16 Chapter Corporate Distributions in Complete Liquidations TRUE-FALSE QUESTIONSCHAPTER 16

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. A corporation generally recognizes gains and losses on sales of property during a complete liquidation. A corporation generally does not recognize loss on an in-kind distribution of depreciated property in complete liquidation. E&P generally disappear upon liquidation. To receive a fair market value basis in the assets of a purchased subsidiary, the parent corporation must liquidate the subsidiary. Under Code Sec. 331, the shareholder will always recognize a capital gain or a capital loss on the stock upon receipt of a liquidating distribution. If a parent corporation receives a basis in the assets of a subsidiary under Code Sec. 334(b)(1), the subsidiary may be subject to depreciation recapture. A shareholder who recognizes gain or loss under Code Sec. 331 will receive a fair market value basis in assets received as part of the liquidating distribution. A corporation may elect not to recognize gain on the sale of its stock in a subsidiary. Code Sec. 337 applies only to subsidiary corporations. A Code Sec. 338 election is irrevocable. If a shareholder assumes a liability on property in a liquidating distribution, the amount of assumed liability always affects the amount of gain recognized by the liquidating corporation. The liquidating corporation must le a separate Form 1099-DIV for each shareholder that receives a liquidating distribution of $600 or more during a calendar year. A liquidating distribution may be treated as a dividend to shareholders if the liquidating corporation has accumulated earnings and prots. If a shareholder receives more than a proportionate share of the assets of a liquidating corporation, the excess is treated as a payment received that is attributable to those shareholders who receive less than their proportionate share. A liquidating corporation may recognize gain or loss on the distribution of installment obligations to shareholders. Code Sec. 331 has no application to a distribution in satisfaction of bona de corporate indebtedness to a shareholder. A parent corporation can satisfy the 80 percent ownership requirement for a Code Sec. 332 liquidation by using constructive ownership rules. Code Sec. 332 does not apply to the liquidation of an insolvent subsidiary. A liquidating corporation cannot recognize loss on distributions to minority shareholders in a Code Sec. 332 liquidation. A Code Sec. 338 election must be led no later than the fteenth day of the fourth month beginning after the month in which the acquisition date occurs. 2009 CCH. All Rights Reserved.

Chapter 16 CCH Federal Taxation Comprehensive Topics MULTIPLE CHOICE QUESTIONS CHAPTER 16

21. The Trap Corporation liquidates. One shareholder, who owned 30 percent of the stock, receives for the stock, inventory worth $90,000 with a basis of $70,000. Trap Corporation will recognize: a. $20,000 of capital gain b. $20,000 of ordinary income

c. $20,000 of Sec. 1231 gain d. No gain

22. Rapid, Inc., a cash basis corporation, distributes $30,000 of accounts receivable to Sylvester, an individual shareholder, in cancellation of his stock, pursuant to a plan of complete liquidation. If Sylvester’s basis in his stock is $10,000 the tax result is: a. Rapid has no gain, but Sylvester has ordinary income of $20,000. b. Rapid recognizes $30,000 of ordinary income and Sylvester has no gain or loss.

c. Rapid recognizes $30,000 of ordinary income and Sylvester has a capital gain of $20,000. d. Rapid recognizes no gain and Sylvester recognizes a capital gain of $20,000 under Section 331.

23. INK, Ltd. distributes inventory with a basis of $20,000 to a shareholder in complete liquidation. The shareholder, who has a basis of $10,000 for the stock, immediately sells the inventory independently for $50,000. Tax results to the parties are: a. INK recognizes $30,000 of ordinary income, and the shareholder recognizes $40,000 of capital gain. b. INK recognizes no gain or loss, but the shareholder recognizes $40,000 of ordinary income.

c. INK recognizes $30,000 of ordinary income and the shareholder recognizes no gain or loss. d. INK recognizes no gain or loss and the shareholder recognizes $30,000 of ordinary income and $10,000 of capital gain.

24. Link, Inc. liquidated and distributed its only asset with a basis of $100,000 and a value of $250,000 to its only shareholder, Lincoln Adams, who has a basis of $50,000 for his stock. The tax consequences, in part, are as follows, if both parties are in the 30 percent tax bracket: a. Basis of property to shareholder: $200,000; combined tax liability: $105,000

b. Basis of property to shareholder: $250,000; combined tax liability: $91,500 c. Basis of property to shareholder: $150,000; combined tax liability: $90,000

d. Basis of property to shareholder: $200,000; combined tax liability: $120,000

25. The following statements about a liquidating distribution of depreciated assets to shareholders are all false, except: a. The liquidating corporation cannot recognize a loss on a liquidating distribution. b. A loss can be recognized on a subsidiary liquidating distribution to which Code Sec. 332 applies.

c. The liquidating corporation cannot recognize a loss on a distribution to a shareholder who is a related taxpayer.

d. The general rule is that all losses are realized and recognized, subject to some exceptions.

