In: Accounting
uestion One and Two: Apply the Section 351 rules to the following fact situation. Is it or isn’t it a Section 351 qualifying transaction? If it is, you must explain why you think so. If you think it doesn’t qualify, then you must give a method of fixing it. This is a proposed transaction and your client gives you the following information:
Abbot has owned 100 percent of the corporation for five years. Abbot did a Section 351 when he created the corporation and has a basis of $10,000 with the FMV of the assets before selling 79.5 was about $250,000.
Your client, Costello, is transferring property with a $100,000 basis ($1,000,000 FMV) for 79.5 percent of the company. Abbot has agreed to transfer a piece of equipment that is worth $8,000 and has a basis of zero (he fully depreciated the equipment) to the corporation as a part of the transaction. Abbot doesn’t want to do this; he would rather keep the equipment.
for USA rule
section 351 deals with transfer of property to a corporation.
first we need to understand what section 351 is.
transfer of property to a corporation solely in exchange for stocks, where the transferor is or (are) in control of the corporation immediately after the transfer.
where property does'not include services
control of corporation means 80% shares are owned.
is or are : section 351 is based on transaction. meaning more than one person can transfer property jointly and it would be considered a valid section 351 transaction.
If the property and control clauses are fulfilled the gain from transfer comes under section 351 and is exempt from tax. meaning no tax is charged from this transfer of property.
In the question above we are given that Abbot owned 100 % of the corporation for 5 years.
FMV is given $250000
Given Castello transfers property having basis of $100000 and fair market value of $1000000 for 79.5% of company
We are given 2 conditions
condition 1 where abbot also transfers property with Castello as a single transaction for $8000
condition 2 where Abbot does'not transfer property with Castello
solution for condition 1
As Castello transfers property to the company still the clause of 80% is not met the transaction is not a valid section 351 transaction. The income/profit from transfer is hence taxable
Basis value 100000
Fair market value 1000000
profit = fair market value - basis value
profit from transfer = 1000000 - 100000 which is $900000
This 900000 is taxable.
Condition 2
where Castello transfers 1000000 fair market value of property for 79.5% control and Abbot transfers $8000 fair market value of equipment.
as Castello transfers 1000000 form 79.5% control
for 100 % control the transfer should have been 1257861.6
Jointly Abbot and Castello would transfer 1000000 + 8000 which is 1008000
percent of control jointly by Abbot and Castello = (1008000 /1257861.6)*100 which is 80.14 approx.
As the control after transfer is above 80% hence this transfer is a valid section 351 transaction and is exempt from tax. Meaning no tax is payable from profit for this transfer.