In 2009, Celia Mueller bought a $1,000 bond issued by
Disco Corporation for $1,100. Instead of paying off the bondholders
in cash, Disco issued 100 shares of preferred stock in
2012 for each bond outstanding. The preferred stock had a fair
market value of $15 per share. What is the recognized gain to be
reported by Mueller in 2012?
(a) The requirement is to determine the recognized
gain to be reported by Mueller on the exchange of her Disco
bond for Disco preferred stock. The issuance by Disco Corporation
of its preferred stock in exchange for its bonds is a nontaxable
“Type E” reorganization (i.e., a recapitalization). Since
Mueller did not receive any boot, no part of her $400 realized
gain is recognized.
On April 1, 2012, in connection with a recapitalization of
Oakbrook Corporation, Mary Roberts exchanged 500 shares that
cost her $95,000 for 1,000 shares of new stock worth $91,000
and bonds in the principal amount of $10,000 with a fair market
value of $10,500. What is the amount of Roberts’ recognized
gain during 2012?
(b) The requirement is to determine the amount of
recognized gain in a recapitalization. Since a recapitalization is a
reorganization, a realized gain will be recognized to the extent
that consideration other than stock or securities is received, including
the FMV of an excess principal amount of securities received
over the principal amount of securities surrendered. Since
no securities were surrendered, the entire $10,500 FMV of the
securities received by Roberts is treated as boot. However, in this
case, Roberts recognized gain is limited to her realized gain
($91,000 + $10,500) – $95,000 = $6,500.