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Prentice Hall's Federal Taxation 2016: Corporations, 29e (Pope)
Chapter C7: Corporate Acquisitions and Reorganizations

LO1: Taxable Acquisition Transactions

1) Taxable acquisition transactions can either be a purchase of assets or a purchase of stock.

Answer: TRUE
Page Ref.: C:7-2
Objective: 1

2) In a taxable asset acquisition, the purchaser does not acquire unknown and contingent liabilities.
Answer: TRUE
Page Ref.: C:7-3
Objective: 1

3) The Sec. 338 deemed sale rules require that 70% of the target corporation's stock be owned.
Answer: FALSE
Page Ref.: C:7-5
Objective: 1

4) Tax attributes of the target corporation are lost when a Sec. 338 deemed liquidation election is made.
Answer: TRUE
Page Ref.: C:7-9 and C:7-10
Objective: 1

5) Identify which of the following statements is false.

A) Taxable acquisition transactions can either be a purchase of assets or a purchase of stock.
B) The tax-free reorganization rules are an example of the wherewithal to pay concept.
C) A taxable acquisition of a target corporation's assets results in the nonrecognition of gain or loss on the
disposition of each individual asset.
D) Sales of depreciable assets as part of a taxable acquisition result in depreciation recapture.
Answer: C
Page Ref.: C:7-2
Objective: 1

6) Identify which of the following statements is false.

A) A taxable acquisition of the assets of a target corporation that is subsequently liquidated, results in a
loss of the target corporation's tax attributes.
B) A taxable acquisition of the assets of a target corporation, that is subsequently liquidated, results in the
target corporation's shareholders recognizing gain or loss on the surrender of their target stock.
C) An acquiring corporation in a tax-free or a taxable acquisition transaction does not recognize gain or
loss when its stock is issued in exchange for property.
D) An acquiring corporation in a taxable acquisition transaction must acquire all of the assets and
liabilities of the target corporation.
Answer: D
Page Ref.: C:7-2
Objective: 1

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Copyright © 2016 Pearson Education, Inc.
7) Axle Corporation acquires 100% of Drexel Corporation's stock from Drexel's shareholders for $500,000
cash. Drexel Corporation has assets with a $600,000 adjusted basis and an $800,000 FMV. The assets are
subject to $200,000 in liabilities. Drexel Corporation shareholders purchased their stock eight years ago
for $300,000. Axle Corporation's basis in the Drexel Corporation stock is
A) $800,000.
B) $600,000.
C) $500,000.
D) $300,000.
Answer: C
Explanation: Purchaser's basis for stock is its cost (Sec. 1012). The target corporation's basis in its assets or
the amount of its liabilities are not relevant in a cash purchase of stock.
Page Ref.: C:7-4
Objective: 1

8) Identify which of the following statements is true.

A) Acquisition of the stock of a target corporation in a taxable acquisition transaction is reflected in an
increased basis for the target corporation's assets on its books.
B) Acquisition of 100% of the stock of a target corporation in a taxable transaction followed by a tax-free
liquidation of the target corporation permits a step-up in the basis of the target corporation's assets to
their FMV.
C) Usually when 100% of the stock of a target corporation is purchased by an acquiring corporation, the
basis of the assets of the target corporation reflects the purchase price of the target stock.
D) All of the above are false.
Answer: D
Page Ref.: C:7-4
Objective: 1

9) Identify which of the following statements is true.

A) A deemed liquidation election is available when a target corporation is liquidated into its parent
corporation.
B) Corporate purchasers generally prefer Sec. 338 treatment because of the significant tax savings
originating from the step-up in basis.
C) The Sec. 338 deemed liquidation rules require that 100% of the target corporation's stock be purchased.
D) All of the above are false.
Answer: D
Page Ref.: C:7-5 and C:7-6
Objective: 1

10) Identify which of the following statements is false.

A) A Sec. 338 election usually triggers taxation to the target corporation.
B) A Sec. 338 election must be made not later than the fifteenth day of the ninth month following the first
stock acquisition in a series of acquisitions that leads to 80% or more stock ownership.
C) When a Sec. 338 election is made, the target corporation is treated as having sold all of its assets at
their FMV at the close of the acquisition date.
D) In a Sec. 338 deemed sale election, the shareholders of the target corporation sell their stock to the
acquiring corporation.
Answer: B
Page Ref.: C:7-5 through C:7-7
Objective: 1

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Copyright © 2016 Pearson Education, Inc.
11) A stock acquisition that is not treated as a purchase for purposes of meeting the Sec. 338 rules is
A) stock whose adjusted basis is determined by its basis in the hands of the person from whom it was
acquired.
B) stock acquired from a decedent.
C) stock acquired in a tax-free reorganization.
D) All of the above are correct.
Answer: D
Page Ref.: C:7-6
Objective: 1

