To apply the general concepts of section 1032 and 351,
let's keep things simple for now and add complexity as we progress.
Assume that each problem you encounter is
an independent situation unless indicated otherwise.
In this problem, Nicholas exchanges property with a $15,000 adjusted basis,
and a $42,000 fair market value for
70 shares of the newly created Sunchaser Shakery Corporation.
Emily exchanges accounting services worth $25,000 for the remaining 30 shares of stock.
And in part A, we want to know what amount of gain or loss,
if any, must Nicholas,
Emily and Sunchaser recognize on the exchange. So where do we begin?
Well, let's first start by looking at whether section 351 applies to this transaction,
because if it does, that will help us determine whether or not we need
to recognize any gain or loss on the transaction.
So let's briefly run through each of the components of
section 351 to figure out if it applies.
So, our first concern is whether or not we have
one or more persons transferring property.
And this is important because for 351 to apply,
we do need a transfer of property.
So do we have this situation? Well, yes.
We have Nicholas who's going to transfer property in exchange for stock.
However, Emily is transferring services,
which you learned in the concepts that services for
section 351 do not equate to property.
So in other words, as we apply this concept of section 351 to this problem,
we can not consider Emily in this situation.
Okay, so let's keep moving.
The next requirement we need is to determine whether or not this exchange or
property was made solely in exchange for stock.
In other words, did Nicholas receive anything else other than stock?
And in this situation, no,
he didn't receive anything else.
So his exchange was solely in exchange for stock.
So we're good here.
And then our final concern is whether there is control of
the corporation immediately after the exchange.
And recall that control for purposes of section 351 is defined
at the 80 percent threshold of both voting and non-voting shares if they exist.
So here though, we cannot include Emily shares of stock
because she did not transfer property, only Nicholas did.
So for looking at Nicholas's shares to determine what he receives.
During the transaction it says that he received 70 shares,
which means Emily receives the other 30 shares,
which was indicated in the problem.
So after the exchange,
Nicholas only holds 70 percent of the shares.
This is obviously less than 80 percent.
And so, we do not meet the control requirement for section 351.
So in other words,
section 351 does not apply to this transaction and that's obviously important for us.
Okay, so with this in mind,
let's now go to each of the three parties involved in the transaction
to figure out the taxation of this specific situation.
So let's begin with Nicholas.
Well, in most property problems we're always going to begin in
the exact same place with the amount realized,
that is what did Nicholas receive in the transaction?
In other words, what's coming in the door to him.
And so, we see that in the problem,
it says that he is giving up property with the fair market value of $42,000.
In the case of a closely held corporation such as Sunchaser,
there is no open market for their shares
such as in New York Stock Exchange or something similar.
So in this situation, basically,
it's a presumption that we make in tax that the value of the stock
he receives will be equivalent to the value of the property he transferred.
In other words, he's going to receive $42,000 worth of stock,
making in an arm's length transaction.
So we're not concerned about what's the adjusted basis of the property that he gave up.
And it says in the problem that he contributed property with the $15,000 adjusted basis.
So this means that he has a,
just abbreviate with our LCD,
realized gain of $27,000.
So how much of that realized gain then is he required to recognize on his tax return?
Well, under section 1000 1b,
we're told that anytime we have a realized gain we typically recognize it,
unless another code section kicks in to tell us not to recognize it.
Such a code section in this situation would be 351.
But we just determined that that code section does not apply to this situation because
Nicholas does not have control on his own after the transaction,
and we're not allowed to include Emily shares in this situation.
So because 351 does not apply,
1000 1b will apply,
forcing him to recognize the $27,000 gain.
Okay, so that's it for Nicholas.
Now let's consider Emily.
So Emily, in this situation,
351 does not apply to her either as we
determined because she does not transfer any property,
instead she transfer services.
So, in the event she transfer services, when she does,
she is going to recognize the value of the stock she receives for those services.
So the fair market value of her services, $25,000,
will be included in her taxable income as
basically compensation for her services under Section 61.
So in other words, she'll pay tax on the $25,000.
And now let's look at Sunchaser,
the final party to this transaction.
When it comes to a corporation,
we're not concerned about section 351 because
Section 1032 governs the corporation and in that situation.
Just remember section 351 only applies to potential shareholders.
That is the transfer ore's.
So for the corporation,
section 1032 says no gain or loss to a corporation when dealing with their own stock.
So in this situation Sunchaser issuing its own stock,
so there is no gain or loss on the transaction.
So that is the answer for the corporation.
So that is everything for part A.
Now let's take a look at part B which says,
let's assume the same facts except Nicholas and Emily
received 82 and 18 shares, respectively.
So what changes in this situation?
We still have one or more persons transferring property.
It's still solely in exchange for stock except now,
Nicholas all on his own is going to achieve the 80 percent control threshold.
And so, if we just look at the control aspect here for
a moment then we see that Nicholas will now have
82 of the 100 shares outstanding,
or in other words, 82 percent.
So control is now officially met,
which means section 351 would apply to the entire transaction.
In other words, we don't need Emily shares for Nicholas to obtain control.
Let's say applies.
So in this case, now with 351 applicable,
Nicholas will recognize no gain or loss.