[Mich-CPA-Soon]

Hello all,

This is my first post! Been a longtime lurker on the forum, so thanks for the all the help so far. Got my last test REG on Monday and just have a quick question on corporate taxes.

Basis for a SHAREHOLDER for contributed property = Basis transferred(including cash) + Gain recognized – Boot received (includes liabilities assumed by corp).

Basis for the CORPORATION for the contributed property = Basis of property transferred(including cash) + gain recognized

So here’s my question. Why is there a difference in the two formulas? I understand shareholder basis would be used when the corporation dissolves to calculate a capital gain on the final distributions. But what is the corporation basis used for? I encountered a simulation where it asked to record the balance sheet amounts for the contributed property, which I guess is only based on the FMV? So this lead me to ask why is the balance sheet and tax basis to the CORPORATION different..?

I know it’s probably some simple logic I’m probably missing but I don’t understand why there is basically three different amounts being used..

Any help is much appreciated!

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[tuanxn]

What's important to remember is that the balance sheet reflects GAAP, instead of Tax, so the value on the balance sheet will be FMV upon contribution. It's weird, but you'd essentially have two sets of books (one tax and one book values).

I don't believe my REG exam ever tested on book value though.

For the shareholder and corporate basis, ideally the transaction would be non-taxable (no gain).
That means the economic positions of both the shareholder and corporation have not changed.

So here's an example with numbers:

Shareholder has property with basis of $50 with $20 of liabilities attached (net $30 position)
Shareholder contributes the property with the liability attached and receives stock in return

The tax value of the stock received will be $30.

The corporation will take a $50 basis in the property and assume the $20 liability (net $30 position)

No one's economic position has changed.

When the shareholder sells his stock, he will receive the same amount he would have had he sold his property and paid off the liability with the proceeds (granted the stock's FMV equals the property's FMV).

The same circumstances apply to the corporation.

Does that help?

[Mich-CPA-Soon]

Yeah that makes sense. For some reason I wasn't even thinking of GAAP lol my bad.

“When the shareholder sells his stock, he will receive the same amount he would have had he sold his property and paid off the liability with the proceeds (granted the stock's FMV equals the property's FMV)” – That was the piece logic I was missing…perfect explanation. Thanks!

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[EuroAddict]

“Basis for a SHAREHOLDER for contributed property = Basis transferred(including cash) + Gain recognized – Boot received (includes liabilities assumed by corp).”

Can you give an example of this? Adding in the gain recognized is throwing me off.

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[Mich-CPA-Soon]

Yeah here's an example:

4 people start a C corp for 25% interest each. All of them contribute property or cash, no one contributes services. Since no services are contributed for stock… at least 80% (in this case 100%) of the corporation is now controlled by people who donated property, so section 351 applies and no gains will be recognized EXCEPT for people who get cash or property back form the corporation.

Jones contributes this to the corporation for his 25% share of stock and also gets $10,000 cash:
FMV of property: $120,000
Liability on property: $60,000
Jones basis of property: $100,000
Cash contributed: 0

Jones needs to recognize a gain since he got 10k from the corp. His gain realized would be 20k but he only got 10k cash so his recognized gain is only up to that amount $10,000.

JONES basis in the 25% stock is now: 100,000 + 10,000 – 10,000 – 60,000 = 40,000

CORPORATION basis in Jones 25% = 100,000 + 10,000 = 110,000

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[EuroAddict]

Man oh man. I'm only using Ninja MCQ and don't recall any Q like that.

I see the addition of 10,000 but why the subtraction?

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[Mich-CPA-Soon]

That's a good question. I think they have the formula setup to make sure you account for everything. Remember to subtract ALL of the boot you receive (cash and corporation liabilities assumed).

The logic behind section 351 is that the economic positions of both the shareholder and corporation should not change when property is contributed. So let's change that example above this:
FMV of property: $105,000
Liability on property: $60,000
Jones basis of property: $100,000
Cash contributed: 0
Cash received $10,000

So the gain realized is $5,000 and you got $10,000 cash so you recognize all the gain.

