Question

3. Finn and Bianca form Spirit Inc., a C-Corporation. Finn transfers land (FMV $150,000 and adjusted basis of 60,000) and agrees to provide services to manage the business after it opens worth $100,000 for 50% of the stock in the corporation. Bianca transfers equipment (FMV 260,000 adjusted basis of $85,000 for 50% of the stock in the corporation and $10,000 cash. The value of the stock received is $250,000 for each Finn and Bianca. (7 points)

a. Will the transfer qualify under §351 as a tax-free transfer? Explain.

b. What are the tax consequences to Finn and Bianca including the basis in the stock they received?

c. What is Spirit Inc.’s basis in the land and equipment received?

d. Would your answers change to question b if Bianca formed Spirit 3 years ago and Finn is making his contribution this year in 2019?

Answer 1

Per Sec 351, when a C corp issues stock in exchange for property, the transaction is not taxable if the following condition is satisfied-

All the contributors of Cash + Property have 80% or more control in the C Corp.

Note that a shareholder contributing only services for stock is not counted as a part of the control group for the purpose of the 80% control. However, where a shareholder provides services in addition to contributing property, he is counted as a part of the control group for the purpose of 80% control.

• Shareholder's basis for stock = Carryover basis (-) Mortgage debt
• Corporation's basis for the property = Carryover basis

Answers to the given questions are:

a. Yes the transfer would qualify under §351 as a tax-free transfer.

Explanation: As both Finn and Bianca have contributed cash/ property to Spirit Inc. and the combined control of both the contributors is 100% which is more than 80%, both the transfers would be non taxable under sec 351. Even though Finn has promised to provide services to Spirit Inc worth $100,000, he would still be considered for counted as a part of the control group for the purpose of 80% control since he has contributed property as well in addition to the services.

b. There would be no tax liability in the hands of Finn and Bianca as the transfer of property would be treated as non taxable. However, Bianca needs to report a ordinary gain of $100,000 in his individual return for the services provided.

Finn's Basis of the stock would be = Carryover basis of the property + Fair Value of the services = $60,000 + $100,000 = $160,000

Bianca's Basis of the stock would be = Carryover basis of the property + cash contributed = $85,000 + $10,000 = $95,000

c. Spirit Inc.'s basis in the land and equipment received = Carryover basis

Basis of land = $60,000

Basis of Equipment = $85,000

d. If Bianca formed Spirit 3 years ago and Finn is making his contribution this year in 2019, the transaction would not qualify under Sec 351 as the control of the contributor (i.e. Finn) is less than 80% in the Spirit Inc. The transfer of land by Finn would be a taxable transaction and Finn would be liable to pay tax on the same.

Tax consequence in the hands of Finn:

• He needs to report a capital gain on the transfer of land for $ 90,000 ($150,000 - $ 60,000)
• He needs to report a ordinary gain of $100,000 in his individual return for the services provided.

Basis of stock in the hands of Finn = $250,000