S-Corp, APIC, and dissolution

[OldJack]

It qualifies as a tax free exchange under Section 351 because you and I own as a group over 80% of the stock after the exchange.

The reason your example is not a tax-free under §351 is the fact that the taxpayer/shareholder has actually sold his property at FMV and actually received value as boot, in this case he actually is receiving a half ownership of the other shareholders contribution of cash. Code §351 was not intended to allow a tax-free sale.

I'm out of here.

[thomtax]

Old Jack and Brad

Just curious - Did you fellows have words before your falling out? :-)

Just kiddin. I have been reading the exchanges and except for the fact that my one track mind seems to get lost in some of it, have been furthering my education hopefully.

Lowell Thomas

[Brad Imsdahl]

The reason your example is not a tax-free under §351 is the fact that the taxpayer/shareholder has actually sold his property at FMV and actually received value as boot, in this case he actually is receiving a half ownership of the other shareholders contribution of cash. Code §351 was not intended to allow a tax-free sale.

My example did not say anything about the property being sold to the corporation. It was contributed in exchange for stock of equal value. That is tax free under Section 351.

I contributed a carpet cleaning machine to the corporation in exchange for stock of equal value.

[Brad Imsdahl]

BTW, Section 351 does not say the tax free exchange depends upon receiving stock worth the equivalent of the cost basis in the property transferred. It is tax free if the one who transfers the property does not receive other cash or property in addition to the stock received. There is no restriction on the value placed upon the stock received that is solely in exchange for property.

Therefore, if I get $1,000 worth of stock in exchange for contributing a machine worth $1,000 with a tax basis of $200, section 351 still applies.

[OldJack]

Therefore, if I get $1,000 worth of stock in exchange for contributing a machine worth $1,000 with a tax basis of $200, section 351 still applies.

Its not that your are getting the "worth" of $1,000 in stock... it is the fact that the corporation is recording it at the sale price of $1,000 FMV. That is the same as if the Corporation purchased it from a disinterested party and in this case you. Look thru the transaction and you will see that if both shareholders now agree to make a return of capital distribution of $200 neither of the shareholders have a gain to recognize, but you have received your money back plus stock that is worth 50% of the corporation. That is a sale with boot.

Exaggerate the numbers and you can see a shareholder can make money by purchasing and making a so call contribution of property at FMV and taking their money back. Then they profiting from other shareholders that invest based upon the scam bookkeeping. No that would not fly with an independent auditor.

They put appraisers and real estate people in jail for fudging fair market values to get sales and mortgage money. What you are suggesting be allowed could be abused much the same way.

[Brad Imsdahl]

Sorry OldJack. You are simply wrong on this one. That is not what Section 351 says. Contributing property with a FMV of $1,000 and an adjusted basis of $200 in exchange for stock worth $1,000 will not trigger gain, unless the 80% control test is not met, or the one contributing the property receives cash or other property back.

[OldJack]

Another reason you can't book the FMV:

If a C-corp you have effectively converted the sale of the machine booked at $1000 from ordinary income for you to capital gains for you. In other words if you were the only shareholder and you sell the machine for $1,000 and liquidate the corporation you get cash of $1,000 with basis of $200 for a capital gain of $800 (of course the C-corp pays tax on it also). If you had personally sold the machine for $1,000 you would have recapture of the depreciation as ordinary income and it is not likely you sold it for more than the original price so there would be no capital gain.

If it is a S-corp the gain from sale of the machine for $1,000 flows through but you have effectively pushed half of the gain and tax effect to the other shareholder and taken half of his cash instead.

Either way if the corporation books the asset at FMV you got something for nothing and you end up not really contributing the asset but actually the transaction is a sale to the corporation.

I really have to stop and do some work or March 15 is going to be a disaster.

[Brad Imsdahl]

Yep, thems the rules. What's your point?

[OldJack]

Sorry OldJack. You are simply wrong on this one. That is not what Section 351 says. Contributing property with a FMV of $1,000 and an adjusted basis of $200 in exchange for stock worth $1,000 will not trigger gain, unless the 80% control test is not met, or the one contributing the property receives cash or other property back.

That is not what §351 says at all. It simply says the individual can contribute property in exchange for stock without recognizing gain. It does not say you can sell it to the corporation at FMV even if you take stock. But the real issue is the corporation cannot record the transaction at FMV when you are contributing it under §351. What the stock is "worth" could be millions and that is not the issue as the corporation may have a million cash in the bank.

Originally Posted by IRC§351(a) :
Sec. 351. Transfer to corporation controlled by transferor

-STATUTE-
(a) General rule
No gain or loss shall be recognized if property is transferred to
a corporation by one or more persons solely in exchange for stock
in such corporation and immediately after the exchange such person
or persons are in control (as defined in section 368(c)) of the
corporation.

[Brad Imsdahl]

OK, lets go back to my example. I contribute the machine worth $1,000 with a basis of $200 for $1,000 worth of stock. Had I sold the machine and just contribute the cash, I would have $800 of depreciation recapture at ordinary rates. You contribute $1,000 cash. We are now 50/50 shareholders in an S corporation. My basis in stock is $200, your basis in stock is $1,000.

