Chat with us, powered by LiveChat Cary Scweitz owns an apartment complex located in Tulsa, Oklahoma which he manages and operates full-time. It is a large complex, and he acquired it in 1998 for $6,000,000. - Writeden

Cary Scweitz owns an apartment complex located in Tulsa, Oklahoma which he manages and operates full-time. It is a large complex, and he acquired it in 1998 for $6,000,000. He added a large section of additional buildings in 2004 at a cost of $2,100,000. He has taken $4,900,000 in MACRS straight-line depreciation in total, which also includes the additional depreciation on the addition. He has located a buyer willing to pay $13,000,000 for the complex, but he will also have to pay a 4% fee to the seller agent that has arranged the deal. He expects to close sometime in early December 2023.

He would like to defer the gain on the property but is uninterested in managing another apartment complex. He has considered purchasing an office building, land leased by a large parking garage in a downtown area, or possibly undeveloped investment land, but is doubtful he’ll be able to find property in Tulsa for the full proceeds from the apartment complex because of the red-hot real estate market. He also has considered investing all of the proceeds from the apartment complex sale in a Real Estate Investment Trust (REIT), which pays dividends on an annual basis of 8%. A final option he has considered is becoming a non-managing member in an LLC taxed as a partnership that holds real estate, which would pay 8% on his initial capital investment as a guaranteed payment plus a share of the remaining profits from operations. If he pursues the LLC option, he will either contribute the apartment complex directly, or sell it and contribute the after-tax cash proceeds, depending on your analysis of the taxability.

List of Authority:

Sec. 1031

Sec. 721

Treasury Reg. 1.1031(a)-1

MAGNESON v. COMM., 55 AFTR 2d 85-911

MAXWELL v. U.S., 62 AFTR 2d 88-5406

CHRISTENSEN v. COMM., 81 AFTR 2d 98-1627



Determine if Cary is eligible to purchase the REIT investment and defer the gain on the sale of his apartment complex. Provide a calculation of his taxable gain assuming he doesn’t locate a property to exchange or qualify for the REIT purchase using 2023 rates. Assume he is single and has taxable income of $650,000 excluding the above proposed transaction. (Hint: it may be beneficial to research the use of an UPREIT).

Provide additional options for Cary regarding the residential real estate exchange and the possible purchase of an LLC share. Provide a conclusion regarding the taxability of both options, specifically relating to qualifying as an eligible deferred gain in a like-kind exchange. You need to include the deferred gain if like-kind treatment is allowed.

Additional Guidance:

Format the research memo like the example memo given on Canvas.

Format all citations as done in the list of citations above.

The facts should be summarized in your own words, so you will have to determine what’s most relevant to your analysis and the client’s decision-making.

The “Analysis” section of the memo is critical:

You must address each numbered issue with relevant primary authority analysis and any required calculations. If you plan on using tables or spreadsheets, please attach those as appendices; don’t include them as the body of your write-up.

Your analysis must be comprehensive enough to support your conclusion for each numbered issue. If you analyze a case, it should be done so to support your conclusion, not a mere rehashing of the opinion.

You need to address all of the relevant authority provided in the list. If you find additional cases or primary authority, you may also use that if it is relevant. Using the textbook or other editorial materials may be useful in getting organized, but you must cite to the relevant primary authority.

You need an adequate amount of analysis for each conclusion. Simply quoting tax law or judicial opinions is necessary to provide a basis for your analysis but shouldn’t be the bulk of your write-up.

When you cite to a case, you need to italicize the parties, cite to the reporter in the paragraph, and provide the relevant facts and holding, and also how it relates to your taxpayer’s situation.

Please don’t provide a recommendation. Just analyze the issues you identify. The taxpayer would decide which option to select in a “real-world” case.

The “conclusions” section should precede the analysis and simply state your finding in one or two sentences. The “conclusion” does not provide any analysis.

You must do your own research and work. I will analyze the memos for academic dishonesty and/or plagiarism, including utilizing Turnitin or a similar software package. I will help with you your research, if necessary, but only after you have read all of the relevant authority and made a good-faith attempt at starting your write-up.

You need at least 2 total pages of analysis for the memo to earn a grade of C (14 points). The facts are given, so your analysis is what will be primarily graded. You need enough analysis to support your conclusions. Significant margins and or spacing will be excluded in my determination of the adequacy of your analysis.

This project is worth 15 points. An “A” write-up (18-20 points) will be typo free, contain at least 2 pages of quality analysis, excluding the facts and issues/conclusions, and be written with professional, concise writing without filler or opinion.


