A shareholder receives a capital account in their name in exchange for donating time, money and property. The account shows their share of the capital assets in the new business. A shareholder can sell their share of an S-Corp so any gain or loss on small business stock is calculated like capital gains on stocks or mutual funds. The shareholder has to know their tax basis in the investment in order to calculate the gain or loss.
The Value of the Property Becomes the Corporation’s Basis
The value of the property becomes the corporation’s basis in it when it is donated, transferred, or converted to an S-Corp. The value is also added to the capital account of the shareholder who donated it. Let’s say you donate a relatively new computer to your newly-formed S-corporation. The “adjusted basis” of the computer is $1,500. You also contribute $10,000 in cash. Here’s how your capital account would look:
Owner’s equity (as it will appear on the company’s balance sheet)William’s capital accountCash $10,000Equipment $1,500Total Capital $11,500
Your total capital contribution to the S-Corp is $11,500.
How To Account for the Contributions
The company’s basis in the donated property is the smaller amount of either its fair market value (FMV) or the shareholder’s adjusted basis, according to the IRS. Adjusted basis is the original cost of the property plus any improvements, plus any purchase costs, plus any selling costs, minus any depreciation. You must calculate two numbers to figure out the value of your capital contribution and to calculate the company’s basis for depreciation: the fair market value of the computer you donated and the computer’s adjusted basis.
An Example of Property Conversion
The computer in this scenario was your personal property. You never used it as business property and you never claimed any depreciation on it. You purchased the computer for $2,000, which included costs for shipping and tax. Your adjusted basis in the computer would be: $2,000 original cost plus $0 improvements plus $0 purchase costs (because shipping and tax were already included in the purchase price) plus $0 selling costs minus $0 depreciation equals a $2,000 adjusted basis. You must next figure out the fair market value of the computer. Check various websites such as eBay and craigslist. You might find out that your computer model is selling for around $1,500 in good condition. You could expect to get about $1,500 for it if you were to sell it in this condition, so this is the FMV of the computer. The value of the computer is therefore $1,500 because that’s the lesser of these two figures. Therefore, Your capital account is increased by $1,500 and the corporation can use $1,500 as its basis for depreciating the computer.
If the Computer Was Business Property
You most likely depreciated the computer’s cost on IRS Schedule C if you used it as an independent contractor. You bought it for $2,000, which included shipping and tax. You bought the computer in June 2021 and took Section 179 depreciation on your 2021 Schedule C, opting to claim its full cost in the first year. Your adjusted basis in the computer would be: $2,000 original cost plus $0 improvements plus $0 purchase costs (because shipping and tax were included) plus $0 selling costs minus $2,000 Section 179 depreciation taken in 2021, equaling $0 adjusted basis. Just as in the example above, the fair market value of the computer is $1,500. The lesser of these two figures is $0, so your computer is unfortunately valued at $0. Your capital account is increased by $0. The corporation cannot depreciate the computer because the corporation’s basis in the computer is also $0.
