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:
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?

Asjusted Basis Fair Market Value Assets: 50,000 50,000 Cash 40,000 40,000 Accounts Recievable 60,000 30,000 inventory 10,000 200,000 Fixed assets 130,000 350,000 Liabilities: 25,000 Trade accounts payable 25,000 175,000 175,000 Notes payable 150,000 Owner's equity -70,000 130,000 350,000 H