Use the formula above and you'll get 100,000 + 5,000 – 10,000 – 60,000 = 35,000

Remember the economic positions of the corp and shareholder really are not supposed to change under 351…so if this person were to sell his land at FMV and pay off the liability his net position would be pocketing $45,000. But in this transaction with the corporation he got $10,000 back; this amount isn't part of stock cause its cash so take it away and you get a basis in the stock of $35,000.

Just remember to use that formula on the test and you'll be good in any situation without having to think too deeply of the logic.

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[EuroAddict]

So this is for the formation of a C corp or does it include S corp? I don't recall deducting gains. Glad I found this thread 🙂

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[Mich-CPA-Soon]

I believe this applies to all corporations so yes this should pertain to S corps. Let me know if any of my examples didn't make sense.

I just hope I get a simulation on this or I'll be pretty disappointed lol.

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[EuroAddict]

@Mich

I hear ya lol. I had studied the crap out of some FAR items that I thought they would do a SIM for b/c it was a large topic and nothing. lol

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[EuroAddict]

I think what confuses me is that in the backers book it says a gain is recognized when liability EXCEEDS basis.

When FMV exceeds basis that factors into realized gain which doesn't enter into the basis calculation. So to me the basis in this Q posted above would be $30,000.

“Jones contributes this to the corporation for his 25% share of stock and also gets $10,000 cash:

FMV of property: $120,000
Liability on property:
$60,000 Jones basis of property:
$100,000
Cash contributed: 0 –

I would have taken Basis 100,000 – liability 60,000 – boot 10,000 = 30,000

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[Mich-CPA-Soon]

I think what ever study materials your using could have a typo for this particular subject. If we were talking about partnerships well that's different. No stock is being issued section 351 doesn't apply. For partnership purposes your basis in the entity is the same as the property decreased by the all the liabilities assumed by the entity, then increased by the share of liabilities now assumed based on your interest. If you contributed property that had a liability that was more than the FMV then you would recognize a gain. This would be logical cause if you sold the stuff at FMV you would still be in debt…but the partnership assumed a portion so really you're debt free.

The formulas in the first post are correct and interprets section 351 and 358. Section 351 paragraph b tells you how to compute a gain. Then section 358 paragraph a tells you how to compute shareholder basis. Note that 358(a)(1)(A)(ii) includes liabilities assumed as defined in paragraph d.

https://www.law.cornell.edu/uscode/text/26/351

https://www.law.cornell.edu/uscode/text/26/358

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[EuroAddict]

I def. need to look this over.

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[EuroAddict]

So to follow up from the example I posted above the basis would be:

100,000 + 10,000 – (boot) 10,000 – (liability)60,000 = $40,000 ?

If I am reading the rule right the gain recognized is limited by the boot received. So if no boot was received the basis would still be 40,000 but calculated at 100,000 – 60,000??

Correct?

In addition, if the boot received was 30,000 the basis would then be

100,000 + 20,000 – 30,000 – 60,000 = 30,000?? I think I am doing something wrong with this one.

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[Mich-CPA-Soon]

Yes both of those are correct based on the formulas in the first post. Those formulas have been giving me the correct answers on the practice questions. I wouldn't over think this too much. You'll probably only see a few questions top on this so just make sure to memorize the formulas, (The gain in the formula is only to the extent of CASH received)

I'll explain the logic though on your fist example. 351 is supposed to be tax/gain free transactions. So if you had property worth 120k and sold it you have 120k cash. But you need to pay off the 60k liability, so really your net position is 60k. Well the corporation gave you 10k (with stock) so basically if you “sold” this asset to the corp for this stock, the stock itself is worth 50k. BUT keep in mind your basis in the property was 100k and it was worth 120k. You would of recognized a gain of 20k if it wasn't for 351…so part of that gain (the other half you didn't recognize) needs to be accounted for in your basis that way you can recognize it later. So take away the 10k deferred gain and your left with 40k tax basis in the shares.

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[Mich-CPA-Soon]

One other thing you mentioned before…. Section 357 paragraph c does mention that if property is contributed where liabilities exceed basis a gain is recognized for the difference. That's the same logic as the partnership example I gave above. Doubt you'll see a corporation question about that though.

AUD 8/14/15 - 84
BEC 9/10/15 - 83
FAR 11/4/15 - 85
REG 12/9/15 - 80

[Author]

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