Sec. 351. Transfer to corporation controlled by transferor
 
(a) General rule
 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 and immediately after the exchange such person
 or persons are in control (as defined in section 368(c)) of the
 corporation.
 
Sections 351(a), 358(a)(1) Ex.1, 362(a), 1223(1) & (2)
 
 

 

 

Assumptions: Together, A, B and C own 100% of Newco. more than the 80% required for purposes of satisfying the 368(c) definition of control.

 

Treatment: No gain or loss is recognized by A, B or C. 351(a). A, B and C have bases in their stock of 30, 90 and 20, respectively, equal to the bases of assets transferred by each. 358(a)(1). Newco has carryover bases of 30, 90 and 20, respectively, in the land, cash and equipment. 362(a).

 

The holding periods of the stock and Newco's assets includes the holding periods of the assets transferred by A, B and C.

 
 (b) Receipt of property
 If subsection (a) would apply to an exchange but for the fact
 that there is received, in addition to the stock permitted to be
 received under subsection (a), other property or money, then -
 (1) gain (if any) to such recipient shall be recognized, but
 not in excess of -
 (A) the amount of money received, plus
 (B) the fair market value of such other property received;
 and
 (2) no loss to such recipient shall be recognized.
 

Sections 351(b), 358(a)(1) Ex. 2, (a)(2) Ex. 1

 
 

Treatment: 351(a) would apply to both A and B but for the receipt of boot. So, gain is recognized, but only to the extent of the FMV of boot received. A has recognized gain of 40, the lesser of A's realized gain of 60 and the 40 FMV of boot received by A. B has recognized gain of 35, the lesser of B's realized gain of 35 and the 50 FMV of boot received by B (30 cash plus 20 FMV of IBM stock). A and B have bases in their stock of 30 and 70, respectively. 358(a)(1). For A: 30 basis in land transferred plus 40 gain recognized less 40 FMV of boot received. For B: 85 basis in land transferred plus 35 gain recognized less 50 FMV of boot received. B has a basis of 20 (i.e., FMV) in the IBM stock. 358(a)(2).

 
 
 
 
 

Sections 351(b)(2), 358(a)(1) Ex. 3, (a)(2) Ex. 2

 

 

Treatment: 351(a) would apply to both A and B but for the receipt of boot. So, A will recognize gain, the lesser of A's realized gain of 60 and the 40 FMV of boot received by A. 351(b)(1). A will have a basis of 30 in the stock: land AB of 30 plus 40 gain recognized less 40 boot received. B will not recognize any of B's realized loss of 65 ((70 + 30 + 20) - 185) due to 351(b)(2). B's basis in the X stock will be 135, land AB of 185 less the 30 cash received and 20 FMV of IBM stock received. 358(a)(1). B has no basis adjustment for gain or loss recognized - there was none. B's basis in the IBM stock will be its FMV of 20. 358(a)(2).

 

 
 
 
 (c) Special rules where distribution to shareholders
 (1) In general
 In determining control for purposes of this section, the fact
 that any corporate transferor distributes part or all of the
 stock in the corporation which it receives in the exchange to its
 shareholders shall not be taken into account.
 

Section 351(c)(1)

 

Treatment: The transfer of property by X and C to Newco qualify under 351(a). Control is achieved because while X technically retains no Newco stock, X's distribution of this stock to its shareholders is not taken into consideration for purposes of determining control. 351(c)(1). Accordingly, X and Y have 100% control of Newco.

 

 (2) Special rule for section 355
 If the requirements of section 355 (or so much of section 356
 as relates to section 355) are met with respect to a distribution
 described in paragraph (1), then, solely for purposes of
 determining the tax treatment of the transfers of property to the
 controlled corporation by the distributing corporation, the fact
 that the shareholders of the distributing corporation dispose of
 part or all of the distributed stock, or the fact that the
 corporation whose stock was distributed issues additional stock,
 shall not be taken into account in determining control for
 purposes of this section.
 

Section 351(c)(2) Ex. 1

 
 

 

Treatment: If the transaction qualifies as a tax-free division under 355, the fact that A and B dispose of their Newco stock (in a tax-free B reorganization) will not defeat a determination that P, a transferor of property, controls Newco, a transferee of property, for purposes of 351(a).

