Question

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, “The Human Vacuum Cleaner.” 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 company’s common stock. The corporation would also assume the company’s liabilities (payables and mortgage).

How much, if any, gain or loss (on a per asset basis) will Brooks recognize if he had taken back a 10-year note worth $79,000 plus stock worth $93,000 plus the liability assumption?

Balance Sheet
		Adjusted Basis			FMV
Assets
Accounts receivable	$	0		$	23,000
Cleaning equipment (net)		43,000			38,000
Building		86,000			93,000
Land		43,000			68,000
Total assets	$	172,000		$	222,000
Liabilities
Accounts payable	$	0		$	28,000
Salaries payable		0			23,000
Mortgage on land and building		53,000			53,000
Total liabilities	$	53,000		$	104,000

Answer 1

The 10-year note is considered boot under §351(b). Brooks must allocate the fair market value of the note to each asset transferred and then recognize gain (not loss) equal to the lesser of the

       ·   Gain realized on the asset transfer, or
·   The fair market value of the note allocated to the asset.

            The FMV of the note is allocated to the assets transferred using the relative fair       market values of the assets.

       Accts Rec:            23,000/222,000 ´ $79,000 = $8185
Equipment:          38,000/222,000 ´ $79,000 = $13,523
Building: 93,000/222,000 ´ $79,000 = $33,095
Land:                   68,000/222,000 ´ $79,000 = $24,198

       Gain recognized:
     Accts Rec:       lesser of $23,000 or $8185     

           Equipment:       the $5,000 loss is not recognized
     Building:         lesser of $7,000 or $33,095
     Land:               lesser of $25,000 or $24,198
     Total gain recognized is $39,383.

       An aside: The tax year(s) in which the gain is recognized depends on whether Brooks accounts for the gain under the installment method (§453) or elects to recognize the entire gain currently. If he does not elect out of the installment method, he will recognize the gain as the principal on the security is collected ($3,938 per year for ten years). Brooks will be subject to interest payments on the deferred tax.