EA2 Study Unit 13.1-13.2 Corporate Formation Questions PDF

EA2 Study Unit 13.1-13.2 Corporate Formation -- Questions 40)In an exchange transaction, Jesse Jenkins transferred land worth \$50,000 to his 80%-controlled corporation for additional stock of the corporation worth \$20,000 and cash of \$20,000. The basis of the property to him was \$15,000 and was...

EA2 Study Unit 13.1-13.2 Corporate Formation -- Questions 40)In an exchange transaction, Jesse Jenkins transferred land worth \$50,000 to his 80%-controlled corporation for additional stock of the corporation worth \$20,000 and cash of \$20,000. The basis of the property to him was \$15,000 and was subject to a \$10,000 mortgage which the corporation assumed. Jenkins must report a gain of A.\$30,000 Answer (A) is incorrect.\ *The mortgage is not recognized because it does not exceed the adjusted basis of the property.* B.\$35,000 **C.\$20,000** **Answer (C) is correct.\ Section 351(a) provides nonrecognition of gain or loss if property is transferred to a corporation by a person solely in exchange for stock in the corporation and, immediately after the exchange, such person is in control of the corporation (i.e., owns at least 80% of the stock). Under Sec. 351(b), if other property or money is received in addition to the stock, any gain realized by the recipient is recognized to the extent of the amount of money plus the fair market value of other property received. Section 351 will apply to Jesse's transaction since its conditions are met even though this is not a corporate formation. Jesse's reportable gain is** **Amount realized (\$20,000 stock + \$20,000 cash + \$10,000 liabilities assumed by the corporation) = \$50,000** **Less: Adjusted basis of land transferred (15,000) = Realized gain \$35,000** **Gain recognized (limited to cash received) = \$20,000** **Note that under Sec. 357(a) liabilities assumed by the corporation (which have a business purpose and are not in excess of basis) are not considered property or money for the purpose of recognizing gain.** D.\$10,000 === 66)Mr. Smith transferred a building that had an adjusted basis of \$50,000 and a fair market value of \$105,000 to XYZ Corporation in exchange for 100% of XYZ's stock and \$10,000 cash. The building was subject to a mortgage of \$20,000, which XYZ assumed for valid business reasons. The fair market value of the stock on the date of the transfer was \$75,000. What are the amounts of Smith's realized gain and recognized gain? A. Realized \$55,000 Recognized \$30,000 Answer (A) is incorrect.\ *The recognized gain does not include the mortgage because it does not exceed the basis of the property.* **B. Realized \$55,000 Recognized \$10,000** **Answer (B) is correct.\ Mr. Smith realized a gain of \$55,000 on the transfer of the property to the controlled corporation (\$75,000 stock + \$20,000 mortgage assumed + \$10,000 cash -- \$50,000 basis in the building). Since money is received in addition to the stock, any gain realized by the shareholder is recognized, up to the amount of the money received. Also, Sec. 357(c) provides that, if the liabilities transferred or assumed (\$20,000) do not exceed the basis of all the property transferred (\$50,000), the liabilities are not recognized as a gain. Thus, Mr. Smith's recognized gain is \$10,000, the money received from the corporation.** C. Realized \$45,000 Recognized \$30,000 D. Realized \$35,000 Recognized \$10,000 === 87)Andrew transferred an office building that had an adjusted basis of \$180,000 and a fair market value of \$350,000 to Barry Corporation in exchange for 80% of Barry's only class of stock. The building was subject to a mortgage of \$200,000, which Barry assumed for valid business reasons. The fair market value of the stock on the date of the transfer was \$150,000. What is the amount of Andrew's recognized gain? A.\$170,000 **B.\$20,000** **Answer (B) is correct.\ Section 351(a) provides for nonrecognition of gain or loss if a person transfers property to a corporation solely in exchange for stock in the corporation and if, immediately after the exchange, such person is in control (owns at least 80% of the stock). However, Sec. 357(c) provides that, if the liabilities transferred or assumed (\$200,000) are greater than the basis of all the property transferred (\$180,000), the excess is treated as a gain from the sale or exchange of property. Thus, Andrew's recognized gain is \$20,000.