Question

On January 10 of the current year, Mary transfer to Green Corporation a machine purchased three years ago for $100,000. On the transfer date, the machine has a $60,000 adjusted basis and a $10,000 FMV. Mary receives all 100 shares of Green stock, worth $100,000, and a two-year Green note worth $10,000. Required:a. What are the amount and character of Mary's recognized gain or loss? b. What is Mary's basis in the stock and note? When does her holding period begin? c. What are the amount and character of Green's gain or loss? d. What is Green's basis in the machine? When does Green's holding period begin?

Answer 1

Answer:

First of all, I believe that their is a mistake on the question, since the FMV of the machine should be $100,000, not $10,000, or else it wouldn't make much sense.

a. What are the amount and character of Mary's recognized gain or loss?

ordinary income of $10,000

The two year note is considered boot and therefore, Mary must report it as ordinary income.

b. What is Mary's basis in the stock and note? When does her holding period begin?

Mary's basis in the stock is $60,000 (the basis of the machine), and $0 for the note (recognized as ordinary income). Her holding period began three years ago when the machine was purchased.

c. What are the amount and character of Green's gain or loss?

Under a carryover basis limit rule (for a section 351 exchange), Green Corporation's basis is reduced, but it not considered a loss or a gain. The basis of the exchanged stock must equal the carryover basis of the property given in exchange.  

d. What is Green's basis in the machine? When does Green's holding period begin?

Same as Mary's, the basis is $60,000 and the holding period is 3 years. Since Mary owns 100% of Green Corporation as a result of the exchange, her basis and the corporation's basis will be the same.