Question

Problem 5-35 (LO. 1, 3) Larry, the sole shareholder of Brown Corporation, sold his Brown stock to Ed on July 30 for $270,000. Larry's basis in the stock was $200,000 at the beginning of the year. Brown had accumulated E & P of $120,000 on January 1 and has current E & P of $240,000. During the year, Brown made the following distributions: $450,000 cash to Larry on July 1 and $150,000 cash to Ed on December 30. If an amount is zero, enter "O". a. How will Larry and Ed be taxed on the distributions? Larry will have the following: Dividend income: $ Return of capital: $ Capital gain: $ Ed will have the following: Dividend income: Return of capital: $ Capital gain: $ b. How much gain will Larry recognize on the sale of his stock to Ed? Larry recognizes a capital gain of $ on the sale of the stock.

Answer 1

A.

Capital gain is a profit during the sale of any capital asset such as stock, land and any non movable property gain is arise only when the consideration price is more than the price of cost of capital price. In the given question larry has sold his share to Ed for $270000 on 30 july and larry's basis in the stock at the beginning of the year was $200000 Total distribution of cash by brown corporation is = $600000 ($45000 + $150000)| Current E & P allocation = (Current E&P x Distribution) Total Distributions E&P allocation to Larry ($240000 $450000) $600000 = $180000 E&P allocation to Ed= (S240000 Ⓡ$150000) $600000 = $60000

Dividend paying capacity of brown is to larry = (Accumulated E&P + current E&P) = $120000+ $180000 = $300000 Therefor $300000 larry's distribution will be treated as dividend income Recovery of capital = $150000 ($450000 - $300000) Stock basis will be = (stock at the beginning of the year - Recovery of capital) = ($200000 - $150000) = $50000 Brown corporation distributed to Ed $150000 out of which $60000 will be treated as dividend income and remaining is recovery of capital that is $90000 ($150000 - $60000) Stock basis of Ed = (purchase price - recovery) = ($270000 - $90000) = $180000 B. On sale of stock for $270000 to Ed. Larry recognizes that as capital gain. Capital gain = sale - stock basis = $270000 - $50000 = $220000