Question

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 contributes services worth $20,000 in exchange for 20 shares of Frost stock. What is Frost corp's basis in the land and the machinery? When does its holding period begin? How does Frost corp treat the amount paid to Karen for her services?

Answer 1

Frost Corporation's basis in the land is $15,000 and the machinery is $35,000, both based on contributors' original cost or adjusted basis, not FMV. The holding period for both assets includes the time the contributors owned them before the exchange. Karen's services are treated as compensation, with the corporation recognizing an expense and Karen owing tax on the stock received.

Step-by-step explanation:

When John, Meg, and Karen form Frost Corporation and contribute various assets and services in exchange for stock, the tax basis of the contributed assets to the corporation is an essential factor for tax purposes. For Frost Corporation:

• The basis of the contributed land by John will be its original purchase price, which is $15,000, not its fair market value (FMV) of $30,000 at the time of the exchange.
• The basis of the machinery contributed by Meg will be its adjusted basis at the time of the contribution, which is $35,000, again not its FMV of $30,000.
• The holding period for the land and machinery begins on the date each was originally acquired by John and Meg, respectively. This means the holding period includes the time prior to contributing the assets to Frost Corporation.
• Karen's services contributed in exchange for stock are treated as compensation, and the corporation would recognize an expense of $20,000, which is the value of the services provided. Karen would be subject to income tax on the $20,000 worth of shares received.

It's key to note that the corporation's basis in the assets is not based on the fair market value at the time of the exchange of stock but rather on the contributor's basis in the assets.