Transfers of Property to Controlled Corporations




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Transfers of Property to Controlled Corporations
A. Purpose--provide tax relief when a person transfers property to a

corporation in exchange for stock in that corporation and has no proceeds

from the sale of the existing property with which to pay the tax on any

realized gain


B. Conditions--one or more persons transfer property to a corporation

solely in exchange for stock in that corporation and immediately after the

exchange such person or persons are in control of the corporation

1. Transfer of Property--property includes cash, real or personal

property, realized or unrealized receivables, intangibles, etc.

a. Services Rendered--property does not include services rendered

2. Stock--the stock received by the transferor must be issued by the

transferee corporation and may be common or preferred, voting or

nonvoting, participating or nonparticipating

a. Stock Rights--stock does not include stock rights and stock

warrants

3. Control--ownership of stock possessing at least 80% of the total

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

a. Immediately After the Exchange

1) Nonsimultaneous Transfers--it is sufficient if all the

transfers are made under a prearranged plan that is carried

out expeditiously

a) Illustration--A and B form a corporation; A contributes

property with a fair market value of $35,000 for 350

shares of stock on January 1; B contributes property with

a fair market value of $15,000 for 150 shares of stock on

March 15

Section 351 applies since the transfers of property

were made under a prearranged plan and were carried

out expeditiously ((350 + 150) > 80% x 500)


2) Momentary Control--if the transferors lose control because they

dispose of sufficient shares of stock or because the

corporation subsequently issues additional shares of stock,

Section 351 applies as long as the subsequent disposals or

stock issues are not part of a prearranged plan

a) Illustration--A and B form a corporation; A contributes

property with a fair market value of $35,000 for 350 shares

of stock; B contributes property with a fair market value

of $15,000 for 150 shares of stock; B dies two weeks after

the formation and leaves his 150 shares of stock to his son

Section 351 applies since control exists because B's

stock is included in the determination of whether

control exists ((350 +150) > 80% x 500)

b. Services Rendered--if a person receives stock for services

rendered to the corporation, he must also contribute property to

the corporation for his stock to be included in the determination

of whether the control test is met

1) Illustration--A and B form a corporation; A contributes

property with a fair market value of $35,000 for 350 shares of

stock; B contributes services with a fair market value of

$15,000 for 150 shares of stock

Section 351 does not apply since control does not exist

because B's stock is not included in the determination of

whether control exists (350 < 80% x (350 + 150))


C. Tax Treatment

1. Stockholder

a. Gain or Loss Recognition

1) Realized Losses--realized losses are not recognized

2) Realized Gains--realized gains are recognized to the extent of

boot received

a) Character of Gain--the character of the gain is determined

by the nature of the asset in the hands of the transferor

b) Liabilities Assumed by Corporation--the assumption of the

transferor's liabilities by the transferee is not

considered to be boot

I) Tax Avoidance--if the principle purpose of the

assumption of the liabilities is the avoidance of tax

or if there is no bona fide business purpose behind

the assumption of the liabilities, all the liabilities,

even those not assumed for the purpose of tax

avoidance, are treated as boot

II) Liabilities Greater Than Basis--if the liabilities

assumed by the corporation exceed the adjusted basis

of the property transferred, the excess is treated as

recognized gain

III) Liabilities of Cash Basis Transferor--if the

transferor uses the cash basis method of accounting,

liabilities will not include those liabilities which

would give rise to a deduction when paid

b. Basis--the basis of stock received by the transferor is the basis

of the property transferred increased by any recognized gain and

decreased by the amount of boot received and by the liabilities

assumed by the corporation

1) Boot Received--the basis of any boot received is its fair

market value on the date of exchange

2) Two or More Classes of Stock Received--if two or more classes

of stock are received by the transferor, the basis of the stock

received is allocated among the two or more classes of stock

received using their relative fair market values

a. Holding Period--the holding period of the stock received by the

transferor includes the holding period of the property transferred

if the property transferred was a capital asset or Section 1231

property in the hands of the transferor and the basis of the

property received was determined by reference to the basis of the

property transferred to the corporation

1) Boot Received--the holding period of any boot received begins

on the date of the exchange

2. Corporation

a. Gain or Loss Recognition--no gain or loss is recognized when the

corporation receives money, other property, or services in exchange

for its stock

b. Basis--the basis of property received by the corporation is the

basis of the property in the hands of transferor increased by any

recognized gain by the transferor

c. Holding Period--the holding period of the assets received by the

corporation includes the holding period of the transferor

3. Illustrations

a. A, B, and C form a corporation; A contributes inventory with a

fair market value of $75,000 and an adjusted basis of $60,000 for

150 shares of stock; B contributes $30,000 in cash for 60 shares

of stock; C contributes services with a fair market value of

$45,000 for 90 shares of stock

Section 351 does not apply since control does not exist

((150 + 60) < 80% x (210 + 90))

