Question

95. Rita forms Finch Corporation by transferring land (basis of $125,000; fair market value of $750,000) which is subject to a mortgage of $375,000. Two weeks prior to incorporating Finch, Rita borrows $125,000 for personal purposes and gives the lender a second mortgage on the land. Finch Corporation issues stock worth $250,000 to Rita and assumes the two mortgages on the land. What are the tax consequences to Rita and to Finch Corporation?

Answer 1

SECTION 375 (b) and (c) are applicable

Because the land is subject to two mortgages that are in excess of basis under section 357 (c)

Rita would have a recognised gain of $375000 on the transfer but section 357(b) also is applicable because rita borrowed the $125000,shortly before incorporating and used the money for personal purposes .As section 357 (b)causes all liabilities to be tainted ,rita has boot of $500000. of rita's realized gain of $625000 ($750000)value of the stock recieved and release of mortgages.-$ 125000 (basis in the land),$500,000gain (the amount of boot )is recognised

when section 357(b) and (c) both apply to the same transfer section 357 (b) predominates .Finch corporation has a basis of $625000 in the land ,computed as follows :$125000 (carryover basis from rita)+$500000 (gain recognised by rita).Rita has a basis of$125000 in her stock ,computed as follows :$125000 (basis in the land) +$500000 (gain recognized)-$500000 (liabilities assumed by finch corporation)

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