Key Takeaways
- Section 351 allows tax-free incorporation if 80% control obtained.
- Transferors must control the corporation "immediately after" the exchange.
- Boot (cash or other property) triggers gain recognition.
- Gain recognized = lesser of realized gain or boot received.
- Corporation takes carryover basis (increased by any gain recognized).
- Services do not count as "property" for 80% control test.
Section 351 Transfers
Why This Matters for the Exam
Section 351 is the gateway to tax-free incorporation. The exam tests the 80% control requirement, boot treatment, and basis calculations.
Expect at least 3-4 questions on §351.
The Basic Rule
Section 351: No gain or loss is recognized when:
| Requirement | Detail |
|---|---|
| Property transferred | To a corporation |
| In exchange for | Stock of the corporation |
| Control | Transferors have 80%+ control "immediately after" |
80% Control Defined
| Control Requirement | Threshold |
|---|---|
| Voting stock | 80% or more |
| Each class of nonvoting | 80% or more |
| Immediately after | Right after the exchange |
"Property" Definition
| Qualifies as Property | Does NOT Qualify |
|---|---|
| Cash | Services |
| Tangible property | Future services |
| Intangible property | Promissory notes by transferor |
| Accounts receivable | |
| Installment obligations |
Key Point: Services do not count for the 80% control test. If someone contributes only services, their stock is ignored when calculating if property transferors have 80% control.
Boot: Triggering Gain
Boot = Non-stock consideration received (cash or other property).
| Boot Received | Effect |
|---|---|
| Cash | Gain recognized |
| Other property | Gain recognized |
| Assumption of liability | Usually not boot (see exceptions) |
Gain Recognition with Boot
| Formula | Calculation |
|---|---|
| Realized gain | FMV received - Adjusted basis given |
| Recognized gain | Lesser of realized gain OR boot received |
| Loss | Not recognized even with boot |
Boot Example
| Item | Amount |
|---|---|
| Property basis | $20,000 |
| Property FMV | $100,000 |
| Stock received (FMV) | $90,000 |
| Cash received (boot) | $10,000 |
| Realized gain | $100,000 - $20,000 = $80,000 |
| Recognized gain | Lesser of $80,000 or $10,000 = $10,000 |
Liability Assumption
| Rule | Treatment |
|---|---|
| General rule | Liability assumed is NOT boot |
| Exception | If liabilities exceed basis = gain |
| Tax avoidance | If principal purpose is tax avoidance = boot |
Shareholder's Basis in Stock
| Formula | Calculation |
|---|---|
| Basis of property transferred | $X |
| + Gain recognized | +$Y |
| - Boot received | -$Z |
| - Liabilities assumed | -$L |
| = Stock basis |
Corporation's Basis in Property
| Rule | Calculation |
|---|---|
| Carryover basis | Same as transferor's basis |
| + Gain recognized by transferor | Increase basis |
| = Corporation's basis |
Real-World Scenario
Scenario: Two individuals form a corporation. A contributes property (basis $50,000, FMV $80,000) for 70% of the stock and $5,000 cash. B contributes cash of $30,000 for 30% of the stock.
- Control test: A and B together own 100% → control requirement met.
- A's realized gain: $85,000 received - $50,000 basis = $35,000.
- A's recognized gain: Lesser of $35,000 or $5,000 = $5,000.
- A's stock basis: $50,000 - $5,000 (boot) + $5,000 (gain) = $50,000.
On the Exam
Expect 3-4 questions on §351, typically:
- Control Questions: "What percentage ownership is required?"
- Boot Questions: "How much gain is recognized?"
- Basis Questions: "What is the shareholder's basis in stock?"
- Property Questions: "Do services count as property?"
The key is to remember: 80% control. Boot triggers gain = lesser of realized gain or boot. Services ≠ property. Carryover basis to corporation.
What ownership percentage is required for §351 tax-free treatment?
Taxpayer transfers property (basis $30k, FMV $50k) for stock worth $45k and $5k cash. Recognized gain?
Do services count as "property" for the §351 control test?