Corporations: Organization and Capital Structure | CPA Exam Regulation

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These lectures covers section 351 transferring property to a corporation, section 357 liabilities assumed, shareholder basis, corporate tax basis and stocks issued for services.

Section 351 Transferring Property to a Corporation

Section 357 Liabilities Assumed by the Corporation

Shareholder Basis and Corporate Tax Basis

Stocks Issued for Services and Non Shareholder Contribution

Section 351 Rationale and General Rules
In contrast to the typical result of full gain or loss recognition, the Code permits nonrecognition of gain or loss in limited circumstances. For example, with both § 1031 (like-kind exchanges)1 and section 351 (transfers of property to controlled corporations), recognition of gain or loss is postponed until a substantive change in the taxpayer’s investment occurs (e.g., a sale of property or ownership shares to outsiders). When a taxpayer exchanges some of his or her property for other property of a like kind, § 1031 provides that gain (or loss) realized on the exchange is not recognized because a substantive change in the tax- payer’s investment has not occurred. The deferral of gain or loss is accomplished by calculating a substituted basis for the like-kind property received. With this substituted basis, the realized gain or loss associated with the property given up is ultimately recognized when the property received in the exchange is sold.

Property Defined
For section 351 purposes, the definition of is comprehensive. For example, along with plant and equipment, unrealized receivables of a cash basis taxpayer and installment notes are considered property.4 Although the disposition of an installment note receivable normally triggers deferred gain, its transfer under § 351 is not treated as a disposition. As a result, gain is not recognized to the transferor. Proprietary processes and formulas as well as proprietary information in the general nature of a patentable invention also qualify as property under section 351.

Stock Transferred
Nonrecognition of gain occurs only when the shareholder receives stock. Stock includes common and most preferred. However, it does not include “nonqualified preferred stock,” which possesses many of the attributes of debt. In addition, the Regulations state that the term stock does not include stock rights and stock warrants. Otherwise, the term stock generally needs no clarification.8
As a result, any corporate debt or (e.g., long-term debt such as bonds) received are treated as boot because they do not qualify as stock. Therefore, the receipt of debt in exchange for the transfer of appreciated property to a controlled corporation causes recognition of gain.

Control of the Corporation
For the transaction to qualify as nontaxable under section§ 351, the property transferors must be in of the corporation immediately after the exchange. That is, the person or persons transferring the property must have at least an 80 percent stock ownership in the corporation, resulting in the entity being a controlled corporation. More specifically, the property transferors must own stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock.

Assumption of Liabilities—section 357
Without a provision to the contrary, the transfer of mortgaged property to a controlled corporation could trigger gain to the property transferor if the corporation took over the mortgage. This would be consistent with the treatment given in like-kind exchanges under § 1031. Generally, when liabilities are assumed by another party, the party who is relieved of the debt is treated as having received cash or boot. Section 357(a) provides, however, that when the acquiring corporation assumes a liability in a § 351 transaction, the liability is not treated as boot received for gain recognition purposes. Nevertheless, liabilities assumed by the transferee corporation are treated as boot in determining the basis of the stock received by the shareholder. As a result, the basis of the stock received is reduced by the amount of the liabilities assumed by the corporation.