Business Entities · Forming a corporation

Transfer and/or receipt of money or property in addition to corporate stock

Boot is what turns a clean IRC § 351 exchange into an arithmetic problem. Nothing about it disqualifies the transaction — the exchange still qualifies, control is still tested the same way — but the transferor recognises gain, and three separate figures then move: the gain recognised, the basis of the stock, and the basis the corporation takes in the property. Getting one of them right does not get the others right, and the errors compound because each feeds the next.

The rule

Gain, capped. where the exchange would qualify but for the receipt of money or other property in addition to stock, gain is recognised but not in excess of the money received plus the fair market value of the other property received, and no loss is recognised (IRC § 351(b))^TY2026

The transferor’s basis. the basis of the stock received is the same as the basis of the property exchanged, decreased by the fair market value of any other property received, by any money received and by any loss recognised, and increased by any amount treated as a dividend and by any gain recognised on the exchange (IRC § 358(a)(1))^TY2026

The corporation’s basis. where property is acquired by a corporation in a transaction to which IRC § 351 applies, or as paid-in surplus or a contribution to capital, its basis is the same as it would be in the hands of the transferor, increased by the gain recognised to the transferor on the transfer (IRC § 362(a))^TY2026

The shareholder’s holding period. in determining the period for which a taxpayer has held property received in an exchange, the period for which the property exchanged was held is included where the property received takes the same basis in whole or in part as the property exchanged, and the property exchanged was at the time of the exchange a capital asset or IRC § 1231 property (IRC § 1223(1))^TY2026

And the corporation’s. in determining the period for which the taxpayer has held property however acquired, there is included the period for which that property was held by any other person if, for the purpose of determining gain or loss from a sale or exchange, it has the same basis in whole or in part in the taxpayer hands as it would have in the hands of that other person — which is how a corporation inherits the transferor holding period in property received under IRC § 351 (IRC § 1223(2))^TY2026

Nothing to the corporation on its own stock. A corporation recognises no gain or loss on the receipt of money or other property in exchange for its own stock, including treasury stock (IRC § 1032(a)).

Current figures

How it works in practice

Work the three figures in a fixed order and the arithmetic falls out.

Gain recognised is the lesser of realised gain and boot received. Realised gain is the total value received — stock plus money plus other property — less the basis of what was given up. Boot is the money plus the fair market value of the other property. Whichever is smaller is what is recognised. Where realised gain is the smaller, some boot escapes tax; where boot is the smaller, some gain is deferred.

No loss, ever. IRC § 351(b)(2) is absolute: a transferor with a realised loss recognises nothing, and receiving boot does not change that. This is the trap that catches people who reason by analogy from IRC § 1031, where the same asymmetry exists but is less often the point. Property with a built-in loss should generally be sold rather than contributed — the loss is otherwise locked into two bases and, since 2004, capped in the corporation’s hands by IRC § 362(e)(2).

Stock basis runs from the property given up: old basis, minus the money and the fair market value of other property received, minus any loss recognised, plus any gain recognised and any amount treated as a dividend. The mnemonic that makes it stick is that basis follows the tax — anything the transferor was taxed on adds to basis, anything they took out reduces it.

Corporate basis is the transferor’s old basis plus the gain the transferor recognised. Note that it is not increased by the boot the corporation paid out. That asymmetry is deliberate: the corporation has given up cash, and the property’s basis reflects what was preserved rather than what was spent.

The result of the two basis rules together is that the deferred gain survives in two places. Whatever the transferor realised and did not recognise remains — once in the stock basis being lower than the stock’s value, and once in the property’s basis being lower than its value. That duplication is the price of nonrecognition and it is the same design as in subchapter K.

Multiple assets. Where a transferor contributes more than one asset and receives boot, the analysis is done asset by asset. Boot is allocated among the assets in proportion to their relative fair market values, and gain is computed separately on each. That matters because an asset with a built-in loss cannot absorb boot allocated to it — the loss is not recognised and the boot allocated to that asset produces nothing — while an asset with a built-in gain recognises up to its share. A transferor contributing one appreciated and one depreciated asset therefore recognises more gain than a net computation would suggest.

