Toby Power, a fellow Illinois resident, is a new client. Prior to her telephone call this morning (late November), all you really knew about Toby was that for the past five years she has been earning a living as a respected golfing instructor at a local club. She just called you to discuss a transaction she has entered into. This is what you learned from your initial conversation with her. She and a group of friends formed a corporation for which the group will own 100% of the stock.
The corporation will be in the business of selling golf balls that it guarantees are indestructible and, because they glow in water and shade, cannot be lost. Toby transferred an office building to the corporation in return for her 20% stock ownership interest. Her eight other friends transferred primarily manufacturing equipment and cash for their evenly divided 80% interest. Toby has owned the office building for seven years and currently owes several hundred thousand dollars on two mortgages on the building. The fair market value of the building she estimates is about $1,000,000.
Toby informs you that her previous tax advisor, about whom she has nothing but negative things to say, counseled her that, in order to avoid paying taxes on the transfer of the building to the corporation, she had to also transfer a personal promissory note of $100,000 to the corporation. All of this occurred last year. She wants to know if the transaction was handled correctly or if she needs to worry.
Through further discussions and review of pertinent documents, you discover the following additional facts:
• Toby purchased the office building seven years ago for $500,000. She paid $100,000 in cash and $400,000 using a note (Note A) secured by the property.
• Two years ago, the fair market value of the property escalated to $ 1,200,000. Toby took out a second mortgage on the property in the amount of $300,000 (Note B). She used the funds to purchase a vacation home in Nevada.
• At the time of the property's transfer to the corporation, the building's fair market value was $1,000,000, determined by an assessor.
• At the time of the property's transfer, Note A had an outstanding balance of $310,000. Note B had a balance of $ 100,000.
• Toby has made no improvements on the property. She has taken approximately $100,000 in depreciation deductions on her tax return.
• The terms of the promissory note Toby gave to the corporation were that she pay the note off over a period of 20 years, paying a single annual payment in the amount of $6,000 ($5,000 principal; $1,000 interest). The first payment is to be made on the anniversary date of the note - September 1. Toby paid the first installment, which was due a few months ago.
Your supervisor said she is aware of a case named Peracchi that may provide some help. (Read any additional cases that the Peracchi case leads you to.)
a. Does the case address the research question(s)?
b. How similar to the facts in Toby's care are the facts in this case?
c. As a result of studying the case, do you believe there are additional facts you should seek?
d. What questions remain that require further research?