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[MUSIC]

Let's apply the built-in loss rules for

section 351 exchanges to Sunchaser Shakery.

Nicholas forms Sunchaser Shakery Corporation by transferring a land parcel

he held as an investment for all of the stock.

At the time of the transfer, the land had a fair market value of of $35,000 and

an adjusted basis of $100,000.

In part a, we want to know what are the tax effects for Nicholas.

And in part b, we want to know what are the tax effects for Sunchaser Shakery.

So let's start with Nicholas for part a.

And so where do we begin?

We begin where we always begin.

Does section 351 apply to Nicholas in this case?

So let's run through the three situations that we've examined so far.

We have one or more persons transferring property.

In this case, he is transferring a land parcel.

So in exchange of stock, he is not receiving anything else, but

shares of of stock in the exchange.

And afterwards, it is says that he holds all of this stock.

So he has 100% control at the end of the transaction.

So all the requirements of section 351 are there.

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And in this case, nothing is new yet.

So what's his amount realize?

He's giving up property with a fair market value of $35,000,

so he is going to receive $35,000 in stock.

What's the adjusted basis of the property that he's contributing?

And in this case, we are told it has $100,000.

And so this is interesting.

because so far,

all of the property that we have dealt with has had a built-in gain.

That is that it has appreciated in value.

But here for the first time, we are seeing the opposite situation where the adjusted

basis exceeds the fair market value which is the focus of this lesson.

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But so far for us, everything here is going to be the same as it's always been.

Because as you learned when there's a built-in loss, by default,

it affects the corporation not the shareholder.

So he has a realized loss.

Of $65,000.

And of course,

we want to know how much of this realized loss as he recognize on his tax return.

Normally, we recognize all of this things,

unless a code section tells us that we're not suppose to.

And here we know, section 351 applies to say, no gain or loss is recognized.

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So what's his basis in the new shares?

Well, it should be our basis formula.

So we begin with the exchange or carryover basis,

the property he contributed which we just said was $100,000.

And to continue using this basis formula even though we haven't discussed all

the concepts yet, we would add any gain recognized.

Subtract the fair market value of any boot received which is again, zero and

subtract any liabilities assumed by the corporation which again is zero.

We're just going to practice using this formula each time.

And then finally, what's his holding period and

the new stock that he just received.

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Well, again, the holding period can be tacked that is include the holding period

of the property that he transferred so long as he transfers a capital asset or

a section 1231 asset.

And in this case,

we're told that he transfers a land parcel that he held as an investment.

If it's an investment asset, then by definition,

it's a capital asset which would then quality it for a tacked holding period.

In other words, even though that he has only owned the stock for a few minutes,

it would automatically have long-term treatment if he has held that capital

asset long-term.

So we'll put it's tacked, because it was an investment.

3:55

So those are the tax effects for Nicholas.

So far, nothing is new.

This is what we've been dealing with so far, but

we know that we have this built-in loss situation kind of lurking and

that's what we're going to deal with next.

So when we go to the corporate side of this and determine the tax effects for

Sunchaser, this is where we have to be careful to factor in the built-in loss.

So let's start with the gain or loss part.

Let's look at amount realized.

The corporation is giving up it's shares of stock in exchange for

this land from Nicholas, which we're told has a fair market value of $35,000.

So that's what's kind of coming in through the door of the corporation.

What is its adjusted basis in its own shares of stock?

Well, zero.

Because it's its own stock.

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So let's make sure we write that down,

because that zero seems kind of weird at first.

So they have a realized gain of 35,000,

but do they recognize this gain?

No, why?

because they're dealing in their own shares of stock.

This is what we've been dealing with so far and that is section 1032.

It says, when a corporation issues their own shares of stock, there's no gain or

loss to recognize.

So once again, nothing new.

5:06

Here's the new part and

that is what is the corporation's basis in the land that it just received.

Well, normally, it would be the exchange for carryover basis.

But now as we know from the concepts part of this lesson, if we go to the slide.

It says, if net built-in loss, property is transferred

under section 351 which is what we have where the adjusted basis is 100,000.

The amount realized is 35,000.

The corporations aggregated adjusted basis is

limited to the fair market value of the property.

So that means when we get to the basis calculation here,

then we have the difference situation than what we've seen before.

So under the code section that we've been

dealing with section 362(e)(2),

basis is limited to fair market value.

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Because we have the built-in loss, so I put BIL for built-in loss.

The fair market value of the property that was transferred was $35,000.

So that´s going to be the basis for the corporation.

And again, the whole point of this is to prevent the double counting of losses with

the duplication of losses across the taxpayer and the corporation.

In other words, only one party can have this loss.

So now, let's look at holding period for the land that I just received.

And in this case, it would be tacked, because section 351 applies.

And so exchange basis is our starting point even though that exchange basis was

ultimately limited to fair market value.

So the holding period would still be tacked in this situation.

So it's also important to know, don't forget that the corporation and

the shareholder can jointly elect the special election that we talked about.

So they can jointly elect to reduce the shareholder's basis in the stock to fair

market value instead of the corporation, but

the default is to adjust the basis of the corporation.

