Question

TJ Magnasen contributed assets with a $200,000 adjusted basis and a $525,000 FMV to Adelante Corporation in exchange for all of its stock. The corporation conducted operations for five years and was liquidated. TJ received the following in a liquidating distribution: $615,000 cash (less federal income taxes of 21% owed on the liquidation by the corporation) The assets that he had originally contributed, which now have a $150,000 adjusted basis and a $615,000 FMV.

a) What are the tax consequences of the corporate formation? (Shareholder’s/corporation’s recognized gain/loss, shareholder’s basis and holding period in his stock, corporation’s basis and holding period in contributed property)

b) What are the tax consequences of the corporate liquidation? (Shareholder’s/corporation’s recognized gain/loss, shareholder’s basis and holding period in distributed property)

Answer 1

(A) Tax consequences of corporate formation:

The assets adjusted basis to TJ Magnasen is $200,000.

The fair market value of the assets at the time of contribution is $525,000

The gain realized is determined by subtracting the basis from the FMV

Computation of the gain realized

Realized gain = Fair market value (FMV) – Adjusted basis

                        = $525,000 - $200,000

                        = $325,000

Therefore, TJ realized a gain of $325,000.

However,

Under section 351(a), TJ will recognize none of the gains realized. (As he has not received any consideration other than stock)

Under section 358(a), TJ’s basis for the stock is $200,000

Under section 362(a), the corporation’s basis for the asset is $200,000

TJ's holding period for the stock he received will include his holding period for those properties he originally transferred. (Assuming TJ transferred such assets either they are capital assets or Section 1231 property.)

(B) Tax consequences of the corporate liquidation:

The adjusted basis at the time of distribution is $150,000

The Fair market value (FMV) at the time of distribution is $615,000

Computation of the gain realized:

Realized gain = Fair market value (FMV) – Adjusted basis

                        = $615,000 - $150,000

                        = $465,000

Therefore, the corporation’s realized a gain of $465,000 when the assets are distributed to TJ, as per provision of the section 336(a).

Computation of Tax:

Tax = Gain * Tax rate applicable

            = $465,000 * 21%

            = $97,650.

Computation of after-tax distribution sums:

Cash distribution = Sum distributed – Tax

                        = $615,000 - $97,650

                        = $517,350

Computation of the gain realized by TJ:

Gain realized by TJ = Cash + Fair market value – Adjusted basis

                                    = $517,350 + $615,000 – $150,000

                                    = $982,350.

Therefore, as per section 331(a), TJ will recognize a gain of $982,350.