 Hello and welcome to this session in which we will discuss property dividend distribution. Now when we think of dividend we always think of cash because when the company distributes dividend to the shareholders they distribute cash because generally speaking this is what investor would like to have cash because you can use the cash for anything. Well sometime the company might distribute something other than cash. Simply put the company can distribute anything they would like to inventory a piece of land property anything a vehicle usually when this happens in the real world usually they will distribute stocks of other companies but we don't have to worry what type of property we are dealing with all what we have to know is its property other than cash something other than cash. Now what do we have to know about when we deal with property distribution well what we have to know is do we have a gain or a loss on this transaction does the company record the gain or a loss what is the effect on the shareholder how much is the amount of the dividend is it the basis is it the fair market value how would the receiver the shareholder treat this distribution also what's the effect on the corporation what if this contribution has a liability or not what if we have a gain what if we have a loss this is what we're going to be learning in this session property dividend distribution on both how does it affect the shareholder how does it affect the corporation and how does it affect the account's current and accumulated earnings and profits simply put what's the effect on earnings and profit let's go ahead and get started. Before we proceed any further I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses my CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles my accounting courses are aligned with your accounting courses broken down by chapter and topics my resources consist of lectures multiple choice questions true false questions as well as exercises go ahead start your free trial today we're going to start by looking at the on the effect of the shareholder well simply put the amount received and property distribution equal to the fair market value of the property so when they give you something when they give you an asset a stock a bond a piece of property inventory what is your amount the amount that you receive is the fair market value of that property now is that amount dividend or not well we're going to go back to our basic rules it's dividend to the extent of earnings and profit if it's distributed from earnings and profit it's dividend which is taxable if if the company don't have earnings and profit and they did make the distribution that they're going to tell you this is a return of capital which is a tax free to the extent of your basis and if you don't have any basis well any amount received an access of the basis capital gain which is basically that's the order that we learn about when it comes to dividend so it doesn't matter whether the dividend is cash or something other than cash we would still treat it the same way as if it's cash for the order of distribution now we're going to reduce the amount distributed by the liability assumed by the shareholder if the shareholder received this asset and with that asset they received a liability then we have to reduce the distribution what does that mean let's assume we gave the shareholder an asset with a fair market value of 80 000 attached to this asset was a 20 000 dollar liability well the shareholder the net the net of the shareholder is only 60 000 so the net is 60 000 because we gave them also a liability so we gave them an asset worth 80 but they really cannot own the asset unless they pay off the liability therefore what they receive is 60 now the basis for the property listen to me carefully the basis for the property for the shareholder is the fair market value it's not affected by the liability the distribution the dividend for the shareholder is 60 but the basis for the shareholder is 80 now so the basis of the property one more time equal to the fair market value of the property as far as the shareholders are concerned basis equal to the fair market value let's take a look at the effect on the share on the corporation well well the corporation will treat this distribution as if they sold the property well if they sold the property for for fair market value when you sell it you either have a gain or a loss here's what's going to happen you're going to recognize the gain you are not going to recognize the loss so the corporation would recognize the gain in case they had a gain now if the distributed property is subject to a liability and that liability is greater than the basis now the fair market value what we say is the fair market value is treated as not being less than the amount of the liability simply put the liability becomes the fair market value let's let me show you an example let's assume we're dealing with an asset that would have a fair market value of 80 000 and attached to with a liability of 95 well if the liability is 95 what we assume now the fair market value is 95 what's the logic behind this well if for one thing is if somebody got received this asset let's assume either the fair market value or the basis is 80 it doesn't matter but the liability is 95 if someone if you gave someone this asset whatever that asset is a building and told them or or a warehouse a small warehouse and told them look this warehouse has a fair market value of 80 000 you'll be great i'm going to give it to you as a dividend distribution okay great but look with that warehouse comes a liability i took out a loan against that warehouse and the loan is for 95 000 and you are assuming the loan if you're assuming the if you're taking the warehouse the loan comes with it it's attached because the mortgage are attached to the asset well really what you gave me for me to own the asset if you're giving me this asset well for me to own it i have to pay off the loan if i pay off the loan and own the property that's the fair market value of the property that that's the definition of fair market value it's what you pay what i'm gonna have to pay is 95 therefore is the if the liability is in excess of the basis or the fair market value it becomes really the fair market value what is the effect of property dividend on earnings and profit remember this account corporate earnings and profit well if we have a gain so of the company does recognize again which is they they have to if there is a gain increase earnings and profit for the access of fair market value over the basis now we have to be careful on the CPA exam or on the exercise you are giving sometime they tell you the earnings and profit is already reflecting the gain sometime they don't if they don't it means you have to increase your earnings and profit now you're gonna have to reduce earnings and profit by the fair market value property distributed less liability on the property or basis of greater so if the basis are greater than the fair market value it means we have a loss what's gonna happen is you are gonna you're gonna reduce the amp by the fair market value okay if the basis is greater it means what you have is you have a loss and also if you have a if you distributed the liability with that asset you reduce your amp by the amount of the liability now bear in mind distribution of