Assume no more depreciation for two years and no other activity.

Now the corporation sells the machine for $1,000 and we liquidate the corporation because you and I can’t get along.

The corporation passes through $400 of ordinary gain on the sale of the machine to you and $400 of ordinary gain to me on the $800 of depreciation recapture.

My basis in stock is now $600 and your basis in stock is $1,400.

You get $1,000 cash and report a $400 capital loss on the liquidation of your stock. The $400 capital loss offsets your $400 of ordinary income. Zero tax consequence to you. You put in $1,000 cash and you get $1,000 cash back.

I get $1,000 cash and report a $400 capital gain on the liquidation of my stock. I now report $400 as a capital gain and $400 of ordinary income for a total of $800 of taxable gain.

As far as the total income I report and the net zero income you report, it is as if we never formed the corporation. Except that I was able to convert $400 of ordinary gain to capital gain.

And what rule says you can’t do that?

[OldJack]

Except that I was able to convert $400 of ordinary gain to capital gain.

And what rule says you can’t do that?

Exactly the problem... had you "contributed" the property rather than sell the property to the corporation you would not have that situation. As to the rules.. GAAP says you can't contribute it at FMV as that is not the cost of the property being contributed. If it is FMV it is a purchase by the corporation.

Well it is in no way the same, but it is somewhat like the concept of a gift being transfered at the donors cost basis. On the other hand I guess you would want to record that at FMV since the donor may have taken a deduction at FMV, not that you would know that he did.

Also, I don't believe that §351 intends for you to be able to convert the property to capital gain when it allows you to "contribute" the property at no recognitions of gain. Just the words "at no recognition of gain" would imply that you contribute at cost so there would be no gain to recognize. If FMV were allowed and say I have a corp and a sch-c business, with fully depreciated and expensive equipment, I would always transfer the equipment I wanted to sell to my corp at FMV for stock and then sell it and eventually get capital gains. That would be a sham transaction and so is recording the contributed property at FMV.

As another post on here says "that would be dead wrong".

[Brad Imsdahl]

Sorry OldJack. You simply do not understand the rules. Look at the examples in IRS Pub 542, page 3. They have the shareholders contributing the property in exchange for stock based on the FMV of the property being contributed. Basis in the property is only used to calculate gain on the transaction when the 80% rule is not met.

You simply are wrong, and I no longer know how to explain it any differently.

[OldJack]

Sorry OldJack. You simply do not understand the rules.

Yes... the example is a fine example if you will look at it close. It does not say you book the contributed property for $300,000. It says the par value of the stock of the company is $300,000 and that you take all the shares of stock of the corporation in exchange for your $100,000 property. Par Value is not REAL dollar value it is just an assigned value for state franchise or registration tax.

Since there are no other shareholders before you the value of the corporation and its stock is ZERO, NOT $300,000 as the example implies at the time it issues stock to you. You could go back to the Secy of State Office and for a small fee you could get authorized 100 million par value stock if the state statutes allows that much. The par value has nothing to do with what value your transaction should be. The corporation does not sell it shares at par value unless it simply wants to, it would sell its shares for whatever price it could get at the time of the sale. ie: the stock market.

The $300,000 is par value of all share authorized to be issued. The example does not say what the par value is of each share authorized. You may issue 1 share of par value stock for your $100,000 property and the value of the corporation would still be the value of the $100,000 property or you may issue all the shares that are authorized totaling $300,000 in par value and you still have property that should be booked at the cost of $100,000. You don't recognize unrealized gain unless you have bought the property at that price. You could issue $300,000 par value stock and the value of your corp is still the value of the $100,000 property.

The real issue you have is that you want 50% ownership for your property. Corporations do not keep capital accounts for each shareholder like a partnership does so there is no concern about the equity account being equal as the corporate equity account belongs to the shareholders on a per share basis. You can issue 50% of the shares for ownership regardless of the amount you book the value of the property. That is how it is done in the supply and demand market.

You simply are wrong, and I no longer know how to explain it other than to say you simply will not accept the fact that your partnership theory accounting is not the same as corporate accounting.

Example 1. You and Bill Jones buy property for
$100,000. You both organize a corporation when the prop
erty has a fair market value of $300,000. You transfer the
property to the corporation for all its authorized capital
stock, which has a par value of $300,000. No gain is
recognized by you, Bill, or the corporation.

[Davc]

Agree with Brad. Om the question of convertin OI to CG being a sham transaction, if it's a single shareholder corporation throughout, that never happens. And if not, it happens regulary. Example.

TP starts S-Corp and buys a widget maker for 100,000. It was a good year for the widget market so he was able to 179 the entire machine. The following year TP2 purchases an equivalent number of shares from the Corp. They proceed to get into an argument on the internet and close the Corp. As part of the process they sell the machine for 80,000. TP received the full benefit of the 179, but TP2 gets 50% of the recapture.

[jerome]

Old Jack, you are out to lunch on this one. Nobody contributes property to a corporation in exchange for stock using basis as the value of stock. That’s ridiculous.

Even the regulations (Sec. 1.351-1(a)(2)) give examples using fair market value of property contributed in exchange for stock of equal value.