Question

Paul owns undeveloped land (a capital asset, FMV $100,000 and adjusted basis $40,000) and transfers the land to the newly created Three Dog Corporation in exchange for the alternative consideration listed below. Assume there is no Original Issue Discount (OID) in any debt, there is not any non-qualified preferred stock and Paul is the sole shareholder. What is the income recognition, if any, and basis consequences to Paul and Three Dog Corporation on the different exchanges listed below?

a. 20 shares of common stock (FMV $20,000) and 80 shares of $1,000 preferred stock paying 8% cumulative dividends

b. 20 shares of common stock (FMV $80,000) and warrants for Jefferson stock (FMV $20,000).

c. 20 shares of common stock (FMV $20,000) and $80,000 principal amount (and FMV) of 20-year, registered bonds paying half the principal after 10 years and the rest at maturity (with 8% interest payable annually).

d. Same as immediately above, except that Paul already owned the 20 shares of Jefferson common stock (acquired for $20,000 cash one year ago) and transfers the land for $100,000 in Three Dog bonds (principal and FMV) and the bonds pay 8% annual interest.

Answer 1

a). No income recognition for Paul. As per section 351 relating to transfer of property by an individual to a corporation and the individual receives 80% of the voting stock and all classes of stock then no gain is recognized by the transferor. The tax on the gain is deferred.

The basis for Paul for common stock will be= Adjusted basis of property trasnsferred x FMV of common stock/(FMV of common stock + FMV of perefrred stock)

= 40000 x 20000(20000+80000) = 40000 x 20000/100000 = $ 8,000

The basis for Paul for Prefered stock will be = 40,000 -8000 = $ 32,000

Total basis for Paul will be $ 40,000

Basis for Three Dog Corporation will be the FMV of the property which is $100,000.

b).Income to be recognized by Paul is $ 20,000 which is the FMV of the Jefferson stock warrants received by Paul. As per section 351 if the transferor receives any consideration (boot) other than the stock as described in (a) above then the lower of the FMV of the boot or the realized gain of the FMV of the property trasnferred has to be recognized as gain by Paul.

The new basis for Paul will be adjusted basis + gain recognized- FMV of boot received = 40000+20000-20000 =40000

The basis for Three Dog corporation will be FMV of property =100,000

c)Income to be recognized by Paul is $ 80,000 which is the FMV of the registered bonds received by Paul. As per section 351 if the transferor receives any consideration (boot) other than the stock as described in (a) above then the lower of the FMV of the boot or the realized gain of the FMV of the property trasnferred has to be recognized as gain by Paul.

The new basis for Paul will be adjusted basis + gain recognized- FMV of boot received = 40000+80000-80000 =40000

The basis for Three Dog corporation will be FMV of property =100,000

d) Income to be recognized by Paul is $ 60,000 which is the FMV of the Three Dog bonds received by Paul reduced by the adjusted basis(cost) of the property transferred to the corporation. Since in this case the transferor does not receive any stock Section 351 does not apply and the difference between the FMV of the consideration received and the basis of the property transferred has to be recognized as gain by the transferor.

The new basis for Paul will be FMV of the Three Dog bonds received =$100,000

The basis for Three Dog corporation will be FMV of property =100,000