Part 1: On June 3 of current year, Eric, Florence, and George form Wildcat Corpo
ID: 2372829 • Letter: P
Question
Part 1:
On June 3 of current year, Eric, Florence, and George form Wildcat Corporation and transfer the following items:
Transferor Asset Basis to Transferor FMV # of Com Share
Eric Land $200,000 $50,000 500
Florence Equipment -0- 25,000 250
George Legal Services -0- 25,000 250
Eric purchased the land (a capital asset) 5 years ago for &200,000. Florence purchased the equipment three years ago for $48,000. The equipment has been fully depreciated.
a. Does the transaction meet the requirement of Sec. 351?
b. What are the amount and character of the gains and losses recognized by Eric, Florence, George, and Wildcat?
c. What is each shareholder%u2019s basis in his or her Wildcat stock? When does the holding period for the stock begin?
d. What is Wildcat%u2019s basis in the land, equipment, and services? When does the holding period for each property begin?
Part 2:
Assume the same facts above:
a. Under what circumstances is the tax result beneficial, and for which shareholders?
b. Can you suggest ways to enhance the tax benefit?
Explanation / Answer
1
a. No. The transaction does not meet the requirements of Sec. 351. Transferors of
property, Eric and Florence, own only 75% (750/1,000 = .75) of the Wildcat stock, which fails the
80% test.
b. Eric recognizes a $150,000 capital loss on the land ($50,000 FMV - $200,000 basis).
Florence recognizes a $25,000 gain ($25,000 FMV - $0 basis) on the equipment. The gain is treated
as ordinary income under Sec. 1245 recapture rules. George recognizes $25,000 of ordinary income
as compensation for his services. Wildcat Corporation recognizes no gain or loss on issuing its stock for property or services.
c. Eric%u2019s basis in his stock is $50,000, its FMV. Florence%u2019s basis in her stock is
$25,000, its FMV. George%u2019s basis in his stock is $25,000, its FMV. They each have a holding
period that begins the day after the exchange date.
d. Wildcat%u2019s basis in the assets received is: land $50,000 (FMV) and equipment
$25,000 (FMV). The holding period for the land and equipment begins the day after the exchange.
The legal services may be deductible by Wildcat if incurred after operations have begun. They may
have to be amortized over a period of time depending on when they were incurred and what they
were incurred for. Also, if George has not yet performed the services, deduction may be deferred
until economic performance occurs. pp. C:2-12 through C:2-27.
2
a. The circumstances vary for the shareholders, who may or may not be pleased with
this result. They have avoided the requirements of Sec. 351, which allows Eric to recognize a
$150,000 capital loss. Although Florence has to recognize $25,000 of ordinary income, Wildcat can
depreciate the machinery%u2019s FMV of $25,000. If Eric can use the $150,000 loss to offset capital gains
from other sources, he may be happy with this result. If Florence is in a low tax bracket, she might
not mind that she has to recognize $25,000 of ordinary income. However, if Eric has no capital
gains and cannot use the $150,000 capital loss, avoiding Sec. 351 may not be a desirable result. This is especially true if Wildcat plans to subdivide the land and sell it, thereby generating ordinary
income in the near future. If Sec. 351 applied, Wildcat%u2019s basis in the land would be limited under
the Sec. 362(e)(2) reduction rules to $50,000, its FMV. However, Eric and Wildcat Corporation
could make an election under Sec. 362(e)(2)(C) so that the land would have a $200,000 carryover
basis to Wildcat and, therefore, much less income for Wildcat to report in future years. In such case,
Eric%u2019s basis would be limited to his stock%u2019s FMV of $50,000 rather than the $200,000 basis in the
property contributed. If he is not planning to sell his stock anytime soon, this reduction might not
matter. Also, Florence could avoid recognizing $25,000 of ordinary income on the machinery. On
the other hand, the machinery would have a zero basis to Wildcat, and therefore Wildcat would not
be allowed any depreciation on the machinery. As far as George is concerned, it makes no
difference to him whether Sec. 351 applies or not. The result to him is the same either way.
pp. C:2-21 and C:2-22.
b. If the shareholders decide that meeting the Sec. 351 requirements would produce a
greater tax benefit, they can proceed in several ways. For example:
1. The corporation could give George 150 shares of stock worth $15,000 and
$10,000 of bonds. In such case Eric and Florence would own more than 80%
(750/900 = 0.83) of the stock.
2. Florence and Eric each could contribute an additional $15,000 for 150 shares
of stock. In such case, Eric and Florence would own more than 80%
(1,050/1,300 = 0.808) of the stock.
3. George could contribute $2,500 of cash in addition to his services for 25
more shares. Thus, he would be a property contributor allowing all his
shares to count in the 80% test. In such case, Eric, Florence, and George
would own 100% of the stock.