 Hello and welcome to this session. This is Professor Farhad and this session we would look at a tax simulation. This topic is typically covered in a corporate income tax course, the CPA exam regulation. Obviously, it's a tax simulation. And if you're studying for the enrolled agent exam, this also will be a beneficial simulation for you. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, finance and tax lectures. This simulation will go under my tax course, my corporate tax course, and will go under the CPA exam. So if you're studying for the exam, it'll be very beneficial for you. If you're taking a corporate income tax course, it will be very, very beneficial for you. Please connect with me on Instagram. And if you like my lectures, please like them. Click on the like button. It helps me tremendously, as well as share them with others. On my website, you will have additional resources such as PowerPoints, True or False, Multiple Choice, exercises that are quasi-CPA simulation, and 2000 plus CPA questions if you're studying for your CPA exam. If you're studying for your exam, I strongly encourage you to check out my website. You will have additional resources for you to succeed on the exam. So let's take a look at this simulation, and the simulation involves to compute gain-recognize basis in the stock, holding period, gain-recognize by the corporation, so on and so forth. So it covers six different questions, but it covers a lot of topics that are important for the exam. So let's go ahead and approach this simulation. So notice that this simulation, there's no exhibit, nothing like this. So if there's exhibits, don't let the exhibit scare you. All this information that's given in this problem, I can turn it into an exhibit. So rather than giving you the information per vadum, what they would do, they will take this information and they will show it to you in an exhibit. So I'll give you an example so you know, so you are not intimidated once you get to the exam. Okay? So SING is a single domestic C corporation. On January 1st, of its 2000 issued outstanding shares, so here we go. We have 2,000 shares in total, 1,575 is owned by SNAP, owned by SNAP and the remainder, whatever the remainder is, is owned by unrelated parties. So that's what they told you in this statement, that's what they told you in this statement. Now I can give you this information in an exhibit and scare you, scare the hell out of you. I'll give you, for example, a grid showing you SNAP, 1,575 shares, other related parties or I can call them something else, the remaining shares. Same information except here it's given to you in writing. So don't be scared from the exhibit, just calm down, relax and see what they're giving you. Okay? So far so good. On April 30th, SNAP received from SING an additional 200 shares. So SNAP got an additional 200 shares from SING and $25,000 in cash. So the corporation issued the SING issued to SNAP 200 shares, now my pen is working, plus $25,000 in cash. So SING must be given them something else in exchange for land worth half a million. So they gave him, that's what they gave him, that's what the corporation gave him, that's what SING gave SNAP. So what did SNAP gave them? Well SNAP gave them a land worth half a million, that's the fair market value, is half a million, subject to a mortgage of $250,000 and there's a mortgage against the land for $250,000. Now rather than telling you the mortgage is $250,000, I can show you the bank statement and show you that there's a mortgage on the land for $250,000 and like wow exhibit it's dangerous, I can't read this. So here they're giving you the information, they can give you the same thing in an exhibit. The exchange was a valid for a valid business purpose and not to avoid taxes. Now the reason they're giving you the statement is because you're going to see why in a moment. SING had redeemed the 200 shares of stocks from unrelated party on October 31st for $200,000, that's where SING got the shares, the corporation. The fair market value on April 30th was $1,125 per share, the stock par value was $100 which is we're not going to really use any of this but it's given to you to confuse you. SNAP purchased the land for $200,000. So this is the cost of the land, again rather than telling you this I can give you the closing statement for the purchase and I can show you like a fancy confusing statement but the cost of the land is $200,000. So notice why they gave you this statement that that's a valid business purpose. The cost is $200,000, there's a mortgage against it for $250,000 and there's a fair market value of half a million. So there's a mortgage more than the cost. All what they're telling you it's for a valid business purpose not to avoid taxes. So in other words, we're going to see that the additional $50,000 in addition to the cost it's going to be considered a boot. So he bought it on October 31st, 2009 as an investment that had no made no improvement towards it. They're keeping your life simple. So again, a lot of this information could be given in an exhibit. So the first thing they want you to compute is the gain recognized by SNAP, which is the shareholder. Now, what did SNAP do? SNAP contributed land to the corporation. Now the first thing we need to think about is this section 351. How do we know if it's section 351? If section 351 means the owner will have no tax consequences. Let's see if it's section 351 first and look at the rules. Well, SNAP used to own 1575. Now it owns 200 new shares. Now the company redeemed the share from another shareholder, so if we take this divided by 2000, let's see what would this transaction give us. So if we take 1575 plus 200 equal to 1775 divided by 2000 share, SNAP owns 88%. Now let's assume you misread that they redeemed them from another related party and let's assume they issued the new shares. Let's assume they issued new 200 shares. So here the AICPA made it easy