Question

Currently, Barnes Corporation has four shareholders, shareholders J, K, L and M. Upon creation of the corporation, these shareholders made transfers of the following for their respective shares of stock:
 On April 3, 2019, J transferred $18,000 cash for 1,500 shares of stock
 On June 14, 2019, K and L both transferred property with adjusted tax bases of $31,000 and $42,000, respectively. The fair market value of each property was $30,000 and $48,000 respectively. K received 2,500 shares and L received 4,000 shares.
 On January 19, 2020, M transferred property with an adjusted tax basis $30,000 and a fair value of $28,000 for 2,000 shares.
None of the transfers occurred under a plan of organization. These are the only shareholders and transfers. Finally, the corporation has been authorized a total of 50,000 shares (meaning there can be future transfers). Form the above information, which of the following statements is TRUE?
a. There is no tax effect to Shareholder J.
b. Shareholder K has a realized loss of $1,000.
c. The April 3, 2018 transfer falls under Section 351.
d. All of the above statements are true.

Answer 1

• Issuance of stock in excahnge for cash is a non taxable transaction
• Also, Per Section 351, issuance of stock in exchange for property is also a non taxable transaction only if all the contributors of cash and property have 80% or more control.

The shareholders contributing only service for stock is not counted as part of control group for the purpose of 80% control.

Shareholder Basis for the stock = Carryover basis - Mortgage Debt

Corporation's basis for property = Carryover basis

Exception: When carryover basis of the property is greater than the FMV of the property, Corporation's basis in the property is limited to the FMV of the property.

Thus in the given question:

• Statement 1 : True because J has been issued stock in exchange of cash.
• Statement 2 : True because even though no loss has been recognized due to the application of Section 351, Shareholder K has still realized a loss of $1000 as he has been issued stock worth of $30,000 in exchange of a property having adjusted basis of $31,000. Also the corporation has recorded the asset at a basis which is limited to the FMV of the property i.e. $30,000
• Statement 3 : False because in the April 3, 2019 transaction there is no transfer of property. The stock has been issued in exchange of cash.

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