ch18

COMPREHENSIVE VOLUME--CHAPTER

18--CORPORATIONS: ORGANIZATION AND CAPITAL

STRUCTURE

Student: ___________________________________________________________________________

1. Similar to the like-kind exchange provision, 351 can be partly justified under the wherewithal to pay

concept.

True False

2. Similar to like-kind exchanges, the receipt of boot under 351 can cause loss to be recognized. True False

3. Tina incorporates her sole proprietorship with assets having a fair market value of $100,000 and an adjusted

basis of $110,000. Even though 351 applies, Tina may recognize her realized loss of $10,000.

True False

4. In a 351 transfer, a shareholder receives boot of $10,000 but ends up with a realized loss of $3,000. Only

$7,000 of the boot will be taxed to the shareholder.

True False

5. A taxpayer may never recognize a loss on the transfer of property in a transaction subject to 351.

True False

6. If a transaction qualifies under 351, any recognized gain is equal to the value of the boot received.

True False

7. Allen transfers marketable securities with an adjusted basis of $120,000, fair market value of $300,000, for

85% of the stock of Heron Corporation. In addition, he receives cash of $40,000. Allen recognizes a capital gain

of $40,000 on the transfer.

True False

8. When consideration is transferred to a corporation in return for stock, the definition of property is important because tax deferral treatment of 351 is available only to taxpayers who transfer property.

True False

9. The transfer of an installment obligation in a transaction qualifying under 351 is a disposition of the

obligation that causes gain to be recognized by the transferor.

True False

10. Gabriella and Maria form Luster Corporation with each receiving 50 shares of its stock. Gabriella transfers

cash of $50,000, while Maria transfers a secret process (basis of $0; fair market value of $50,000). Neither

Gabriella nor Maria will recognize gain on the transfer.

True False

11. Because services are not considered property under 351, a taxpayer must report as income the fair market

value of stock received for such services.

True False

12. For 351 purposes, stock rights and stock warrants are included in the definition of stock. True False

13. In a 351 transaction, if a transferor receives consideration other than stock, the transaction can be taxable.

True False

14. The receipt of nonqualified preferred stock in exchange for the transfer of appreciated property to a

controlled corporation results in recognition of gain to the transferor.

True False

15. Ruth transfers property worth $200,000 (basis of $60,000) to Goldfinch Corporation. In return, she receives

80% of its stock (worth $180,000) and a long-term note, executed by Goldfinch and made payable to Ruth

(worth $20,000). Ruth will recognize no gain on the transfer.

True False

16. The control requirement under 351 requires that the person or persons transferring property to the

corporation, immediately after the transfer, own stock possessing at least 80% of the total combined voting

power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of

stock of the corporation.

True False

17. In order to retain the services of Eve, a key employee in Teds sole proprietorship, Ted contracts with Eve to make her a 30% owner. Ted incorporates the business receiving in return 100% of the stock. Three days later,

Ted transfers 30% of the stock to Eve. Under these circumstances, 351 will not apply to the incorporation of

Teds business. True False

18. Beth forms Lark Corporation with a transfer of appreciated property in exchange for all of its

shares. Shortly thereafter, she transfers half her shares to her son, Ted. The later transfer to Ted could cause

the original transfer to be taxable.

True False

19. A person who performs services for a corporation in exchange for stock cannot be treated as a member of

the transferring group even if that person also transfers some property to the corporation.

True False

20. The use of 351 is not limited to the initial formation of a corporation, and it can apply to later transfers as

well.

True False

21. Because boot is generated under 357(b) (i.e., the liability is not supported by a bona fide business

purpose), the transferor shareholder will always have to recognize gain.

True False

22. When incorporating her sole proprietorship, Samantha transfers all of its assets and liabilities. Included in

the $30,000 of liabilities assumed by the corporation is $500 that relates to a personal expenditure. Under these

circumstances, the entire $30,000 will be treated as boot.

True False

23. In determining whether 357(c) applies, assess whether the liabilities involved exceed the bases of all

assets a shareholder transfers to the corporation.

True False

24. A taxpayer transfers assets and liabilities to a corporation in return for its stock. If the liabilities exceed the

basis of the assets transferred, the taxpayer will have a negative basis in the stock.

True False

25. If both 357(b) and (c) apply to the same transfer (i.e., the liability is not supported by a bona fide

business purpose and also exceeds the basis of the properties transferred), 357(c) predominates.

True False

26. When a taxpayer transfers property subject to a mortgage to a controlled corporation in an exchange

qualifying under 351, the transferor shareholders basis in stock received in the transferee corporation is increased by the amount of the mortgage on the property.

True False

27. Basis of appreciated property transferred minus boot received (including liabilities transferred) plus gain

recognized equals basis of stock received in a 351 transfer.

