Shareholder and Corporation Basis, Built-In Loss Property, and Holding Period

Basis at the Shareholder and Corporation Level

Basis at the Shareholder Level

  • As a general rule, it’s a substituted basis. The shareholder transfers assets to the corporation and whatever basis the shareholder had in those assets is the basis they have in the stock, so it’s a substituted basis.
  • A realized gain is not recognized
  • A deferred gain is preserved in the lower stock basis

Treatment of Boot at the Shareholder Level

If boot is issued, the gain will be recognized to the lesser of fair market value of the boot itself, or the realized gain. Property that’s treated as boot will have a basis of fair market value in the hands of the shareholder. The deferred gain on the property that has been transferred into the corporation will be preserved, but it will also be reduced by the amount of the gain recognized as a result of the boot distribution.

Basis at the Corporate Level

As a general rule, this will have carryover basis which is driven by Section 362, which says that assets transferred into the corporation have the same basis that they had in the shareholder’s hands.

Remember, substituted basis means the basis the shareholder had on the property will be the basis of the stock he gets from the corporation, and carryover basis means that the basis the assets had in the hands of the shareholder will be the basis of the assets inside the corporation.

Transfer to the corporation results in a second built-in gain that is subject to being taxed when the corporation sells the asset. There’s one built-in gain in the stock that the shareholder takes back from the corporation, and a second built-in gain on the asset inside the corporation.

The deferred gain is preserved by the lower asset basis, which will be recognized when the asset is sold.

Treatment of Boot at the Corporate Level

Gain that is recognized will increase the basis of the assets contributed to the corporation. The deferred gain is reduced by the amount of gain recognized as a result of the boot distribution.

Built-In Loss Property

Remember that the contribution of an appreciated asset results in two built-in gains- at the shareholder level and the corporate level.

The same things happens the other way around: A property with a built-in loss that’s contributed to a corporation will results in a second built-in loss at the corporate level. This was beginning to be abused before 2004 by using the built-in loss to shelter other gains.

Section 262 (e)(2) required that the corporation holds the loss property with a basis equal to its fair market value on the date of the contribution, which gets rid of the second built-in loss.

The corporation and the shareholder can also elect to have the shareholder reduce the value of their stock to fair market value to remove the built-in loss at the shareholder level.

The test to determine whether there’s a built-in loss is not an an asset-by-asset basis, but in aggregate.

So, Congress allows potential double built-in gains, but removes the possibility of double built-in losses.

Holding Period

The holding period will determine whether or not the sale of a capital sale will be taxed at short term rates or long term rates.

As long as the assets transferred in are either capital assets or 1231 assets, then the holding period that the shareholder had into those assets will be tacked onto the stock the shareholder receives. For example, if I contributed a capital asset I had owned for three years, the stock I receive will have a holding period of 3 years tacked on. This means that I could sell the stocks the next day and it would be taxed at the long term rate.

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