[murano]

A contributed $20000 and B contributed 10 motorcycles to form a C corp. They control 100%. The corp gave back A a motorcycle(FMV=1500).
should A recognize gain or not?

[DoubleBogey]

I don't think so because the constitute the control club.

[Nate]

This would be dividend income to A then a decrease in A's basis, because a non-liquidation distribution of property is recognized as FMV up to E&P, and anything past E&P is a decrease in the shareholder's basis. So unless the motorcycles had an adjusted basis of 0 to B when they were given to the corp, this distribution of a motorcycle to A would first be dividend income to the gain that the corp recognized on this distribution (calculated by taking the FMV and subtracting the carryover basis from B since no services were provided and they obtained over 80%) as that would add to Current Earnings & Profit, and the rest would be a decrease in A's basis. So if for example the motorcycle had a basis of $500 to B, then that'd be the same basis for the corp, then the corp would recognize a gain on this distribution of $1,000 ($1,500 FMV – $500 Basis) and that would add to the current E&P, but since it appears there was no previous accumulated or current E&P because the company was just formed, this would be the only E&P creating a $1,000 current E&P. So up to that E&P, this distribution of $1,500 (FMV) would first be $1,000 dividend income (up to total E&P), then would reduce A's basis in the corp by $500 to $19,500. So I guess, technically there would be no gain, cause a gain wouldn't be recognized by the shareholder unless it was a liquidating distribution or the distribution exceeded their basis. I hope that makes sense, but that question seems to be missing some important details.

[murano]

@Nate Thanks for the detailed explanation. I really appreciate it.

[murano]

@Nate What happens if:
A contributed $20000 and B contributed 10 motorcycles to form a C corp. They control 100%. The corp gave back A a motorcycle(FMV=1500) at the formaton since A felt unfair.(Maybe the FMV motorcylces is much less than 20000.)
I don't know if I made myself clear, not good at English. 🙁

[Nate]

@murano

It's hard to fully know what's going on with this question as it's missing a couple of details, what I would like to know is what's B's adjusted basis in the motorcycles and how much ownership each has, but since A feels this was unfair, and because in most questions the basis is below the FMV, I'll assume they each got 50/50 ownership and B's basis in each motorcycle is $500. In this case, since they control over 80% with cash and property and no services, the corp would have the same basis as B in the motorcycles for $5,000 total. This would mean A's basis for 50% in the corp is $20,000 and B's is only $5,000, which is why A would consider this unfair. When the corp gives the motorcycle to A, they will recognize a gain of $1,000 for the difference between FMV ($1,500) and the basis ($500), which again would increase E&P by $1,000 for the c corp. When a non-liquidating property distribution is made it's recognized by the shareholder at FMV, so A would receive a distribution worth $1,500. When a shareholder receives a distribution, it's normally dividend income because a C corp is not a pass-through entity, therefore the shareholders are not being taxed on the c corp's income, so they are taxed via dividend income. So the distributions is treated as dividend income to the extend of the corp's Earnings & Profits, in this case I will assume the company had no accumulated earnings & profits before this distribution so with this distribution they will have current earnings & profits of $1,000, so the $1,500 distribution will first be dividend income of $1,000 to A because dividend income cannot be higher than earnings & profits. For the remaining $500, this will decrease A's basis as any distribution will first be counted as dividend income to the extent of accumulated and current earnings & profit (unless accumulated earnings & profit has a negative balance, then just to current earnings & profit) and then a decrease in the shareholder's basis. So the remaining $500 will decrease A's basis from $20,000 to $19,500. I hope that makes sense and isn't confusing.

[murano]

@Nate Thanks again for your explaination. It helps a lot.

[murano]

@Nate Can you have a look at this situation?
A contributed a Car (FMV=$20000,NBV=15000) and B contributed 10 motorcycles to form a C corp. They control 100%. The corp gave back A a motorcycle(FMV=1500).
Should A recognize gain or not?
Actually this was my original point: should A recognize gain on the property he contributed when he receives that motorcycle.(and I said “A contributed $20000 cash”, by mistake at first)

[Nate]

Does the question provide the basis of the motorcycles? Cause it's pretty much the same for A regardless of what A contributed, that plays no factor in if the non-liquidating property distribution is gain or not, it's only a gain if the distribution exceeds the corps E&P and the shareholder's basis. Does that make sense?

[murano]

@Nate After I proceed to C corp distribution today what you said begins to make sense.
Thank you for your patience! You are such a kind person. 🙂

[Nate]

I'm glad to hear that! I'm sure you'll do great with REG. And my pleasure, I've benefited from others helping me so I just want to do the same for others when I can. When are you taking REG? I'm taking it Sat morning.

