In: Accounting
Ron and Hermione formed Wizard Corporation on January 2. Ron contributed cash of $220,000 in return for 50 percent of the corporation’s stock. Hermione contributed a building and land with the following fair market values and adjusted bases in return for 50 percent of the corporation’s stock:
FMV | Tax-Adjusted Basis | ||||
Building | $ | 136,000 | $ | 34,000 | |
Land | 204,000 | 136,000 | |||
Total | $ | 340,000 | $ | 170,000 | |
To equalize the exchange, Wizard Corporation paid Hermione $120,000
in addition to her stock
a. What amount of gain or loss does Ron realize on the formation of the corporation? What amount, if any, does he recognize?
b. What is Ron’s tax basis in the stock he receives in return for his contribution of property to the corporation?
c. What amount of gain or loss does Hermione realize on the formation of the corporation? What amount, if any, does she recognize?
d. What is Hermione’s tax basis in the stock she receives in return for her contribution of property to the corporation?
e. What adjusted basis does Wizard Corporation take in the land and building received from Hermione?
f.Assume Hermione’s adjusted basis in the land was $220,000.What amount of gain or loss does Hermione realize on the formation of the corporation? What amount, if any, does she recognize?
a. What amount of gain or loss does Ron realize on the formation of the corporation? What amount, if any, does he recognize?
Answer:
Gain or loss realized |
0 |
Gain or loss recognized |
0 |
Explanation
Ron recognized 0 .It is because that Ron contributed only cash for the formation. So, Ron does not realize gain on this transfer.
b. What is Ron’s tax basis in the stock he receives in return for his contribution of property to the corporation?
Answer:
Tax basis |
220,000 |
Explanation
$220,000 which is equal to the cash transferred to the corporation, is Ron’s tax basis in the stock he receives in return for his contribution of property to the corporation
c. What amount of gain or loss does Hermione realize on the formation of the corporation? What amount, if any, does she recognize?
Answer:
Gain or loss realized |
170,000 |
Gain or loss recognized |
120000 |
Explanation
Recognizes gain the lesser of gain realized or the fair market value of the boot received
FMV of stock received |
220,000 |
Add: Cash Received |
120,000 |
Amount received |
340,000 |
Less: Adjusted basis of property transferred |
170,000 |
Gain realized |
170,000 |
The $120,000 of boot is allocated as follows:
Building: $136,000 / $340,000× $120,000 = $48,000
Land: $204,000 / $340,000× $120,000 = $72,000
Hermione then computes the gain recognized by computing the amount of gain or loss on each asset transferred in the exchange and then recognizing the lesser of the gain realized or the amount of boot allocated to each asset as follows:
Building |
Land |
|
Fair market value of stock received |
88,000 |
132,000 |
+ Cash received |
48,000 |
72,000 |
Amount realized |
136,000 |
204,000 |
– Adjusted basis of assets transferred |
34,000 |
136,000 |
Gain realized |
102,000 |
68,000 |
Hermione recognizes gain of $120,000, equal to the lesser of gain realized or boot received on each of the assets computed as follows: A $48,000 gain is recognized on the building and a gain of $72,000 is recognized on the land.
d. What is Hermione’s tax basis in the stock she receives in return for her contribution of property to the corporation?
Answer:
Tax basis |
170,000 |
Explanation
Tax basis in the stock = adjusted tax basis of building and land + gain recognized – additionalboot received
Adjusted basis of property contributed |
170,000 |
Add: Gain recognized on the exchange |
120,000 |
Less: Cash (boot) received |
-120,000 |
Tax basis of stock received |
170,000 |
e. What adjusted basis does Wizard Corporation take in the land and building received from Hermione?
Answer:
Land |
Building |
|
Adjusted basis |
208,000 |
82,000 |
Explanation
Land : 136,000 + 20,000 + $204,000 / $340,000× $120,000 % = 208,000
Building: 34,000 + 136,000 / $340,000× $120,000% = 82,000
f.Assume Hermione’s adjusted basis in the land was $220,000.What amount of gain or loss does Hermione realize on the formation of the corporation? What amount, if any, does she recognize?
Answer:
Gain or loss realized |
86,000 |
Gain or loss recognized |
48,000 |
Explanation
Hermione computes the gain recognized by computing the amount of gain or loss on each asset transferred in the exchange and then recognizing the lesser of the gain realized or the amount of boot allocated to each asset.
A $48,000 gain is recognized on the building and no gain is recognized on the land because a loss was realized
The calculation is below:
Buildingg |
Land |
|
Fair market value of stock received |
88,000 |
132,000 |
Add: Cash received |
48,000 |
72,000 |
Amount realized |
136,000 |
204,000 |
Less: Adjusted basis of assets transferred |
34,000 |
220,000 |
Gain realized |
102,000 |
-16,000 |