True False

28. Carl and Ben form Eagle Corporation. Carl transfers cash of $50,000 for 50 shares of stock of Eagle. Ben

transfers a secret process with a tax basis of zero and a fair market value of $50,000 for the remaining 50 shares

in Eagle. Carl will have a tax basis of $50,000 in his stock in Eagle Corporation, but Bens basis in his stock will be zero.

True False

29. In general, the basis of property to a corporation in a transfer that qualifies as a nontaxable exchange under

351 is the basis in the hands of the transferor shareholder decreased by the amount of any gain recognized on

the transfer.

True False

30. In return for legal services worth $60,000 rendered incident to its formation, Crimson Corporation issues

stock to Greta, an attorney. Crimson cannot immediately deduct the value of any of this stock but instead must

capitalize it as an organizational expenditure.

True False

31. Kim, a real estate dealer, and others form Eagle Corporation under 351. Kim contributes inventory (land

held for resale) in return for Eagle stock. The holding period for the stock includes the holding period of the

inventory.

True False

32. A shareholder transfers a capital asset to Red Corporation for its stock. If the transfer qualifies under 351,

Reds holding period for the asset begins on the day of the exchange. True False

33. A shareholders holding period for stock received under 351 includes the holding period of the property transferred to the corporation.

True False

34. When depreciable property is transferred to a controlled corporation under 351, any recapture potential

disappears and does not carry over to the corporation.

True False

35. In order to encourage the development of an industrial park, a county donates land to Ecru Corporation. The

donation does not result in gross income to Ecru.

True False

36. A city contributes $500,000 to a corporation as an inducement to locate in the city. Within the next 12

months, the corporation uses the money to purchase property. The corporation has income of $500,000 and

must reduce its tax basis in the property by the same amount.

True False

37. To ease a liquidity problem, all of the shareholders of Osprey Corporation contribute additional cash to its

capital. Osprey has no tax consequences from the contribution.

True False

38. A shareholder contributes land to his wholly owned corporation but receives no stock in return. The

corporation has a zero basis in the land.

True False

39. In structuring the capitalization of a corporation, the tax law is neutral for the investor as to debt versus

equity financing.

True False

40. To help avoid the thin capitalization problem, it is advisable to make the repayment of the debt contingent

upon the corporations earnings. True False

41. Ira, a calendar year taxpayer, purchases as an investment stock in Redbird Corporation on November 1,

2012. On February 1, 2013, Redbird Corporation is declared bankrupt, and Iras stock becomes worthless. Presuming 1244 (stock in a small business corporation) does not apply, Ira has a short-term capital

loss for 2013.

True False

42. Amy owns 20% of the stock of Wren Corporation, which she acquired several years ago at a cost of

$10,000. Amy is Vice-President of Wren and earns a salary of $80,000 annually. Last year, Wren Corporation

was experiencing financial problems, and Amy loaned the corporation $25,000. In the current year, Wren

becomes bankrupt, and both her stock investment and the loan become worthless. Amy has a nonbusiness bad

debt deduction this year of $25,000.

True False

43. If a shareholder owns stock received as a gift from her mother, it cannot be 1244 stock.

True False

44. Mitchell and Powell form Green Corporation. Mitchell transfers property (basis of $105,000 and fair

market value of $90,000) while Powell transfers land (basis of $8,000 and fair market value of $75,000) and

$15,000 of cash. Each receives 50% of Green Corporations stock (total value of $180,000). As a result of these transfers:

A. Mitchell has a recognized loss of $15,000, and Powell has a recognized gain of $67,000.

B. Neither Mitchell nor Powell has any recognized gain or loss.

C. Mitchell has no recognized loss, but Powell has a recognized gain of $15,000.

D. Green Corporation will have a basis in the land of $23,000.

E. None of the above.

45. Jane transfers property (basis of $180,000 and fair market value of $500,000) to Green Corporation for 80%

of its stock (worth $425,000) and a long-term note (worth $75,000), executed by Green Corporation and made

payable to Jane. As a result of the transfer:

A. Jane recognizes no gain.

B. Jane recognizes a gain of $75,000.

C. Jane recognizes a gain of $270,000.

D. Jane recognizes a gain of $320,000.


46. Eileen transfers property worth $200,000 (basis of $190,000) to Goldfinch Corporation. In return, she

receives 80% of the stock in Goldfinch Corporation (fair market value of $180,000) and a long-term note (fair

market value of $20,000) executed by Goldfinch and made payable to Eileen. Eileen recognizes gain on the

transfer of:

A. $0.

B. $10,000.

C. $20,000.

D. $190,000.


47. Gabriella and Juanita form Luster Corporation. Gabriella transfers cash of $50,000 for 50 shares of stock,

while Juanita transfers a secret process (basis of zero and fair market value of $50,000) for 50 shares of stock.

