A Section 351 exchange lets a taxpayer transfer property to a corporation in return for stock, without recognizing gain or loss, as long as the transferors have control immediately after the exchange. Control means owning at least 80% of voting power and 80% of each class of nonvoting stock.
What qualifies as property
Property includes money, tangible assets, and intangible assets. Services do not count as property. Stock issued for services is taxable compensation, not part of the Section 351 control test.
When gain is recognized
Even if Section 351 applies, gain is recognized when the transferor receives:
- Money or other property (“boot”)
- Liabilities assumed by the corporation in excess of basis, unless the liability would produce a deduction when paid (e.g., accounts payable)
Loss is never recognized in a Section 351 exchange.
Basis rules for shareholders
Shareholder stock basis starts with the basis of property transferred, then:
- Increase: gain recognized, amounts treated as dividends
- Decrease: cash received, FMV of other property received, liabilities assumed (unless deductible when paid)
Any non‑stock property received has a basis equal to its FMV.
Basis rules for the corporation
The corporation takes the transferor’s basis, increased by any gain the transferor recognized. If the property has a built‑in loss, special rules may limit the corporation’s basis to FMV.
Services and control
If a person receives stock for services, those shares do not count toward the 80% control test. This can cause the entire exchange to fail Section 351, making all transfers taxable.
Investment company exception
Section 351 does not apply if property is transferred to an investment company as defined under §351(e).
Summary
A Section 351 exchange is a powerful nonrecognition rule, but it requires:
- Transfer of property, not services
- 80% control immediately after the exchange
- Careful tracking of boot, liabilities, and basis adjustments
These rules ensure that forming or funding a corporation is tax‑neutral when ownership continuity exists.