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Section 351(a) allows that no gain or loss “shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation” as long as those persons control the corporation immediately after the transfer. Control means 80% ownership in terms of all stock and is defined in Section 368(c). In a hypothetical example, H (a person) transfers appreciated property in a Section 351 transaction, with a FMV and adjusted basis of $100,000 and $95,000 respectively.

In exchange H receives stock with a FMV of $85,000, plus boot in the form of a short-term note worth $15,000. It is provided that this is a Section 351 transaction so the control requirement is assumed met, and the gains or losses will be deferred but for exceptions to non-recognition of gains under Section 351(b). The issue here is to calculate and clarify what is H’s basis in the stock, given he has received other property in a Section 351 transfer.

If property or “money” other than stock is received in the exchange, then the recipient shall recognize a gain per Section 351(b)(1) equal to the amount of money received plus the FMV of other property received. Section 351(b) states that the transferor’s gain is limited to the gain on transferred property or the FMV of boot received.

In this example, H received stock with a FMV of $85,000, along with a short-term note, considered to be money worth $15,000. The old basis given up is $95,000. With non-recognition property under Section 358(a) the basis would be the old basis, minus the FMV of other property or money received, plus any recognized dividend or gain. Here, H’s adjusted basis transferred is $95,000, his boot received is $15,000, and his gain recognized is limited to the $5,000 difference between FMV and Adjusted basis of property transferred.

Thus, his basis is $95,000 minus $15,000 plus $5000, or $85,000. In conclusion, H’s basis in stock received is $85,000 because his recognized gain is limited to the lesser of the $5,000 gain on property he transferred in the exchange, rather than the $15,000 FMV of boot he received.

Worldview Consulting & Accounting, Inc. is an Oregon registered CPA accounting firm. William Burwell, CPA, CFF, MBA, CPIM, is a business consultant and financial forensic accounting services professional with over twenty years of high technology industry experience. Licensed in Oregon and Massachusetts.

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