AICPA Representative Tasks (verbatim). 1. Application, Calculate a shareholder's tax realized and recognized gain (loss) on the contribution of noncash property to an S corporation, and the S corporation's basis in the property contributed. 2. Application, Calculate the tax realized and recognized gain (loss) for both an S corporation and shareholders on a nonliquidating distribution of noncash property, and the shareholders' basis in the property received. 3.
When a shareholder contributes property to an S corporation, IRC §351 controls whether gain or loss is recognized. The same rules that apply to C corporation formations apply to S corporations.
For §351 nonrecognition to apply, the transferor(s) must control the corporation immediately after the exchange, meaning ownership of at least 80% of voting power and 80% of each class of nonvoting stock.
KEY: Gain is recognized only to the extent of boot received (cash or other property). If boot received exceeds realized gain, recognized gain is limited to realized gain, never negative.
Common mistakes
- Treating liability assumption as automatic gain. Liabilities assumed by an S corporation reduce stock basis but trigger gain only when total liabilities exceed total basis of contributed property. Trap: "liability assumed equals boot received." Correct: liabilities are boot only to extent they exceed basis.
- Forgetting corporate-level gain on property distributions. S corporations recognize gain (not loss) when distributing appreciated property, unlike partnerships. Trap: "property distribution is tax-free at corporate level." Correct: corporation recognizes gain as if property sold at FMV.
- Applying E&P ordering before AAA. Distributions first reduce AAA (tax-free), then accumulated E&P (dividend), then remaining basis. Trap: "any S corp distribution is dividend income if E&P exists." Correct: AAA absorbs distributions before E&P applies.
Bottom line
- §351 contributions to an S corporation are tax-free if transferors control 80% immediately after; shareholder recognizes gain only to the extent of boot received
- Liabilities assumed are boot only to the extent total liabilities exceed the total basis of contributed property; otherwise they merely reduce stock basis
- Shareholder stock basis equals contributed property basis minus boot plus gain recognized; corporation takes carryover basis increased by the shareholder's recognized gain
- S corporation distributions follow AAA-first ordering: AAA (tax-free to extent of stock basis), then accumulated E&P (dividend), then remaining basis (tax-free), then excess (capital gain)
Exam shortcut
"Basis → Boot → Basis." Stock basis calculation follows three steps: start with property basis, subtract boot received, add back gain recognized. Quick self-check: ending basis plus boot should equal FMV of stock received plus gain recognized. "AAA before E&P." Distributions always hit AAA first. An S corporation with no accumulated E&P never creates dividend income: all distributions are either basis reduction or capital gain.
The full lesson (about 2,619 words, 17 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.B2
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