Question

Tom and Gail form Owl Corporation with the following consideration:

Consideration Transferred Basis to Transferor Fair Market Value Number of Shares Issued From Tom— Cash $50,000 $50,000 Installment note 240,000 350,000 40 From Gail— Inventory 60,000 50,000 Equipment 125,000 250,000 Patentable invention 15,000 300,000 60

The installment note has a face amount of $350,000 and was acquired last year from the sale of land held for investment purposes (adjusted basis of $240,000). Regarding these transactions, provide the following information:

If an amount is zero, enter "0".

a. Tom’s recognized gain or loss. Answer: $0

Section 351 provides that gain or loss is not recognized upon the transfer of property to a corporation when certain conditions are met. This provision reflects the principle that gain should not be recognized when a taxpayer's investment has not substantively changed.

b. Tom's basis in the Owl Corporation stock. Answer: $290,000

c. Owl Corporation's basis in the installment note. Answer: $240,000

d. Gail’s recognized gain or loss. Answer: $0

e. Gail's basis in the Owl Corporation stock. Answer: $200,000

f. Owl Corporation’s basis in the inventory, equipment, and patentable invention.
Inventory: $60,000
Equipment:$125,000
Patentable invention: $15,000

g. Would your answers to the preceding questions change if Tom received common stock and Gail received preferred stock?
No , because there is no requirement that the transferors receive the same type of stock.

h. Would your answers change if Gail was a partnership instead of an individual?
No , because there is no requirement that the transferors be individuals.

i. Gail is considering an alternative to the plan as presented above. She is considering selling the inventory to an unrelated third party for $50,000 in the current year instead of contributing it to Owl. After the sale, she will transfer the $50,000 sales proceeds along with the equipment and patentable invention to Owl for 60 shares of Owl stock. Whether or not she pursues the alternative, she plans to sell her Owl stock in six years for an anticipated sales price of $700,000. In present value terms and assuming she later sells her Owl stock, determine the tax cost of (1) contributing the property as originally planned, or (2) pursuing the alternative she has identified.

Assume a discount rate of 6%. The present value factors at 6% are 1.000 for year 1 and 0.7050 for year 5. Further, assume Gail's marginal income tax rate is 32% and her capital gains rate is 15%.

If required, round your answers to the nearest dollar.

The present value of tax cost associated with sale of Owl stock for $700,000 is $52,875.

The present value of the tax cost associated with the current sale of inventory for $50,000 and subsequent sale of Owl stock for $700,000 is:

$??????

I only Need this last question answered under section i.

All others are correct.

Answer 1

Tax cost associated with sale of Owl stock for $700,000:
Amount realized		$700,000
Less: Basis of Owl stock		-200,000
Capital gain recognized	500,000
Tax cost	75000
PV Factor	0.705
Present value of the tax cost		52875
Tax cost associated with the current sale of inventory for $50,000 and subsequent sale of Owl stock for $700,000:
Amount realized—sale of inventory		50000
Less: Basis of inventory		-60000
Ordinary loss recognized		-10000
Tax benefit ($10,000 × 28%)		2800
Present value factor		1
Present value of the tax benefit		2800
Amount realized—sale of Owl stock		700000
Less: Basis of Owl stock ($125,000 + $15,000 + $50,000)		-190000
Capital gain recognized		510000
Tax cost ($510,000 × 15%)		76500
Present value factor		0.705
Present value of the tax cost		53932.5
Total tax cost of this alternative ($53,933 – $2,800)		51132.5
Present value of the tax cost of the alternative ($52,875 −$51,133)		1742.5	I.e, less than the tax cost associated with the original plan