** C.\$0 Answer (C) is incorrect.\ *A gain on the transfer is recognized.* D.\$350,000 === ****Study Unit 13: Corporate Formation \| Subunit 2: Basis of Assets Transferred in an Exchange**** 13)Ms. D transferred the following assets to Corporation E: Adjusted Basis Fair Market Value Cash \$1,000 \$1,000 Equipment 2,000 1,500 Land 4,500 6,000 In exchange, Ms. D received 51% of E's only class of outstanding stock. The stock had no established value. What is Corporation E's total basis in all the assets received, assuming that Ms. D recognized the correct amount of gain on the exchange? **A.\$8,500** **Answer (A) is correct.\ Because less than 80% of E's stock was exchanged for the assets, this transfer does not qualify for nonrecognition under Sec. 351. When a transaction does not qualify as a tax-free transfer under Sec. 351, the corporation's initial basis in the property is the FMV of the stock at the time of the exchange. If the FMV of the stock at the time of the exchange cannot be determined, the basis is the FMV of the property received. Since the stock had no established value, the corporation's basis is the FMV of the property, and E's basis in the transferred property is therefore** **Cash \$1,000 Equipment 1,500 Land 6,000 Total basis \$8,500** B.\$7,000 C.\$7,500 D.\$6,000 === 31)The basis of stock received in exchange for property transferred to a controlled corporation is the same as the basis of the property transferred with certain adjustments. All of the following would decrease the basis of the stock ****EXCEPT**** A.Any money received. Answer (A) is incorrect.\ All of these decrease the basis of the stock. **B.Any amount treated as a dividend.** **Answer (B) is correct.\ Section 358(a)(1) provides that, in a Sec. 351 exchange, the basis of the stock received by the transferors (shareholders) is the basis of the property transferred decreased by the fair market value of other property received, the amount of any money received, the amount of any liability relief, and the amount of loss that was recognized by the taxpayer. The basis is increased by the amount of gain recognized by the taxpayer. Any amount treated as a dividend increases the basis.** C.The fair market value of other property received. D.Any loss recognized on the exchange. === 4)Hank transfers land with an adjusted basis of \$500,000 to Handy Hank's, Inc. In exchange, he receives shares of stock with a fair market value of \$300,000 and cash in the amount of \$175,000. Hank owns 51% of all the outstanding stock of Handy Hank's, Inc., immediately after the transfer. What is Hank's deductible loss on the transaction, if any?  A.\$200,000 loss. B.\$25,000 loss. Answer (B) is incorrect.\ This transfer does not qualify under Sec. 351 but is subject to Sec. 267 related party transaction rules. Therefore, Hank cannot recognize the \$25,000 loss. C.\$325,000 loss. **D.\$0** **Answer (D) is correct.\ Even though this transaction does not qualify as a tax-free transfer under Sec. 351, Hank cannot deduct the \$25,000 loss. Under Sec. 267(a)(1), if the shareholder owns more than 50% of the corporation's stock, directly or indirectly, he cannot recognize any losses on an exchange of the property for the corporation's stock or other property.** === 7)Jack transferred property having an adjusted basis of \$42,000 and a fair market value of \$50,000 to Corporation X. In exchange for the property, he received \$5,000 cash, an automobile having an adjusted basis of \$6,000 and a fair market value of \$10,000, and 80% of Corporation X's only class of stock. At the time of the transfer, the Corporation X stock that Jack received had a fair market value of \$35,000. What is the amount of Jack's recognized gain? A.\$5,000 **B.\$8,000** **Answer (B) is correct.\ Section 351(a) provides for nonrecognition of gain or loss if a person transfers property to a corporation solely in exchange for stock in the corporation and if immediately after the exchange such person is in control (owns at least 80% of the stock). If other property or money is received in addition to the stock, any gain realized by the recipient is recognized but not in excess of the sum of the money plus the fair market value of other property received. Jack's realized gain is \$8,000 \[(\$35,000 stock + \$10,000 auto + \$5,000 cash) -- \$42,000 basis\], and this realized gain is less than the property received of \$15,000 (\$10,000 auto + \$5,000 cash). Thus, the realized gain is the maximum amount that must be recognized, or \$8,000.