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partnership). This sale is a deemed asset which results in a timing issue. This does the gain from the sale of 50% of the
sale for tax purposes under Rev. Rul. not impact the basis of the underlying target will be split equally between the
99-5 or the sale of a partnership inter- assets. It should be noted that this would two shareholders regardless of what
est. The portion not sold is considered a effectively shift all Sec. 1245 recapture to happens after the transaction. However,
rollover interest. Some buyers may prefer Shareholder A (of course, the purchase cash will shift from Shareholder A to
to purchase a partnership interest in price Shareholder A pays Shareholder B Shareholder B either through Share-
order to receive the Sec. 743 deductions could be adjusted to compensate for this holder A’s purchase of Shareholder B’s
rather than purchasing a disregarded impact). stock or the new S corporation redeem-
entity and negotiating such tax items as Alternatively, the new S corporation ing Shareholder B’s interest entirely
how depreciation will be allocated be- could distribute a portion of the target for cash. This creates a timing issue for
tween the parties. That issue, however, is to Shareholder A in a redemption under Shareholder A where gain is recognized
outside the scope of this discussion. Sec. 302. This would trigger a Sec. but a portion of the associated cash goes
The gain from the sale is then al- 311(b) gain within the new S corpora- to Shareholder B.
located to the shareholders based on tion, which would be split between the The alternative to a redemption or
their ownership percentage of the new S shareholders. However, it would also one shareholder buying out the other
corporation. However, in the examples allow Shareholder A, rather than the S is a straight stock sale. In the straight
discussed here, Shareholder B wants to corporation, to now own 50% of a part- stock sale, the buyer purchases the stock
exit the investment entirely and not roll nership directly (the disregarded entity from the S corporation shareholders in
any equity, which means that the cash would automatically convert to a part- the percentages they want to sell. Share-
proceeds should not be distributed pro nership), with a stepped-up basis. This holder B would sell 100% of her stock
rata. In these situations, the sellers have could also potentially trigger a taxable and would report the gain on her tax
a couple of options, none of which get event for both shareholders. Shareholder return. Shareholder A would simply hold
the shareholders to where they would be A could have taxable income if the basis his stock or contribute his stock to the
if they were selling a partnership or C of the assets distributed exceeds the basis buyer in exchange for stock in the buyer.
corporation interest. of the stock; however, Shareholder A Depending on the buyer’s legal structure,
They could adjust the ownership may not take a loss on this redemption. this could convert the target to a C cor-
immediately prior to the transaction or Once the transaction happens, Share- poration. Additionally, the buyer would
immediately after the transaction. Either holder A may contribute his interest in not receive a step-up in the underlying
way, this would be treated as a separate the target to the buyer under Sec. 721 if assets without a valid election to the
transaction from the acquisition of the the buyer is a partnership. If the buyer is contrary (Secs. 338(h)(10), 336(e), etc.).
target by the buyer. a C corporation, then the contribution Ultimately, practitioners need to be
would be subject to tax unless it qualifies aware of nonprorated S corporation
Pre-transaction ownership under Sec. 351 as a tax-free contribu- rollovers and understand the unexpected
adjustment tion. Of course, Shareholder A could tax consequences. Modeling to help
Prior to the transaction, the sharehold- also simply hold his interest as a direct quantify the impact could identify the
ers could adjust ownership through one partner in the target. Note that Share- adverse tax effect to the rolling share-
shareholder buying the other out, or they holder A’s otherwise tax-free rollover is holder; however, there will be a tax effect
could distribute the equity of the target taxed pursuant to Sec. 311(b) when dis- for each shareholder. Utilizing Secs.
(which is now a disregarded entity). If tributed, which results in a timing issue 301, 302, 311, 351, and 721, advisers can
Shareholder A buys out Shareholder B, for Shareholder A similar to that created determine which method is best for sell-
then both shareholders will have a tax- in the first pre-transaction ownership ing shareholders.
able event. Shareholder B will be taxed adjustment option. From Jonathan Drysdale, CPA, and
on the gain associated with the sale to Matthew Coscia, CPA, Plano, Texas ■
Shareholder A. Shareholder A will step Post-transaction ownership
up his basis in his stock in an amount adjustment Editor
equal to the price paid B and will be If the shareholders adjust the owner-
taxed when he sells 50% of the target ship after the transaction, the same two Mark Heroux, J.D., is a tax principal in
to the buyer, as the intent is to roll his options still exist — one shareholder the Tax Advocacy and Controversy
initial ownership. Shareholder A will re- buying out the other or a distribution of Services practice at Baker Tilly US, LLP
ceive the benefit of the stepped-up basis property in redemption of Shareholder in Chicago.
when he finally exits the investment, B. Once the sale transaction happens,

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