Rich owns 60 of the 100 outstanding shares of Rainbow Corporation's stock and 80 of the 100 outstanding shares of Oz Corporation's stock. Rich's basis in his Rainbow shares is $12,000, and his basis in his Oz shares is $8,000. Rich sells 30 of his Rainbow shares to Oz Corporation for $50,000. At the end of the year of the sale, Rainbow and Oz Corporations have E&Ps of $25,000 and $40,000, respectively.a)What is the amount and character of Rich's gain or loss?b)What is Rich's basis in his remaining shares of the Rainbow and Oz stock?c)How does the sale affect the E&Ps of Rainbow and Oz Corporations?d)What basis does Oz Corporation take in the Rainbow shares it purchases?e)How would your answer to part (a) change if Rich owns only 50 shares of the 100 outstanding shares of Oz Stock?
What will be an ideal response?
| a) | The sale is recast as a redemption of Oz stock issued as a result of Rich's capital contribution of |
| • | Rich's ownership of Rainbow stock before the redemption: 60% of Rainbow stock. |
| • | Rich's ownership after the redemption: 30 shares directly and 80% × 30 shares indirectly = |
The redemption is treated as a $50,000 dividend to Rich since the combined E&P of Rainbow and Oz Corporations is $65,000 ($25,000 + $40,000).
| b) | Rich's basis in his remaining Rainbow stock is $6,000 (30/60 × $12,000). Rich's basis in his Oz |
| c) | Oz's E&P is reduced by the first $40,000 of the distribution, and Rainbow's E&P is reduced by |
| d) | Oz's basis in its Rainbow shares is $6,000, the same as Rich's pre-sale basis. |
| e) | If Rich owned only 50% of the Oz stock before the sale, Rich owns 60% of the Rainbow stock |
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