Sato, Jose, and Satish form a new corporation. Each individual contributes $100,000 in appreciated property and receives a one-third (equity) ownership interest. Jose and Satish also lend the corporation $250,000 cash in exchange for two 30-year notes (debt) bearing annual interest at a below-market rate of 3.5%.
a. From the corporation’s and the shareholders’ perspectives, what are the principal advantages of capitalizing with debt as opposed to equity?
b. What are the tax consequences to Sato, Jose, and Satish if the property transfer meets the requirements of Sec. 351?
c. What tax consequences to the corporation and its shareholders would ensue if the IRS recharacterizes the debt as equity?