Question

Kevin and Bob have owned and operated SOA as a C corporation for a number of years. When they formed the entity, Kevin and Bob each contributed $100,000 to SOA. They each have a current basis of $100,000 in their SOA ownership interest. Information on SOA's assets at the end of year 5 is as follows (SOA does not have any liabilities): Assets FMV Adjusted Basis Built-in Gain Cash $200,000 $200,000 $0 Inventory $80,000 $40,000 $40,000 Land and Bldg $220,000 $170,000 $50,000 Total $500,000 At the end of year 5, SOA liquidated and distributed half of the land, half of the inventory, and half of the cash remaining after paying taxes (if any) to each owner. Assume that, excluding the effects of the liquidating distribution, SOA's taxable income for year 5 is $0. Also, assume that if SOA is required to pay tax, it pays at a flat 30 percent tax rate.
a. What is the amount and character of gain or loss SOA will recognize on the liquidating distribution? Distribution of the inventory Distribution of the land and building
b. What is the amount and character of gain or loss Kevin will recognize when he receives the liquidating distribution of cash and property? Recall that his stock basis is $100,000 and he is treated as having sold his stock for the liquidation proceeds.

Answer 1

Answer:

Assets                  FMV                  Adjusted Basis       Built-in Gain

Cash                    $200,000         $200,000               $0

Inventory             $80,000           $40,000                  $40,000

Land and Bldg    $220,000         $170,000                 $50,000

total                     $500,000

A) Since SOA is making a liquidating distribution, it will be taxed as if they sold their assets at fair market value:

• distribution of the inventory results in a $40,000 ordinary gain = $40,000 x 30% = $12,000 in taxes
• distribution of the land and building results in a $50,000 Sec. §1231 gain = $50,000 x 30% = $15,000 in taxes

total recognized gain = $90,000 (= $40,000 + $50,000)

B) After taxes are paid, SOA's total assets = $500,000 - $27,000 = $473,000 which must be divided equally between Kevin and Bob. Each owner should receive $236,500.

So Kevin's gain = $236,500 - $100,000 = $136,500