Reference no: EM13160026
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:
Adjusted Basis Fair Market Value
Assets:
Cash 50,000 50,000
Account Receivable 40,000 40,000
Inventory 30,000 60,000
Fixed Assets 10,000 200,000
130,000 350,000
Liabilities
Trade accounts payable 25,000 25,000
Notes Payable 175,000 175,000
Owner's Equity (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 ($20,000 - $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 this gain?
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