IRC Sec. $351$ Review Problem

Several years ago, your client, Brett Favre, started an office cleaning service. His business was very successful, owing much to his namesake and legacy as a great football player. Brett operated his business as a sole proprietorship and used the cash method of accounting. Brett 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. Brett has come to you for advice on the tax implications of incorporation. His balance sheet is presented below. Under the terms of the incorporation, Brett 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$).$

Balance Sheet

Adjusted tax basis

Fair Market Value

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$

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$

Answer the following questions:

a$.$ How much gain or loss $($on a per$-$asset basis$)$ does Brett realize on the transfer of each asset to the corporation?

b$.$ How much, if any, gain or loss $($on a per$-$asset basis$)$ does Brett recognize?

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 corporation's stock?

d$.$ What tax basis does Brett have in the corporation's stock?

e$.$ What is the corporation's adjusted tax basis in each asset it receives from Brett?

f$.$ How much, if any, gain or loss $($on a per$-$asset basis$)$ will Brett recognize if he had taken back a $10-$year note worth $$25,000$ plus stock worth $$75,000$ plus the liability assumption?

g$.$ Will Brett be able to transfer the accounts receivable to the corporation and have the corporation recognize the income when the receivable is collected?

h$.$ Brett was depreciating the equipment $(200$ percent declining balance$)$ and building $($straight$-$line$)$ using MACRS when it was held inside the proprietorship. How will the corporation depreciate the equipment and building? Assume Brett owned the equipment for four years $($seven$-$year property$)$ and the building for six years.

i$.$ Will the corporation be able to deduct the liabilities when paid? Will it matter which accounting method $($cash or accrual$)$ the corporation uses?

j$.$ Would you advise Brett to transfer the land and building to the corporation? What other tax strategy might you suggest to Brett with respect to the real estate?

Prepare your answers in excel and clearly label your work.