Calendar year ParentCo purchased all of the stock of SubCo on January 1, year 1, for $500,000. In year 1, SubCo produced a loss of $150,000 and distributed cash of $25,000 to ParentCo. In year 2, SubCo generated a loss of $450,000; in year 3, it recognized net income of $90,000. What is ParentCo's capital gain or loss) if it sells all of its
SubCo stock to a nongroup member on year 4 for $150,000?
A) $185,000
B) $150,000
C) $35,000)
D) $535,000)
E) All gain/loss is ordinary when subsidiary stock is sold.

Question

Quizplus · Accepted Answer

ParentCo's capital loss is calculated as the difference between the purchase price and the selling price of the stock. ParentCo purchased the stock for $500,000 and sold it for $150,000, resulting in a capital loss of $350,000. However, the losses from SubCo ($150,000 in year 1 and $450,000 in year 2) total $600,000, which offsets the capital loss. The net income of $90,000 in year 3 reduces the offset to $510,000. Therefore, the capital loss is $500,000 - $150,000 = $350,000, and after considering the net income, the effective capital loss is $350,000 - $510,000 = $160,000. However, since the losses exceed the capital loss, the effective capital loss is $0, and the cash distribution of $25,000 is added back, resulting in a net capital gain of $185,000.

Calendar Year ParentCo Purchased All of the Stock of SubCo