12) Melon Corporation makes its first purchase of 30% of Hill Corporation stock on July 31 of this year.
Melon Corporation uses a calendar tax year. To use the Sec. 338 election, Melon Corporation must
purchase
A) an additional 50% of Hill Corporation stock by December 31 of this year.
B) an additional 50% of Hill Corporation stock by July 30 of next year.
C) an additional 51% of Hill Corporation stock by December 31 of this year.
D) an additional 51% of Hill Corporation stock by July 30 of next year.
Answer: B
Page Ref.: C:7-6; Example C:7-4
Objective: 1

13) Jersey Corporation purchased 50% of Target Corporation's single class of stock on June 1 of this year.
They purchased an additional 40% on November 20 of this year. The Sec. 338 election must be made on or
before
A) June 30 of this year.
B) November 30 of this year.
C) August 15 of next year.
D) June 30 of next year.
Answer: C
Explanation: A Sec. 338 election must be made not later than the fifteenth day of the ninth month after
the month in which the acquisition date (November 20, of this year) occurs.
Page Ref.: C:7-5
Objective: 1

14) Identify which of the following statements is true.

A) When the acquiring corporation makes the Sec. 338 election, the target corporation is treated in many
respects as a new corporation.
B) A Sec. 338 election requires the adoption of the old target corporation's tax year by the new target
corporation.
C) Tax attributes of the target corporation are not lost when a Sec. 338 deemed liquidation election is
made.
D) All of the above are false.
Answer: A
Page Ref.: C:7-5
Objective: 1

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Copyright © 2016 Pearson Education, Inc.
15) Identify which of the following statements is true.
A) The total basis of the target corporation's assets following a Sec. 338 election in general equals the
amount paid for the target corporation's stock minus the target corporation's liabilities.
B) The residual method ensures that any premium paid for the target stock is reflected in depreciable
assets.
C) The allocation of the total basis of the target corporation's assets to the individual assets following a
Sec. 338 election occurs under the residual method.
D) All of the above are false.
Answer: C
Page Ref.: C:7-8 and C:7-9
Objective: 1

16) Which of the following definitions of Sec. 338 property classes is not correct?
A) Class I: cash, demand deposits, and similar accounts in banks, savings and loan associations, etc.
B) Class II: actively traded personal property such as publicly traded securities
C) Class III: covenants not to compete, similar restrictions on trade, etc.
D) Class IV: inventory or other property held primarily for sale to customers
Answer: C
Page Ref.: C:7-8 and C:7-9
Objective: 1

17) When gain is realized by a target corporation from disposing of its assets in a tax-free reorganization,
the gain is
A) recognized if boot is received and immediately distributed to its shareholders.
B) recognized without exception.
C) recognized if boot is received and retained.
D) never recognized.
Answer: C
Page Ref.: C:7-11
Objective: 2

18) In a Sec. 338 election, the target corporation

A) will no longer file a separate return.
B) must use the preacquisition tax year.
C) will have a holding period for assets beginning on the day after the acquisition date.
D) is considered to be a continuation of the old target corporation for purposes of the tax attribute
carryover rules.
Answer: C
Page Ref.: C:7-12
Objective: 2

19) Brown Corporation has assets with a $650,000 basis and an $800,000 FMV. The assets are subject to
$250,000 in liabilities. Clark Corporation acquires all of Brown's assets and liabilities for $600,000 in cash.
Brown Corporation then liquidates. What is Clark Corporation's basis in the acquired assets?
Answer: In a taxable asset acquisition, the purchaser's basis for the assets is their acquisition cost (Sec.
1012). In this instance, the acquisition cost is $600,000 cash plus the assumption of $250,000 in liabilities
for a total of $850,000.
Page Ref.: C:7-3
Objective: 1

4
Copyright © 2016 Pearson Education, Inc.
20) Pacific Corporation acquires 80% of the stock of Jackson Corporation for $3,000,000 in the current
year. Jackson's assets have a basis of $2,000,000 and its liabilities are $800,000. The assets are worth
$3,500,000. What gain is recognized by Jackson Corporation on the deemed sale of its assets if a Sec. 338
election is made?
Answer: FMV of $3,500,000 less basis of $2,000,000 equals a recognized gain of $1,500,000.
Page Ref.: C:7-5
Objective: 1

21) Dreyer Corporation purchased 5% of Willy Corporation's stock five years ago for $100,000. Dreyer
then decides to purchase an additional 80% of the Willy stock for $1,000,000 on April 15 of the current
year. On the acquisition date, Willy Corporation's liabilities are $150,000. A $300,000 tax liability is
incurred by Willy on the Sec. 338 deemed sale. What is the total basis of Willy Corporation's assets for
Sec. 338 basis allocation purposes?
Answer: Grossed-up basis of recently purchased stock = $1,000,000 × [(100% - 5%)/80%] = $1,187,500.