A. The transfers to Luster are fully taxable to both Gabriella and Juanita.

B. Juanita must recognize gain of $50,000.

C. Because Juanita is required to recognize gain on the transfer, Gabriella also must recognize gain.

D. Neither Gabriella nor Juanita will recognize gain on the transfer.


48. Three individuals form Skylark Corporation with the following contributions: Cliff, cash of $50,000 for 50

shares; Brad, land worth $20,000 (basis of $11,000) for 20 shares; and Ron, cattle worth $9,000 (basis of

$6,000) for 9 shares and services worth $21,000 for 21 shares.

A. These transfers are fully taxable and not subject to 351.

B. Rons basis in his stock is $27,000. C. Rons basis in his stock is $6,000. D. Brads basis in his stock is $20,000. E. None of the above.

49. Kevin and Nicole form Indigo Corporation with the following transfers: inventory from Kevin (basis of

$360,000 and fair market value of $400,000) and improved real estate from Nicole (basis of $320,000 and fair

market value of $375,000). Nicole, an accountant, agrees to contribute her services (worth $25,000) in

organizing Indigo. The corporations stock is distributed equally to Kevin and Nicole. As a result of these transfers:

A. Indigo can deduct $25,000 as a business expense.

B. Nicole has a recognized gain of $55,000 on the transfer of the real estate.

C. Indigo has a basis of $360,000 in the inventory.

D. Indigo has a basis of $375,000 in the real estate.


50. Ann transferred land worth $200,000, with a tax basis of $40,000, to Brown Corporation, an existing entity,

for 100 shares of its stock. Brown Corporation has two other shareholders, Bill and Bob, each of whom holds

100 shares. With respect to the transfer:

A. Ann has no recognized gain.

B. Brown Corporation has a basis of $160,000 in the land.

C. Ann has a basis of $200,000 in her 100 shares in Brown Corporation.

D. Ann has a basis of $40,000 in her 100 shares in Brown Corporation.


51. Dick, a cash basis taxpayer, incorporates his sole proprietorship. He transfers the following items to newly

created Orange Corporation.

Adjusted Fair Market

Basis Value

Cash $ 10,000 $ 10,000

Building 120,000 175,000

Mortgage payable (secured by the building and held for

15 years) 135,000 135,000

With respect to this transaction:

A. Orange Corporations basis in the building is $120,000. B. Dick has no recognized gain.

C. Dick has a recognized gain of $5,000.

D. Dick has a recognized gain of $10,000.


52. Albert transfers land (basis of $140,000 and fair market value of $320,000) to Gold Corporation for 80% of

its stock and a note payable in the amount of $80,000. Gold assumes Alberts mortgage on the land of $200,000.

A. Albert has a recognized gain on the transfer of $140,000.

B. Albert has a recognized gain on the transfer of $80,000.

C. Albert has a recognized gain on the transfer of $60,000.

D. Gold Corporation has a basis in the land of $220,000.


53. Rachel owns 100% of the stock of Cardinal Corporation. In the current year Rachel transfers an installment

obligation, tax basis of $180,000 and fair market value of $350,000, for additional stock in Cardinal worth

$350,000.

A. Rachel has a taxable gain of $180,000.

B. Rachel has a taxable gain of $170,000.

C. Rachel recognizes no taxable gain on the transfer.

D. Rachel has a basis of $350,000 in the additional stock she received in Cardinal Corporation.


54. Rob and Fran form Bluebird Corporation with the following investments.


Basis Value

From Rob Cash $400,000 $400,000

From Fran Land 500,000 440,000

Each receives 50% of Bluebirds stock. In addition, Fran receives cash of $40,000. One result of these transfers is that Fran has a:

A. Recognized loss of $60,000.

B. Recognized loss of $20,000.

C. Basis of $460,000 in the Bluebird stock (assuming Bluebird reduces its basis in the land to $440,000).

D. Basis of $400,000 in the Bluebird stock (assuming Bluebird reduces its basis in the land to $440,000).


55. Wade and Paul form Swan Corporation with the following investments. Wade transfers machinery (basis

of $40,000 and fair market value of $100,000), while Paul transfers land (basis of $20,000 and fair market value

of $90,000) and services rendered (worth $10,000) in organizing the corporation. Each is issued 25 shares in

Swan Corporation. With respect to the transfers:

A. Wade has no recognized gain; Paul recognizes income/gain of $80,000.

B. Neither Wade nor Paul has recognized gain or income on the transfers.

C. Swan Corporation has a basis of $30,000 in the land transferred by Paul.

D. Paul has a basis of $30,000 in the 25 shares he acquires in Swan Corporation.


56. Rick transferred the following assets and liabilities to Warbler Corporation.


Basis Value

Building $210,000 $225,000

Equipment 45,000 75,000

Trucks 15,000 30,000

Mortgage (held for four years) on building 30,000 30,000

In return, Rick received $75,000 in cash plus 90% of Warbler Corporations only class of stock outstanding (fair market value of $225,000).

