Research Problem 1.

Lynn Jones, along with Shawn, Walt, and Donna, are deciding whether they should
organize a corporation and transfer their shares of stock in several corporations to this new corporation.
All of their shares are listed on the New York Stock Exchange and are readily marketable. Lynn would
transfer shares in Brown Corporation, Shawn would transfer stock in Rust Corporation, Walt would
transfer stock in White Corporation, and Donna would transfer stock in several corporations. The stock
would be held by the newly formed corporation for investment purposes. Lynn asks you, her tax
adviser, whether she would have gain on the transfer of her substantially appreciated shares in Brown
Corporation if she transferred the shares to a newly formed corporation. Your input will be critical as
they make their decision. Prepare a letter to your client, Lynn Jones, and a memo for the firm’s files.
Lynn’s address is 1540 Maxwell Avenue, Highland, KY 41099.

Along with Shawn, Walt, and Donna, you own shares of stock in several corporations. All of these shares
are listed on the New York Stock Exchange and are readily marketable. If you proceed with your plan,
each of you would transfer your shares in these corporations to the newly formed corporation in
exchange for the shares in the newly formed corporation. The stock in the corporations you each now
own would be held by the newly formed corporation for investment purposes. The essential tax issue
here is whether there will be tax consequences on the transfer. You, Shawn, Walt, and Donna would
each recognize gain on the transfer of your stock. A transfer of property to an investment company such
as the one you are contemplating is a taxable event. Should you need more information or need to
clarify our conclusion, do not hesitate to contact me

