Federal Income Taxation of Corporations and Shareholders (Bittker&Eustice, with the current supplement)
Questions:
Assumptions: Realty Corporation owns a rental building (its only asset) with a gross fair market value of $1,000,000, subject to a nonrecourse mortgage of $400,000. Realty Corporation's adjusted basis for this building is $300,000. Aaron owns all of Realty Corporation's stock, with a total basis of $100,000. Realty Corporation has $200,000 of earnings and profits. Realty Corporation is on the accrual method of accounting and reports on the calendar year. Assume that the corporate tax payable by Realty Corporation on $700,000 gain is $250,000 and on $600,000 gain is $200,000.
For each of the following problems (1) through (7) below, determine the amounts and character of realized and recognized gain or loss to all parties, the time of recognition, and the transferee's basis in any property received in kind. Each question should be reproduced in bold italic type, followed by your answer in normal type. They should simply be sufficient to answer the questions.
(1) Realty Corporation sells the building, subject to the mortgage, to Barbara in the current year for $600,000 in cash. Realty Corporation then liquidates, distributing to Aaron all of the cash remaining after paying its taxes, in cancellation of Aaron's stock in the current year.
Alternatives:
(a) Barbara pays $300,000 cash and gives Barbara's $300,000 note payable in equal annual installments over five years. Realty Corporation's plan of liquidation provides that Realty Corporation will stay in existence for five years for the sole purpose of collecting the note and paying the net amount over to Aaron annually.
(b) Barbara pays $300,000 in cash and gives Barbara's $300,000 (face and fair market value) note payable in equal annual installments plus interest over 5 years. In liquidation, Realty Corporation distributes the net cash and the note to Aaron in the year of sale.
(c) Change the facts in (1) and (1)(b) above to assume that Realty Corporation is an S corporation and § 1374 does not apply.
(2) Realty Corporation adopts a plan of complete liquidation and distributes the property to Aaron "in kind" pursuant to this plan. Aaron then sells the property to Barbara for $600,000 in cash, with Barbara taking subject to the $400,000 mortgage. Would it matter if Aaron's shares had varying prices per share? What if the property were subject to contingent environmental liabilities?
Alternative: Realty Corporation is an S corporation and § 1374 does not apply.
(3) Aaron sells the stock in Realty Corporation to Barbara for $600,000 in cash. Barbara promptly liquidates Realty Corporation to get direct ownership of, and a $1,000,000 basis in, the building. Was Barbara wise to pay $600,000? Could Barbara obtain a better tax result by electing S corporation status for Realty Corporation before liquidating Realty Corporation?
Alternative: Realty Corporation always had been an S corporation.
(4) Suppose that in (1) above, the gross FMV of Realty Corporation's property is actually $1,000,000, but to induce Realty Corporation to sell, Barbara also gives Realty Corporation a "contingent" right (with no ascertainable fair market value) to receive from Barbara an additional $500,000 in 5 years if Barbara earns profits from the building in excess of any profits it historically had earned.
(5) Suppose that in (2) above, the basis for Realty Corporation's property is $1,500,000 instead of $300,000? Would your answer change if Aaron had organized Realty Corporation two years ago by contributing the building then worth $1,500,000 with a $1,500,000 basis in exchange for all the stock and Aaron's stock basis is now $1,500,000 (assume no debt is involved)?
(6) Suppose that in (2) above, the value of Realty Corporation's property is $350,000 and Realty Corporation liquidates with Aaron taking subject to the $400,000 mortgage. Aaron then sells to Barbara subject to the mortgage and for no additional consideration.
(7) Realty Corporation has one shareholder, Aaron, whose stock basis is $100,000. Realty Corporation operates a business in a building whose value is $1,000,000 with an adjusted basis of $300,000. Realty Corporation has $1,000,000 in the bank. In the current year, Realty Corporation sells its operating business assets for $1,000,000 cash, which increases Realty Corporation's total earnings and profits to $1,500,000. Also in the current year, in exchange for other assets Realty Corporation receives an installment note reportable under § 453, enters into a lease for the building with the buyers of its business, and retains part of its inventory for gradual sale in the future. Aaron, who is age 70, comes to you after all these steps have been taken and inquires whether Realty Corporation should be liquidated or should elect S corporation status to avoid paying double tax on the installment gain, the rent, the future inventory sales, and a possible sale of the building in a few years. What do you advise?