A:

Realized Gain = 75,000 - 60,000 = 15,000



Recognized Gain = 15,000

Stock Basis = 75,000

B:

Stock Basis = 30,000



C:

Ordinary Income = 45,000

Stock Basis = 45,000
Corporation:

Inventory Basis = 75,000


b. A, B, and C form a corporation; A contributes inventory with a

fair market value of $75,000 and an adjusted basis of $60,000 for

150 shares of stock; B contributes $30,000 in cash for 60 shares

of stock; C contributes services with a fair market value of

$27,000 and equipment with a fair market value of $18,000 and an

adjusted basis of $10,000 for 90 shares of stock

Section 351 applies since control exists

((150 + 60 + 90) > 80% x 300)


A:

Realized Gain = 75,000 - 60,000 = 15,000

Recognized Gain = 0

Stock Basis = 60,000

B:

Stock Basis = 30,000


C:

Ordinary Income = 27,000

Realized Gain = 18,000 - 10,000 = 8,000

Recognized Gain = 0

Stock Basis = 10,000 + 27,000 = 37,000

Corporation:

Inventory Basis = 60,000

Equipment Basis = 10,000

c. A and B form a corporation; A contributes inventory with a fair

market value of $100,000 and an adjusted basis of $70,000 for 200

shares of stock; B contributes equipment with a fair market value

of $50,000 and an adjusted basis of $60,000 for 100 shares of

stock

Section 351 applies since control exists



((200 + 100) > 80% x 300)

A:

Realized Gain = 100,000 - 70,000 = 30,000



Recognized Gain = 0

Stock Basis = 70,000

B:

Realized Loss = 50,000 - 60,000 = 10,000



Recognized Loss = 0

Stock Basis = 60,000


Corporation:

Inventory Basis = 70,000

Equipment Basis = 60,000
d. A and B form a corporation; A contributes inventory with a fair

market value of $125,000 and an adjusted basis of $70,000 for 200

shares of stock and $25,000 in cash; B contributes $35,000 in cash

and equipment with a fair market value of $15,000 and an adjusted

basis of $10,000 for 100 shares of stock

Section 351 applies since control exists

((200 + 100) > 80% x 300)
A:

Realized Gain = 125,000 - 70,000 = 55,000

Recognized Gain = 55,000 or 25,000 = 25,000

Stock Basis = 70,000 + 25,000 - 25,000 = 70,000


B:

Realized Gain = 15,000- 10,000 = 5,000

Recognized Gain = 0

Stock Basis = 35,000 + 10,000 = 45,000


Corporation:

Inventory Basis = 70,000 + 25,000 = 95,000

Equipment Basis = 10,000

e. A and B form a corporation; A contributes inventory with a fair

market value of $125,000 and an adjusted basis of $131,000 for 200

shares of stock and $25,000 in cash; B contributes $35,000 in cash

and equipment with a fair market value of $15,000 and an adjusted

basis of $10,000 for 100 shares of stock

Section 351 applies since control exists

((200 + 100) > 80% x 300)


A:

Realized Loss = 125,000 - 131,000 = 6,000

Recognized Loss = 0

Stock Basis = 131,000 - 25,000 = 106,000


B:

Realized Gain = 15,000 - 10,000 = 5,000

Recognized Gain = 0

Stock Basis = 35,000 + 10,000 = 45,000


Corporation:

Inventory Basis = 131,000

Equipment Basis = 10,000
f. A and B form a corporation; A contributes inventory with a fair

market value of $125,000 and an adjusted basis of $70,000 for 100

shares of stock and $75,000 in cash; B contributes $85,000 in

cash and equipment with a fair market value of $15,000 and an

adjusted basis of $10,000 for 200 shares of stock

Section 351 applies since control exists

((100 + 200) > 80% x 300)
A:

