Zhang incorporated her sole proprietorship by transferring inventory, a building, and land to the corporation in return for 100 percent of the corporation's stock. The property transferred to the corporation had the following fair market values and adjusted tax bases: FMV Adjusted Tax Basis Inventory $ 64,000 $ 32,000 Building 480,000 320,000 Land 736,000 960,000 Total $ 1,280,000 $ 1,312,000 The corporation also assumed a mortgage of $100,000 attached to the building and land. The fair market value of the corporation's stock received in the exchange was $1,180,000.
When a sole proprietor incorporates their business by transferring assets to a corporation in exchange for stock, the tax implications of the transfer are governed by Section 351 of the Internal Revenue Code (IRC). Under IRC Section 351, if a person transfers property to a corporation in exchange for stock in such corporation and immediately after the exchange is in control of the corporation (meaning they own at least 80% of the stock), the exchange is generally tax-free. This means no gain or loss is recognized on the transfer. In Zhang's case, she transferred inventory, a building, and land to the corporation and received 100% of the corporation's stock, which means she meets the control requirement after the exchange. The corporation's assumption of the mortgage is treated as if Zhang received cash for the transfer. Since the mortgage is $100,000, Zhang is considered to have received $100,000 in addition to the stock. However, since the total adjusted tax bases of the transferred assets ($1,312,000) is more than the fair market value of the assets ($1,280,000), there is no gain to be recognized even with the mortgage assumption because the liabilities assumed do not exceed the basis of the assets transferred. Here's a breakdown of the tax implications: - Inventory: No gain or loss is recognized on the transfer. The corporation's basis in the inventory would be the same as Zhang's adjusted basis ($32,000). - Building: No gain or loss is recognized. The
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