatment results. DIF: 1 REF: p. 4-20 to 4-23 NAT: AICPA FN-Reporting | AACSB Analytic

c.

d.

PTS: 1 OBJ: 6 MSC: 10 min

17