CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, an S corporation, distributes land with a fair market value (FMV) of $120,000 and an adjusted basis of $80,000 to its sole shareholder. The S corporation has no accumulated earnings and profits (AE&P), and its accumulated adjustments account (AAA) balance is $70,000 before the distribution. What is the amount of gain, if any, recognized by the S corporation on this distribution?
- A$50,000
- B$40,000
- C$0
- D$120,000
Show answer & explanationAnswer & explanation
Correct answer: B. $40,000
When an S corporation distributes appreciated property, it must recognize gain as if it sold the property at its fair market value. The gain recognized is the FMV ($120,000) minus the adjusted basis ($80,000), which equals $40,000. This gain flows through to the shareholder and increases their AAA and stock basis.
Why the other options are wrong
- A. Incorrect. This might arise from miscalculating the gain or incorporating AAA/AE&P incorrectly.
- C. Incorrect. An S corporation recognizes gain on the distribution of appreciated property.
- D. Incorrect. The recognized gain is the appreciation, not the full FMV.
S Corp Property Distribution Gain
An S corporation recognizes gain (but not loss) on the distribution of appreciated property to its shareholders, as if the property were sold at its fair market value.
- Gain is recognized if FMV > adjusted basis.
- Loss is NOT recognized if FMV < adjusted basis.
- Recognized gain flows through to shareholders, increasing their basis and AAA.
- This rule prevents the avoidance of gain recognition at the corporate level.
Memory trick: Appreciated Property, Always Gain.