Realized Gain = 125,000 - 70,000 = 55,000

Recognized Gain = 55,000 or 75,000 = 55,000

Stock Basis = 70,000 + 55,000 - 75,000 = 50,000


B:

Realized Gain = 15,000 - 10,000 = 5,000

Recognized Gain = 0

Stock Basis = 85,000 + 10,000 = 95,000


Corporation:

Inventory Basis = 70,000 + 55,000 = 125,000

Equipment Basis = 10,000

g. A and B form a corporation; A contributes inventory with a fair

market value of $125,000 and an adjusted basis of $70,000 and

subject to a $25,000 liability for 200 shares of stock; B

contributes equipment with a fair market value of $85,000 and an

adjusted basis of $20,000 and subject to a $35,000 liability for

100 shares of stock

Section 351 applies since control exists

((200 + 100) > 80% x 300)
A:

Realized Gain = 125,000 - 70,000 = 55,000

Recognized Gain = 0

Stock Basis = 70,000 - 25,000 = 45,000


B:

Realized Gain = 85,000 - 20,000 = 65,000

Recognized Gain = 20,000 - 35,000 = 15,000

Stock Basis = 20,000 + 15,000 - 35,000 = 0


Corporation:

Inventory Basis = 70,000

Equipment Basis = 20,000 + 15,000 = 35,000
h. A forms a corporation; A contributes inventory with a fair market

value of $100,000 and an adjusted basis of $70,000 for common stock

with a fair market value of $60,000 and preferred stock with a fair

market value of $40,000

Section 351 applies since control exists

(100% > 80% x 100%)


A:

Realized Gain = 100,000 - 70,000 = 30,000

Recognized Gain = 0

Common Stock Basis = 60,000 / (60,000 + 40,000) x 70,000 =

42,000

Preferred Stock Basis = 40,000 / 100,000 x 70,000 = 28,000


Corporation:

Inventory Basis = 70,000


i. A forms a corporation; A contributes $10,000 in cash and accounts

receivable with a fair market value of $55,000 and an adjusted

basis of $0 from his cash basis business for 500 shares of stock;

the corporation assumes accounts payable with a fair market value

of $15,000 and an adjusted basis of $0 from his business

Section 351 applies since control exists

(500 > 80% x 500)
A:

Realized Gain = 55,000- 15,000 = 40,000

Recognized Gain = 0

Stock Basis = 10,000


Corporation:

Accounts Receivable Basis = 0


D. Special Considerations

1. Depreciation--depreciation on property transferred to the corporation

is computed using the transferor's period and method

a. Corporation's Basis Exceeds Transferor's Basis--if the

corporation's basis for the property transferred exceeds the

transferor's basis, the corporation treats the excess as newly

purchased ACRS property and may select whatever recovery period

and method is desired

b. Illustrations

1) A contributes equipment with an original cost of $5,000 and an

ACRS recovery period of 5 years to a corporation on January 1;

A purchased the equipment last year and used accelerated

depreciation to compute the cost recovery under ACRS; A

recognized no gain on the transfer of the equipment

Depreciation = 32% x 5,000 = 1,600

2) A contributes equipment with an original cost of $5,000 and an

ACRS recovery period of 5 years to a corporation on January 1;

A purchased the equipment last year and used accelerated

depreciation to compute the cost recovery under ACRS; A

recognized $3,000 of gain on the transfer of the equipment; the

corporation elected to use accelerated depreciation to compute

the cost recovery under ACRS for the portion of the basis

attributable to the gain recognized by A

Depreciation = 32% x 5,000 + 20% x 3,000 = 2,200


2. Depreciation Recapture--any depreciation recapture potential on

property transferred to the corporation carries over to the corporation

and is recognized when the corporation disposes of the property

a. Illustration--A contributes equipment with an original cost of

$35,000 and an adjusted basis of $10,000 to a corporation; A

recognized no gain on the transfer of the equipment; the

corporation sells the equipment for $12,000 after taking $6,000

more depreciation

A:

Depreciation Recapture = (35,000 - 10,000) or 0 = 0


Corporation:

Depreciation Recapture = ((35,000 - 10,000) + 6,000) or

(12,000 - (10,000 - 6,000)) =

8,000







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