[Anonymous]

Can someone please explain to me why the answer isn’t c?? I thought that the FMV of property transferred to a corporation was never taken into consideration when solving for the corporation’s basis in the asset. I was under the impression that the corporation’s basis in the asset was the greater of 1) the adjusted basis of the transferor or 2) the asset’s liability aquired. Becker drilled this point in pretty hard, but I’m also confused by the whole “80% control test” which I’m sure is the kicker here. Thanks so much!!

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Porter, the sole shareholder of Preston Corp., transferred property to the corporation as a contribution to capital. Two years later, Corley transferred property to the corporation in exchange for a 10% interest in corporate stock. The property transferred was valued as follows:

Basis FMV

Porter’s transferr $50,000 $200,000

Corley’s transfer $250,000 $500,000

What amount represents the corporation’s basis in the property received?

a. $700,000

b. $550,000

c. $300,000

d. $450,000

Explanation

Choice “b” is correct. Porter’s transfer is not taxable because the 80% control test is met. The corporation’s basis in the property is the basis of $50,000. Corley’s transfer is taxable because the 80% control test is not met. The corporation’s basis in the property is $500,000. The corporation’s total basis in the properties is $550,000 ($50,000 + $500,000).

Choice “a” is incorrect. $700,000 would be correct if the basis of both properties used fair market value.

Choice “d” is incorrect. $450,000 would be correct if Porter’s property used fair market value and Corley’s property used carryover basis.

Choice “c” is incorrect. $300,000 would be correct if the basis of both properties used carryover basis.

[leglock]

Corps basis will be ab plus gain recognized or liability acquired, whatever is greater.

When porter transferred, there was more than 80% ownership acquired so you use the ab of the property he transferred which is 50000 with no gain to recognize.

Then, when Corley transferred property for 10%, it did not meet the 80% test, since only 10% was being acquired. Therefore, it is taxable. So, you can take the ab of Corley 250000 and the gain corley recognizes 250000 for a total of 500000

Add the 50000 and the 500000 and you get 550000

[Anonymous]

Haha, I got this wrong when I tried to solve it because I mixed up P and C.

So the 80% rule is saying that if I try to “contribute” an asset to a company in exchange for an interest/share, I'm basically BUYING a portion of the company, rather than investing in it.

If you remember how corporations are taxed when they distribute property (property dividend) as if they sold the asset, it's the same logic I think.

I have an car worth $500 with a basis of $250.

I can:

A – SELL the car for $500 cash, resulting in a $250 taxable gain. Contribute the $500 cash for a 10% interest

B – “Contribute” the car to the company for a 10% interest worth $500.

If the government was dumb they would let you avoid the gain. But the government sees through what you're trying to do, which is to materially change the nature of your asset (a car that's going to lose value over time vs. a stock) and it's going to tax the INVESTOR. NOT THE CORPORATION.

The corporation pays no tax whatsoever. They're irrelevant. It's the INVESTOR that pays the tax (can someone back me up on this?).

So in scenario B, you're basically forced to pay taxes AS IF you sold the car, and as a result the basis of the car gets stepped up. In general, when you pay taxes on something, the basis goes up. If you defer taxes, basis goes down/stays the same.

If you do contribute property for more than 80% the government would say “OK, looks like you're really investing in the company, and not just screw us over” and will let you get away with contributing a property you originally bought for $250, for a stock worth $500, without recognizing any gain.

However, the basis of the property will carryover to the corporation ($250) since nobody paid any tax on it (think gift tax).

ALSO, your basis in the stock should be $250 as well. So that's kind of double ouch.

[Anonymous]

the 80% thing is part of a tax policy–

Tax policy reasons for Code Sec. 351: Freedom to choose entity type without immediate tax consequences; mere change in form of the business but no economic change in the business or ownership, continuity of investment (owner did not “cash out” of his business via a sale); wherewithal to pay doctrine

C. Requirements per Sec. 351 (transfers to controlled corp):

1. property is transferred to a corporation

2. solely in exchange for corporation’s own stock

3. transferors are in control (80% or more) immediately after the exchange

[Anonymous]

cprv19 could you tell me where you looked up that info. Especially “Tax policy reasons for Code Sec. 351: Freedom to choose entity type without immediate tax consequences; mere change in form of the business but no economic change in the business or ownership, continuity of investment (owner did not “cash out” of his business via a sale); wherewithal to pay doctrine”

It's a bit too late now, with my exam on Monday, but the most frustrating part of studying tax is not knowing the rationalte/goals of a tax legislation.

[Anonymous]

its from an outline one of my teachers made (getting a master's in tax accounting)

just think of it like this—most people who incorporate their business are just moving property from their sole proprietorship or partnership. it wouldn't really be fair to tax them on it

[Anonymous]

Man, it's the tax professor huh =/

I wish there was a textbook or commentary that focused a little more on the concepts and political backgrounds of legislation, rather than just rules.

Edit: Ooooh, I just got a random lightbulb in my head.

I've always wondered what basis represented due to all the weird adjustments that can be made on it, especially with taxes.

Basis basically represents cost paid out. E.g. cash, or FMV of services provided.

TAXES ARE A COST!!!

Doh.

So if you pay taxes on something, then your basis should go up to reflect that. It's just as much as a cost as you pay when you pay the store clerk for an asset.

So if you don't pay taxes, that's basically either a cost you didn't pay, or are avoiding. So the basis should be reduced/carried over to reflect that.

[Anonymous]

Ya thats a good way to look at it. That's why its good to keep records of what u originally pay for things cause the irs will automatically give u a basis of 0 and then u have to recognize a huge gain when u sell the property or transfer it

[Anonymous]

See I feel like takeaways like that are what's really important =/

Not this rote memorization. It's the takeaways of the rules that make an accountant different from a book.

[Anonymous]

Thanks so much everyone!! Very helpful. You're all heroes

[Author]

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