Chandler Corp. previously operated as a C-Corporation and has made an S-Election as of 1/21/21. It is filing an S-Corporation return for the 2021 tax year. In this year it had a ($35,000) ordinary loss, a LTCG of $170,000. It also had non-deductible expenses of $21,000, made a distribution of $300,000 to its sole shareholder Mr. Bing, and repaid the entire $400,000 value on his loan to the corporation.

As of the date of electing S-Status, Mr. Bing had a basis in his shares of the corporation of $60,000 and the corporation had the following balance sheet:

The corporation has received a notice from the IRS that it is under examination due to concerns related to built-in gains tax, distributions and their classification, and the loan repayment.


What are the requirements for Chandler Corp. to maintain its S-Status in its continuing operations?

What are the tax consequences for taking the distribution from Chandler Corp.?

Will the taxpayer be subject to a penalty tax on the sale of appreciated assets?

Will the repayment of the loan to Mr. Bing result in an increased tax liability in the current year?


In future years the corporation will need to be careful surrounding the passive income tax and inadvertent termination due to operating in the past as a C-Corporation.

A portion of the distributions made by Chandler Corp. should be classified as C-Corporation dividends and included in Mr. Bing’s taxable income. The remaining portion will be applied against his basis.

The built-in gains tax will result in an increased tax liability for Chandler Corp., which will be passed through to the shareholder as a loss.

The repayment of the loan to Mr. Bing will not result in an increased tax liability.


Issue 1

The general rule under IRC Section 1362 is that “a small business corporation may elect, in accordance with the provisions of this section, to be an S corporation” [Sec. 1362(a)(1)]. This election is only valid if each shareholder agrees to the election and, generally, if the election is made “on or before the 15th day of the 3d month of the taxable year” [Sec. 1362(b)(B). Both requirements were met by Chandler Corp. at the date it elected S-status. The IRS does not seem concerned by this election in the current tax year, but S-status may be terminated in future years under several circumstances.

Because Chandler Corp. previously operated as a C-corporation, it is more likely to have its status revoked as detailed in IRC Section 1362. An S-Corporation may have its status unintentionally terminated if it is not an eligible domestic corporation, has more than 100 eligible shareholders, or has more than one class of stock. Its status may also be terminated if it has excessive passive income. The corporation has accumulated earnings and profits and according to this section an election “shall be terminated whenever the corporation—(I) has accumulated earnings and profits at the close of each of 3 consecutive taxable years, and (II) has gross receipts for each of such taxable years more than 25 percent of which are passive investment income” [Sec. 1362(d)(3)(A)(i)].

Chandler Corp. has already taken action to avoid this by selling its investments, but because the organization has the possibility of retaining accumulated earnings and profits over the next three years, it will be important to avoid passive income. The risk of termination can be further reduced through further distributions in future tax years to Mr. Bing from these accumulated earnings and profits to reduce the balance.

Issue 2

Despite the S-status of Chandler Corp., it is still possible for S-Corporation’s distributions to be treated as C-Corporation dividends under certain circumstances. IRC Section 316 defines a dividend as distributions of property made from a corporation’s accumulated earnings and profits [Sec. 316(a)(1)]. Dividends under this definition are classified as C-Corporation dividends even when distributed from a corporation with S-Status. This means that any distributions for Chandler Corp. which are deemed to be made from the earnings and profits accumulated during its time as a C-Corporation could result in its distributions being defined as dividends.

The general way to determine which account distributions are made from is defined in IRC Section 1368. S-Corporations should maintain an accumulated adjustments account. This account is increased by income and decreased by expenses and losses of the corporation, but not for income and related expenses which are exempt from tax [Sec. 1368(e)(1)(A)]. This account balance is then used to determine the treatment of distributions by the corporation based on a prescribed ordering process.

For an S-Corporation with accumulated earnings and profits distributions made to the extent of the balance of the accumulated adjustments account “shall not be included in gross income to the extent that it does not exceed the adjusted basis of the stock” [ Sec. 1368(b)(1)]. This is likely the treatment that Chandler Corp. was expecting for its entire distribution, but there is different treatment highlighted under this section as well. If distributions exceed the accumulated adjustments account, the remainder “shall be treated as a dividend to the extent it does not exceed the accumulated earnings and profits of the S Corporation” [Sec. 1368(c)(2)].

As this was the first year that Chandler Corp. operated as an S-Corporation, there was no beginning balance for the accumulated adjustments account. The corporation’s long-term gain increased the account by $170,000 and decreased it by a total of $56,000 due to the non-deductible expenses and the ordinary loss. The account was further reduced by the $28,350 built-in gains tax (calculated in the next section). This left $85,650 remaining for a distribution from the corporation from Mr. Bing. The remaining $214,350 of the $300,000 distribution should then be taken from the accumulated earnings and profits [See Appendix]. This amount must be treated as a C-Corporation dividend, which would explain the classification by the IRS.