Holding period. The stock takes the holding period of the property given up, provided that property was a capital asset or IRC § 1231 property in the transferor’s hands (IRC § 1223(1)). Contributing inventory or a receivable therefore starts a fresh holding period in the stock, because the tacking rule requires the exchanged property to have been of the right character. On the other side, the corporation tacks the transferor’s holding period in the property under IRC § 1223(2), because it takes a basis determined by reference to the transferor’s.

Scenarios

How this has changed

The boot rules in IRC § 351(b) and the basis rules in IRC §§ 358 and 362(a) have been stable for decades and have not been amended in a way that affects this topic.

What has changed around them is IRC § 362(e)(2), enacted in 2004, which caps the corporation’s aggregate basis at fair market value where the transferred property carries a net built-in loss. Before it, the combination of IRC §§ 358 and 362(a) preserved a built-in loss in two places with no limit, so the same economic loss could be recognised twice — by the corporation on selling the property and by the shareholder on selling the stock. The cap closed the corporate side, with an election to reduce the shareholder’s stock basis instead.

The practical consequence for this topic is that the symmetry between the two basis rules, which used to be exact, now holds only for property with a net built-in gain. For property with a net built-in loss the two sides no longer mirror each other, and material describing IRC §§ 358 and 362 as a matched pair without qualification is describing the position before 2005.

Exam focus

Almost every question here is the same computation with different numbers, and the marks are in doing it in order: realised gain, boot, gain recognised as the lesser of the two, then stock basis, then corporate basis. Write the three figures out rather than trying to reach the answer directly.

Distractors are predictable. The full boot offered as the gain, where realised gain is smaller. The realised gain offered, where boot is smaller. And the corporation’s basis offered as the transferor’s basis plus the boot rather than plus the gain.

Where a question describes a realised loss, the answer is nil recognised — check whether any option offers a loss, because that option is always wrong.

Check yourself

1. A transferor gives property worth $600,000 with a basis of $200,000 and receives stock worth $500,000 and $100,000 of cash. What gain is recognised?

Answer: $100,000. Realised gain is $400,000 and boot is $100,000; IRC § 351(b)(1) recognises gain but not in excess of the money received plus the fair market value of other property received, so the lesser figure governs.

2. On the same facts, what is the transferor’s basis in the stock and the corporation’s basis in the property?

Answer: $200,000 and $300,000. Under IRC § 358(a)(1) stock basis is the $200,000 old basis, decreased by the $100,000 of money received and increased by the $100,000 of gain recognised. Under IRC § 362(a) the corporation takes the $200,000 transferred basis increased by the $100,000 of gain recognised to the transferor.

3. A transferor gives property worth $250,000 with a basis of $230,000 and receives stock worth $180,000 and $70,000 of cash. What gain is recognised?

Answer: $20,000. Realised gain is $20,000 and boot is $70,000, and IRC § 351(b)(1) caps recognition at the lesser. $50,000 of the cash is received without tax because no further gain exists to recognise.

4. A transferor gives property worth $300,000 with a basis of $410,000 and receives stock worth $260,000 and $40,000 of cash. What is recognised?

Answer: nothing. IRC § 351(b)(2) provides that no loss is recognised to the recipient, and receiving boot does not change that. The $110,000 loss is preserved in the stock basis, which is $410,000 less the $40,000 of money received, so $370,000 — against stock worth $260,000.

5. A transferor contributes shares held for six years and receives stock in the corporation. What is the holding period of the stock received?

Answer: it includes the six years. IRC § 1223(1) includes the period for which the property exchanged was held where the property received takes the same basis in whole or in part, provided the property exchanged was a capital asset or IRC § 1231 property at the time of the exchange. Shares held as an investment qualify; inventory would not, and the stock’s holding period would then begin afresh.