Mel, Fred, and Mary form Canary Corporation. Mel and Fred each contribute cash of $250,000, while Mary contributes land (basis of $100,000; fair market value of $300,000). Each transferor receives one-third of Canary's shares, and Mary also receives $50,000 in cash. Which, if any, of the following choices is a correct result of the incorporation?

Question

Quizplus · Accepted Answer

When Mary contributes land to the corporation, her basis in the stock she receives is determined by the lesser of:
(1) the adjusted basis of the property contributed, or
(2) the amount of liabilities assumed by the corporation.

In this case, there are no liabilities assumed by the corporation, so Mary's basis in the stock is the adjusted basis of the land she contributed, which is $100,000.

Canary Corporation's overall basis in the land is stepped up to its fair market value of $300,000. However, because Mary's basis in the stock is determined by the adjusted basis of the land, her basis in her shares will be $100,000. As a result, the other shareholders' bases in their shares must be adjusted to give Mary a total basis of $150,000 (one-third of $450,000), which is accomplished by increasing their bases to $200,000 each ($250,000 cash plus $50,000 cash received by Mary). Therefore, the correct answer is B.

Mel, Fred, and Mary Form Canary Corporation