When a corporation distributes property as a dividend, how is the gain treated for tax purposes?

When a corporation distributes property as a dividend, the gain is treated for tax purposes as though the corporation has sold the property. This treatment is rooted in the Internal Revenue Code, which states that a corporation recognizes gain or loss when it distributes property to shareholders. The corporation must calculate the difference between the fair market value of the property on the date of distribution and its adjusted basis in the property to determine the gain.

By treating the distribution as a sale, any gain is subject to taxation at the corporate level. This is important for both the corporation and the shareholders as it aligns the tax treatment of property distributions with the fundamental principle of recognizing gains and losses on asset transactions.

The other choices do not reflect the correct tax treatment: returning capital does not involve a gain recognition event, ordinary income pertains to income generated in the regular course of business (which does not apply in this distribution context), and classifying it as a loan is inapplicable as there is no obligation for the shareholders to repay the value distributed. The distribution of property as a dividend inherently triggers a recognition of gain equivalent to a sale.