Reference no: EM132466129
point 1: To share its profits with its two equal shareholders, Orange Corporation and Gustavo, it distributes cash of $200,000 to Orange and real estate worth $300,000 (adjusted basis of $20,000) to Gustavo. The real estate is subject to a mortgage of $100,000, which Gustavo assumes.
point 2: The distribution is made on December 31, Lime's year-end. Lime Corporation has had both good and bad years in the past. More often than not, however, it has lost money. Despite this year's banner profits, the GAAP-based balance sheet for Lime indicates a year-end deficit in retained earnings.
point 3: Consequently, the distribution of cash and land is treated as a liquidating distribution for financial reporting purposes, resulting in a reduction of Lime's paid-in capital account. The tax consequences of the distributions to Lime Corporation and its shareholders depend on a variety of factors that are not directly related to the financial reporting treatment.
Question 1: Identify these factors and explain the tax effects of the distributions to both Lime Corporation and its two shareholders.
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