This year, John, Meg, and Karen form Frost Corporation. John contributes land purchased as an investment four years ago for $25,000 that has a $30,000 FMV in exchange for 30 shares of Frost stock. Meg contributes machinery (Sec. 1251 property) purchased four years ago and used in her business having a $50,000 adjusted basis and a $30,000 FMV in exchange for 30 shares of Frost stock. Karen
contributes services worth $15,000 and $5,000 cash in exchange for 20 shares of Frost stock.
a) What is the amount of John's recognized gain or loss?
b) What is John's basis in his Frost shares? When does his holding period begin?
c) What is the amount of Meg's recognized gain or loss?
d) What is Meg's basis in her Frost shares? When does her holding period begin?
e) How much income, if any, must Karen recognize?
f) What is Karen's basis in her Frost shares? When does her holding period begin?
g) What is Frost Corporation's basis in the land and the machinery? When does its holding period begin? How does Frost Corporation treat the amount paid to Karen for services?
a) Since Sec. 351 would apply to the exchange, John would not recognize any gain or loss.
b) John's basis is $25,000. His holding period begins in his year of purchase four years ago.
c) Meg does not recognize any loss.
d) Meg's basis is $50,000. Her holding period begins in her year of purchase four years ago.
e) Karen must recognize $15,000 of ordinary income.
f) Karen's basis for her shares is $20,000 and her holding period begins on the day after the exchange date.
g) Frost Corporation's basis in the land and machinery are $25,000 and $30,000, respectively. Because Meg contributed loss property, unless an election is made, the basis in the loss property must be reduced to FMV by the corporation. Frost's holding period for the land begins four years ago. Frost's holding period for the machinery begins the day after transfer to Frost Corporation. The services, if capitalized, would have a $15,000 basis. The services may be amortizable if they are organizational or start-up expenditures.
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