Tim is a real estate

Tim is a real estate broker who specializes in commercial real estate.

Although he usually buys and sells on behalf of others, he also maintains a portfolio of

property of his own. He holds this property, mainly unimproved land, either as an

investment or for sale to others.

In early 2011, Irene and Al contact Tim regarding a tract of land located just outside

the city limits. Tim bought the property, which is known as the Moore farm, several years

ago for $600,000. At that time, no one knew that it was located on a geological fault line.

Irene, a well-known architect, and Al, a building contractor, want Tim to join them in

developing the property for residential use. They are aware of the fault line but believe

that they can circumvent the problem by using newly developed design and construction

technology. Because of the geological flaw, however, they regard the Moore farm as being

worth only $450,000. Their intent is to organize a corporation to build the housing project,

and each party will receive stock commensurate to the property or services contributed.

After consulting his tax adviser, Tim agrees to join the venture if certain modifications

to the proposed arrangement are made. The transfer of the land would be structured as

a sale to the corporation. Instead of receiving stock, Tim would receive a note from the

corporation. The note would be interest-bearing and due in five years. The maturity value

of the note would be $450,000—the amount that even Tim concedes is the fair market

value of the Moore farm.

What income tax consequences ensue from Tim’s suggested approach? Compare this

result with what would happen if Tim merely transferred the Moore farm in return for

stock in the new corporation.