26. The advantages of making a Code Sec. 338(h)(10) election include the following, except: a. Gains are recognized on the targets assets.

b. The seller does not recognize gain on the sale of stock. c. Appreciated assets receive a step-up in basis to fair market value.

d. The subsidiarys tax attributes remain with the consolidated selling group.

27. The following statements about property distributions in complete liquidations with liabilities in excess of fair market value are all false, except: a. A loss may be recognized. b. The shareholder receives a basis in the property equal to the amount of liability.

c. The distributor recognizes gain equal to the excess of liabilities over basis. d. Since liabilities exceed fair market value, no depreciation recapture will occur.

28. A parent corporations liquidation of a 90 percent owned subsidiary meets the requirements of Code Sec. 332. Which of the following statements is correct? a. The subsidiarys bases in its assets will not carry over to the parent.

b. Once the subsidiary goes out of existence, its earnings and prots vanish. c. The parent may recognize gain or loss on the receipt of subsidiarys assets.

d. Minority shareholders must recognize gain or loss on their stock.

29. ABC Corporation acquired 100 percent of the stock of GAP, Inc. for $500,000 in one transaction and immediately made a Code Sec. 338 election to treat the acquisition as an asset purchase. GAPs tangible assets were worth $450,000, had a basis of $300,000 and earnings and prots were $100,000. Which of the following statements is incorrect? a. GAP is subject to the recapture of cost recovery deductions on a deemed sale of its assets. b. GAPs bases in its assets will change to $450,000.

c. GAP may le consolidated returns with ABC after the Code Sec. 338 election becomes effective. d. GAP may be subject to ITC recapture on the deemed sale of its assets.

30. Mark receives a liquidating distribution from Arosa Corporation as part of a redemption of all of its stock. Marks basis for his Arosa stock is $10,000. In exchange for his stock, Mark receives property with a $10,000 basis and a $25,000 fair market value that is subject to a $12,000 mortgage, and also receives cash of $15,000. What is Marks recognized gain? a. $42,000

b. $30,000 c. $18,000

d. $3,000

31. Which of the following statements regarding the Code Sec. 338 election is correct? a. The old subsidiary is deemed to have sold its assets for the parents grossed-up basis. b. Gains recognized by the old subsidiary on its deemed liquidation may be included on the purchasers consolidated return. c. The subsidiary’s E&P only disappears if it is physically liquidated.

d. The new subsidiary becomes a member of the purchasing corporations affiliated group as of the day after the acquisition date.

32. Which of the following statements regarding E&P of a liquidating corporation is incorrect? a. The character of an individual shareholders gain does not depend on the E&P of the liquidating corporation.

b. The E&P of the liquidating corporation is not reduced by the amount distributed in liquidation. c. When a subsidiary is liquidated into its parent, the subsidiarys E&P is extinguished.

d. The process of liquidating may increase the E&P of the liquidating corporation.

33. Savoy Razors, Inc. adopts a plan of complete liquidation. Sal Stringer, who has a basis in his stock of $12,000, receives a pick-up truck originally purchased for $18,000, worth $10,000 with a basis of $7,000. As a result, the tax consequences most likely will include the following: a. Savoy has ordinary income of $3,000 and Sal will recognize $2,000 of capital loss.

b. Savoy recognizes no gain or loss and Sal has a capital loss of $5,000. c. Savoy has $11,000 of recapture income and Sals holding period for the truck begins on the date of receipt. d. Savoys recapture potential carries over to Sal, who takes a carryover basis in the truck.

34. Liquidations and stock redemptions that are treated as exchanges have many similar tax consequences to the corporation and its shareholders. These include the following, except: a. The corporation must recognize depreciation recapture.

b. The corporation may recognize a loss on the distributed property. c. The shareholder receives a fair market value basis in the distributed property.

d. E&P is either reduced or eliminated.

