Question

Hazel transferred the following assets to Starling Corporation: Adjusted Basis Fair Market Value Cash $120,000 $120,000 Machinery 48,000 36,000 Land 108,000 144,000 In exchange, Hazel received 50% of Starling Corporation's only class of stock outstanding. The stock has no established value. However, all parties sincerely believe that the value of the stock Hazel received is the equivalent of the value of the assets she transferred. The only other shareholder, Rick, formed Starling Corporation five years ago and did not transfer any property to Starling Corporation for stock at this time. Select one: a. Hazel has no gain or loss on the transfer. b. Starling Corporation has a basis of $48,000 in the machinery and $108,000 in the land. c. Starling Corporation has a basis of $36,000 in the machinery and $144,000 in the land. d. Hazel has a basis of $276,000 in the stock of Starling Corporation. e. None of the above.

Answer 1

Answer:

c. Starling Corporation has a basis of $36,000 in the machinery and $144,000 in the land.

Explanation:

Note: The data in the question are merged together. For clarity purpose, they are therefore sorted before answering the question as follows:

                          Adjusted Basis            Fair Market Value

Cash                     $120,000                        $120,000

Machinery                48,000                            36,000

Land                        108,000                          144,000

The explanation to the answer is now provided as follows:

Since the control requirement of Sec. 351 that permits a tax-free incorporation transfer, this is therefore a taxable exchange.

This will therefore make Starling Corporation to have a basis of $180,000 in the machinery and land. That is,

Total Starling Corporation basis in  machinery and land = Fair market value of machinery + Fair market value of land = $36,000 + $144,000 = $180,000

This implies that on machinery, a loss of $12,000 has been recognized by Hazel, while a gain of $36,000 has also been recognized by Hazel on the land. That is,

Loss recognized by Hazel on Machinery = Machinery Adjuted basis - Machinery fair market value = $48,000 - $36,000 = $12,000

Gain recognized by Hazel on land = Land fair market value - Land adjuted basis = $144,000 - $108,000 = $36,000

In addition, Hazel has a basis of $300,000 in the Starling Corporation stock she receives. That is,

Hazel Basis = Fair market vale of cash + Fair market value of machinery + Fair market value of land = $120,000 + $36,000 + $144,000 = $300,000

Based on the analysis above, therefore, the correct option is c. Starling Corporation has a basis of $36,000 in the machinery and $144,000 in the land.