Reference no: EM132672615
Problem - Ted purchased equipment and used materials to develop a patent. The development costs were deducted on prior returns. The bases and fair market values of the assets are presented below.
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Assets
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Fair Market Value
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Basis
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Equipment
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$350,000
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Cost
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$350,000
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Less: Depreciation
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(250,000)
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Patent
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250,000
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-0-
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$600,000
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$100,000
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Sarah has made an offer to purchase the assets. Under one plan, she would pay $200,000 now and $400,000 plus interest at 5% (the Federal rate) in one year. Alternatively, Ted would incorporate the assets and then sell the stock to Sarah. Incorporating the assets would not be a taxable event to Ted, and his basis in the stock would equal his basis in the assets of $100,000. The corporation's basis in the assets would also be $100,000, the same as Ted's basis for the stock. Because the corporation would have a basis in the assets of less than the fair market value (and therefore, there would be less depreciation and amortization than with an asset sale by Ted), Sarah would pay $200,000 in the current year but only $350,000, plus interest at 5%, in one year. Assume that Ted's combined Federal and state marginal tax rate is 35% and his combined capital gain tax rate is 20%.
Required -
a. What is Ted's gain in the year of sale from the installment sale of his assets?
b. Assuming that Ted's time value of money is 5%, would he prefer the sale of the assets or the sale of the stock? Why?
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