Chapter 16 CCH Federal Taxation Comprehensive Topics

35. The stock of Hill Corp. is 60 percent owned by Joe and 40 percent owned by Joes brother, Bob. During 2008, Bob transferred land (basis of $300,000; FMV of $320,000) as a contribution to capital to Hill Corp. During March 2009, Hill Corp. adopted a plan of liquidation and subsequently made a pro rata distribution of the land back to the brothers. At the time of the liquidating distribution, the land had a FMV of $160,000. What amount of loss can be recognized by Hill Corp. on the distribution of land? a. $0

b. $16,000 c. $40,000

d. $60,000

36. The stock of Ajax Corp. is owned 60 percent by Brian and 40 percent by Dave, who are unrelated individuals. During 2008, Brian transferred land (basis of $300,000; FMV of $200,000) as a contribution to capital to Ajax Corp. During March 2009, Ajax adopted a plan of liquidation and subsequently made a non pro rata distribution of the land to Dave. At the time of the liquidating distribution, the land had a FMV of $180,000. What amount of loss can be recognized by Ajax Corp. on the distribution of land to Dave? a. $ 8,000 b. $ 20,000

c. $ 48,000 d. $120,000

37. Tyson Corp. a 75 percent owned subsidiary of Delmar Corp., made a pro rata distribution of a parcel of land that had been used in its business in redemption of its stock in a complete liquidation. The parcel of land had a basis of $300,000 and a fair market value of $425,000. What amount and character of gain (if any) must be recognized by Tyson as a result of the distribution? a. $0 gain

b. $31,250 Sec. 1231 gain c. $125,000 Sec. 1231 gain

d. $125,000 capital gain

38. In 2009, pursuant to a plan of complete liquidation, Woods Corp. distributed all of its property to its shareholders. Among the property distributed was cash of $200,000, and land that had been held as an investment that had a basis of $100,000, and a fair market value of $160,000. The land was subject to a mortgage of $170,000 which the shareholders assumed. What amount of gain must Woods Corp. recognize as a result of its liquidating distributions? a. $0 b. $10,000

c. $60,000 d. $70,000

39. Parker Corp. purchased 20 percent of Servco Corps stock on each of the following dates: January 2, 2008; April 1, 2008; July 15, 2008; December 15, 2008; and January 5, 2009. If Parker wants to apply the provisions of Sec. 338, by what date must an election be made? a. No Sec. 338 election can be made b. August 31, 2009

c. September 15, 2009 d. October 15, 2009

40. Babb Corporation owns 80 percent of Atley Corporations stock and Linda owns the remaining 20 percent of Atleys stock. Babb Corporations basis for its Atley stock is $300,000 and Lindas Atley stock has a basis of $80,000. Pursuant to a plan of complete liquidation of Atley Corporation, Babb Corporation receives property with a $400,000 adjusted basis and a $480,000 fair market value, and Linda receives property with a $130,000 adjusted basis and a $120,000 fair market value. The bases of the properties to Babb Corporation and Linda are:a. Babb: $480,000; Linda: $120,000

b. Babb: $400,000; Linda: $130,000 c. Babb: $300,000; Linda: $80,000

d. Babb: $400,000; Linda: $120,000

41. Barnett Corporation owns an office building that originally cost $1,000,000, on which $600,000 of straight-line depreciation has been taken. As a result, the building has a basis of $400,000, a FMV of $500,000, and is subject to a $600,000 mortgage. Barnett Corporation is liquidated and the building is distributed to shareholders who assume the mortgage. As a result of the distribution and assumption of the mortgage by shareholders, Barnett Corporation must recognize-a. $400,000 gain

b. $300,000 gain c. $200,000 gain

d. $100,000 gain

42. Paula receives a liquidating distribution from Pell Corporation as part of a redemption of all of its stock. Paulas basis for her Pell stock is $10,000. In exchange for her stock, Paula receives property with an $8,000 basis and a $15,000 FMV that is subject to a $2,000 mortgage, and also receives cash of $5,000. What is Paulas recognized gain? a. $12,000

b. $10,000 c. $8,000

d. $0

43. Prime Corporation liquidates its 80%-owned subsidiary, Bass Corp. Bass Corp. distributes land to its minority shareholder, Shirley, who owns 20% of the Bass Corp. stock. The land received by Shirley has a $55,000 FMV. The land was used in Bass Corp.s business and has an adjusted basis of $50,000 and is subject to a $10,000 liability which is assumed by Shirley. Shirleys basis in her stock is $25,000. What gain will Shirley and Bass Corp. recognize on the distribution of the land? a. $20,000 gain $0

