In the current year, Donovan sells to an unrelated individual 500 shares of preferred stock in Flamingo Corporation for $15,000. Donovan received the preferred stock in a nontaxable stock dividend four years ago from Flamingo (E & P of $700,000). At that time, the preferred stock had a fair market value of $45,000, and $20,000 of common stock basis was properly allocated to the preferred stock. Donovan will recognize a $5,000 loss as a result of the sale of the preferred stock.

Question

Quizplus · Accepted Answer

Donovan will actually recognize a $10,000 gain on the sale of the preferred stock. This is because the amount realized ($15,000) is less than the adjusted basis in the stock ($25,000, which includes the $20,000 allocated basis plus the $5,000 loss that was disallowed when the stock was received in the nontaxable dividend). Therefore, there is a gain of $10,000 ($15,000 - $25,000).

In the Current Year, Donovan Sells to an Unrelated Individual