Sergio and Chris agree to combine their sole proprietorships and form a corporation. Sergio will contribute cash of $20,000 and business property worth $120,000 (adjusted basis of $50,000) for a 25% interest. Chris will contribute cash of $200,000 and business property worth $220,000 (adjusted basis of $200,000) for a 75% interest. Which of the following statements concerning the tax treatment of Sergio and Chris's exchange of assets is/are correct?
I.Because neither owner owns more than 80% of the stock in the corporation, the transfers do not qualify for tax-free treatment.
II.Based on the wherewithal-to-pay concept, each owner is taxed on the cash they contributed to the corporation.
III.Sergio will recognize a $70,000 gain and Chris will recognize a $20,000 gain.
IV.No gain or loss is recognized on the exchange.

Question

Sergio and Chris agree to combine their sole proprietorships and form a corporation. Sergio will contribute cash of $20,000 and business property worth $120,000 (adjusted basis of $50,000) for a 25% interest. Chris will contribute cash of $200,000 and business property worth $220,000 (adjusted basis of $200,000) for a 75% interest. Which of the following statements concerning the tax treatment of Sergio and Chris's exchange of assets is/are correct?
I.Because neither owner owns more than 80% of the stock in the corporation, the transfers do not qualify for tax-free treatment.
II.Based on the wherewithal-to-pay concept, each owner is taxed on the cash they contributed to the corporation.
III.Sergio will recognize a $70,000 gain and Chris will recognize a $20,000 gain.
IV.No gain or loss is recognized on the exchange.
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Quizplus · Accepted Answer

IV. No gain or loss is recognized on the exchange. This is because under Section 351 of the Internal Revenue Code, no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation, and immediately after the exchange, such person or persons are in control (meaning ownership of at least 80% of both the stock and voting power) of the corporation. In this scenario, Sergio and Chris together control 100% of the corporation after the exchange, thus qualifying for tax-free treatment under Section 351.

Sergio and Chris Agree to Combine Their Sole Proprietorships and Form