whether it's cash or property cannot generate or add a deficit to earnings and profit so when you distribute cash or property you cannot make earnings and profit has a deficit you just simply stop at zero any access once CEP and AEP are used anything remaining is considered return of capital then capital gains we already know this so deficit and earnings and profit can only arise through corporate losses so you could have a deficit or more of a deficit when it's when you have taxable income that's taxable loss plus or minus the adjustments gives you a loss then that's this will give a rise to a deficit negative EMP but distribution don't don't give you negative EMP it just basically CEP and EEP they don't go negative from distribution they don't go negative from distribution let's look at an example starting with the loss example blue enterprises own 10 percent and emerald emerald industries emerald has sufficient earning and profit to cover any distribution made so they have plenty of this plenty of AEP and CEP they distributed to blue enterprise a vacant property with an adjusted basis of 70 and a fair market value of 40 so this is what emerald did they distributed this property so what about what's what's what's unusual about this property it's a loss a loss of 30 000 so they distributed a land and they have a loss on that land so blue okay blue the the company that's receiving this this this piece of land they have a taxable dividend of 40 000 why because it's the fair market value of the land that the fair market value of the land is 40 000 and their basis in the land is 40 000 you have a taxable dividend of 40 000 and the basis in the land of 40 000 now obviously if they're a corporation they have a dividend receive deduction but that's a different story the company that distributed emerald they cannot deduct the loss of 30 000 so what should have they done if they cannot deduct the loss if i was in there if they're asking me for an advice i would say sell the property to a third party recognize the loss of 30 000 then give the cash to blue enterprises well blue enterprises would still have a basis of 40 000 either way you gave them 40 000 they have taxable amount of 40 000 whether you gave them the property or you gave them the cash but what you did if you sold the property you recognized the loss and that's the trick here now assume in the previous example that the land is subject to a liability of 75 000 if the land is subject to a liability of 75 000 it means that's the fair market value minus the basis then you have a gain of 5000 okay blue corporation here has no dividend blue when they receive this when they receive this asset they have no dividend why under those circumstances the debt is greater than the fair market value the debt is greater than 40 000 the debt is greater than the cost basis basically what it is you gave them that that's what you basically gave them you gave them you're responsible for 75 000 if you want to own this property pay the bank 75 000 the basis in the land is 75 000 to own the land free and clear pay off the debt well you didn't really give me anything although you did this you gave me an obligation i have no dividend but i have a property with the basis of 75 assuming you know once i pay it i have to pay 75 000 to the bank let's take a look at another example ruby incorporated distributed an asset with a basis of 15 fair market value of 25 to media its shareholder now we have a gain because 25 000 is an excess of the basis ruby's EMP are raised by 10 000 by the gain because we sold this in quote we sold it since we distributed the asset we have a gain so we increase EMP by 10 000 of the gain then reduce EMP by the distribution by the fair market value therefore the net decrease on EMP on EMP is 15 000 because we increased it by the gain reduced it by the fair market value of dividend distributed as far as Mia is concerned she received a dividend of 25 000 again assuming EMP exists which is if that's the case that's dividend to Mia because that's coming from EMP now we're going to change the scenario a little bit let's assume the basis is 30 000 for ruby remember so what we're doing here is we are changing the scenario we're assuming the basis is 30 000 if the basis is 30 000 this asset will have a loss of 5 000 and ruby cannot recognize the loss why because it cannot it's losses are not recognized but what's going to happen is we're going to reduce EMP by 30 000 because we have to reduce earnings and profit by for by 30 000 Mia would report dividend of the fair market value of 25 000 why because this is how much she received in dividend she doesn't care what the basis are she received a fair market value of 25 therefore it's 25 let's change the scenario a little bit again assume a liability of 6 000 is assumed by Mia so with this asset comes a liability of 6000 and we're assuming the basis 30 well we're going to reduce EMP by 30 minus 6 we're going to reduce EMP by 24 we means ruby incorporated and Mia will have a dividend of 25 minus 6 which will equal to 19 that's her dividend what is Mia's basis Mia's basis is still the fair market value of 25 000 but her dividend now notice her dividend is 19 the basis is 25 000 let's take a look at another example property is distributed the corporate basis is 25 and we have three different scenarios and assume cap and current and cap are both 154 each it means we have plenty of plenty of AEP and CEP to absorb the dividend which is only it's going to be 60 10 and 40 which have plenty to absorb so under the first scenario we have a fair market value of the property is 60 the basis is 25 we have no liability involved well 60 minus 25 equal to a gain of 35 that's recognized and once the gain is recognized we increase EMP but then we reduce EMP by the fair market value of asset distributed scenario two we we distributed the property with a fair market value of 10 basis of 25 we have a loss of 15 we have a loss of 15 well here's what's going to happen we have no liability no gain to be recognized no increase in no increase in asset no increase in the EMP because we have a loss what about EMP decrease we have a decrease by the basis of 25 000 let's look at scenario three the fair market value is 40 the basis is 25 well we have a liability of 15 as well what about the gain the gain is 40 minus 25 15 this is how we come up with the gain now what is the effect on EMP well since we have a gain it's going to increase it's going to increase EMP but also what's going to happen is this since we distributed an asset with a 40 000 fair market value but since we gave a liability with it then we're going to reduce this by 15 and that's going to be 25 we're going to reduce EMP by 25 by 25 now obviously you can net those if you if you'd like to net them but this is what we are doing here what should you do now you should go to far hat lectures look at additional mcqs through false exercises that's going to help you understand property dividend property dividend is an important concept that's it's tested on the CPA exam especially they try to trick you with the earnings and profit account how does it affect earnings and profit you need to know the rules when it comes to shareholders corporation and it's a fact on EMP good luck study hard invest in yourself whether you are a CPA exam candidate enrolled agent or an accounting student good luck