Seven years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation for 2,000 shares of Blue Corporation in a transaction that qualified under § 351. The assets had a tax basis to her of $400,000 and a fair market value of $700,000 on the date of the transfer. In the current year, Blue Corporation (E & P of $1 million) redeems 600 shares from Eleanor for $260,000 in a transaction that does not qualify for sale or exchange treatment. With respect to the redemption, Eleanor will have a:

Question

Quizplus · Accepted Answer

Since the redemption does not qualify for sale or exchange treatment, it will be treated as a distribution to the shareholder. The distribution will be treated as a dividend to the extent of the corporation's current and accumulated earnings and profits (E&P), and then as a return of capital to the extent of the shareholder's basis in the stock. In this case, Blue Corporation's E&P is $1 million, which is greater than the amount of the distribution ($260,000). Therefore, the entire distribution will be treated as a dividend to Eleanor. Her basis in the 600 shares redeemed is $280,000 (600/2000 x $700,000). Thus, she will have a $260,000 dividend ($260,000 distribution - $0 return of capital) and her basis in the remaining 1,400 shares of Blue Corporation will be adjusted to $140,000 ($280,000 - $140,000).

Seven Years Ago, Eleanor Transferred Property She Had Used in Her