4-11
If Section 351 Does Not Apply?
Tax Impacts:
C Corp
• Linda recognizes 100k income
• Linda stock basis equals 200k
Equipment
- Basis 100k
- FMV 200k
Stock
• Linda has new holding period in stock
• Corp’s basis in equipment 200k
• Corp has new holding period in equipment
Shareholder
Linda
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
• Corp has no income recognition per 1032
4-12
Rule 1: The 351 Rule
No gain or loss is recognized by the transferor on the transfer of
property to a corporation in exchange for stock of the corporation if:
1. Property is transferred
2. Solely in exchange for stock
3. Transferor(s) in “control” “immediately after exchange.
Two 80% requirements – 80% of all voting stock and 80% of total
shares of all classes of stock.
Example: XYZ Inc issues 100 share of its stock to its sole
shareholder Jim for equipment worth 200k that has a basis of 100k.
Jim recognizes no gain or loss on the exchange.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-13
If Section 351 Does Apply?
Tax Impacts:
C Corp
• Linda recognizes no income (Rule 1)
• Linda stock basis equals 100k (Rule 3)
Equipment
- Basis 100k
- FMV 200k
Stock
Shareholder
Linda
• Linda has tacked holding period in stock
(Rule 4)
• Corp’s basis in equipment 100k (Rule 6)
• Corp has tacked holding period in equipment
(Rule 7)
• Corp has no income recognition per 1032
(Rule 5)
Note: Double basis impact trade-off for shareholder
non-recognition. What is future impact?
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-14
Section 351 Eligibility Traps
Trap
Solution
Stock for services
Keep under 20% or have dual consideration
and meet 10% standard of Rev. Proc. 77-37
Multiple transfers
at different times
Document part of integrated plan
Subsequent stock sale
Prohibit; require time lapse; no prearrangement;
gifts generally not a problem
Accommodation transfers
Meet 10% threshold of Rev. Proc. 77-37
Subsequent corp property
sales
Consistent with ordinary business or insure
time lapse and no pre-arrangement
Nonvoting stock
80% of each class. Only direct ownership counts
Nonqualified preferred
Boot for income recognition purposes
Investment company risk?
Diversification issue is ballgame
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Rule 2: The 351(b) Boot Rule
4-15
If 351 would apply except that corporation issues property in
addition to stock (“boot”) to the shareholder, then shareholder
recognizes gain on the property transferred to corporation equal to
the lesser of:
1. The built-in gain on the property transferred – the excess of
FMV over basis
2. The FMV of boot received by the shareholder.
Example: XYZ Inc issues 100 share of its stock and 80k cash to its
sole shareholder Jim for equipment worth 200k that has a basis of
100k. Jim recognizes gain equal to boot – 80k. If 120k boot was
paid by XYZ Inc in addition to stock, Jim would recognize gain
equal to 100k – excess of 200k FMV over 100k basis.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-16
Section 351 With Boot
Tax Impacts:
C Corp
• Linda recognizes 80k income (Rule 2)
• Linda stock basis equals 100k (Rule 3)
Equipment
- Basis 100k
- FMV 200k
Stock
and 80k
cash
Shareholder
Linda
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
• Linda has tacked holding period in stock
(Rule 4)
• Corp’s basis in equipment 180k (Rule 6)
• Corp has tacked holding period in equipment
(Rule 7)
• Corp has no income recognition per 1032
(Rule 5)
Rule 3: The 358 Basis Rule
4-17
If 351 applies to an exchange of property for stock in a corporation, the
basis of the stock received by the shareholder equals:
1. The basis of the property transferred to the corporation in the
hands of the shareholder, plus
2. Any gain recognized the shareholder ala the 351(b) rule, less
3. The FMV of any boot received.
Example: XYZ Inc issues 100 share of its stock and 80k cash to its sole
shareholder Jim for equipment worth 200k that has a basis of 100k. Jim
recognizes gain equal to boot – 80k. Jim’s basis in stock is equal to 100k
(basis in equipment), plus 80k gain less 80k boot = 100k.
If 120k boot was paid by XYZ Inc in addition to stock, Jim would
recognize gain equal to 100k. Basis in stock would equal 100k, plus
100k gain, less 120k boot = 80k basis.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-18
Rule 4: The Shareholder Tacking Rule
If 351 applies to an exchange of property for stock in a
corporation, the holding period of the property transferred
by the shareholder is “tacked on” to the holding period of
the stock if the transferred property was a capital asset or a
1231 asset (asset used in trade or business). No inventories
or receivables.:
Example: XYZ Inc issues 100 share of its stock and 80k
cash to its sole shareholder Jim for equipment worth 200k
that has a basis of 100k. Jim’s holding period of equipment
is “tacked on” in determining holding period of stock.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-19
Rule 5: The 1032 Rule
Corporation recognizes no gain or loss on receipt of
money or property in exchange for its own stock
Example: XYZ Inc issues 100 share of its stock and 80k
cash to its sole shareholder Jim for equipment worth
200k that has a basis of 100k. XYZ Inc recognizes no
gain or loss.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-20
Rule 6: The 362 Rule
A corporation’s basis in property acquired in exchange for
its stock in a transaction that qualifies under 351 equals
the shareholder’s basis in the property’s basis plus any
gain recognized by the shareholder. But if net built-in loss,
basis limited to FMV of property unless all elect to reduce
stock basis of shareholder to FMV.
