Section 351 Notes

economics exam answers

Section 351 transferors covered

Non-recognition section

Allows transferors to not recognize gain or loss realized





Section 357


Transferee assumes liabilities of transferor

Example: mortgage


None of the liabilities will be treated as “boot”

If transferee assumes transfer of transferor, it does not become boot

At time of transfer

FMV of building is 100,000

Adjusted basis (cost + improvements – depreciation) $40,000

Owns bank 30,000 on mortgage

Gets stock in return of a 60,000 gain

Section 351

If transferor gives stock only in exchange, its not recognizable gain

The 60,000 gain based in stock is reduced by basis. So when the stock is sold its 20,000


357 A will not apply

The assumption of the transferor’s liabilities will be taxed as boot if

Liabilities assumed do not constitute a business purpose

Liabilities in excess of basis

If liabilities assumed exceed the adjusted basis of the assets transferred

The excess is taxed as boot


Liabilities exceed basis by 20,000 – meaning that much must be taxed

10,000 adjusted basis on property

30,000 mortgage

Gets stock worth 70,000

20,000 realized gain

10,000 + 20,000 gain – recognized gain = 0


The amt of any deductible liabilities will not be considered liabilities in the excess liabilities calculation


Deductible liability is any liability that if paid would create a tax deduction






Lobbyist files schedule C

Cash basis

Incorporates lobbying business due to worry of liabilities

Accounts Receivable 60,000

Office Equipment 40,000

-Adjusted Basis 28,000

Total adjusted basis of assets being totaled in is 28,000

-cash basis, so he has not reported 60,000

FMV of everything is 100,000

Debts: Accounts payable: 55,000

25,000 note payable to bank

Total is 80,000


Lobbyist is transferor. Corporation is transferee

Lobbyist gets stock


351 – no gain or loss recognized

357 – debts assumed shall not be treated as boot

–          80,000 worth of liabilities gained

  • Exception: if any not business related its bad
    • All business
  • If any liabilities exceed basis, difference is taxed
    • 80,000 – 28,000 = 52,000
      • take out any good liabilities that can be deducted
        • 55,000 can be deducted
        • 25,000 cannot
        • 25k is < 28k basis
          • No boot
  • Jack’s Realized Gain: 72,000
    • 100,000 amount realized – 28,000 basis = 72,000
      • None is recognized as liabilities are not exceeding
  • Adjusted basis of jack’s stock
    • 28,000 beginning basis in asset transferred + 0 reg gain – 25,000 nondeduction =
      • 3,000
  • Corporation’s Basis in receivables
    • 28,000 gain – 25,000 bad liabilities = 3,000



351 gain or loss must be recognized by the transferor if the corporation is an investment company


Transfer to an Investment company if 2 conditions are met

1: transfer results in diversification of the transferor interests

2:  More than 80% of the corporation’s asset’s value is held for investment


Stock and securities are held for investment unless they are held for sale to customers or used in the business of banking, insurance, brokerage, or similar business.


Diversification occurs where 2+ persons transfer non-identical stock/securities to a corporation in exchange for stock


10,000 worth of stock transferred to corporation and received 50% of corporation

50+ transferors transfer securities and stock worth 200 dollars to corporation to get other 50% interest in corporation

n  Diversification


Person A, B and C


A transfers 10,000 marketable securities x to corp  à gets 50 shares of stock 49.5%

B transfers 10,000 marketable securities x to corp à gets 50 shares of stock 49.5%

C transfers 200 marketable securities y to corp à one share  1%


No diversification because an insignificant portion are non-identical

-rule is therefore disregarded



section 385 explains the difference in stock and debt

secretary is authorized to prescribe regulations to determine whether an interest in a corporation is to be treated as stock or a debt

  1. Is there a written unconditional promise to pay on demand/ on a date a sum and interest
  2. Subordination over the debt of the corporation
  3. Debt equity ratio
    1. Higher than 3-1
    2. Whether note is convertible
    3. Relationship of shareholder debt to shareholder ownership percentages

    -These are general notes and not meant for use for any decision making


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