On December 1, 2022, the Joel Freedman, owner of Advanced Technologies was approached by Environmental Solutions, Inc., and offered to buy his company. After consulting with his attorney and further negotiation with management of Environmental Solutions, Inc., Mr. Freedman decided to go through with the transaction on August 1, 2023. On August 15, 2023, a letter of intent was signed by Mr. Freedman's attorney on his behalf, and the law firm representing Environmental Solutions, documenting the parties' intention that Advanced Technologies would transfer all of its assets and liabilities to Environmental Solutions for the sum of $ 5 million. The letter of intent was presented to the Board of Directors of Environmental Solutions, Inc. on September 30, 2023, and on that day the Board approved the final terms of the transaction and a proposed final contract prepared by the company's counsel. This transaction was consummated and closed on October 15, 2023. You have been asked to assist in meeting the tax compliance requirements with respect to the transaction, and to provide tax advice as to the consequences of the transaction to both the seller, Advanced Technologies, and the buyer, Environmental Solutions. Advanced Technologies was founded in 2012, by Joel Freedman and has always operated as a sole proprietorship. Prior to starting this company, Mr. Freedman worked full-time as an environmental engineer for a large company. While employed, he pursued scientific experimentation in the field of environmental and hazardous waste removal technology on his own time. His research led to the discovery of a new technique that could result in a more efficient and effective removal of hazardous waste. He promptly patented this technology and decided to start his own company so he could put his new technology to use. Therefore, he resigned from his position as an environmental engineer and founded Advanced Technologies. Data from the records of Advanced Technologies was presented reflecting the following on date of the transaction: Advanced Technologies Schedule of Assets and Liabilities Book Value Tax Basis Fair Market Value * Assets Cash 100,000 100,000 100,000 Accounts Receivable 250,000 250,000 250,000 Allowance for Bad Debts (10,000) - (10,000) Inventory 125,000 125,000 100,000 Equipment 150,000 150,000 110,000 Depreciation Allowance- Equipment (50,000) (60,000) Building 250,000 100,000 500,000 Depreciation Allowance- Building** (20,000) (10,000) Intangible Assets (Patent) *** 220,000 25,000 1,000,000 Total Assets 1,015,000 680,000 2,050,000 Liabilities: Book Value Tax Basis Fair Market Value Accounts Payable 90,000 90,000 90,000 Accrued Payroll 10,000 10,000 10,000 Long-term Debt 200,000 200,000 200,000 Total Liabilities 300,000 300,000 300,000 Equity 715,000 380,000 1,750,000 Contingent Environmental Claim Liability (footnote disclosure) **** 2,000,000 *The fair market values were determined by appraisals and valuations performed by Advanced Technologies, and validated by Environmental Solutions, Inc. in its due diligence process. Both parties agree as to the valuation of the assets, including any impairment or decline in realizable value thereof, as reflected in the "Fair Market Value" column of this schedule. The valuation allowance on accounts receivable was reviewed in the due diligence period and was determined to reflect a reasonable estimate of amounts expected to be uncollectible. The sale contract contains a written agreement by the parties as to the fair market value of the identifiable assets, and the amount of the total consideration amount that reflects a fair price for each of those assets. **The building is an old, abandoned structure that Mr. Freedman purchased a long time ago. He renovated and converted it for use in his business operations. It houses the company's offices, vehicles, and operating equipment. Both the building and the equipment have been depreciated under the applicable MACRS depreciation method. ***The patent relates to the new hazardous waste removal technology developed by Mr. Freedman. The book basis of $220,000 reflects original book value of $250,000, based on fair value of the patent on the date it was contributed to Advanced Technologies, net of $30,000 of accumulated amortization, according to GAAP. The tax basis of $25,000 above reflects his costs of developing and patenting this technology of $35,000, net of amortization of $10,000 he has deducted for tax purposes. ****The contingent liability was disclosed in the footnotes to Advanced Technologies' financial statements. It pertains to a lawsuit filed by certain former employees claiming that they have suffered health problems as result of being exposed to hazardous materials while working for the company. In the action, the plaintiffs request compensatory and punitive damages of $5 million. The company's management believes this action is completely without merit but was advised by the company's accountants that it needs to disclose an amount in its financial statements as a contingent liability that reflects the potential loss as a result of the probable outcome of this trial. This amount was estimated to be $2 million by the company's counsel. During the negotiation and due diligence period, Environmental Solutions' counsel reviewed and agreed with the estimate of $2 million as a good estimate of the likely potential amount of exposure due to this legal action. Environmental Solutions has accordingly relied on that estimate in formulating its offer. Advanced Technologies incurred the following costs with respect to this transaction: Expenditure Amount Incurred on Appraisal (valuation of FMV of Company's Assets) 50,000 February 2023 Due diligence: Investigation of Financial, Credit, and Legal Standing of ES 15,000 Jan - April 2023 Negotiation of transaction's structure and terms 10,000 March - May 2023 Legal costs of drafting and executing the sale contract 150,000 September 2023 Escrow & Recording Fees 25,000 October 10, 2023 Total 250,000 Environmental solutions incurred the following costs with respect to the acquisition. Expenditure Amount Incurred on Appraisal (valuation of FMV of Target's Assets) 50,000 February 2023 Due diligence: Investigatin of Financial, Credit, and Legal Standing of AT 15,000 Jan - April 2023 Negotiation of transaction's structure and terms 30,000 March - May 2023 Obtaining Approval of Shareholders 20,000 Septempber 20-30, 2023 Legal costs of drafting and executing the sale contract 180,000 September 25-29, 2023 Escrow & Recording Fees 25,000 October 9,2023 Total 320,000 Later, in 2024, the plaintiffs in the lawsuit against Advanced Technologies continued their action against Environmental Solutions, Inc. as the successor to the previous defendant. On June 25, 2024, Environmental Solutions reached an agreement with the plaintiffs to settle this lawsuit for $1,000,000. Both companies use the accrual method for tax purposes.

1. What is the overall consideration amounts in the transaction for both the buyer, Environmental Solutions Inc., and the seller, Advanced Technologies?
2. Are there any capital gains and/or ordinary income that must be recognized as a result of the transaction by Advanced Technologies?
3. What is the characterization and basis of the assets acquired by Environmental Solutions Inc.?
4. How are the costs incurred during the investigative phase of the engagement treated; capitalized, or deducted?
5. What are the tax consequences from the contingent liability for both the buyer and the seller, and how should they be taken into consideration?

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