Six years ago, Darby purchased land as an investment. The land cost $160,000 and is now worth $410,000. Darby plans to transfer the land to Baxter Corporation, which will subdivide it and sell individual tracts. Baxter's income on the land sales will be ordinary in character.

Requirement a. What are the tax consequences of the asset transfer and land sales if

Darby

contributes the land to

Baxter

in exchange for all its stock?

Darby recognizes

on the transfer of land to Baxter Corporation.

Baxter's basis in the land will be		. All gain on the subsequent sales will be	ordinary income
to Baxter.

This alternative results in the		that accrued prior to Darby's transfer and the
	earned from subdividing the land

Requirement b. In what alternative ways can the transaction be structured to achieve more favorable tax results? Assume

Darby's

marginal tax rate for capital gains is

23.8%

(20%

+

3.8%

on net investment income), and

Baxter's

tax rate is

21%.

A.

Darby

could elect out of the Sec. 351 provisions. By including an election with her timely filed income tax return in the year of the transfer,

Darby

can avoid the Sec. 351 provisions.

B.

Darby

could find another investor who is willing to contribute property valued at

$160,000

in exchange for 50% of the stock of the corporation.

C.

There are no alternatives that will allow

Darby

to avoid Sec. 351.

D.

Darby

could transfer the land to

Baxter

in exchange for stock and debt instruments equal to her realized gain. In this case,

Darby

would recognize a long-term capital gain and

Baxter's

basis in the land would be the FMV of the land. The pre-contribution capital gain (net of any capital losses that

Darby

has recognized) is taxed at the applicable capital gains tax rate (in this case,

23.8%,

including the

3.8%

net investment tax). The step-up in basis permits

Baxter

to use the additional basis to offset income earned from subdividing the land that otherwise would be taxed at a

21%

marginal tax rate.