** C.\$15,000 Answer (C) is incorrect.\ The recognized gain equals the lesser of the cash and property received or the realized gain. D.\$0 === 9)Price Corporation has common stock with a par value of \$25 per share. Price entered into an exchange whereby the company gave up stock worth \$350,000 and received land with a fair market value of \$350,000 and an adjusted basis to the transferor of \$100,000. At the time of the exchange, Price common stock was selling for \$35 per share. The gain that Price must recognize as a result of the exchange is **A.\$0** **Answer (A) is correct.\ No gain or loss is recognized by a corporation on the receipt of money or other property in exchange for its stock, including treasury stock \[Sec. 1032(a)\].** B.\$350,000 C.\$100,000 Answer (C) is incorrect.\ No gain or loss is recognized by the corporation. D.\$250,000 === 10)Sam owns 100% of M Corporation's single class of stock. Sam transfers land and a building having a \$30,000 and \$100,000 adjusted basis, respectively, to M Corporation in exchange for additional M Corporation common stock worth \$200,000 and Q Corporation stock worth \$20,000. The Q Corporation stock had a \$5,000 basis on M Corporation's books. Peter transfers \$50,000 in cash for 15% of the M Corporation common stock. What amount of gain or loss is recognized by Sam and M Corporation on the exchange? **A. Sam \$20,000 M Corporation \$15,000** **Answer (A) is correct.\ Section 351 states that no gain or loss is recognized when property is transferred to a corporation in exchange for the corporation's stock if the person(s) transferring the property is(are) in control of the corporation immediately after the transfer. "Control" is defined by the Code as at least 80% ownership of the corporation's voting and nonvoting stock. Because Sam meets the control test, he recognizes no gain on the receipt of the M Corporation stock. However, he does recognize a \$20,000 gain on the receipt of the Q Corporation stock. Section 351(b)(1) states that, if other property is received by the transferor, the transferor must recognize gain equal to the fair market value of the property. Therefore, Sam must recognize a \$20,000 gain. M Corporation recognizes no gain or loss on the receipt of the land and building in exchange for its own stock (Sec. 1032). However, M Corporation does recognize a gain on the transfer of the Q Corporation stock. Under Sec. 311(b)(1), if a corporation distributes appreciated property, the corporation will recognize gain to the extent that the property's fair market value exceeds its adjusted basis. Therefore, M Corporation must recognize a \$15,000 gain (\$20,000 fair market value -- \$5,000 basis) on the transfer of the Q Corporation stock to Sam.** B. Sam \$0 M Corporation \$15,000 C. Sam \$0 M Corporation \$0 Answer (C) is incorrect.\ Both Sam and M Corporation must recognize a gain on the transfer. D. Sam \$20,000 M Corporation \$0 === 11)In a Sec. 351 transaction, Mr. Biller transferred assets with an adjusted basis of \$76,000 and a fair market value of \$80,000 to Bay View Corporation in exchange for its capital stock with a fair market value of \$72,000. Bay View Corporation also assumed a liability from Mr. Biller of \$81,000. What is Mr. Biller's recognized gain? A.\$8,000 B.\$1,000 **C.\$5,000** **Answer (C) is correct.\ Section 351(a) provides for nonrecognition of gain or loss if a person transfers property to a corporation solely in exchange for stock in the corporation and if immediately after the exchange such person is in control (owns at least 80% of the stock). Also, Sec. 357(c) provides that, if the liabilities transferred or assumed (\$81,000) are greater than the basis of all the property transferred (\$76,000), the excess is treated as a gain from the sale or exchange of property. Thus, Mr. Biller's recognized gain equals \$5,000 (\$81,000 liability assumed -- \$76,000 basis in property transferred).** D.\$9,000 Answer (D) is incorrect.\ The gain does not equal the liability assumed less the fair market value of the stock received. === 13)Sarah acquired 90% of Fast Corporation's shares in exchange for consulting services worth \$85,000. The fair market value of 90% of Fast Corporation's shares is \$93,500. How much income does Sarah recognize? A.