Step Up Basis, S-Corp & a Bypass Trust

Technical topics regarding tax preparation.
#1
Wiles  
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I need some help figuring out this puzzle.

S-Corporation owns Intel stock and commercial real estate. The Intel stock is worth $2 million and the real estate is worth $2 million. To keep it simple, assume the corporation has no basis in either.

The stock of the S-Corp is owned 35% by Carol and 65% by a Bypass Trust created when Carol's husband passed away years ago. Carol has a $350K basis in the stock and the Bypass Trust has a $650K basis in the stock.

Carol has now passed away. The stock of the corporation is valued at $4 million. The Bypass Trust receives no step-up. Carol's estate gets a step up to $1.4 million (35% x $4 million)

Carol's 3 daughters are the beneficiaries of both the estate and the Bypass trust. They do not want to sell the real estate, but are trying to figure how to get their hands on that Intel stock and not pay any tax. They thought they could transfer $1.4 million of the Intel stock out of the corporation to Carol's estate. Sell it and pay no tax.

The problem here, of course, is that the transfer out of the corporation is treated as a sale. The corporation will recognize a $1.4 million gain. Everybody will get K-1's reporting their share of this gain.

Anybody have any thoughts on this?
Last edited by Wiles on 14-Aug-2018 7:50pm, edited 1 time in total.
 

#2
Wiles  
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I am thinking we can have the S-Corp redeem the estate's stock for $1.4 million. The Bypass Trust would get a K-1 from the S-Corp showing $910K LTCG. The estate will get a K-1 showing $490K LTCG, but then the estate can a claim the offsetting capital loss on the redemption.

They still need to pay tax on the $910K, but, at least, that's better than $1.4 million.
 

#3
Wiles  
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Question regarding my redemption idea...

Since the beneficiaries of the estate and the bypass trust are the same people, would the redemption of only the estate qualify as a redemption? Or would this just be a distribution?
 

#4
Doug M  
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The only way to get the Intel stock out without a tax hit is to distribute the real estate to Carol also. Treat as complete liquidation. I think. This article also looks at partial liquidations.

https://www.thetaxadviser.com/issues/20 ... older.html
 

#5
Wiles  
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Sec 1239 causes a problem if we distribute the real estate. That gain will be treated as ordinary.

We also have that Bypass Trust with no step up. Therefore no loss on dissolution.
 

#6
Wiles  
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Any thoughts on the redemption of the estate’s 35%? Is that doable.
 


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