b. $20,000 gain $ 5,000 gain c. $30,000 gain $15,000 gain

d. $30,000 gain $ 5,000 gain

44. The stock of Kenny is Corp. owned equally by two brothers. During 2005, they transferred land (basis of $300,000; FMV of $320,000) as a contribution to capital to Kenny Corp. During September, 2009, Kenny Corp. adopted a plan of complete liquidation and subsequently made a pro rata distribution of land back to the brothers. At the time of the liquidating distribution, the land had a FMV of $180,000. What amount of loss can be recognized by Kenny Corp. on the distribution of land? a. $0

b. $20,000 c. $120,000

d. $140,000

45. Palace Corp. acquired land as a contribution to capital in 2008. The land had a basis of $500,000 and a fair market value of $450,000 on the date of transfer. Palace Corp. has two unrelated shareholders. Robert owns 70% of the stock in Palace Corp. and Susan owns 30%. Palace Corp. adopts a plan of complete liquidation in 2009 and makes a prorata distribution of the land to Robert and Susan. At the time of the liquidating distribution, the land had a fair market value of $300,000. What amount of loss can be recognized by Palace Corp. on the distribution of the land? a. $150,000 b. $60,000 c. $50,000 d. $45,000 e. $0

Chapter 16 780 CCH Federal Taxation Comprehensive Topics SUPPLEMENTARY PROBLEMSCHAPTER 16

46. The Boom Dynamite Corporation adopted a plan of liquidation, sold some assets for cash and notes, and distributed the rest, together with sales proceeds, to its two 50 percent shareholders, Min and Bill. Their stock bases are $5,000 and $8,000, respectively. Bill, who is an explosives dealer himself, received the inventory, worth $20,000, in which Boom has a basis of $15,000. Min received $5,000 in cash and an installment note with a face and fair market value of $15,000 due in a lump sum three years later, together with $5,000 in accrued interest. What are the tax consequences to Boom, Min, and Bill?

47. Sue Sugarman owns 100 percent of the stock in Fairview Apartments, Inc. in which her basis is $100,000. Fairviews only asset is an apartment building worth $900,000 with an adjusted basis of $950,000, subject to a mortgage of $75,000 and was acquired 12 years ago. Fairview liquidates and distributes the building and mortgage to Sue. (a.) What are the gains or losses to Fairview and Sue upon the transfer of the building? (b.) What is Sues basis in the building? (c.) What cost recovery method is available to Sue for the building? (d.) Does Fairviews holding period tack on to Sues? 48. Henry Hopkins is the sole shareholder of Teak Corporation. Teak has the following assets and liabilities: Basis Value Cash $ 7,000 $ 7,000 GM stock 20,000 25,000 Printing press (accumulated depreciation, $15,000) 30,000 38,000 Land (used in business) 15,000 80,000 Mortgage payable (35,000) (35,000) Common stock -125,000 Oak Corporation is a potential purchaser of the business. (a.) What are the tax consequences to Henry, Teak, and Oak if Oak purchases the stock for $125,000 and does not make a Section 338 election? (b.) What if the Section 338 election is made? (c.) What if Oak buys the assets, other than cash, for $143,000, with Teak paying off the mortgage from the proceeds and distributing the remainder in complete liquidation? 49. Candy Heaven, Inc. adopted a plan of complete liquidation. Pursuant to such plan, it distributed its FIFO inventory with a basis of $20,000 and a value of $32,000 to a 57 percent shareholder, Alf Anderson, who had a $13,000 basis in his stock. (a.) What is Candy Heavens gain on the distribution? (b.) What is the amount and character of Alfs gain on the receipt of the candy? (c.) What is Alfs basis in the candy? (d.) If Alf sells the candy in bulk for $25,000 and is not a dealer, what is the amount and character of his gain or loss? (e.) What tax results if Candy Heaven sold the candy to an independent third party for $32,000 and distributed the cash to Alf? 50. Sandra Presto owns 300 shares in White Hen, Inc. She purchased 100 shares for $5,000 and her mother left her 200 shares with an

estate value of $15,000. White Hen, Inc. completely liquidates and makes the following payments to Sandra: Year 1 $20 per share Year 2 $40 per share Year 3 $60 per share What are Sandras gains or losses in each of the three years? Chapter 16 2009 CCH. All Rights Reserved. Testbank 781

