Swan Corporation makes a property distribution to its sole shareholder, Matthew. The property distributed is a cottage (fair market value of $135,000; basis of $110,000) that is subject to a $175,000 mortgage that Matthew assumes.Before considering the consequences of the distribution, Swan's current E & P is $25,000 and its accumulated E & P is 100,000. Swan makes no other distributions during the current year. What is Swan's taxable gain on the distribution of the cottage?
A)$0.
B)$15,000.
C)$25,000.
D)$65,000.
E)None of the above.

Question

Quizplus · Accepted Answer

When property is distributed to a shareholder and there is a liability attached to the property assumed by the shareholder, the amount of the liability is treated as the amount of money received by the shareholder. In this case, since Matthew assumed the $175,000 mortgage, it is as if he received $175,000 cash from Swan. The amount of the deemed distribution exceeds both Swan's current E&P ($25,000) and accumulated E&P ($100,000). Therefore, Swan has a taxable gain of $175,000 – $135,000 (fair market value of the property) = $40,000. This amount is subject to corporate-level tax and is reported on Swan's tax return.

Swan Corporation Makes a Property Distribution to Its Sole Shareholder