Homework Set 4--Contribution of Property to a Corporation
Sections 351, 357, 358 and 362
Case 1
Jenny Culpepper has run a successful manufacturing company for several years. Last month, she was
approached by a large competitor with an offer to join forces and expand her operations. The proposal is
for Jenny and the competitor, Wilcox Instruments, to form a new corporation, Wilpepper, Inc. Jenny
would contribute the assets and liabilities of her existing business to Wilpepper in exchange for 10,000
shares of Wilpepper stock. Wilcox Instruments would contribute $10,000,000 cash in exchange for
20,000 shares. The cash will be used to expand Jenny’s manufacturing operations substantially and
establish a new distribution network that reaches a broader market. Jenny is excited about the
opportunity and has come to us for advice.
Assume that Jenny will contribute the following assets and liabilities to the new company:
Tax
Basis
Cash
$250,000
Accounts Receivable
0
Inventory
350,000
Equipment
300,000
Accumulated depr. ( 190,560)
Land
200,000
Building
624,000
Acc. Depr., bldg
( 160,000)
$1,373,440
FMV
$250,000
60,000
650,000
300,000
N/A
500,000
1,185,000
N/A
$2,945,000
Mortgage
0
0
0
100,000
200,000
500,000
________
$800,000
Note that the new company will claim the same amount of depreciation on property received in a Sec.
351 exchange as the shareholder would have been allowed to claim had the new corporation not been
formed. Assume that the equipment is five-year property acquired three years ago. The building is 39year property.
1.
How much taxable gain or loss will be recognized by each of the investors?
None. Wilcox will record its portion of the exchange as follows:
Stock in Wilpepper
Cash
$10,000,000
$10,000,000
Jenny will record her portion as follows:
Stock in Wilpepper $573,440
Liabilities
800,000
Acc. Depr-equip
190,560*
Acc. Depr-bldg
160,000
Cash
A/R
Inventory
Equipment
Land
Bldg
2.
$250,000
0
350,000
300,000
200,000
624,000
What will be their tax bases in the stock received from Wilpepper?
See above
3.
How much would Wilpepper record as deferred tax liability in connection with the assets
received from Jenny?
Ignoring goodwill, Wilpepper is taking on a deferred tax liability of $534,330 [($2,945,000$1,373,440) * .34]. Of course, Wilpepper is also acquiring goodwill, for which it will receive
no tax basis. If it paid FMV for the goodwill, it would take a tax basis of $2,855,000
($5,000,000 stock value + $800,000 debt assumed - $2,945,000 FMV of tangible assets). The
company would be allowed to amortize this asset over 15 years for tax, so it represents
another $970,700 to be added to deferred tax liability—not sure we picked this portion up
in class.
4.
Prepare book and tax balance sheets for Wilpepper. For this purpose, assume the initial book
value of the new corporation’s property is equal to its fair market value. You must record both
goodwill and deferred tax liability on the book balance sheet (neither will have a value on the tax
balance sheet).
Tax
Book
Cash
$10,250,000
$10,250,000
Accounts Receivable
0
60,000
Inventory
350,000
650,000
Equipment
300,000
300,000
Accumulated depreciation-equipment
(190,560)
0
Land
200,000
500,000
Building
624,000
1,185,000
Accumulated depreciation-building
(160,000)
0
Goodwill
0
4,360,030
$11,373,440
$17.305.030
Mortgages
$800,000
$800,000
Deferred tax liability
0
1,505,030
Common stock
10,573,440
15,000,000
$11,373,440
$17,305,030
5.
What is the present value of Wilpepper’s deferred tax liability? (Assume a discount rate of 4.7%)
Wilpepper’s deferred tax liability with respect to each asset is summarized below:
Built-in
Gain
A/R
Inventory
Equipment
Land
Building
Deferred Tax
Liability (34%)
60,000
300,000
190,560
300,000
721,000
________
Present Value of
DTL
19,4841
97,4211
164,0832
03
111,4364
_________
$392,424
$20,400
102,000
64,790
102,000
245,140
_________
$534,330
The present value of the amortization deduction for goodwill would be calculated as the
present value of a 15-year annuity equal to the tax savings associated with the goodwill
deduction the company would receive if it had paid $5,000,000 for the assets in a taxable
transaction (GW÷15, times 34% tax rate).
1
2
Calculated by dividing difference by 1.047.
The DTL with respect to the equipment will be recovered over six years, as follows:
Actual*
Year 1 depr (4th yr
of actual
Year 2 depr
Year 3 depr
Year 4 depr
Year 5 depr
Year 6 depr
Totals
43,760
32,820
32,820
0
0
0
109,400
Allowed if Basis
Stepped up
60,000
96,000
57,600
34,560
34,560
17,280
300,000
Present Value
of difference**
15,511
57,635
21,590
28,760
27,469
13,118
164,083
* any method used to recover remaining $109,400 over remaining depreciable life is acceptable,
given that the problem misstated the accumulated depreciation on the equipment.
** calculated as difference divided by 1.047 raised to the power of n, where n = 1-6.
3
Assuming land will not be disposed of. If you assume it will be disposed of at the end of 39
years, you would divide 102,000 by 1.047 raised to the power of 39.
4 Present value of an annuity equal to $245,140/39 (= 6,286) over 39 years at 4.07%
(calculation per excel).
Case 2
Assume the same facts as in Case 1 above. Further assume that two years after formation of the new
corporation, Wilpepper Inc. agrees to admit a new investor. The new investor will contribute property
with an original cost and tax basis of $850,000 and a fair market value of $6,000,000. The property is
encumbered by a $1,500,000 mortgage for which Wilpepper will assume full responsibility. In
exchange, she will receive stock making her a 20% shareholder in Wilpepper.
1.
Will the new shareholder recognize any gain or loss on the exchange of property for her
20% stake in Wilpepper stock? If so, how much?
Here, because the new shareholder receives only 20% of Wilpepper’s stock (and no
other shareholders contribute property), the exchange is not between a shareholder
and a controlled corporation. Accordingly, Sec. 351 does not apply and the
transaction is wholly taxable. The new investor will recognize $5,150,000 gain on the
exchange as reflected in the following accounting entry:
Stock
Mortgage
2.
$4,500,000
1,500,000
Property
Gain
850,000
5,150,000
What will be her tax basis in her newly received Wilpepper shares?
$4,500,000 as indicated above.
3.
What will be Wilpepper’s tax basis in the property received?
Wilpepper will take a FMV basis in the property ($6,000,000)
4.
How much will Wilpepper record as deferred tax liability with respect to the property
acquired from the new shareholder?
Zero – Wilpepper’s tax basis in the property will be equal to its fair market value.