A. Rick has a recognized gain of $60,000.

B. Rick has a recognized gain of $75,000.

C. Ricks basis in the stock of Warbler Corporation is $270,000. D. Warbler Corporation has the same basis in the assets received as Rick does in the stock.


57. Sarah and Tony (mother and son) form Dove Corporation with the following investments: cash by Sarah of

$65,000; land by Tony (basis of $25,000 and fair market value of $35,000). Dove Corporation issues 400 shares

of stock, 200 each to Sarah and Tony. Thus, each receives stock in Dove worth $50,000.

A. Section 351 cannot apply since Sarah should have received 260 shares instead of only 200.

B. Section 351 may apply because stock need not be issued to Sarah and Tony in proportion to the value of the

property transferred.

C. Tonys basis in the stock of Dove Corporation is $50,000. D. As a result of the transfer, Tony recognizes a gain of $10,000.


58. Rhonda and Marta form Blue Corporation. Rhonda transfers land (basis of $55,000 and fair market value

of $180,000) for 50 shares plus $20,000 cash. Marta transfers $160,000 cash for 50 shares in Blue

Corporation.

A. Rhondas basis in the Blue Corporation stock is $55,000. B. Blue Corporations basis in the land is $55,000. C. Blue Corporations basis in the land is $180,000. D. Rhonda recognizes a gain on the transfer of $125,000.


59. Erica transfers land worth $500,000, basis of $100,000, to a newly formed corporation, Robin Corporation,

for all of Robins stock, worth $300,000, and a 10-year note. The note was executed by Robin and made payable to Erica in the amount of $200,000. As a result of the transfer:

A. Erica does not recognize gain.

B. Erica recognizes gain of $400,000.

C. Robin Corporation has a basis of $100,000 in the land.

D. Robin Corporation has a basis of $300,000 in the land.


60. Hazel transferred the following assets to Starling Corporation.


Basis Value

Cash $120,000 $120,000

Machinery 48,000 36,000

Land 108,000 144,000

In exchange, Hazel received 50% of Starling Corporations only class of stock outstanding. The stock has no established value. However, all parties believe that the value of the stock Hazel received is the equivalent of the value of the assets she transferred. The only other shareholder, Rick, formed

Starling Corporation five years ago.

A. Hazel has no gain or loss on the transfer.

B. Starling Corporation has a basis of $48,000 in the machinery and $108,000 in the land.

C. Starling Corporation has a basis of $36,000 in the machinery and $144,000 in the land.

D. Hazel has a basis of $276,000 in the stock of Starling Corporation.


61. Dawn, a sole proprietor, was engaged in a service business and reported her income on a cash basis. Later,

she incorporates her business and transfers the assets of the business to the corporation in return for all the stock

in the corporation plus the corporations assumption of the liabilities of her proprietorship. All the receivables and the unpaid trade payables are transferred to the newly formed corporation. The assets of the proprietorship

had a basis of $105,000 and fair market value of $300,000. The trade accounts payable totaled $25,000. There

was a note payable to the bank in the amount of $95,000 that the corporation assumes. The note was issued for

the purchase of computers and other business equipment.

A. Dawn has a gain on the transfer of $15,000.

B. The basis of the assets to the corporation is $300,000.

C. Dawn has a basis of $10,000 in the stock she receives.

D. Dawn has a zero basis in the stock she receives.


62. Carl transfers land to Cardinal Corporation for 90% of the stock in Cardinal Corporation worth $20,000 plus

a note payable to Carl in the amount of $40,000 and the assumption by Cardinal Corporation of a mortgage on

the land in the amount of $100,000. The land, which has a basis to Carl of $70,000, is worth $160,000.