Total grossed-up basis of stock = $1,187,500 (grossed-up basis of recently purchased stock) + $100,000
(basis of nonrecently purchased stock) = $1,287,500.

Adjusted grossed-up basis (allocated to individual assets) = $1,287,500 + $150,000 nontax liabilities +
$300,000 taxes = $1,737,500. This basis is allocated to the individual assets by using the residual method.
Page Ref.: C:7-5 through C:7-8
Objective: 1

22) Parent Corporation purchases all of Target Corporation's stock for $200,000 and makes a deemed
liquidation election. Target Corporation has Class I assets with an adjusted basis of $55,000 and an FMV
of $55,000; Class II assets with an adjusted basis of $40,000 and an FMV of $60,000; and Class V assets
with an adjusted basis of $70,000 and an FMV of $100,000. The Class V assets are subject to a $20,000
liability. Assume a 34% corporate tax rate. What is the adjusted grossed-up basis of Target Corporation's
stock?
Answer:
ADSP = [$200,000 + $20,000 - (0.34 × $165,000)]/(1 - 0.34)
=($220,000 - $56,000)/0.66
= $248,333

Purchase price of stock $200,000

Plus: Target Corp. non tax liabilities 20,000
Plus: federal tax on deemed sale
($248,333 - $165,000) × 0.34 28,333
Adjusted grossed-up basis of stock $248,333
Page Ref.: C:7-6 through C:7-7
Objective: 1

5
Copyright © 2016 Pearson Education, Inc.
23) Parent Corporation purchases all of Target Corporation's stock for $200,000 and makes a deemed
liquidation election. Target Corporation has Class I assets with an adjusted basis of $55,000 and an FMV
of $55,000; Class II assets with an adjusted basis of $40,000 and an FMV of $60,000; and Class V assets
with an adjusted basis of $70,000 and an FMV of $100,000. The Class V assets are subject to a $20,000
liability. Assume a 34% corporate tax rate.

Assuming that the adjusted grossed-up basis is $237,000 ($200,000 + $20,000 + $17,000 federal income
taxes), what is the allocation of adjusted grossed-up basis to Class VI assets?
Answer:
Adjusted grossed-up basis $237,000
Minus: Class I FMV ( 55,000)
Class II FMV ( 60,000)
Class V FMV (100,000)
Allocation to Class VI assets $ 22,000
Page Ref.: C:7-8 and C:7-9
Objective: 1

24) The assets of Bold Corporation have a $1,000,000 basis and a $3,000,000 FMV. Its liabilities are
$500,000. Tidel Corporation acquires 80% of the Bold Corporation stock for $2,000,000. What gain is
recognized by Bold Corporation if a timely Sec. 338 election is made by Tidel Corporation? What is the
total basis of the assets to Bold Corporation following the deemed sale? Assume a 34% corporate tax rate.
Answer: Bold Corporation will recognize a $2 million gain on the deemed sale. The gain is the difference
between the FMV of the assets ($3,000,000) and the corporation's basis in the assets ($1,000,000).
Assuming a 34% corporate tax rate, the tax liability on the gain is $680,000 ($2,000,000 × 0.34). The
grossed-up basis for the recently purchased stock is $2,500,000 [$2,000,000 × (100%/80%)]. The assets take
a total basis of $3,680,000 ($2,500,000 grossed-up basis + $500,000 nontax liabilities + $680,000 taxes). This
basis is allocated to the individual assets by using the residual method. Assuming none of the $3,000,000
FMV for the assets given in the facts relates to Class IV assets (e.g., goodwill), $680,000 of the total basis
will be allocated to goodwill.
Page Ref.: C:7-8 and C:7-9
Objective: 1

25) What are the two steps of a Sec. 338 deemed liquidation election?
Answer: First, the target corporation's shareholders sell their stock to the acquiring corporation. Then the
acquiring corporation makes a Sec. 338 deemed liquidation election with respect to the acquisition of the
target corporation's stock. This election results in a hypothetical sale of the "old" target corporation's
assets to a "new" target corporation for their FMV in a transaction that requires the seller ("old" target) to
recognize all gains and losses.
Page Ref.: C:7-5
Objective: 1

