[ipb15]

In Becker and Wiley there is a simulation on corporate formation. I’m not sure how they came up with the corporations basis and would appreciate some help!

Example : token (shareholder) ownership: 15%

Sh contributes: $10,000 cash, property worth 40,000 (5000 basis) with a related assumed recourse liability of 20,000.

We have to calculate the corporations tax basis in noncash property received from the shareholder.

The answer is as follows: the corps basis for the property transferred is the basis 5000 + recognized gain of 5000 = 10,000.

However, I thought that a corp basis in property is the greater of : nbv+ gain recognized or debt assumed by the corp. with that in mind, I thought the corp basis would be the 20,000 recourse liability.

Thanks for the help!

[Tripin93]

Bump. I'd like to hear an explanation too..

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[tuanxn]

hey ipb15,

The basis of the property in the corporation's hands will never automatically be the assumed liability (although it may coincidentally be).

Let's break it down:

For gain calculation purposes, you want to look at this like a sale transaction.
In that respect, it's as if the shareholder has $15,000 of basis ($10,000 cash contributed + $5,000 basis of property contributed) and receiving $20,000 (the liability taken off his hands). Therefore he would report $5,000 of gain.

Corporations are allowed to receive contributions without being taxed on them. The corporation would take a carryover value of $5,000 + $5,000 gain that the shareholder recognized, resulting in a basis of $10,000.

If you think about it logically, the shareholder is now $5,000 better off than he was before; so he must report a gain of $5,000.

On the shareholder's side it'll look like this:
Debit Liability $20,000
Credit Cash $10,000
Credit Property $5,000
Credit Gain $5,000

Likewise the corporation will now have in its possession:
Debit $10,000 of cash
Debit $10,000 of basis in the property ($5,000 carryover basis + $5,000 gain that the shareholder recognized)
Credit $20,000 liability

–>Since the shareholder recognized gain, we're allowed to add that gain to the basis of the property. If we did not, then once we sell the property for $40,000; we would recognize $35,000 of gain, instead of $30,000—Effectively recognizing the gain of $5,000 twice (once upon contribution by the shareholder, and once when the corporation sells the property). This way, the system is “balanced.”

**To take it a step further, let's assume the property took a basis of the liability assumed:

Then the corporation would possess:
Debit Cash $10,000
Debit Property $20,000
Credit Liability $20,000

The account doesn't balance.

**The situation where you're seeing the property taking a basis of the liability assumed is when the liability assumed is greater than the basis of the property and there isn't anything else in the contributing transaction to offset the gain.
e.g. if you contribute property to a corporation with:
FMV $10,000
Basis $5,000
Liability attached $20,000

You recognize a gain of $15,000

The corporation would take a basis in the property of $20,000 (Basis of $5,000 + $15,000)
It's just coincidence that the new basis and assumed liability are the same. The original problem had the factor of cash contributed which increased the basis of the shareholder in the transaction to offset the gain from the assumed liability.

Hope that made sense, it turned out a lot longer than I expected it to be…

[Anonymous]

Tuanxn,

Thank you for explanation on this topic, that clarification does help a lot. I have one follow up question that I would like to see if you could assist me with. In Sim 1 of Regulation 3 there is an answer explanation to a problem where you are required to calculate the corporate tax basis of the property.

This specific problem is not a case where using the higher assumed debt as the basis is done. Becker provides this explanation, “The rule that allows a corporation to take a higher amount of liability assumed as the basis is a special rule that only applies if the shareholder recognizes gain due to liabilities being in excess of basis of all property contributed.”

From this explanation I understand the it's only used when the debt exceeds the basis of ALL property contributed (cash etc.). I can't tell specifically if this is the same idea you shared above or not, as they state ALL property. I'm simply trying to understand when exactly the assumed debt should be used as the basis. I appreciate any guidance you can give me.

[Author]

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