ANSWERS TO TRUE-FALSE QUESTIONSCHAPTER 16 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. True. False. Subject to exceptions, losses are recognized True. False. A Code Sec. 338 election can be made without liquidating the purchased subsidiary. False. The stock must be a capital asset. Code Sec. 331 only treats a liquidating distribution as a sale or exchange. If the stock is Sec. 1244 stock, a loss may be treated as an ordinary loss to a limited extent. False. If basis carries over, there is no recapture. True. True. True. True. False. It only affects the amount of the liquidating corporations gain if the amount of liability exceeds the propertys fair market value. True. False. Liquidating distributions receive exchange treatment and are never treated as dividends. True. True. True. False. The 80 percent control requirement must be satised by direct stock ownership of the subsidiary corporation. True. True. False. The election must be made by the fteenth day of the ninth month beginning after the month in which the acquisition date occurs.

ANSWERS TO MULTIPLE CHOICE QUESTIONSCHAPTER 16

21. b. The type of recognized gain depends on the character of the property distributed. Inventory is neither a capital nor Sec. 1231 asset.

22. c. Rapid has no basis in the receivables and recognizes ordinary income. Sylvester recognizes gain under Code Sec. 331.

23. a. Code Sec. 336 applies to INK, Ltd. and Code Sec. 331 applies to the shareholder who receives a fair market value basis.

24. b. Lincoln recognizes a gain of $155,000 ($250,000 less 30 percent tax on $150,000, less $50,000).

25. d. Losses are generally recognized.

26. a. Recognizing gains is hardly an advantage.

27. c. Gain is recognized to the extent that fair market value (or the liability if greater) exceeds basis.

28. d. Minority shareholders fall outside the scope of Code Sec. 332, and are subject to Code Sec. 331.

29. b. The assets bases will be equal to the $500,000 paid for the stock.

30. c. Computation: Property FMV $25,000 Cash 15,000 Less mortgage (12,000) Amount realized $28,000 Less stock basis 10,000 Recognized gain $18,000

31. d. Since it does not become a member of the purchasing corporations affiliated group until the day after the acquisition date, the gain resulting from the deemed sale of assets cannot be included on the purchasing corporations consolidated tax return.

32. c. If the liquidation falls under Code Sec. 332, the E&P of the subsidiary is transferred to the parent.

33. a. Savoys recapture income equals $10,000 less $7,000. Sals capital loss equals $12,000 less $10,000.

34. b. It is generally true in a liquidation but not in a redemption.

35. a. No loss can be recognized because each brother constructively owns 100 percent of the corporation and the property was acquired in a carryover basis transaction within the five-year period preceding the liquidating distribution.

36. b. Since the property was acquired in 2008 in a carryover basis transaction, the lands basis to the corporation is limited to its fair market value of $200,000. Only the post-acquisition loss ($200,000 - $180,000) can be recognized.

37. c. The gain is a Sec. 1231 gain because the parcel of land had been used in the corporations business.

38. d. Since the amount of mortgage ($170,000) exceeds the property’s fair market value ($160,000), the amount of mortgage must be used to determine the amount of recognized gain.

39. c. The election must be made on or before the fifteenth day of the ninth month beginning after the month in which the acquisition date occurs. Since Parker had acquired 80 percent during December, 2008, the election must be made by September 15, 2009.

40. d. This is a Code Sec. 332 liquidation since Babb Corporation owns 80 percent of Atley Corporation. As a result, Babbs basis for the property received is a transferred basis of $400,000. In contrast, the liquidation is taxable to the minority shareholder, Linda, so her basis in the property received is its fair market value of $120,000.

41. c. Gain must be recognized to the extent that the office buildings fair market value, or the liability if greater, exceeds the buildings adjusted basis. Here, the gain is $600,000 - $400,000 = $200,000.

42. c. The amount realized includes the property’s fair market value of $15,000 and cash of $5,000, reduced by the $2,000 liability, or $18,000. $18,000 - $10,000 stock basis = $8,000 recognized gain.

43. b. Bass Corps gain is the lands fair market value of $55,000 reduced by the lands basis of $50,000, or $5,000. Shirley’s gain is the lands fair market value of $55,000 reduced by the liability of $10,000 and her stock basis of $25,000, resulting in a gain of $20,000.

44. a. Since the brothers constructively own each others stock, each brother is a 100 percent shareholder. Since the land was received as a capital contribution within five years of the liquidating distribution, the land is disqualified property. As a result, no loss can be recognized because the land represents a distribution of disqualified property to a more than 50 percent shareholder.