6
Copyright © 2016 Pearson Education, Inc.
26) Define the seven classes of assets used in allocating basis when using the residual method.
Answer: The residual method requires the adjusted grossed-up basis amount be allocated to the
corporation's tangible and intangible property on a priority basis.
Class I: Cash, demand deposits, and similar accounts in banks, savings and loan associations, etc.
Class II: Actively traded personal property (as defined in Sec. 1092(d)(1)) such as stock this is part of a
straddle, U.S. government securities and publicly traded securities.
Class III: Accounts receivable, mortgages and credit card receivables from customers that arise in the
ordinary course of business.
Class IV: Inventory or other property held primarily for sale to customers in the ordinary course of the
taxpayer's trade or business.
Class V: All assets other than Class I, II, III, IV, VI, and VII assets. Included here would be tangible and
intangible property without regard to whether they are depreciable, depletable, or amortizable.
Class VI: All amortizable Sec. 197 assets except those in the nature of goodwill and going concern value.
Class VII: Sec. 197 intangible assets in the nature of goodwill and going concern value.
Page Ref.: C:7-8
Objective: 1

27) John Van Kirk owns all the stock of Monmouth Restaurant Corporation in Pittsburgh. John would like
to sell his business and retire to sunny Florida now that he has turned 65. Pam, a long-time bartender at
Monmouth Restaurant, offers to purchase all the business's noncash assets in exchange for a 25% down
payment, with the remaining 75% being paid in five equal annual installments. Interest will be charged at
a 10% rate on the unpaid installments. John plans to liquidate the corporation that has operated the
restaurant and have Monmouth Restaurant distribute the installment notes and any remaining assets.
What tax issues should Monmouth Restaurant, John, and Pam consider with respect to the purchase
transaction?
Answer: The following tax issues should be considered by John Van Kirk when evaluating Pam's
proposal and by Pam in drafting her proposal:

John:
• What is the amount and character of the gain or loss Monmouth Restaurant will recognize on the sale
of the noncash assets? On distributing the installment obligation?
• What is the amount and character of the gain or loss John will recognize on surrendering his
Monmouth Restaurant stock? On receipt of the subsequent payments?
• Does Monmouth Restaurant have to file a corporate tax return for the portion of the final tax year it is
in existence? If so, what income and expenses are included in the return?
• Can Monmouth Restaurant deduct the liquidation expenses on its final tax return?
• Can Monmouth Restaurant deduct any unamortized organizational costs on the final return? Start-up
costs?
• What is the relative tax cost (and nontax benefits) of receiving a lump-sum cash payment? Of selling
the Monmouth Restaurant stock to Pam?
• How will the interest income from the installment obligations be taxed to John?
• Would it be advantageous to lower the interest rate charged on the installment sale to below 10% and
increase the sales price?
• What are the tax costs and benefits of Monmouth Restaurant remaining in business to collect the
installment payments and then liquidating?

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Copyright © 2016 Pearson Education, Inc.
Pam:
• What will Pam's total basis be for the noncash assets to be acquired? What portion of the total basis is
allocated to each individual asset?
• What capital recovery rules apply to each individual asset?
• What business form and capital structure should be used to conduct the business?
• What are the tax consequences of transferring the assets to the business entity form that is selected?
• Should the asset be acquired by Pam or by her business entity?
• What tax year and accounting methods should Pam elect for her new business?
• Are any of her preacquisition costs deductible? Capitalizable as start-up expenses? Are any
capitalized costs amortizable?
• Is the interest paid on the installment sale deductible?

The gain realized on the asset sale may be reportable under the installment sale rules. If so, the total gain
can be reported by the Monmouth Restaurant Corporation over a six-year period. The installment sale
method cannot be used if Monmouth Restaurant uses the accrual method of accounting. The interest
income earned on the installment obligations will be reported as ordinary income by the corporation
while it holds the debt. Pam can deduct the interest expense incurred on the installment debt. A special
tax advantage is available if Monmouth Restaurant uses the cash method of accounting. If the corporation
sells the assets using an installment sale and liquidates within a 12-month period, it will have to
recognize any realized gain (i.e., the difference between FMV of the obligations and their basis on the
corporation's books) when the obligations are distributed to the shareholders. John does not have to
recognize his gain on the sale or exchange of his stock as part of Monmouth Restaurant's liquidation
except to the extent he receives cash on the liquidation date. His remaining gain is recognized as the
installment obligations are collected. John might consider the stock sale alternative to defer his total tax
burden. Pam may find she has a major disadvantage—no step-up in basis for the acquired assets.
Page Ref.: C:7-2 through C:7-13
Objective: 1

LO2: Comparison of Taxable and Nontaxable Acquisitions

1) In a nontaxable reorganization, shareholders of the target corporation recognize gain or loss.

