This year, John, Meg, and Karen form Frost Corporation. John contributes land purchased as an investment four years ago for $15,000 that has a $30,000 FMV in exchange for 30 shares of Frost stock. Meg contributes machinery (Sec. 1231 property) purchased four years ago and used in her business having a $35,000 adjusted basis and a $30,000 FMV in exchange for 30 shares of Frost stock. Karen

Question

contributes services worth $20,000 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 her services?

Answer 1

a) Since Sec. 351 does not apply because 25% (20 shares out of 80 total shares) of the stock is issued for services, John must recognize $15,000 of capital gain.
b) John's basis in his shares is $30,000 and his holding period begins on the day after the exchange date.
c) Meg recognizes a $5,000 Sec. 1231 loss.
d) Meg's basis in her shares is $30,000 and her holding period begins on the day after the exchange date.
e) Karen must recognize $20,000 of ordinary income.
f) Karen's basis in her shares is $20,000. Her holding period begins on the day after the exchange date.
g) Frost Corporation has a $30,000 basis in the land and a $30,000 basis in the machinery. Its holding period for each asset begins on the day after the exchange date. The services, if capitalized, would have a $20,000 basis. The services may be amortizable if they are organizational or start-up expenditures.