Corporations: Organization and

Capital Structure 4-17
© 2017 Cengage Learning
®
. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole
or in part.
49. (LO 6)
a. The basis of the stock to Gigi
is $60,000.
 b. The basis of the stock for
purposes of § 1244 is only
$40,000.
c. Gigi would have a $22,000
loss ($38,000 – $60,000), only
$2,000 ($38,000 – $40,000) of
which would be ordinary under §
1244. The remaining $20,000 loss
would be a capital loss.
50. (LO 5, 7) The shareholders of
Purple Corporation have avoided
pro rata holding of debt by having
Mitch lease property to the
corporation and receive an annual
rent that approximates the yield on
the
loans from Frank and Cora.
Because the loans are not pro rata,
the IRS may have difficulty in
reclassifying the debt as equity. In
addition, Purple Corporation can
defend its debt-equity ratio by
stressing the fair market value of
its assets. If the tax basis of Purple
Corporation’s assets is used, the
ratio is 6 to 1 [$300,000
(liabilities) to $50,000 (tax basis of
assets)]. However, if fair market
value of
its assets is used, the ratio is only
0.5 to 1 [$300,000 (liabilities) to
$600,000 (value of assets)]. Thus,
Purple appears to have an
acceptable debt-equity ratio.
RESEARCH PROBLEMS
1. Hoffman, Raabe, Maloney,
& Young, CPAs
5191 Natorp Boulevard
Mason, OH 45040
August 22, 2016
Ms. Lynn Jones
1540 Maxwell Avenue
Highland, KY 41099
Dear Lynn:
This letter is in response to your
question regarding the potential
transfer of shares in Brown
Corporation to a newly formed
corporation. Our conclusion is
based upon the facts as outlined in
your
August 10, letter. Any change in
facts may cause our conclusion to
be inaccurate.
Along with Shawn, Walt, and
Donna, you own shares of stock in
several corporations. All of these
shares are listed on the New York
Stock Exchange and are readily
marketable. If you proceed with
your plan, each of you would
transfer your shares in these
corporations to the newly formed
corporation in exchange for the
shares in the newly formed
corporation. The stock in the
corporations
you each now own would be held
by the newly formed corporation
for investment purposes. The
essential tax issue here is whether
there will be tax consequences on
the transfer. You, Shawn, Walt,
and Donna would each recognize
gain on the transfer of your stock.
A transfer of property to an
investment company such as the
one you are contemplating is a
taxable event. Should you need
more
information or need to clarify our
conclusion, do not hesitate to
contact me.
Corporations: Organization and
Capital Structure 4-17
© 2017 Cengage Learning
®
. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole
or in part.
49. (LO 6)
a. The basis of the stock to Gigi
is $60,000.
b. The basis of the stock for
purposes of § 1244 is only
$40,000.
 c. Gigi would have a $22,000
loss ($38,000 – $60,000), only
$2,000 ($38,000 – $40,000) of
which would be ordinary under §
1244. The remaining $20,000 loss
would be a capital loss.
50. (LO 5, 7) The shareholders of
Purple Corporation have avoided
pro rata holding of debt by having
Mitch lease property to the
corporation and receive an annual
rent that approximates the yield on
the
loans from Frank and Cora.
Because the loans are not pro rata,
the IRS may have difficulty in
reclassifying the debt as equity. In
addition, Purple Corporation can
defend its debt-equity ratio by
stressing the fair market value of
its assets. If the tax basis of Purple
Corporation’s assets is used, the
ratio is 6 to 1 [$300,000
(liabilities) to $50,000 (tax basis of
assets)]. However, if fair market
value of
its assets is used, the ratio is only
0.5 to 1 [$300,000 (liabilities) to
$600,000 (value of assets)]. Thus,
Purple appears to have an
acceptable debt-equity ratio.
RESEARCH PROBLEMS
1. Hoffman, Raabe, Maloney,
& Young, CPAs
5191 Natorp Boulevard
Mason, OH 45040
August 22, 2016
Ms. Lynn Jones
1540 Maxwell Avenue
Highland, KY 41099
Dear Lynn:
This letter is in response to your
question regarding the potential
transfer of shares in Brown
Corporation to a newly formed
corporation. Our conclusion is
based upon the facts as outlined in
your
August 10, letter. Any change in
facts may cause our conclusion to
be inaccurate.
Along with Shawn, Walt, and
Donna, you own shares of stock in
several corporations. All of these
shares are listed on the New York
Stock Exchange and are readily
marketable. If you proceed with
your plan, each of you would
transfer your shares in these
corporations to the newly formed
corporation in exchange for the
shares in the newly formed
corporation. The stock in the
corporations
you each now own would be held
by the newly formed corporation
for investment purposes. The
essential tax issue here is whether
there will be tax consequences on
the transfer. You, Shawn, Walt,
and Donna would each recognize
gain on the transfer of your stock.
A transfer of property to an
investment company such as the
one you are contemplating is a
taxable event. Should you need
more
information or need to clarify our
conclusion, do not hesitate to
contact me.
 Corporations: Organization and
Capital Structure 4-17
© 2017 Cengage Learning
®
. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole
or in part.
49. (LO 6)
a. The basis of the stock to Gigi
is $60,000.
b. The basis of the stock for
purposes of § 1244 is only
$40,000.
c. Gigi would have a $22,000
loss ($38,000 – $60,000), only
$2,000 ($38,000 – $40,000) of
which would be ordinary under §
1244. The remaining $20,000 loss
would be a capital loss.
50. (LO 5, 7) The shareholders of
Purple Corporation have avoided
pro rata holding of debt by having
Mitch lease property to the
corporation and receive an annual
rent that approximates the yield on
the
loans from Frank and Cora.
Because the loans are not pro rata,
the IRS may have difficulty in
reclassifying the debt as equity. In
addition, Purple Corporation can
defend its debt-equity ratio by
stressing the fair market value of
its assets. If the tax basis of Purple
Corporation’s assets is used, the
ratio is 6 to 1 [$300,000
(liabilities) to $50,000 (tax basis of
assets)]. However, if fair market
value of
its assets is used, the ratio is only
0.5 to 1 [$300,000 (liabilities) to
$600,000 (value of assets)]. Thus,
Purple appears to have an
acceptable debt-equity ratio.
RESEARCH PROBLEMS