Answer: FALSE
Page Ref.: C:7-13
Objective: 2

2) In a nontaxable reorganization, the acquiring corporation has a holding period for the acquired assets
that begins on the day after the transaction date.
Answer: FALSE
Page Ref.: C:7-12; Topic Review C:7-2
Objective: 2

3) In a nontaxable reorganization, the holding period for the stock received by the target shareholders
includes the holding period of the stock surrendered.
Answer: TRUE
Page Ref.: C:7-13; Topic Review C:7-3
Objective: 2

8
Copyright © 2016 Pearson Education, Inc.
4) Identify which of the following statements is true.
A) In a tax-free reorganization, the acquiring corporation's holding period for the acquired properties
includes the period of time the target corporation held the properties.
B) In a tax-free reorganization, if the acquiring corporation uses nonmonetary boot property, gains or
losses will be recognized by the acquiring corporation.
C) The receipt of cash by a shareholder results in the recognition of all of his or her realized gain even if
the transaction qualifies as a tax-free reorganization.
D) All of the above are false.
Answer: A
Page Ref.: C:7-16
Objective: 3

5) Acquiring Corporation acquires all of the assets of Target Corporation in exchange for $3,000,000 of
Acquiring common stock and the assumption of $2,000,000 of Target's liabilities. The assets had a
$2,300,000 adjusted basis to Target. Target's sole shareholder, Paula, had a $1,000,000 adjusted basis for
her stock. Target Corporation had $600,000 of E&P on the acquisition date. Paula receives all of the
Acquiring common stock in the liquidation of Target. What are the tax consequences of the acquisition to:
Acquiring, Target, and Paula?
Answer: Acquiring: Acquiring Corporation does not recognize any gain when it issues its common stock
in exchange for Target's assets (Sec. 1032). The assets take a $2,300,000 adjusted basis on Acquiring's
books (Sec. 362). Acquiring assumes Target's $600,000 E&P balance (Sec. 381).

Target: Target realizes a $2,700,000 [($3,000,000 + $2,000,000) - $2,300,000 adjusted basis] gain on the
transfer of its assets. No boot is received and retained, so no gain is recognized (Sec. 361(a)). No gain is
recognized on the distribution of the Acquiring Corporation stock to Target's sole shareholder (Sec.
361(c)).

Paula: Paula realizes a $2,000,000 ($3,000,000 - $1,000,000) gain on the exchange of her Target stock for the
Acquiring stock. None of the gain is recognized (Sec. 354). Her basis for the Acquiring stock is $1,000,000
(Sec. 358). Her holding period for the Acquiring stock includes her holding period for the Target stock
(Sec. 1223).
Page Ref.: C:7-13
Objective: 2

6) Why would an acquiring corporation want an acquisition to be tax-free if it gets only a substituted
basis rather than a step-up basis for the acquired assets?
Answer: Although the motivation for the tax-free acquisition comes from the target corporation and the
target's shareholders, there are two reasons the acquiring corporation may also desire the acquisition be
tax-free. First, if the acquiring corporation has no cash to acquire the assets, it must use stock as
consideration for the purchase. Second, the target corporation may have favorable tax attributes that the
acquiring corporation would like to use.
Page Ref.: C:7-12
Objective: 2

9
Copyright © 2016 Pearson Education, Inc.
LO3: Types of Reorganizations and Their Tax Consequences

1) The acquiring corporation does not recognize gain or loss in a reorganization where it receives boot.
Answer: TRUE
Page Ref.: C:7-14 and C:7-15
Objective: 3

2) Identify which of the following statements is true.

A) Depreciation recapture rules do not override the nonrecognition of gain or loss rules.
B) The acquisition of liabilities by an acquiring corporation will trigger a gain.
C) A target corporation will recognize a gain when it distributes stock to its shareholders.
D) The basis of property acquired in a reorganization is its FMV.
Answer: A
Page Ref.: C:7-14 and C:7-15
Objective: 3

3) Identify which of the following statements is true.

A) The target corporation in a tax-free reorganization generally recognizes no gain or loss when boot
property is received in exchange for assets because such property is usually distributed to its
shareholders and creditors when the target corporation is liquidated.
B) In tax-free reorganizations, one transaction cannot qualify for more than one type of tax-free
reorganization.
C) The Sec. 1245 recapture rules override the nonrecognition of gain or loss rules for an asset-for-stock
tax-free reorganization.
D) All of the above are false.
Answer: A
Page Ref.: C:7-14
Objective: 3

10
Copyright © 2016 Pearson Education, Inc.
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