Joel has operated his business as a sole proprietorship for many years but has decided to incorporate the business in order to limit his exposure to personal liability. The balance sheet of his business is as follows:
Assets: Adjusted Basis Fair Market Value
Cash 50,000 50,000
A/R 40,000 40000
Inventory 30,000 60000
Fixed Asset 10,000 200,000
$130,000 $350,000
Liabilities:
Trade A/P 25,000 25,000
Note Payable 175,000 175,000
Ownerâs E (70,000) 150,000
$130,000 $350,000
One problem with this plan is that the liabilities of his sole proprietorship exceed the basis of the assets to be transferred to the corporation by $70,000 ($200,000-$130,000). Therefore, Joel would be required to recognize a gain of $70,000. He is not pleased with this result and asks you about the effect of drawing up a $70,000 note that he would transfer to the corporation. Would the note, which promises a future payment to the corporation of $70,000, enable Joel to avoid recognition of the gain? Explain
Joel has operated his business as a sole proprietorship for many years but has decided to incorporate the business in order to limit his exposure to personal liability. The balance sheet of his business is as follows:
Assets: Adjusted Basis Fair Market Value
Cash 50,000 50,000
A/R 40,000 40000
Inventory 30,000 60000
Fixed Asset 10,000 200,000
$130,000 $350,000
Liabilities:
Trade A/P 25,000 25,000
Note Payable 175,000 175,000
Ownerâs E (70,000) 150,000
$130,000 $350,000
One problem with this plan is that the liabilities of his sole proprietorship exceed the basis of the assets to be transferred to the corporation by $70,000 ($200,000-$130,000). Therefore, Joel would be required to recognize a gain of $70,000. He is not pleased with this result and asks you about the effect of drawing up a $70,000 note that he would transfer to the corporation. Would the note, which promises a future payment to the corporation of $70,000, enable Joel to avoid recognition of the gain? Explain
Related questions
Several years ago, your client, Brooks Robinson, started an office cleaning service. His business was very successful, owing much to his legacy as the greatest defensive third baseman in major league history and his nickname, âThe Human Vacuum Cleaner.â Brooks operated his business as a sole proprietorship and used the cash method of accounting. Brooks was advised by his attorney that it is too risky to operate his business as a sole proprietorship and that he should incorporate to limit his liability. Brooks has come to you for advice on the tax implications of incorporation. His balance sheet is presented below. Under the terms of the incorporation, Brooks would transfer the assets to the corporation in return for 100 percent of the companyâs common stock. The corporation would also assume the companyâs liabilities (payables and mortgage). (Negative amounts should be indicated by a minus sign. Leave no answer blank. Enter zero if applicable.)
| Balance Sheet | |||||
| Adjusted Basis | FMV | ||||
| Assets | |||||
| Accounts receivable | $ | 0 | $ | 5,000 | |
| Cleaning equipment (net) | 25,000 | 20,000 | |||
| Building | 50,000 | 75,000 | |||
| Land | 25,000 | 50,000 | |||
| Total assets | $ | 100,000 | $ | 150,000 | |
| Liabilities | |||||
| Accounts payable | $ | 0 | $ | 10,000 | |
| Salaries payable | 0 | 5,000 | |||
| Mortgage on land and building | 35,000 | 35,000 | |||
| Total liabilities | $ | 35,000 | $ | 50,000 | |
a. How much gain or loss does Brooks realize on the transfer of each asset to the corporation?
|
b. How much, if any, gain or loss (on a per asset basis) does Brooks recognize?
| Realized gain/loss | |
| Accounts receivable | |
| Equipment | |
| Building | |
| Land | |
| Total | $0 |
c. How much gain or loss, if any, must the corporation recognize on the receipt of the assets of the sole proprietorship in exchange for the corporationâs stock?
Gain or loss recognized -
d. What tax basis does Brooks have in the corporationâs stock?
|
e. What is the corporationâs tax basis in each asset it receives from Brooks?
| Tax Basis | |
| Accounts Receivable | |
| Equipment | |
| Building | |
| Land | |
| Total |
f. How much if any gain or loss will Brooks recognize if he had taken back a 10-year note worth $25,000 plus stock worth $75,000 plus the liability assumption? (Do not round intermediate calculations. Round your final answers to the nearest whole dollar amount.)
| Realized gain/loss | |
| Accounts receivable | |
| Equipment | |
| Building | |
| Land | |
| Total | $0 |