for you and if you made that mistake, let's assume you made that mistake 1575 plus 200 divided by 2200, it's 80.68. So you are still more than 80%. Why am I doing this? It means 80% plus. So this transaction give SNAP an 80% control. What does that mean? This is a section 351. Now that's the good news, section 351. The bad news is although it's section 351, SNAP received a boot. What did SNAP receive? Well remember SNAP received $25,000 in cash. That's a boot and if there's a boot, remember every time there's a boot, you might have tax consequences because you received something. So receive the boot of $25,000. You say okay, so a boot of $25,000. So you mean there's tax consequences. Now how do we compute, what are the gain? Now he would need to recognize the gain. The gain is the lower up, so you need to first know the lower up. Realized gain or boot. Now the realized gain is $300,000. The fair market value of the asset was half a million. The cost was $200,000. So the realized gain is $300,000. Now what's the boot? The boot was $25,000 cash. That's clearly there plus, and here's where you students miss. Remember we have liabilities in excess of the cost. Remember the cost of this asset, the land was $200,000. We had a liability of $250,000, liability of $250,000. It has a mortgage of $250,000. Well the excess $50,000, the excess $50,000 in this situation, it's a boot because he relieved himself of $50,000. Well guess what? The excess liability over the cost, that's also a boot. So what is the gain realized then? The gain realized is $300,000. The boot is $75,000. We recognize the lower of these two. Which one the lower of these two? $75,000. So the gain recognized by SNAP is $75,000. Generally there shouldn't be any gain because it's a section 351. But since SNAP received a boot, cash, and the relief of a liability, guess what? SNAP will be hit with a $75,000 realized gain. So we finished the first question. Let's go ahead and put the answer because we're going to need this answer later on. So I'm going to delete everything that's on the screen. And go to question two. So the gain recognized is $75,000. It's the taxable gain that he can get away with at $75,000. What is a SNAP basis in the stock? So now SNAP received those 200 shares. What's his basis? Well, we need to know the formula for the basis. What's the formula for basis? Well, let's go through here. Let me erase this then go through the formula because why do I like this exercise? Because it's going to give you a chance to practice the formula. It's the basis in the land, the basis of what you give up, plus any gain you recognized, plus gain recognized. Because remember, if you recognize the gain, you pay taxes. Therefore, you can increase your basis minus boot if you received any boot, minus any liability that was relieved. OK, let's plug in those numbers. The basis in the land is $200,000. The gain recognized is $75,000. So you have the right to increase your basis by $75,000. The boot cash received, now the boot is the cash received $25,000 minus any liability minus $250,000. So if we net them, the basis of SNAP stocks is $0,000. So basis in his stock is $0,000. Simply put, if he sell the stock for $1, he's going to recognize gain, capital gain. So the basis in the stock is $0,000. So now we're done with the basis in the stock. Now let's look at question three. Question three state, SNAPs holding period for the stock on October 31st, 2019. So he owned the stock. Now he owned an additional $200 year. The question is, he got those shares from exchanging the land. What's his holding period? So when do we consider SNAP owns the share? Remember, section 351, basis holding period transfer. So it's basically having the land or having the stocks as a continuation. That's why section 351 is non-taxable. Well, the holding period start when he bought this land. Well, he bought this land October 31st, 2019, which is a long time ago, which is 120 month because usually they want you to do it in terms of month and that's five years or 120 month. Why? Again, it's a continuation. It's a continuation when section 351 applies, the reason we don't have gain taxable consequences because the reason is it's a continuation. So continuation, it's also continuation for the holding period. Now, gain recognized by Seng, hold on a second, are we Enron, right? Corporation cannot recognize a gain by issuing its own stock. Therefore, gain or losses for that matter, therefore zero. Zero, this is by the corporation. Nothing, zero, that's easy answer. Seng's holding period for the land, again, it's a continuation between SNAP and Seng. If it's a continuation, as far as the corporation is concerned, 120 month period. Seng basis in the land. Now, the corporate basis in the land. You need to know the formula for the corporate basis. You need to know the formula for the corporate basis. What's the formula for the corporate basis? It's the basis plus if the shareholder recognized any gain, recognized gain. Well, what's the basis? 200,000, did SNAP recognize gain? Yes, he did look at number one here, recognized 75,000 of gain. So for the corporation, the basis is 275. Make sure you know the formula for the corporate basis. Okay, it's very, two easy numbers basis plus any recognized gain, 275. Now, if you want to learn a little bit more about section 351 about these topics, obviously go to my income tax course, which I have plenty of resources. And if you're studying for your exam, I would like to remind you again to visit my website. You study for your exam once. It's a lifetime investment. You wanna make sure you make the right investment. Check out my website. I have additional resources that will help you succeed. Passing the exam is important for your career. It's gonna open more doors for you and it's gonna propel your career down the road and give you more option in life. Good luck, study hard. I'm always here to help you and subscribe.