A. Carl will have a recognized gain on the transfer of $90,000.

B. Carl will have a recognized gain on the transfer of $30,000.

C. Cardinal Corporation will have a basis in the land transferred by Carl of $70,000.

D. Cardinal Corporation will have a basis in the land transferred by Carl of $160,000.


63. Kirby and Helen form Red Corporation. Kirby transfers property, basis of $20,000 and value of $300,000,

for 100 shares in Red Corporation. Helen transfers property, basis of $40,000 and value of $280,000, and

provides legal services in organizing the corporation. The value of her services is $20,000. In return Helen

receives 100 shares in Red Corporation. With respect to the transfers:

A. Kirby will recognize gain.

B. Helen will not recognize any gain or income.

C. Red Corporation will have a basis of $280,000 in the property it acquired from Helen.

D. Red will have a business deduction of $20,000.


64. Joe and Kay form Gull Corporation. Joe transfers cash of $250,000 for 200 shares in Gull Corporation. Kay

transfers property with a basis of $50,000 and fair market value of $240,000. She agrees to accept 200 shares in

Gull Corporation for the property and for providing bookkeeping services to the corporation in its first year of

operation. The value of Kays services is $10,000. With respect to the transfer: A. Gull Corporation has a basis of $240,000 in the property transferred by Kay.

B. Neither Joe nor Kay recognizes gain or income on the exchanges.

C. Gull Corporation has a business deduction under 162 of $10,000.

D. Gull capitalizes $10,000 as organizational costs.


65. Earl and Mary form Crow Corporation. Earl transfers property, basis of $200,000 and value of $1,600,000,

for 50 shares in Crow Corporation. Mary transfers property, basis of $80,000 and value of $1,480,000, and

agrees to serve as manager of Crow for one year; in return Mary receives 50 shares of Crow. The value of

Marys services is $120,000. With respect to the transfers: A. Mary will not recognize gain or income.

B. Earl will recognize a gain of $1,400,000.

C. Crow Corporation has a basis of $1,480,000 in the property it received from Mary.

D. Crow will have a business deduction of $120,000 for the value of the services Mary will render.


66. Four individuals form Chickadee Corporation under 351. Two of these individuals, Jane and Walt, made

the following contributions:


Basis Value

From Jane Cash $360,000 $360,000

Patent 0 40,000

From Walt Equipment (depreciation claimed of $100,000) 240,000 370,000

Both Jane and Walt receive stock in Chickadee Corporation equal to the value of their investments.

A. Jane must recognize income of $40,000; Walt has no income.

B. Neither Jane nor Walt recognize income.

C. Walt must recognize income of $130,000; Jane has no income.

D. Walt must recognize income of $100,000; Jane has no income.


67. Leah transfers equipment (basis of $400,000 and fair market value of $500,000) for additional stock in

Crow Corporation. After the transfer, Leah owns 80% of Crows stock. Associated with the equipment is 1245 depreciation recapture potential of $70,000. As a result of the transfer:

A. Leah recognizes ordinary income of $70,000.

B. The 1245 depreciation recapture potential carries over to Crow Corporation.

C. The 1245 depreciation recapture potential disappears.

D. Leah recognizes ordinary income of $70,000 and 1231 gain of $30,000.


68. In order to induce Yellow Corporation to build a new manufacturing facility in Knoxville, Tennessee, the

city donates land (fair market value of $400,000) and cash of $100,000 to the corporation. Several months after

the donation, Yellow Corporation spends $450,000 (which includes the $100,000 received from Knoxville) on

the construction of a new plant located on the donated land.

A. Yellow recognizes income of $100,000 as to the donation.

B. Yellow has a zero basis in the land and a basis of $450,000 in the plant.

C. Yellow recognizes income of $500,000 as to the donation.

D. Yellow has a zero basis in the land and a basis of $350,000 in the plant.


69. George transfers cash of $150,000 to Finch Corporation, a newly formed corporation, for 100% of the stock

in Finch worth $80,000 and debt in the amount of $70,000, payable in equal annual installments of $7,000 plus

interest at the rate of 9% per annum. In the first year of operation, Finch has net taxable income of $40,000. If

Finch pays George interest of $6,300 and $7,000 principal payment on the note:

A. George has dividend income of $13,300.

B. Finch Corporation does not have a tax deduction with respect to the payment.

C. George has dividend income of $7,000.

D. Finch Corporation has an interest expense deduction of $6,300.


70. Adam transfers cash of $300,000 and land worth $200,000 to Camel Corporation for 100% of the stock in

Camel. In the first year of operation, Camel has net taxable income of $70,000. If Camel distributes $50,000 to

Adam:

A. Adam has taxable income of $50,000.

B. Camel Corporation has a tax deduction of $50,000.

C. Adam has no taxable income from the distribution.

D. Camel Corporation reduces its basis in the land to $150,000.


71. Wren Corporation (a minority shareholder in Lark Corporation) has made loans to Lark Corporation that

become worthless in the current year.

A. Wren Corporation is not permitted a deduction for the loans.

B. The loans result in a nonbusiness bad debt deduction to Wren Corporation.

C. The loans provide Wren Corporation with a business bad debt deduction.

D. Wren claims a capital loss due to the uncollectible loans.


72. George (an 80% shareholder) has made loans to Mountainview Corporation that become worthless in the

current year. George is not employed by Mountainview.