[murano]

@Nate
I'm still waiting for the NTS. I think I can take REG before August.
One more thing. I read the federal taxation textbook with regard to corporate tax this evening and I think maybe there is something wrong with what you said.
In my opinion, the distribution is not a dividend, but a boot to get A's car, since this transaction happens at the formation of the coporation. Below is the explanation(if you have time)

The machanism is the same in like-kind exchange:
When a taxpayer exchanges property for other property of a
like kind, §1031 provides that gain (or loss) on the exchange is not recognized because
a substantive change in the taxpayer’s investment has not occurred and there is no wherewithdraws(boot receved)to pay the tax. Section 1031 is merely a deferral mechanism and does not authorize the permanent nonrecognition of
gain or loss. The deferral mechanism is accomplished by calculating a substituted basis
for the like-kind property received. With this substituted basis, the realized gain or loss
associated with the property given up is ultimately recognized when the property
received in the exchange is sold. When there is boot received, however, gain is recognized to the extent of boot received as mentioned below.
what is boot?
In a like-kind exchange, the recognition of gain is avoided only to the extent the taxpayer
receives like-kind property. However, the taxpayer must recognize some or all of
the realized gain when receiving “boot” (i.e., property of an unlike kind, such as cash,and the party who is
relieved of the debt is treated as having received cash or boot. Notice, the relief of debt is treated diffrently in corporate formation, while the property of an unlike kind is not)
so in like-kind exchange, we have
amount realized= FMV old property = FMV new property + boot received – boot paid
gain realized= FMV old property- ab old property
gain recognized= min{gain realized,boot received)
basis of new property= ab old property + recognized gain – recognized loss(=0,since loss is always deferred)+ boot paid – boot received
This machanism is the same in transfering property to a controlled (>80%) corporation because when a business is incorporated, the owner’s economic status remains the same; only the form of the investment has changed. Since the shareholder controlls the company, we have Section 351.
There is only one major difference between section 351 and section 1031, which is the treatment of relief of debt,
but that dosen't matter in this case, so I will merely write down the results.
to the share holder, which is the transferee,
amount realized: FMV old property = FMV stock + boot received – boot paid
gain realized= FMV old property- ab old property
gain recognized = min{gain realized,fmv property received, excess liablity} —this difference to like-kind exchange is because the different treatment of relief of debt
basis of new property(which is stock)= ab old proerty+gain recognized- recognized loss(=0,since loss is always deferred)+ boot paid – boot received
So what I'm saying here is that maybe the motorcycle recevied by A not dividend. It is , in my opinion, the boot corporation gave to get A's property. For A, it is not dividend income , but a capital gain.
So my answer for the situation is (say the ab for the motorcycle is 500)
A recognizes a gain of 1500
And A's stock basis is 15000+1500-1500=15000 the motorcycle's basis is 1500
b'S stock basis is 5000
the corporation recognizes gain in the distribution of B's motorcylce:
recognized gain =realized gain =1500 -500 =1000
the corporations basis of A's Car: 15000+1500=16500
of B's motorcycles: 5000+1000=6000

[murano]

corporate's basis of b's motorcycle should be 5000+1000-1500=4500

[murano]

and the coporation should not recognize that 1000 gain.
no gain/loss is recognized by the corporatioin at formation, contribution increases corp's basis,while distribution decrease corp's basis(in ab).
The corp simply uses 5000-500=4500 as its basis in b's motorcycle.
I asked a tax guy about this.

[Nate]

Well, like I said, the question you asked was vague so I was making assumptions, nowhere was it mentioned that this was simultaneous or a like-kind exchange, so I just took the little info I had, and as I pointed out, made assumptions. And regarding the $1,000 gain, I was referring to if that was a non-liquidation distribution, I explained there was a carryover basis. But sounds like someone answered your question, so it doesn't matter anyways. Best of luck to you.

[Adam]

1031 exchanges have strict requirements..this would not qualify as it does not meet those requirements..No boot is involved so i dont see why you're even mentioning it..you seem like you're just wanting to here yourself speak when ANTE gave you a pretty solid answer to your question, then you wanted to overrule him.

But without making assumptions..

A contributes 20,000 so that is there basis.
B contributes 15,000 of property so that is there basis.
Total PIC is 35,000

Carryover basis is mostly used in regard to an LLC, 1065 or 1120-S..Neither party owns more then 80% of the stock so there is no carryover basis.

You realize the contribution of property at its FMV and then the shareholder picks up any gain above basis at the personal level as the assets is looked as being sold to the corporation. This is to avoid contributing property with Built in Gains.

Nate has everything correct in regards to E&P being disbursed first, before becoming a taxable dividend. Shareholders recognize a taxable dividend to the extent a distribution is paid out of corporate earnings and profits (E&P). If the distribution exceeds E&P, the excess reduces the shareholder's stock basis. Any amount in excess of the shareholder's stock basis is capital gain (Secs. 301(b)(1) and (c)).

[Author]

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