So if you see a problem on an exam or the CPA exam that does not indicate that

a special election under 362(e)(2) was made, then you automatically adjust

the corporation's basis like we did in this problem.

7:09

Nicholas formed Sunchaser Shakery Corporation by transferring the assets

below in a section 351 transaction.

The fair market value of the stock received was $400,000.

So we have inventory of the fair market value of 100,000,

adjusted basis of 50,000.

Building with a fair market value of 100,000 and adjusted basis of 250,000.

Land with a fair market value of 200,000 and adjusted basis of 150,000.

And we want to know what is the realized gain or loss for both Nicholas and

Sunchaser.

So where do we begin?

So let's start with Nicholas.

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So we were already told that section 351 applies.

So we don't need to specifically go through the three characteristics, but

we can easily see that they're all present.

The other thing to notice as is the topic of this lesson is that we have

a built-in loss within these assets.

So that's going to be important as we work through everything,

but the other thing to keep in mind though is that the built-in loss rules only apply

by default to the corporation.

The shareholder and the corporation can jointly make an election to affect

the shareholder, but we were not told of such election in this situation.

So the default will be the corporation.

In other words, we will encounter that issue more specifically when we get to

part b where we're determining the tax effects for Sunchaser.

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So to continue, we will start where we always start, amount realized.

So in this situation,

we're told that Nicholas is going to receive shares that are worth $400,000.

So now, we need the adjusted basis of the property that he's going to contribute and

we have three items he is contributing.

The inventory, the building and the land.

So we have just a basis of 50,000, 250,000 and 150.

So the total basis of the property that he is contributing

in the situation are $450,000.

So he has an overall realized loss of 50,000 and

how much of this loss will he recognize?

Well, we're told that section 351 applies and 351 says, no gain or

loss is recognized.

So zero.

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What's his basis in the new shares of stock that he receives from

the corporation?

Well, we'd our formula as we've done before.

We would start with exchanged or carryover basis.

In other words, the basis of the property that he contributed which we just added

up to be $450,000.

We would factor in any gain recognized by the shareholder minus the fair market

value of any boot received minus any liabilities assumed by the corporation and

we have yet to really address this situation.

10:01

Now, we need to consider everything for Sunchaser.

So we know that there is no gain or loss recognized for Sunchaser,

because they are dealing in their own stock in section 1032 as we've used

before does not make us recognize any gain or losses in such situations.

The issue of concern will be the basis, of course, and

the reason is that we have to build-in loss property.

So that's the real element of this problem.

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So we have a built-in loss property.

So if we go back and look at the property that was contributed here by Nickolas to

the corporation, we see we have the inventory, the building and the land.

And so the inventory itself actually has a $50,000 built-in gain and

the land also has a $50,000 built-in gain.

But the building, however, has depreciated in value by $150,000.

So that automatically raises some concern.

However, when we actually the code sections that we've been dealing

with respect to built-in loss property,

you have to remember that it actually addresses only the aggregate.

The aggregate amount realized and

the aggregate adjusted basis of the property contributed.

So let's make a note here, so that you have something to think about when you

look at these problems again later.

So for the corporation,

this is just a recap of the rules that we've learned already.

They're going to receive.

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So let's look at each asset that's being transferred,

because that's what we'll need to know the basis in.

We have inventory, the building and the land.

So let's just start with the easy part, what's the exchange carry over basis?

In other words, what's the basis in the asset that was given to the corporation by

the shareholder?

So the exchange basis in the inventory would be 50,

250 for the building and 150 for the land just as a starting point.

We know that's not going to stay that way, because we have to make an adjustment for

this built-in loss.

But we can use this as a starting point, exchange basis.

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And just as a quick check here, let's just, even though we know that's right.

Let's add that up and we should get $450,000.

And that $450.000 matches the $450,000 of total adjusted basis of property

transferred, but we know we can't have that stay that way and the reason that we

can't have that stay that ways is because we have this built-in loss going on.

And so if you think back to the previous problem and just the rule in general,

it says, when you have the built-in loss that the basis is limited to the fair

market value, the lower amount basically rather than the adjusted basis amount.

So the total fair market value of all the assets transferred was $400,000.

We're looking at the aggregate here, because we have multiple property types.

We were doing the same thing in the prior problem.

We just had one asset to consider.

So that was indeed the aggregate.

So if we go back to the rule, the note that we wrote a few minutes ago.

We said, they received exchange for

carryover bases reduced by the aggregate net built-in loss.

So once all property is considered.

So if we look at all property considered,

we have a fair market value of $400,000 and then the adjusted basis of $450,000.

So in aggregate, we have a $50,000 built-in loss.

So that $50,000 is the amount that we now need to allocate or

figure out where it goes, which item or property to attribute it to.

And so if we go back and we look at the problem, the problem here that we have is

that the only asset that has a built-in loss is the building.

So that's what's causing this particular issue.

So we're going to actually put this $50,000 adjustment

on the asset that's causing the issue, $200,000.

And now we when we consider all of the assets together,

we have the $400,000 amount that we're looking for.

That is the fair market value.

So in other words, we can kind of write a final conclusion here that

the aggregate corporation's basis as the rule states is now limited.