Question

Amira and Lynette Majors own 36 percent of the outstanding stock of Echo Valley, which has approximately $5 million earnings and profits. Echo Valley owns 38 tracts of undeveloped land in central Colorado. Amira and Lynette want to acquire one of the tracts (tract D6) to develop as a campground and recreational park. The appraised FMV of tract D6 is $420,000, although the corporation's tax basis is only $211,000. At the most recent shareholder meeting, Amira and Lynette convinced the other shareholders to distribute tract D6 to them as a dividend. (The other shareholders would receive cash dividends proportionate to their stock ownership.) Would the distributions of tract D6 as a dividend be a taxable event to Echo Valley?

Answer 1

Yes, the distribution of tract D6 as a dividend to Amira and Lynette would likely be a taxable event for Echo Valley, which would potentially recognize a gain on the distribution that is equal to the FMV of the property minus its tax basis. Amira and Lynette would also face individual tax implications on the value of the land received.

Step-by-step explanation:

When Amira and Lynette Majors convinced the shareholders of Echo Valley to distribute tract D6 to them as a dividend, certain tax implications arise. A distribution of property by a corporation to its shareholders such as a dividend is generally a taxable event for both the corporation and the shareholders under the Internal Revenue Code. For the corporation, the distribution is treated as a sale of the property at its Fair Market Value (FMV). The taxable event for Echo Valley would involve recognizing a gain based on the difference between the FMV of the land when it was distributed and the corporation's tax basis in the land. Since the FMV is appraised at $420,000 and the tax basis is only $211,000, Echo Valley would have a taxable gain of $209,000 ($420,000 - $211,000). However, whether the corporation actually owes tax on this gain depends on its earnings and profits and the specifics of the tax law, including any potential adjustments, deductions, or credits that may apply.

Amira and Lynette would also have their own tax consequences to address, as the receipt of the land would be considered a dividend distribution for them, valued at the tract's FMV. They would need to report this distribution as income. In addition, if Amira and Lynette decide to develop the land as a campground and recreational park, they would have a tax basis in the property equal to its FMV at the time of distribution, which impacts the calculation of any potential gain or loss upon subsequent sale or disposition of the property.