Example: XYZ Inc issues 100 share of its stock and 80k
cash to its sole shareholder Jim for equipment worth 200k
that has a basis of 100k. Jim recognizes gain equal to boot
– 80k. XYZ Inc.’s basis in equipment is 100k (Jim’s basis
in equipment), plus 80k gain recognized by Jim = 180K.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-21
Rule 7: The Corp Tacking Rule
If 351 applies to an exchange of property for stock in a
corporation, the holding period of the property
transferred by the shareholder is “tacked on” in
determining the holding period of the property in the
hands of the corporation.
Example: XYZ Inc issues 100 share of its stock and 80k
cash to its sole shareholder Jim for equipment worth
200k that has a basis of 100k. Jim’s holding period of
equipment is “tacked on” in determining XYZ Inc.’s
holding period of equipment.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-22
Rule 8: The Assumed Liability Rule
General Rule: If corporation assumes liability of shareholder
in 351 exchange:
1. Assumption not considered “boot” for gain or loss
purposes. 357(a)
2. Assumption does reduce shareholder stock basis by
debt amount. 358(d)
Exception: Debt treated as “boot” for gain purposes if:
1. Tax avoidance purpose or not bona fide business
purpose. Burden on taxpayer to prove by clear
preponderance of evidence.
2. Debt exceeds basis of all property transferred to corp –
then excess treated as taxable boot.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-23
Section 351 With Assume Debt
Tax Impacts:
C Corp
• Linda recognizes 20k income (Rule 8)
• Linda stock basis equals 0 (Rule 3)
Equipment
- Basis 100k
- FMV 300k
Stock
and 120k
debt
assumed
Shareholder
Linda
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
• Linda has tacked holding period in stock
(Rule 4)
• Corp’s basis in equipment 120k (Rule 6)
• Corp has tacked holding period in equipment
(Rule 7)
• Corp has no income recognition per 1032
(Rule 5)
4-24
Section 351 Assumed Debt Traps
Trap
Solution
Tax avoidance purpose
Bad purpose taints all debt. Proof burden on
taxpayer. Recent debts suspect.
Lingering shareholder
Liability
Leave no doubt as to parties’ expectations.
Nonrecourse debts
Specify amount to be paid from outside assets.
Amount should never exceed FMV.
Future accountable debts
Not debt for 351 purposes. Identity and exclude.
Both deductibles (cash basis APs) and capital
expenditures excluded. Rev. Rule 95-74
Basis pumping
Helps to avoid debt in excess of basis problem.
Will personal notes do job? The Peracchi impact.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-30
Partnership Rules Comparison
Corporate
Partnership
Rule 1: The 351 Rule
721: No gain or loss to partner and
control requirement. But built-in
gain allocated back to partner on
sale per 704(c)
Rule 2: The 351(b) Boot Rule
Allocate portion of contributed
property basis to Boot and treat
Boot portion of transaction as
sale or exchange. Reg. 1.707-3(f)
Example 1.
Rule 3: The 358 Basis Rule
722: Carryover basis plus any
investment company gain
recognized under 721(b).
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
4-31
Partnership Rules Comparison
Corporate
Partnership
Rule 4: Shareholder Tacking Rule
Same per 1223 (1)
Rule 5: The 1032 Rule
Same per 721 if for property
Rule 6: The 362 Rule
Same per 723, but no built-inloss rule
Rule 7: The Corp Tacking Rule
Same per 1223(2)
Rule 8: The Assumed Liability Rule
New Game
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Partnership Liability Game
4-32
1. 752 Upside Twist: Increase in partner’s share of partnership’s liabilities
deemed contribution of money to partnership. Basis increase.
2. 752 Downside Twist: Decrease in partner’s share of partnership’s
liabilities deemed money distribution. If money distribution exceeds
basis before distribution, then gain recognized to extent of excess per
731. No negative basis.
3. Recourse liability allocation: Allocated to partners according to how
partners agree to bear ultimate risk for liability.
4. Non-recourse liability: Allocated to partners according to profits
interests with some flexibility. But if property contributed with NR
debt in excess of basis, debt first allocated to contributing partner to
amount of gain allocated to such partner under 704(c) if property
sold for debt.
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com
Partnership Capital Interest For Services
4-33
Capital Interest: An interest that gives service partner a share of the partnership’s
existing capital and future profits. A profits interest only gives share of future
profits. Test: If partnership liquidated now, would service partner get
anything?
Triple Impact: Capital interest for services
1. Partner has section 61 compensation income equal to FMV of interest,
subject to section 83 game.
2. Partnership gets section 162 deduction in same amount, allocated to
existing partners (not new partner)
3. Existing partners may share gain equal to FMV of interest transferred
over allocable basis of each partner. Deemed sale from existing to new.
Proposed Regs would eliminate deemed sale
Copyright 2005 Dwight Drake. All Rights Reserved.
Business Planning: Closely Held Enterprises
www. drake-business-planning.com