Question

What are the tax consequences to the sole shareholder of contributing encumbered property to the corporation as a contribution to capital?

Answer 1

A transferors cost basis for contributed property carries over to the corporation and also becomes the transferors basis for stock revived. However, if the corporations carry overs basis for all the property one has transferred is more than property fair value immediately after the contribution, the corporation basis is reduced to property's fair market value under q carry over basis limit rule. If this rule applies the transferor and corporation can jointly elect apply the basis reduction to cost basis of the stock received by the transferor ,instead of the corporations basis in the property.

Control

Control means ownership of 80% of voting power of voting stock of corporations voting stock and 80% of number of shares in each class of non -voting stock. One important exception is that a transferor who has entered into a binding commitment to dispose of stock to be received for transfer of property doesn't count towards 80% control requirement.

If persons transfering the property do not control the corporation immediately after the transfer each transferor recognize gain or loss equal to difference between his or her basis in transferred property and value of stock received. Note however that if loss recognized ,it will not necessarily be deductible

Boot

Even if control test is met, a transferor receives cash or property (boot) other than stock of transferee in exchange for transferors property. Debt securities are treated as boot for this purpose, as are certain types of redeemable or adjustable rate preferred stock.

If transaction includes receipt of boot the transferor will recognize the lesser of (a) the gain realized as to property over the transferor basis in property transferee ,or b) the cash and other boot received The transferor basis in stock is the basis the transferor had in property transfers ,plus gain recognized, minus boot received

If boot is property other than cash, the amount of boot is fair market value of property This value also becomes the shareholders basis for boot property.

Assumption of debt

If, as part of transaction described above, the transferee corporation assumes, or takes property subject to, liabilities, the liabilities are ordinarily not treated as taxable boot received by shareholder, but treated as boot in determining basis. However if the liabilities exceed shareholders basis for property v, gain will ordinarily be recognized by shareholder. An example of effect of mortgage where gain is not recognized by transferor is as follows

Example: Josh contributes land to his controlled corporation in exchange solely for stock. The land was subject to a $4000 mortgage. Josh basis in land was $10000 and it's value was $20000.Josh still doesn't recognize any gain because boot is not received for these purposes. Josh basis in stock he gets, however, is just $6000-the $10000 basis he had in land minus the $4000 debt(treated as boot for this purpose)

If significant portion of properties transferred to corporation are marketable stock or securities, including interests in a regulated investment company or real estate investment trust ,it could be transfer to an investment company on which gain would be recognized thereby invoking another set of complex rules.

Conclusion

If you are contemplating transfer of property to a corp, it would be wise to seek review of transaction by tax counsel if there will be other transferors, if property has declined in value since you acquired it., if there is a plan to transfer any stock that will be received in transaction, if property is subject to debt or other liabilities, or if you are transferring marketable securities.