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CHAPTER 18 CORPORATIONS: ORGANIZATION AND CAPITAL STRUCTURE LECTURE NOTES ORGANIZATION OF AND TRANSFERS TO CONTROLLED CORPORATIONS In General 1. Under § 351, neither gain nor loss is recognized on the transfer by one or more persons of property to a corporation solely in exchange for stock in that corporation if, immediately after the exchange, such person or persons are in control of the corporation to which the property was transferred. a. The justification for this nonrecognition provision is similar to the justification supporting other tax-deferral sections (e.g., § 1031 like-kind exchange). (1) There has been a lack of substantive change in the taxpayer’s investment. (2) The property transferor lacks the wherewithal to pay a tax on gain realized. (3) The notion that tax rules should not impede the exercise of sound business judgment. b. Receiving cash or property (other than corporate stock) from the corporation, causes gain recognition to the extent of the lesser of the gain realized or “boot” received. (1) Boot is equal to fair market value of other property and money received. (2) Type of gain recognized (capital, ordinary) is based on assets transferred, not boot received. 18-1
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18-2 2009 Comprehensive Volume/Instructor’s Guide with Lecture Notes (3) Long-term debt securities (bonds) received in a § 351 transaction are boot and may trigger gain recognition. c. Loss is never recognized by a property transferor in a § 351 transaction. 2. Nonrecognition is accompanied by a substituted basis. Section 358 provides that the basis of stock received in a § 351 transfer is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange and decreased by boot received. 3. Section 351 is mandatory if all of the requirements of the provision are met. Property Defined 4. Definition of “property” is comprehensive. a. Property includes items such as cash, unrealized receivables, installment obligations, and secret processes and formulas. b. Definition of property under § 351 specifically excludes services rendered. Therefore, the value of any stock the shareholder receives in exchange for services rendered must be reported as income (i.e., compensation for services rendered). Stock Transferred 5. “Stock” under § 351 includes common and most preferred stock. It does not include the following items. a. Nonqualified preferred stock. This preferred stock possesses many attributes of debt. Note that loss may be recognized when the transferor receives only nonqualified preferred stock. See § 351(g). b. Stock rights and warrants. See Reg. § 1.351-1(a)(1)(ii). c. Securities (long-term debt, i.e., bonds). ADDITIONAL LECTURE RESOURCE Nonqualified Preferred Stock and Tracking Stock are not categorized as “stock” for § 351.
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