A. George is not permitted a deduction for the worthless loans.

B. The loans provide a nonbusiness bad debt deduction to George in the current year.

C. The loans provide George with a business bad debt deduction.

D. George may claim an ordinary loss as to the worthless loans.


73. When Pheasant Corporation was formed under 351, Kristen transferred property (basis of $26,000 and fair

market value of $22,500) for 1244 stock. Kristens basis in the Pheasant stock is $26,000. Three years later, Pheasant Corporation goes bankrupt and its stock becomes worthless. Kristen, who is single, owned the stock

as an investment. Kristens loss is: A. $26,000 capital.

B. $22,500 ordinary and $3,500 capital.

C. $3,500 ordinary and $22,500 capital.

D. $26,000 ordinary.


74. Art, an unmarried individual, transfers property (basis of $130,000 and fair market value of $120,000) to

Condor Corporation in exchange for 1244 stock. The transfer qualifies as a nontaxable exchange under

351. Because the property is loss property, Condor takes a basis in the property of $120,000. Five years later,

Art sells the Condor stock for $50,000. With respect to the sale, Art has:

A. An ordinary loss of $80,000.

B. An ordinary loss of $70,000 and a capital loss of $10,000.

C. A capital loss of $80,000.

D. A capital loss of $30,000 and an ordinary loss of $50,000.


75. Penny, Miesha, and Sabrina transfer property to Owl Corporation for 75% of its stock. Nancy, their

attorney, receives 25% of the stock in Owl for legal services rendered in incorporating the business. What are

the tax consequences of these transactions? How should this transaction have been handled?

76. Nick exchanges property (basis of $100,000; fair market value of $3 million), for 65% of the stock of

Yellow Corporation. The other 35% of the stock is owned by Gloria who acquired it several years ago. What

are the tax consequences to Nick?

77. Perry organized Cardinal Corporation 10 years ago by contributing property worth $2 million (basis of

$450,000) for 2,500 shares of stock in Cardinal, representing 100% of the stock in the corporation. Perry later

gave each of his children, Brittany and Julie, 750 shares of stock in Cardinal Corporation. In the current year,

Perry transfers property worth $600,000 (basis of $150,000) to Cardinal for 1,000 shares in the corporation.

What gain, if any, will Perry recognize on the transfer?

78. Ashley, a 70% shareholder of Wren Corporation, transfers property with a basis of $250,000 and a fair

market value of $900,000 to Wren Corporation for additional stock. Ashley owns 78% of Wren after the

transfer. Two other shareholders in Wren transfer a nominal amount of property to Wren along with Ashleys transfer so that Ashley and the two shareholders own 90% of the Wren stock after the transfer. Does Ashley

have taxable gain on the transfer?

79. Rita forms Finch Corporation by transferring land (basis of $125,000; fair market value of $750,000) which

is subject to a mortgage of $375,000. Two weeks prior to incorporating Finch, Rita borrows $125,000 for

personal purposes and gives the lender a second mortgage on the land. Finch Corporation issues stock worth

$250,000 to Rita and assumes the two mortgages on the land. What are the tax consequences to Rita and to

Finch Corporation?

80. Nancy, Guy, and Rod form Goldfinch Corporation with the following consideration.


Basis Value

From Nancy Cash $120,000 $120,000

Inventory 90,000 130,000

From Guy Land and building 120,000 250,000

From Rod Legal and accounting services to incorporate 0 50,000

Goldfinch issues its 500 shares of stock as follows: 250 to Nancy, 200 to Guy, and 50 to Rod. In addition, Guy gets $50,000 in cash.

a. Does Nancy, Guy, or Rod recognize gain (or income)?

b. What basis does Guy have in the Goldfinch stock?

c. What basis does Goldfinch Corporation have in the inventory? In the land and building?

d. What basis does Rod have in the Goldfinch stock?

81. Sean, a sole proprietor, is engaged in a service business and uses the cash basis of accounting. In the current

year, Sean incorporates his business by forming Aqua Corporation. In exchange for all of its stock, Aqua

receives: assets (basis of $400,000 and fair market value of $2 million), trade accounts payable of $110,000,

and loan due to a bank of $390,000. The proceeds from the bank loan were used by Sean to provide operating

funds for the business. Aqua Corporation assumes all of the liabilities transferred to it.

a. Does Sean recognize any gain on the incorporation? Explain.

b. What basis does Sean have in the Aqua stock?

c. What basis does Aqua Corporation have in the assets it receives?