1. Hoffman, Raabe, Maloney,
& Young, CPAs
5191 Natorp Boulevard
Mason, OH 45040
August 22, 2016
Ms. Lynn Jones
1540 Maxwell Avenue
Highland, KY 41099
Dear Lynn:
This letter is in response to your
question regarding the potential
transfer of shares in Brown
Corporation to a newly formed
corporation. Our conclusion is
based upon the facts as outlined in
your
August 10, letter. Any change in
facts may cause our conclusion to
be inaccurate.
Along with Shawn, Walt, and
Donna, you own shares of stock in
several corporations. All of these
shares are listed on the New York
Stock Exchange and are readily
marketable. If you proceed with
your plan, each of you would
transfer your shares in these
corporations to the newly formed
corporation in exchange for the
shares in the newly formed
corporation. The stock in the
corporations
you each now own would be held
by the newly formed corporation
for investment purposes. The
essential tax issue here is whether
there will be tax consequences on
the transfer. You, Shawn, Walt,
and Donna would each recognize
gain on the transfer of your stock.
A transfer of property to an
investment company such as the
one you are contemplating is a
taxable event. Should you need
more
information or need to clarify our
conclusion, do not hesitate to
contact me.
Corporations: Organization and
Capital Structure 4-17
© 2017 Cengage Learning
®
. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole
or in part.
49. (LO 6)
a. The basis of the stock to Gigi
is $60,000.
b. The basis of the stock for
purposes of § 1244 is only
$40,000.
c. Gigi would have a $22,000
loss ($38,000 – $60,000), only
$2,000 ($38,000 – $40,000) of
which would be ordinary under §
1244. The remaining $20,000 loss
would be a capital loss.
50. (LO 5, 7) The shareholders of
Purple Corporation have avoided
pro rata holding of debt by having
Mitch lease property to the
corporation and receive an annual
rent that approximates the yield on
the
loans from Frank and Cora.
Because the loans are not pro rata,
the IRS may have difficulty in
reclassifying the debt as equity. In
addition, Purple Corporation can
defend its debt-equity ratio by
stressing the fair market value of
its assets. If the tax basis of Purple
Corporation’s assets is used, the
ratio is 6 to 1 [$300,000
(liabilities) to $50,000 (tax basis of
assets)]. However, if fair market
value of
its assets is used, the ratio is only
0.5 to 1 [$300,000 (liabilities) to
$600,000 (value of assets)]. Thus,
Purple appears to have an
acceptable debt-equity ratio.
RESEARCH PROBLEMS
1. Hoffman, Raabe, Maloney,
& Young, CPAs
5191 Natorp Boulevard
Mason, OH 45040
August 22, 2016
Ms. Lynn Jones
1540 Maxwell Avenue
Highland, KY 41099
Dear Lynn:
This letter is in response to your
question regarding the potential
transfer of shares in Brown
Corporation to a newly formed
corporation. Our conclusion is
based upon the facts as outlined in
your
August 10, letter. Any change in
facts may cause our conclusion to
be inaccurate.
Along with Shawn, Walt, and
Donna, you own shares of stock in
several corporations. All of these
shares are listed on the New York
Stock Exchange and are readily
marketable. If you proceed with
your plan, each of you would
transfer your shares in these
corporations to the newly formed
corporation in exchange for the
shares in the newly formed
corporation. The stock in the
corporations
you each now own would be held
by the newly formed corporation
for investment purposes. The
essential tax issue here is whether
there will be tax consequences on
the transfer. You, Shawn, Walt,
and Donna would each recognize
gain on the transfer of your stock.
A transfer of property to an
investment company such as the
one you are contemplating is a
taxable event. Should you need
more
information or need to clarify our
conclusion, do not hesitate to
contact me.
She wishes to know if she would recognize gain on a transfer of appreciated, readily marketable stock to
a newly formed corporation. Three other individuals, Shawn, Walt, and Donna, who also have readily
marketable stock in other corporations, would transfer their stock to the newly formed corporation as
well. The stock would be held by the newly formed corporation for investment purposes. Lynn, Shawn,
Walt, and Donna would own all of the stock of the newly formed corporation after the transfers. At
issue: Would the transfer of readily marketable stock to a corporation in exchange for control of the
corporation be a taxable event? Conclusion: A transfer of property resulting in a diversification of the
transferor’s interest to an investment company is a taxable exchange. Section 351(e)(1) provides that
such a transfer does not qualify for the general nonrecognition provisions of § 351. A transfer of
property to an investment company is defined by Reg. § 1.351-1(c) as a transfer that results, directly or
indirectly, in a diversification of the transferor’s interests if the transferee is a regulated investment
company, a real estate investment trust, or a corporation controlled by more than 80% ownership and
whose assets (excluding cash and nonconvertible debt obligations) are held for investment and are
readily marketable stock or securities. The stock Lynn would transfer to a newly formed corporation,
with the stock of the three other individuals, is readily marketable. The Regulation provides that a
transfer results in the diversification of the transferors’ interests if two or more persons transfer
nonidentical assets to a transferee corporation.
Lynn Jones would recognize gain on the transfer of her readily marketable stock in Brown Corporation to
a newly formed corporation

Lynn Jones

1540 Maxwell Avenue

Highland, KY 41099

Dear Lynn,

This letter is in response to your question regarding the transfer of shares to a newly formed investment
company. By transferring your shares from Brown Corporation to the newly formed corporation, you
will hold stock in the newly formed corporation. You will recognize a gain on this transfer. This transfer is
considered a taxable event.

Best,

Janet Mark

MEMORANDUM: Lynn will recognize gain if she transfers her readily marketable stock in Brown
Corporation to a newly formed corporation. Transfer of property resulting in diversification of the
transferor’s interest to an investment company is considered a taxable exchange.