Purchase of S-Corp Stock

[Taxman]

I have a client who purchased 100% of the stock of an S-Corp for $97,000 in 2004. In 2005 their basis was $97,000. The client then turned around and sold the assets of the S-Corp to another buyer in 4/2005 for $70,000. On the clients S-Corp return which was prepared by another preparer, they show the sale of the business assets and are reducing the clients basis for depreciation taken from 1985 - 2005 which was about $95,000. Hence the client is left with a gain of about $70,000. Does this sound like the correct treatment for the sale? It looks like the client should have bought the assets and not the Stock.

[OldJack]

You have 2 different type transactions here. When the client purchased the stock of the S-corp he has a basis of $97,000 in the stock... not the assets of the S-corp. The S-corp than sold the assets (form 4797) for $70,000 gain as probably the assets were zero tax cost basis and recapture of depreciation at ordinary income passing thru to your client shareholder on the K-1. This would be correct as the S-corp has to recognize gain or loss on the sale of assets.

Now your client needs to show the sale/redemption of stock on Sch-D for the gain or loss of the S-corp liquidating distribution netted to his cost basis of his original purchase plus or minus any profit or loss by the S-corp as shown on his 1040 since ownership.

[John of PA]

Built in Gains Tax

One point to be sure of here. If the S Corp elected S status as a previous C Corp less than 10 years ago, then you have to pay, what is called the "Built in Gains" tax using as a cost basis of the assets sold, the FMV when S status was elected.

[Taxman]

Thanks for the Responses

Old Jack so what you are saying is the S-Corp records the sale of the assets which was $70,000 sales price less 0 basis in the assets because they were full depreciated, the S-Corp would show a gain of $70,000 which goes on the K-1.

Then the shareholder would report the liquidation of the S-Corp and all shares on schedule D of their 1040. Their original basis was $97,000 and since there is nothing left of the S-Corp the value would be 0?


The other preparer deducted the shareholder's basis on form 4797 which should have only been the sale of the S-Corp's assets. Does it look like form 4797 should be redone to exclude the shareholder's basis in the stock?

Thanks again for your help.

[OldJack]

Form 4797 is only attached to the S-corp 1120S and would show the taxable gain on the sale with the sale price ($70,000) less the cost basis (zero) as this sale is by the corporation, not the individual. This is not the sale of stock or anything to do with the shareholder. It is just the sale of assets like a desk, equipment, or goodwill being sold by the S-corp. The seller and buyer are supposed to both file a form 8594 with their S-corp tax return showing they agree to the same sale price for the assets by type or group. [See code 1060.]

The S-corp then liquidates resulting in the purchase/redemption of the shareholders stock and thus the individual reports gain or loss on Sch-D. The $70,000 profit/gain passed thru on the 1120S-K1 increases his stock basis each year with all distribution decreasing his basis for Sch-D. Until the S-corp liquidates and redeems his stock it is not written off on any tax return and can only be written off on liquidation/redemption on his 1040 Sch-D. The final liquidating distribution is reported by the S-corp on 1099-DIV, box 8 & 9, and becomes the sale price for the 1040 Sch-D.