erry purchased land from Winter Harbor Corporation, his 100%-owned corporation, for $275,000. The corporation purchased the land three years ago for $300,000. Similar tracts of land located nearby have sold for $400,000 in recent months. What tax issues should be considered with respect to the corporation's sale of the land?

Question

What will be an ideal response?

Answer 1

• What reasons might cause the sale to be $125,000 below the apparent prevailing market?
• What gain or loss does Winter Harbor recognize on the sale?
• What is Winter Harbor Corporation's E&P balance?
• Do the related party sale rules apply to the sale?
• If the $125,000 shortfall is a dividend, what gain or loss does Winter Harbor recognize on the distribution?
• What is the shareholder's gross income?
• What is the shareholder's basis for the land?
• What is the shareholder's holding period for the land?
• What is the distributing corporation's gain or loss on the distribution?
• What effect does the distribution have on the distributing corporation's E&P?

One issue is whether Winter Harbor can recognize a $25,000 loss on the sale of the land to Jerry for $275,000 ($275,000 sale - $300,000 adjusted basis). It appears that Sec. 267 will prevent the recognition of the loss since Jerry and Winter Harbor Corporation are related parties under Sec. 267(b). An additional issue is whether Jerry has a constructive dividend. If similar land has sold recently for $400,000, it appears that the sale should have been $400,000 instead of $275,000. The $125,000 difference between the actual sales and the amount paid for similar land therefore should be considered a constructive dividend. Classifying the difference as a constructive dividend causes Winter Harbor to recognize a $100,000 ($400,000 - $300,000) capital gain on the deemed land sale that occurs under Sec. 311(b) when appreciated property is distributed. It also will trigger a $34,000 ($100,000 × 0.34) income tax liability that will reduce E&P. Jerry will take a $400,000 basis in the land. The distribution will reduce E&P by $125,000.