Montclair Corporation had current and accumulated E&P of $500,000 on December 31 of the current year. On December 31, the company made a distribution of land to its sole shareholder, Molly Pitcher. The land's fair market value was $200,000 and its tax and E&P adjusted tax basis to Montclair was $50,000. Molly assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Montclair in the current year would be:

Question

Montclair Corporation had current and accumulated E&P of $500,000 on December 31 of the current year. On December 31, the company made a distribution of land to its sole shareholder, Molly Pitcher. The land's fair market value was $200,000 and its tax and E&P adjusted tax basis to Montclair was $50,000. Molly assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Montclair in  the current year would be:

BlackTom AI · Accepted Answer

First, restate the scenario: Montclair Corporation has current and accumulated E&P of $500,000. It distributes land to its shareholder, Molly Pitcher. Fair market value of the land is $200,000; the land has tax basis to Montclair of $50,000. Molly assumes a $25,000 liability attached to the land. We are asked for the tax consequences to Montclair in the current year.

Option analysis, step by step:

- Option A: No gain recognized and a reduction in E&P of $200,000.
  This would imply that the distribution has no corporate gain and reduces E&P by the full FMV of the property ($200,000). However, under the tax rules for corporate property distributions, the corporation generally recognizes a gain equal to the excess of FMV over the adjusted basis of the distributed property (FMV 200k minus basis 50k equals 150k). Therefore, claiming no gain is inconsistent with the fundamental gain rule for property distributions. This makes Option A incorrect.

- Option B: $150,000 gain recognized and a reduction in E&P of $200,000.
  This option correctly states the corporation recognizes a gain of 150,000 (FMV 200k minus adjusted basis 50k). But it asserts the E&P reduction is the full FMV $200,000, ignoring the fact that the liability Molly assumes ($25,000) should offset the amount realized by the corporation for E&P purposes. Since part of the value is tied up in the liability, the reduction to E&P should be adjusted accordingly. Therefore, this option misstates the E&P reduction. Hence, Option B is not correct.

- Option C: $150,000 gain recognized and a reduction in E&P of $175,000.
  This aligns with the gain recognition rule (FMV minus basis equals 150,000). For E&P purposes, the reduction is based on the amount realized from the distribution, which is FMV minus liabilities assumed by the shareholder. The liability of $25,000 reduces the amount realized from $200,000 to $175,000. Consequently, the E&P would be reduced by $175,000. This option correctly matches both the recognized gain and the adjusted E&P reduction due to the liability.

- Option D: No gain recognized and a reduction in E&P of $175,000.
  This asserts no corporate gain, which contradicts the general rule that a distribution of appreciated property triggers gain to the corporation to the extent FMV exceeds basis. Since FMV (200k) exceeds basis (50k) by 150k, recognizing no gain is incorrect. Therefore, Option D is wrong.

Putting it together, the only option that consistently satisfies both the gain recognition rule (150,000 gain) and the adjusted E&P impact (175,000 reduction after subtracting the 25,000 liability) is Option C.

SU25-BL-BUS-A329-2695 Quiz 19

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