Briefly describe the reason a corporation might distribute a property dividend to a shareholder in lieu of a cash distribution. Describe the tax effects of the property distribution on the shareholder and on the corporation

Answer 1

A corporation could distribute property to a shareholder because a shareholder may want a particular piece of property held by the corporation. Another reason might be that the corporation has low cash reserves but still wants to make a distribution to its shareholders.

The amount distributed to the shareholder is measured by the fair market value of the property on the date of distribution. Like cash, the portion of a property distribution covered by existing E & P is a dividend, and any excess is treated as a return of capital. If the market value of the property distributed exceeds the corporation's E & P and the shareholder's basis in the stock investment, a capital gain usually results. The amount distributed is reduced by any liabilities to which the distributed property is subject immediately before and immediately after the distribution and by any liabilities of the corporation assumed by the shareholder. The basis of the distributed property for the shareholder is the fair market value of the property on the date of the distribution.

All distributions of appreciated property generate gain to the distributing corporation. In effect, a corporation that distributes gain property is treated as if it had sold the property to the shareholder for its fair market value. However, the distributing corporation does not recognize loss on the distributions of property. If the distributed property is subject to a liability in excess of basis or the shareholder assumes such a liability, a special rule applies. For purposes of determining gain on the distribution, the fair market value of the property is treated as not being less than the amount of the liability (and this deemed fair market value will also be the basis of the property in the shareholder's hands). Corporate distributions reduce E & P by the greater of the fair market value or the adjusted basis of property distributed, less the amount of any liability on the property. E & P is increased by gain recognized on appreciated property distributed as a property dividend. A property distribution cannot generate a deficit in E & P or add to a deficit in E & P.