\$0 **B.\$93,500** **Answer (B) is correct.\ Stock issued for services falls outside the general rule of Sec. 351, and the FMV of stock received is gross income to the shareholder when stock is transferred for services. The FMV of 90% of the stock is \$93,500.** C.\$85,000 Answer (C) is incorrect.\ The FMV of stock received is gross income to the shareholder when stock is transferred for services. The FMV of 90% of the stock is \$93,500. The consulting services are valued at \$85,000. D.\$76,500 === 16)Anthony, Bill, and Chester decided to form Paradise Corporation. Anthony transferred property with an adjusted basis of \$35,000 and a fair market value of \$44,000 for 440 shares of stock. Bill exchanged \$33,000 cash for 330 shares of stock. Chester performed services valued at \$33,000 for 330 shares of stock. The fair market value of Paradise Corporation's stock is \$100 per share. What is Paradise's basis in the property received from Anthony? A.\$35,000 Answer (A) is incorrect.\ Less than 80% of the stock was acquired for property. B.\$9,000 **C.\$44,000** **Answer (C) is correct.\ Because less than 80% of the stock was acquired for property (30% was acquired for services), the control requirement fails, and the transfer by Anthony does not qualify for tax-free treatment. Therefore, Paradise takes the property from Anthony with a basis equal to \$44,000, the fair market value of the property as well as the stock exchanged for it.** D.\$0 === 17)Mr. L transferred the following assets and liabilities to Corporation K: Adjusted Basis  \| Fair Market Value Building \$10,000 \| \$60,000 Mortgage on building 40,000 \| 40,000 Truck 5,000 \| 10,000 Machine 20,000 \| 15,000 In the exchange, Mr. L received 95% of K's only class of outstanding stock. What is K's total basis in the assets received, assuming that Mr. L properly recognized the true amount of gain on the exchange? A.\$45,000 B.\$35,000 Answer (B) is incorrect.\ The amount of \$35,000 is the transferred property basis. C.\$85,000 **D.\$40,000** **Answer (D) is correct.\ Section 362(a) provides that the basis to a corporation of property acquired in a Sec. 351 transaction is the same as the basis in the hands of the transferor, increased by the gain recognized by the transferor. If property is transferred to a corporation by a person solely in exchange for stock and, immediately after the exchange, the person is in control, the shareholder recognizes no gain or loss on the transfer \[Sec. 351(a)\]. Mr. L by owning 95% of K's stock is in control of Corporation K after the transfer.** **However, Sec. 357(c) provides that, if the liabilities transferred to the corporation exceed the adjusted basis of all the property transferred, the excess is treated as a gain resulting from the sale or exchange. Thus, Mr. L had to recognize a gain of \$5,000 (\$40,000 mortgage -- \$35,000 adjusted basis of assets). Corporation K's total basis in the assets received is \$40,000 (\$35,000 transferred property basis + \$5,000 gain recognized by Mr. L).** === 18)Ms. R transferred property with an adjusted basis of \$35,000 and a fair market value of \$40,000 to Rain Corporation in exchange for 60% of Rain Corporation's only class of stock. At the time of transfer, the stock Ms. R received had a fair market value of \$45,000. What is Rain Corporation's basis in the property after the exchange? A.\$0 **B.\$45,000** **Answer (B) is correct.\ The corporation's initial carryover basis in property exchanged by a control group shareholder for its stock is an adjusted carryover basis. This carryover basis is also increased by the gain recognized by the shareholder on the transfer. Because Ms. R receives only 60% of Rain Corporation's stock, she fails to meet the control test and the transfer does not qualify under Sec. 351. Ms. R must recognize a gain of \$10,000 (\$45,000 stock -- \$35,000 adjusted basis of property). Thus, the \$10,000 is added to the adjusted basis of the property of \$35,000, for a \$45,000 basis of property in the hands of the corporation.** **Authors' Note: The selling price is the \$45,000 FMV of the stock received, not the \$40,000 FMV of the asset given up.** C.\$40,000 Answer (C) is incorrect.\ The basis does not equal the fair market value of the property at the time of transfer. D.\$35,000