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Questions and Answers
What is the primary purpose of basis reduction in the context of shareholder contributions?
Which of the following assets contributed by shareholders would typically not recognize gain or loss under a tax-free exchange?
In the case of property contributions, what is one key limitation regarding loss recognition?
What is the holding period for property received by a corporation in a Section 351 exchange?
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How is the adjusted basis of equipment determined for shareholder A in the formation of X corporation?
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What is the primary basis for a shareholder's stock when cash is contributed during corporate formation?
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What happens generally when property is contributed to a corporation in exchange for stock, without special interventions?
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Which of the following is NOT a basic requirement under Section 351 for a tax-free exchange?
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What is meant by 'carryover or exchanged basis' when Section 351 applies?
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Under what condition would a corporation recognize a gain from issuing its own shares?
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Which of the following best describes the holding period for shares issued for cash?
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What is the significance of 'control' as defined in Section 351?
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What is the corporate treatment of cash received for shares issued during formation?
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How is the holding period of stock determined in a corporate formation scenario?
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What does Section 1032 state regarding the issuance of stock by a corporation?
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What happens to the basis of property received by the corporation from the shareholder?
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What limitation does Section 351 impose regarding capital contributions involving loss property?
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In a situation where properties with built-in losses are transferred, how is the corporation's basis determined?
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How does the concept of 'tacked' holding period influence a corporation's basis?
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Which situation leads to a duplicated gain in the context of corporate formations?
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What is a consequence when a corporation receives property with a net built-in loss?
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Study Notes
Corporate Formation: Section 351
- Shareholder Holding Period: The shareholder's holding period of stock includes the period during which the transferred property was held if the property is a capital asset or a 1231 asset. Otherwise, the holding period begins on the day of the transfer.
- Corporation's Non-Recognition of Gain or Loss: A corporation does not recognize gain or loss on the issuance of its own stock.
- Carryover Basis: The corporation steps into the shoes of the shareholder for basis purposes, meaning the property received from the shareholder has the same basis inside the corporation as it had in the hands of the taxpayer.
- Carryover Holding Period: The corporation receives a "tacked" holding period, meaning it carries over the basis and holding period from the shareholder.
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Limitations to Section 351:
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Contributions of Loss Property:
- Duplicated Gain: If property with a built-in loss is transferred, the corporation's adjusted basis is limited to the fair market value of the property at the time of transfer.
- Basis Reduction Allocation: Basis reduction is allocated on a transferor-by-transferor basis if multiple loss properties are contributed.
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Transferred Property with a Net Built-in Loss:
- Net Built-in Loss: A net built-in loss occurs when the aggregate adjusted basis of the property transferred exceeds its fair market value.
- Gain Recognition: Any gain recognized on the transfer is considered when determining the net built-in loss.
- Multiple Properties: Multiple properties contributed by the same transferor are aggregated to determine if there's a net built-in loss.
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Contributions of Loss Property:
- Basis Reduction Election: The shareholder and corporation may jointly elect to reduce the shareholder's basis in the stock they receive to its fair market value, reducing the built-in loss.
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General Principle of Corporate Formation:
- Initial Operating Capital: Corporations generally receive initial operating capital through the issuance of stock or borrowing.
- Cash Received for Shares: This is treated as a cash purchase, with the shareholder's basis in the stock being the amount of cash contributed.
- Corporation's Basis in Cash: The corporation's basis in cash is the face value.
- No Gain or Loss on Stock Issuance: Corporations generally do not recognize gain or loss on the issuance of their own shares.
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Stock Issued in Exchange for Property:
- Taxable Exchange: Without Section 351, this would be a taxable exchange, with both the shareholder and corporation potentially recognizing gain or loss.
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Section 351: Tax-Free Transfers:
- Non-Recognition Provisions: Section 351 generally makes transfers of property for stock tax-free.
- Policy Reasons: This is considered a mere change in form of ownership or investment, with no real economic change.
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Section 351 Requirements:
- Property Transfer: One or more persons must transfer property to the corporation.
- Sole Exchange for Stock: The transfer must be solely in exchange for the corporation's stock.
- Control Requirement: The transferor(s), as a group, must be in control of the corporation immediately after the exchange (at least 80% of voting power and 80% of all other classes of stock).
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Section 351 Results:
- No Gain or Loss: Shareholder does not recognize gain or loss but receives a "carryover or exchanged basis" in the stock.
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