82. Trish and Ron form Pine Corporation. Trish transfers inventory (basis of $60,000 and fair market value of

$110,000) for 50% of the stock in Pine. Ron transfers machinery (basis of $20,000 and fair market value of

$60,000) and agrees to serve as manager of Pine Corporation for one year for 50% of the stock. What are the

tax consequences to Trish, Ron, and Pine Corporation?

83. Tan Corporation desires to set up a manufacturing facility in the western part of the United States. After

considerable negotiations with Butte, Montana, Tan accepts the following offer: land (fair market value of $4.5

million) and cash of $1.5 million.

a. How much income, if any, must Tan recognize?

b. What basis will Tan Corporation have in the land?

c. Within one year of the contribution, Tan purchases equipment for $1.6 million. What basis will Tan have in the equipment?

84. Lark City donates land worth $300,000 and cash of $100,000 to Orange Corporation as an inducement to

locate in the city. Four months later, Orange purchases additional land and a building at a cost of $500,000 and

moves its operations to Lark City. Ann, the sole shareholder, contributes equipment (basis of $70,000 and fair

market value of $200,000) to help Orange in its new operations. What are the tax consequences of these

transfers to Orange Corporation?

85. Stock in Merlin Corporation is held equally by Jane, Eve, and Fred. Merlin seeks additional capital to buy a

valuable tract of land that will cost $6,000,000. Jane, Eve, and Fred propose to loan Merlin $2,000,000 each,

taking from Merlin a $2,000,000 ten-year note with interest payable annually at five points above the prime

rate. Merlin Corporation has current taxable income of $7,000,000. How are the payments on the notes treated

for tax purposes?

86. Karen formed Grebe Corporation with an investment of $100,000 cash, for which she received $10,000 in

stock and $90,000 in 7% interest-bearing bonds maturing in ten years. A few years later, Karen loaned Grebe an

additional $60,000 on open account. Grebe becomes insolvent in the current year and is adjudged bankrupt.

Karen was the president of Grebe Corporation and was paid an annual salary of $50,000 for the past three years.

Karen has no other employment. How will Karen treat her losses for tax purposes?

87. Four years ago, Don, a single taxpayer, acquired stock in a corporation that qualified as a small business

corporation under 1244, at a cost of $60,000. Don wants to give his son, Ron, $20,000 to help finance Rons college education. The stock is currently worth $20,000. Don is considering selling the stock in the current year

for $20,000 and giving the cash to Ron. As an alternative, Don could give the stock to Ron and let Ron sell it

for $20,000. Which alternative should Don choose?

88. Joyce, a single taxpayer, transfers property (basis of $120,000 and fair market value of $60,000) to Wren

Corporation in exchange for shares of 1244 stock. As the transfer qualifies under 351, Joyce takes a

$120,000 basis in the Wren stock. In the current year, Joyce sells the Wren Corporation stock for

$40,000. What are the consequences of the sale to Joyce?

89. What is the rationale underlying the tax deferral treatment available under 351?

90. How is the transfer of liabilities in a property transaction generally treated for tax purposes? How is a

transfer of liabilities generally treated in a 351 transaction? What exceptions could arise to this usual

treatment in a 351 setting?

91. For transfers falling under 351, what are the holding period rules for stock received by the shareholder and

for the assets transferred to the corporation?

92. When forming a corporation, a transferor-shareholder may choose to receive some corporate debt along

with stock. Identify some of the issues the transferor must consider when deciding whether debt should be a

part of the transaction.

93. What are the tax consequences if an individual investor incurs a loss on the following:

a. Stock that is not 1244 stock.

b. Stock that is 1244 stock.

c. Corporate bond.

d. An uncollectible loan made to a corporation.

COMPREHENSIVE VOLUME--CHAPTER

18--CORPORATIONS: ORGANIZATION AND CAPITAL

STRUCTURE Key

1. TRUE

2. FALSE

3. FALSE

4. FALSE

5. TRUE

6. FALSE

7. TRUE

8. TRUE

9. FALSE

10. TRUE

11. TRUE

12. FALSE

13. TRUE

14. TRUE

15. FALSE

16. TRUE

17. TRUE

18. TRUE

19. FALSE

20. TRUE

21. FALSE

22. TRUE

23. TRUE

24. FALSE

25. FALSE

26. FALSE

27. TRUE

28. TRUE

29. FALSE

30. TRUE

31. FALSE

32. FALSE

33. TRUE

34. FALSE

35. TRUE

36. FALSE

37. TRUE

38. FALSE

39. FALSE

40. FALSE

41. FALSE

42. FALSE

43. TRUE

44. B

45. B

46. B

47. D

48. B

49. C

50. C

51. C

52. A

53. C

54. C

55. D

56. A

57. B

58. A

59. D

60. C

61. C

62. E

63. E

64. C

65. D

66. B

67. B

68. D

69. D

70. A

71. C

72. B

73. B

74. D

75. 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.

