Question

Kevin and Bob have owned and operated SOA as a C corporation for a number of years. When they formed the entity, Kevin and Bob each contributed $100,000 to SOA. They each have a current basis of $100,000 in their SOA ownership interest. Information on SOA’s assets at the end of year 5 is as follows (SOA does not have any liabilities):

Assets	FMV		Adjusted Basis		Built-in Gain
Cash	$	200,000	$	200,000	$	0
Inventory		80,000		40,000		40,000
Land and building		220,000		170,000		50,000
Total	$	500,000

At the end of year 5, SOA liquidated and distributed half of the land, half of the inventory, and half of the cash remaining after paying taxes (if any) to each owner. Assume that, excluding the effects of the liquidating distribution, SOA's taxable income for year 5 is $0.

b. What is the amount and character of gain or loss Kevin will recognize when he receives the liquidating distribution of cash and property? Recall that his stock basis is $100,000 and he is treated as having sold his stock for the liquidation proceeds.

Answer 1

By making a liquidating distribution, SOA is treated as though it sold its assets for their fair market value. On the distribution,

SOA will recognize ordinary income of $40,000 on the distribution of the inventory (the built in gain) and $50,000 of Sec. 1231 gain/ordinary income (depending on accumulated depreciation) on the distribution of the land and building.

===================================

b. $136,500 long-term capital gain. SOA must pay tax on the $90,000 of income it recognizes in the distribution. Because its marginal rate is 30% it pays $27,000 tax on the distribution.

The tax payment reduces SOAs cash to $173,000 ($200,000 - $27,000). The fair market value of the assets SOA distributes to its shareholders is $473,000 ($500,000 total value minus $27,000 taxes).

One-half of the $473,000 ($236,500) is distributed to Kevin. Consequently, Kevins long-term capital gain on the distribution is $136,500 ($236,500 received minus $100,000 basis in his stock).

The gain is long-term capital gain because the stock is a capital asset and Kevin held the stock for more than a year before the liquidating distribution