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
Owner’s 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
Required: Provide an overview of (Would the note, which promises a future payment to the corporation of $70,000, enable Joel to avoid recognition of the gain? Explain)