76. Nick has a taxable gain of $2,900,000. Section 351 does not apply because Nick failed to receive at least 80% control of Yellow Corporation.

Therefore, the transaction is a taxable exchange. Nick has a $3 million basis in his stock and Yellow Corporation has a basis of $3 million in the

property.

77. Perry recognizes a gain of $450,000 on the transfer [$600,000 (value of the stock received) $150,000 (basis in the property)]. The transfer does not qualify under 351. Although Perry originally owned 100% of Cardinal Corporation, Perry only owns 57% of Cardinal Corporation after the

transfer [2,500 (shares originally owned) 1,500 (shares transferred to Brittany and Julie) + 1,000 (shares acquired in the transfer), or 2,000 shares out of a total of 3,500 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.]

78. 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.

79. Both 357(b) and (c) are applicable. Because the land is subject to two mortgages that are in excess of basis, under 357(c) Rita would have a

recognized gain of $375,000 on the transfer. But 357(b) also is applicable because Rita borrowed the $125,000 shortly before incorporating and

used the money for personal purposes. As 357(b) causes all the liabilities to be tainted, Rita has boot of $500,000. Of Ritas realized gain of $625,000 [$750,000 (value of the stock received and release of mortgages) $125,000 (basis in the land)], $500,000 gain (the amount of boot) is recognized.

When 357(b) and (c) both apply to the same transfer, 357(b) predominates. Finch Corporation has a basis of $625,000 in the land, computed as

follows: $125,000 (carryover basis from Rita) + $500,000 (gain recognized by Rita). Rita has a basis of $125,000 in her stock, computed as

follows: $125,000 (basis in the land) + $500,000 (gain recognized) $500,000 (liabilities assumed by Finch Corporation).

80.

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)].

c. 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)].

d. Rods basis in the Goldfinch stock is $50,000.

81.

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. $10,000 [$400,000 (basis in the assets) $390,000 (bank loan assumed by Aqua Corporation)].

c. $400,000 (Seans basis in the assets).

82. Rons stock in Pine Corporation is counted in determining control for purposes of 351. All of Rons stock, not just the shares received for the machinery, is included because the property he transfers has more than a nominal value in comparison to the value of the services rendered. (The

property transferred has a value of at least 10% of the value of the services provided.) Trish recognizes no gain on the transfer and has a basis of

$60,000 in the stock received. Pine Corporation has a basis of $60,000 in the inventory it receives. Ron recognizes ordinary income of $50,000 on

the transaction. Even though the transfer of the machinery qualifies under 351, his transfer of services for stock does not. Ron has a basis of

$70,000 in his stock, computed as follows: $20,000 (his basis in the machinery) + $50,000 (value of his services). [His services are valued at

$50,000 as this is the difference between the value of the property transferred ($60,000) and the value of the stock received ($110,000).] Pine

Corporation has a basis of $20,000 in the machinery and can claim a deduction of $50,000 for the services Ron will render.

83.

a. Tan Corporation does not recognize any income from the receipt of land and cash as it is a nontaxable capital contribution under 118.

b. Tan has a zero basis in the land. 362(c)(1)(B)

c. Tan Corporation must apply the $1.5 million cash against the cost of the equipment. Thus, the basis of the equipment is $100,000 ($1.6

million $1.5 million).

84. 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.

85. 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.

86. If the stock is 1244 stock, Karen has an ordinary loss on the worthless stock. Otherwise, her $10,000 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 $60,000 open account debt are nonbusiness bad debts and, therefore, short-term capital

losses. Karen would counter with the argument that the $60,000 open account debt 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 continually. Thus,

in that context, the salary is more than the investment. Further, she only works for the corporation.

87. Don should sell the stock. He will have a $40,000 ordinary loss deduction in the current year. Only the original holder of the stock (Don) qualifies

under 1244 for ordinary loss treatment. If Don gives the stock to Ron, Ron will have a basis of $20,000 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.

88. Joyce recognizes a loss of $80,000 [$40,000 (selling price of the stock) $120,000 (basis)]. She has an ordinary loss under 1244 of $20,000 [$40,000 (selling price) $60,000 (basis under 1244)] and a capital loss of $60,000.

89. 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).

90. 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.

91. In a 351 transaction, the shareholders holding period for stock received in exchange for a capital asset or 1231 property includes the holding period of the property transferred to the corporation. That is, the holding period of the property is tacked on to the holding period of the stock. The holding period for stock received for any other property begins on the day after the exchange. The corporations holding period for property acquired in a 351 transfer is the holding period of the transferor-shareholder, regardless of the character of the property in the transferors hands.

92. 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.

93.

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.

c. 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.

d. 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.

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