45. d. Since the land was received as a capital contribution and its basis of $500,000 exceeded its fair market value, the lands basis to Palace must be reduced to its fair market value of $450,000. Since the capital contribution was received within five years of the liquidating distribution, the land represents disqualified property. As a result, no loss can be recognized on the distribution to Robert who is a more than 50 percent shareholder. On the other hand, the loss on the distribution to Susan can be recognized because she is not a more than 50 percent shareholder ($450,000 $300,000) x 30% = $45,000.

ANSWERS TO SUPPLEMENTARY PROBLEMSCHAPTER 16 Boom: Gain or loss is recognized on sales or distributions. Gain on installment note is accelerated as well. Bill: Property value less stock basis equals $12,000 ($20,000 less $8,000). Gain is recognized under Code Sec. 331. Gain is capital, if stock is a capital asset, even if property received is inventory. Fair market value basis results under Code Sec. 334(a). Min: First allocate stock basis between cash and installment note: Cash: $5,000 x $5,000 = $1,250 $20,000 Note: $5,000 x $15,000 = $3,750 $20,000 No gain is recognized on receipt of note (Code Sec. 453(b)). Gross prot percentage $3,750 = .25, i.e., 25% $15,000 Gain on stock (Code Sec. 331) $5,000 - $1,250 = $3,750 47. (a.) Fairview recognizes a loss of $50,000 on the building. Although Sue is a related taxpayer the loss is allowed since the property is not disqualied property and the distribution, per denition, is pro rata, Sue being the only shareholder. Whether Fairview can utilize the loss, which is a Code Sec. 1231 loss, is another matter. Sues gain equals value received of $825,000 ($900,000 - $75,000) less her stock basis of $100,000, or $725,000, which most likely is a capital gain. (b.) Sues basis in the building is its value of $900,000. (c.) MACRS is available to Sue who has acquired the building in a taxable exchange. Since the building is residential real property, its basis must be recovered straight-line over 27 1/2 years. (d.) Since the transaction is fully taxable Sues holding period begins when the building is received. 48. (a.) The tax consequences to Henry, Teak, and Oak are: Henry: Capital gain or loss on his stock (Code Sec. 1001). Teak: None. Teaks assets retain their historical basis. Oak: Cost basis of $125,000 in the Teak stock. (b.) If a Section 338 election is made, the tax consequences are as follows: Henry: Same as (a). Old Teak: Deemed to have sold all assets for fair market value. The $8,000 of Teak: ordinary income is recognized under Code Sec. 1245, the $5,000 gain on stock is a capital gain, and the $65,000 gain on land is a Code Sec. 1231 gain.

New Teak: Deemed to have purchased all of Old Teaks assets for $125,000 to be allocated among the assets in proportion to fair market value. (The $125,000 will be adjusted for the mortgage assumed, plus any tax liabilities.) Oak: Same as (a). (c.) In this instance, the tax consequences would be as follows: Proceeds received less basis in his stock equals a capital gain or loss Henry: on a liquidating distribution (Code Sec. 331). If a liquidation plan is adopted all gains will be recognized. Teak is Teak: liquidated and none of its tax attributes survive. Oak: Cost basis of $143,000 to be allocated to individual assets. 49. (a.) $12,000 of ordinary income. (b.) $32,000 less $13,000, or $19,000 under Code Sec. 331. It is capital gain if Alfs stock is a capital asset. (c.) Under Code Sec. 334(a), Alf receives a fair market value basis of $32,000 since the exchange was taxable. (d.) $25,000 less $32,000 is a $7,000 loss. Since Alf is not a dealer, it will be a capital loss, short or long term, depending on how long Alf has owned the candy. (e.) Both Candy and Alf would still recognize gain, ordinary and capital, respectively. 46. 2009 CCH. All Rights Reserved. Chapter 16 784 CCH Federal TaxationComprehensive Topics 50. The cost recovery method is used under Section 331. Purchased Year 1 Stock Adjusted basis $5,000 Distribution 2,000 No gain/loss -Year 2 Adjusted basis $3,000 Distribution 4,000 Gain $1,000 Year 3 Adjusted basis -Distribution $6,000 Gain $6,000 Inherited Stock $15,000 4,000 -$11,000 8,000 -$ 3,000 12,000 $9,000 Chapter 16 2009 CCH. All Rights Reserved. Testbank 785 DIFFICULTY LEVEL RATINGSCHAPTER 16 The following table denotes the relative difculty level of each question. Teachers may wish to organize test questions based on the difculty level of the particular class.