Question

Fred, Barney, and Wilma form Hard Rock, Inc., to manufacture gravel. They contribute the following in exchange for equal shares of stock:

Shareholder    Property                                  FMV               AB

Fred                 Cash                                        $50,000           $50,000

                        Property                                  $50,000           $5,000

                      Debt                                        $10,000                                                          

Barney            Stocks                                     $90,000           $80,000

Wilma             Equipment                              $90,000           $45,000

Betty also provides accounting services in exchange for 10% of the stock.

Fred and Wilma are married, as are Barney and Betty.

1. What are the tax consequences to Fred?

2. What are the tax consequences to Barney?

3. What are the tax consequences to Wilma?

4. What are the tax consequences to Betty?

5. What basis will Fred take in the stock?

6. What basis will Barney take in the stock?

7. What basis will Wilma take in the stock?

8. What basis will Betty take in the stock?

Answer 1

Answer:

Fred, Barney, and Wilma form Hard Rock, Inc. They contribute exchange for equal shares of stock.

Betty also provides accounting services in exchange for 10% of the stock.

This implies Fred, Barney, and Wilma have 30% share each and Betty gets 10%.

Together Fred, Barney, and Wilma would have 90% shares post transfer of properties to Hard Rock, Inc.

As such 80% test is met; shareholders won't recognize any gain unless boot is received.

Answer 1.

No gain is recognized by Fred. It is tax free exchange.

Answer 2.

No gain is recognized by Barney. It is tax free exchange.

Answer 3.

No gain is recognized by Wilma. It is tax free exchange.

Answer 4.

Betty provides accounting services in exchange of 10% of stock.

We need to determine value of services.

Fair value of properties contributed Fred, Barney and Wilma each =$90,000 of 30% share.

Hence value of 10% share = ($90,000 /30%) * 10% = $30,000

As such Betty must recognize $30,000 as ordinary income.

Answer 5:

The basis Fred will take in the stock is = Basis of cash + Basis of property - Debt = $50,000 + $5,000 -$10,000 =$45,000

Answer 6:

The basis Barney will take in the stock = Barney's basis in stock = $80,000

Answer 7:

The basis Wilma take in the stock = Wilma's basis in equipment = $45,000

Answer 8:

The basis Betty take in stock = $30,000