For the shareholder, these two types of distributions will have differing tax consequences. IRC section 301 dictates that “that portion of the distribution which is a dividend…shall be included in gross income” [Sec. 301(c)(1)]. This means that Mr. Bing will be required to report the $214,350 of the distribution which came from accumulated earnings and profits as dividend income. The remaining portion “which is not a dividend shall be applied against and reduce the adjusted basis of the stock’ [Sec. 301(c)(2)]. The shareholder in this instance had adequate basis to be applied against the amount of distribution not deemed a dividend. This amount would not be taxable for the shareholder.

In Paula Construction Co. the petitioner, Paula Construction Co. (PCC) distributed earnings to its shareholders, but did not record the intent to, or in fact, compensate them despite “substantial and valuable” services being performed by two of the shareholders. The petitioner is arguing that the amounts paid to these two shareholders should be deductible as compensation due to the intent behind them. Despite the services performed, there was no record of the “intent” to use the distribution amounts as compensation for these services. Due to this, the court ruled in favor of the Commissioner and the deduction was not allowed [58 TC 1055].

That case points to an issue regarding distributions not yet considered. Mr. Bing appears to have adequate education in Chandler Corp.’s field to provide his services. If the corporation utilizes his services and wishes to deduct compensation for them, it is important to hold regular meetings regarding the treatment and amount of such compensation. Distributions of income can be regarded as compensation, but only with prior record of this intent.

Issue 3

Although S-Corporations do not typically pay tax at the corporate level, there are certain special taxes to ensure that the corporation cannot simply convert forms to evade tax that would have been paid as a C-Corporation. One of these taxes is the built-in gains tax that is referenced by the IRS in the examination letter. This tax results when there is a built-in gain on the assets of a corporation on the date that it elected S-Status like when Chandler Corp. made the election.

At the date of electing S-Status, Chandler Corp. possessed assets with a total fair market value of $4,825,000 with a corresponding total basis of $1,975,000. The difference of $2,850,000 is the amount of “net unrealized built-in gain” as defined in IRC Section 1374(d)(1). Over the course of the first five years of operation as an S-Corporation, an entity may be required to recognize income up to this amount. The triggering event for recognition is the sale of an asset resulting in a gain which would normally be passed on to shareholders as a capital gain.

In general, IRC Section 1374 requires that “for any taxable year beginning in the recognition period an S corporation has a net recognized built-in gain, there is hereby imposed a tax… on the income of such corporation for such taxable year” [Sec. 1374(a)]. This “net recognized built-in gain” is defined as the lesser of “(i) the amount which would be the taxable income of the S corporation for such taxable year if only recognized built-in gains and recognized built-in losses were taken into account, or (ii) such corporation’s taxable income for such taxable year” [Sec. 1374(d)(2)(A)]. The amount of tax imposed on the net recognized built-in gain may be reduced by any net operating loss carryforwards from years when the corporation was operating as a C-Corporation and by certain business credit carryforwards from this same time [Sec. 1374(b)(2)-Sec. 1374(b)(3).

As previously mentioned, Chandler Corp. had a net unrealized built-in gain of $2,850,000. This is the maximum amount that will be recognized by the corporation. During the current year the corporation sold its investments for a gain of $170,000. If the corporation was operating as a C-Corporation the total taxable income that would have been recognized would be $135,000. IRC 1374 allows a corporation to recognize the lesser of these two amounts. This means that Chandler Corp. will be responsible for a tax liability associated with the $135,000 net recognized built in gain. The amount of tax imposed on corporations under IRC Section 11(b) is 21 percent. This leaves the corporation with a tax liability of $28,350. The amount taxed under this special tax should be passed through to the shareholder as a loss item.

In Colorado Gas Compression, Inc. v. Commissioner, the petitioner became an S-Corporation in 1988 for one year before returning to its C-Status until 1994 when it once again elected S-Status. During this period operating as an S-Corporation, it sold assets that had accrued a gain before 1994. The commissioner determined deficiencies of $52,073, $709,939, and $161,037 related to the sale of these assets in 1994, 1995, and 1996. The petitioner, P, argued that the gains should not be taxed at the corporate level due to the code language at the time of the corporation’s initial election for S-Status. At that time, the ruling was that the built-in gains tax would only be recognized in the first three years of operation. The petitioner felt that it should not have to recognize the accrued gain as it initially elected S-Status in the year 1988, which was longer than three years before the first asset sale in 1994. Between elections the code had changed to require the same gain to be recognized during the first 10 years of operation, but the petitioner felt its initial election should be used in determining the applicability of the IRC. The respondent point to Section 1374(d)(9), which at the time of the case stated, “Any reference in this section to the 1st taxable year for which the corpo-ration was an S corporation pursuant to its most recent election under section 1362.” It was this clear language that led the court to ruling in favor of the IRS commissioner. Colorado Gas Compression, Inc. was required to pay tax on the determined deficiencies [116 TC 1].

