Question

Dawn, a sole proprietor, was engaged in a service business and reported her income on a cash basis. Later, she incorporates her business and transfers the assets of the business to the corporation in return for all the stock in the corporation plus the corporation's assumption of the liabilities of her proprietorship. All the receivables and the unpaid trade payables are transferred to the newly formed corporation. The assets of the proprietorship had a basis of 105,000 and fair market value of300,000. The trade accounts payable totaled 25,000. There was a note payable to the bank in the amount of95,000 that the corporation assumes. The note was issued for the purchase of computers and other business equipment. What is the basis of the assets to the corporation?

1) $105,000
2) $300,000
3) $325,000
4) $400,000
5) None of these choices are correct.

Answer 1

The basis of the assets to the corporation after Dawn incorporates her business and transfers assets and liabilities is $105,000, which was the basis in the hands of Dawn prior to the transfer, in compliance with IRC Section 351.

Step-by-step explanation:

The student's question relates to the determination of the asset's basis for tax purposes when a sole proprietor incorporates her business. In this scenario, Dawn incorporates her business and receives stock in the corporation along with the corporation's assumption of her business's liabilities.

The basis of the assets to the corporation would be the same as the adjusted basis in the hands of the transferor (Dawn) at the time of the transfer, which is $105,000, provided that certain tax code conditions are met, particularly under IRC Section 351.

These conditions include the transfer being solely in exchange for stock and the transferors (Dawn in this case) are in control of the corporation immediately after the exchange. This is true even though the liabilities assumed by the corporation ($95,000 note payable + $25,000 trade accounts payable) exceed Dawn's basis in the assets transferred.