When making a nonliquidating distributionA distribution of cash or property made by an entity to its owners. After the distribution is made, the entity remains in existence and ownership is not affected., a C corporation may distribute cash or property. Cash distributions are dividends to the extent of earnings and profitsThe measure of a corporation's economic ability to pay dividends to its shareholders. Current E&P (CEP) is calculated annually by adjusting taxable income (loss) for noncash and other items and then reducing by dividends paid. It may be positive or negative (ie, deficit). Undistributed positive CEP or deficit CEP carries forward to future tax years as accumulated E&P.. Property distributions are treated as a hypothetical sale to the shareholder and the corporation recognizes gain equal to the excess of the property's FMVThe price of an item or service in an arm's length transaction that is dictated by a market of buyers and sellers. over adjusted basisThe cost of acquiring, making ready, and placing in service an asset less any adjustments (eg, accelerated expensing, accumulated depreciation, write-offs).. Losses (FMV ˂ adjusted basis) are not recognized to prevent the manipulation of corporate income.

For property, the amount of the distribution is the property's FMV determined on the date of the distribution less any liabilities assumed by the shareholder. However, if appreciated propertyWhen the FMV of property exceeds its adjusted basis. distributed is encumberedProperty that is subject to a liability (eg, mortgaged real property). with a liability greater than its FMV, the liability is treated as the "true FMV" of the property. Therefore, the corporation's recognized gain is calculated as the difference between the liability assumed and the adjusted basis (Choices A and B).

In this scenario, the corporation distributed appreciated personal propertyAnything that is subject to ownership and is not considered real property (eg, movable or intangible things). with a note payable that was assumed by the shareholder. Because the $12,000 note payable exceeds the property's $10,000 FMV, the note is considered the FMV. The corporation's recognized gain is $8,000 ($12,000 considered FMV − $4,000 adjusted basis).

(Choice D) A gain of $18,000 erroneously added the $12,000 liability assumed and the $6,000 difference between FMV and the adjusted basis of the property.

Things to remember:
In a nonliquidating distribution of appreciated property, a corporation must recognize gain equal to FMV less adjusted basis. However, when the property is encumbered by a liability that exceeds the property's FMV and the shareholder assumes the debt, the liability is considered the true FMV. A corporation's gain equals the difference between the liability and adjusted basis of the property.