Question

Comprehensive Problem 19-58 (LO 19-1, LO 19-2, LO 19-3, LO 19-4, LO 19-5)

Rex and Felix are the sole shareholders of the Dogs and Cats Corporation (DCC). After several years of operations using the accrual method, they decided to liquidate the corporation and operate the business as a partnership. Rex and Felix hired a lawyer to draw up the legal papers to dissolve the corporation, but they need some tax advice from you, their trusted accountant. They are hoping you will find a way for them to liquidate the corporation while minimizing their total income tax liability.

Rex has a tax basis in his shares of $60,000 and Felix has a tax basis in his shares of $30,000. The DCC’s tax accounting balance sheet at the date of liquidation is as follows: Corporate tax rate (Negative amounts should be indicated by a minus sign. Leave no answer blank. Enter zero if applicable.)

	Adjusted Basis			FMV
Assets
Cash	$	30,000		$	30,000
Accounts receivable		10,000			10,000
Inventory		10,000			20,000
Equipment		30,000			20,000
Building		15,000			30,000
Land		5,000			40,000
Total assets	$	100,000		$	150,000
Liabilities
Accounts payable				$	5,000
Mortgage payable—Building					10,000
Mortgage payable—Land					10,000
Total liabilities				$	25,000
Shareholders’ Equity
Common stock—Rex (80%)	$	60,000		$	100,000
Common stock—Felix (20%)		30,000			25,000
Total shareholders equity	$	90,000		$	125,000

Required:

Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming each shareholder receives a pro rata distribution of the corporation’s assets and assumes a pro rata amount of the liabilities.

Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming Felix receives $25,000 in cash and Rex receives the remainder of the assets and assumes all of the liabilities.

For parts c and d: Assume Felix received the accounts receivable and equipment and assumed the accounts payable.

Will Felix recognize any income when he collects the accounts receivable?

Will Felix be able to take a deduction when he pays the accounts payable?

For parts e and f: Assume Rex is a corporate shareholder of DCC.

Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming each shareholder receives a pro rata distribution of the corporation’s assets and assumes a pro rata amount of the liabilities.

Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming Felix receives $25,000 in cash and Rex receives the remainder of the assets and assumes all of the liabilities.

(The values already filled in are correct)

	Part A Part B Gain or loss recognized by Rex Gain or loss recognized by Felix $(5,000) Gain or loss recognized by DCC $50,000 $60,000

c. Accounts receivable No d. Accounts payable No

	Part E Part F Gain or loss recognized by Rex $0 $0 Gain or loss recognized by Felix $(5,000) Gain or loss recognized by DCC $12,000 $0

Answer 1

a) Gain or loss recognised by Rex, Felix and DCC

Rex:

FMV of assets received = $120,000 (150,000*80%)

Less: Liability assumed = 20,000 (25000*80%)

Amount realised $100,000

Less: Tax Basis of stock 60,000

Gain recognised $40,000

Felix:

FMV of assets received = $30,000 (150,000*20%)

Less: Liability assumed   = 5,000 (25000*20%)

Amount realised $25,000

Less: Tax Basis of stock 30,000

Loss recognised $5,000

DCC:

Gain recognised:

Building ($35000-$15000) = $15,000

Inventory ($20000-$10000) = $10,000

Land ($40000-$5000) = $35,000

Total gain $60,000

Loss recognised

Equipment ($20000-30000) =$10,000

b) Rex and Felix recognise the same gain or loss. But DCC cannot recognise the loss on the equipment because loss property is distributed to related person.

c) Will Felix recognize any income when he collects the accounts receivable?

No. His basis in accounts receivable will be $10000 which is equal to the amount to be collected.

d) Will Felix be able to take a deduction when he pays the accounts payable?

No.