That case demonstrates the manner the built-in gains tax will be applied to Chandler Corp. It also highlights the consequences if a corporation is required to or chooses to operate briefly as a C-Corporation before remaking an S-Election. As Chandler Corp. has the potential to have its S-Status terminated due to the initial risk associated with having accumulated earnings and profits, it is possible the corporation will face a similar scenario as in that case. Any reference to the date of election is to the most recent effective date. If the corporation were to remake the election at a future date, any gains associated with IRC Section 1374 would be reset and ruled upon by updated code.

Issue 4

The repayment on the principal of loans to the corporation by a shareholder can result in gain recognition at the individual level. This occurs when the amount of payment for a loan exceeds the shareholder’s basis much like with a distribution. A reduction in basis for a loan may occur in the instance that the loan basis was applied to increase the deductions allowed for a shareholder which may otherwise be limited by his basis in the corporation’s stock.

IRC Section 1367(b)(2)(A) states that in the event that if reductions to a shareholder’s stock are in excess of his basis “such excess shall be applied to reduce (but not below zero) the shareholder’s basis in any indebtedness of the S corporation to the shareholder.” In tax periods where there is a significant distribution and repayment on a loan from a shareholder, it is important to analyze whether this indebtedness has been reduced. If it has been, a gain must be recognized for the difference between the amount repaid and the shareholder’s current basis.

In this case, the initial basis in stock for the shareholder was $60,000. This amount was increased by the $170,000 long-term capital gain recognized on the sale of investments by the corporation consistent with IRC Section 1367(a)(1)(A). This left adequate basis remaining to receive the $85,650 distribution without recognizing a gain but reducing the basis to $144,350. The remaining deductions to basis described in IRC Section 1367(a)(2) totaled $84,350. At the end of adjustments, the shareholder basis was reduced to $60,000 [See Appendix]. In this tax period there was adequate basis to avoid affecting the loan basis for the shareholder.

In the event that a portion of the distribution had not received dividend treatment, this would not have been the case. A gain of $70,000 would be recognized due to the distribution exceeding shareholder basis under IRC Section 1368(b)(2). The shareholder loan basis would then be reduced by $84,350 and applied to the stock basis to allow for the additional deductions leaving a remaining basis of $315,650. The difference between the repayment of $400,000 and this basis would then be recognized as a gain on the repayment of the loan [See Appendix].

Meruelo v. Commissioner highlights the issues involved with deducting additional losses by applying a shareholder’s loan basis. Humero Meruelo, the petitioner in that case incurred a $13 million loss as a shareholder in the S-Corporation, Merco. Meruelo asserted that he “had a sufficient basis in Merco’s indebtedness” for him to deduct the full amount. He himself had made a capital contribution of $5 million to the corporation. The remaining debt the petitioner claimed ran through several other entities. There were several other S-Corporations that Meruelo had interest in that would frequently pay expenses on behalf of each other which were recorded as accounts payable. In the year in question, Merco had accounts payable from these transactions netting to just over $9 million. At the end of the year, a CPA reclassified this amount to a shareholder loan. Meruelo argued that he had “economic outlay” due to his interest in these entities and therefore had essentially loaned Merco the money. The court was not persuaded by this argument as all the transactions ran through these separate entities. It ruled in favor of the commissioner that Meruelo had not loaned this amount to Merco and did not have adequate basis to deduct the full loss amount [123 AFTR 2d 2019-1784].

The entire loan was repaid in the current year, but Mr. Bing may choose to contribute additional funds to Chandler Corp. allowing him to deduct future losses to the extent of his loan basis and his stock basis. The Meruelo case demonstrates the importance of utilizing the correct form in making these loans. There must be a clear focus and a demonstrable economic outlay. The corporation should maintain the practice of creating a promissory note and a repayment schedule. This will create a clear argument in favor of the taxpayer deducting additional losses.




Accumulated Adjustments Account

Adjustments to Loan and Shareholder Basis (with partial dividend treatment)

Adjustments to Loan and Shareholder Basis (without partial dividend treatment)



List of Authority

Sec. 11

Sec. 1362

Sec. 1367

Sec. 1368

Sec. 1374

Sec. 301

Sec. 316

Colorado Gas Compression, Inc. v. Commissioner, 116 TC 1 (2001)

MERUELO v. COMM., 123 AFTR 2d 2019-1784 (923 F.3d 938) (2019)

Paula Construction Co., 58 TC 1055 (1972)