OPEN

 
 
 

Section 351(c)(2) Ex. 2

 
 

Treatment: If the transaction qualifies as a tax-free division under 355, Newco's issuance of additional stock (100 shares) to the public is ignored for purposes of determining whether P controls Newco, satisfying 351(a). P's distribution of Newco stock to A and B is likewise ignored. 351(c)(1). Accordingly, P does control Newco for purposes of 351(a).

 

 
 
 (d) Services, certain indebtedness, and accrued interest not
 treated as property
 For purposes of this section, stock issued for -
 (1) services,
 (2) indebtedness of the transferee corporation which is not
 evidenced by a security, or
 (3) interest on indebtedness of the transferee corporation
 which accrued on or after the beginning of the transferor's
 holding period for the debt,
 shall not be considered as issued in return for property.
 

Section 351(d)

 
 

Assumptions: Of the accrued interest on the long-term note held by C, 12 accrued after C acquired the note and 8 before. The note's FMV of 100 includes this 20 of accrued interest.

 

Treatment: The services transferred by A, the accounts receivable owed by X to B, and 12 of the accrued interest on the X note held by C are not considered property for purposes of 351. 351(d)(1), (2), and (3), respectively. Accordingly, while A, B and C are all considered transferors of property by virtue of the remaining consideration that each transfers, and therefore V351(b) applies, receipt of stock for the services, the accounts receivable and 12 of the accrued interest is considered to be boot.

 
 
 (e) Exceptions
 This section shall not apply to -
 (1) Transfer of property to an investment company
 A transfer of property to an investment company. For purposes
 of the preceding sentence, the determination of whether a company
 is an investment company shall be made -
 (A) by taking into account all stock and securities held by
 the company, and
 (B) by treating as stock and securities -
 (i) money,
 (ii) stocks and other equity interests in a corporation,
 evidences of indebtedness, options, forward or futures
 contracts, notional principal contracts and derivatives,
 (iii) any foreign currency,
 (iv) any interest in a real estate investment trust, a
 common trust fund, a regulated investment company, a
 publicly-traded partnership (as defined in section 7704(b))
 or any other equity interest (other than in a corporation)
 which pursuant to its terms or any other arrangement is
 readily convertible into, or exchangeable for, any asset
 described in any preceding clause, this clause or clause (v)
 or (viii),
 (v) except to the extent provided in regulations prescribed
 by the Secretary, any interest in a precious metal, unless
 such metal is used or held in the active conduct of a trade
 or business after the contribution,
 

Section 351(e)(1)(B)(v)

 
 

Assumptions: Newco will operate a jewelry manufacturing business, using the contributed gold and silver in the manufacturing process.

 

Treatment: Newco will not be an investment company and, therefore, 351 will apply to A and B's transfers. For purposes of determining whether an investment company exists, cash is considered, "stock or securities". But, precious metals are not considered, "stock or securities" if those metals are used by the company after the contribution (351(e)(1)(B)(v)), as is the case here.

 

 
 
 (vi) except as otherwise provided in regulations prescribed
 by the Secretary, interests in any entity if substantially
 all of the assets of such entity consist (directly or
 indirectly) of any assets described in any preceding clause
 or clause (viii),
 

Section 351(e)(1)(B)(vi)

 
 

X is an investment company. While only 1000 of 2400 of the value of X assets is in the form of actual stock or securities, X's ownership interest in the T partnership will be treated as a stock or security because it is an entity and all of T's assets are treated as "stock or securities". 351(e)(1)(B)(vi). Accordingly, A and B's transfers are not pursuant to 351.

 

 
 
 (vii) to the extent provided in regulations prescribed by
 the Secretary, any interest in any entity not described in
 clause (vi), but only to the extent of the value of such
 interest that is attributable to assets listed in clauses (i)
 through (v) or clause (viii), or
 (viii) any other asset specified in regulations prescribed
 by the Secretary.
 The Secretary may prescribe regulations that, under appropriate
 circumstances, treat any asset described in clauses (i) through
 (v) as not so listed.
 

Section 351(e)(1)

 
 

Newco is an investment company and, therefore, 351 does not apply. 351(e)(1). Of the 500 FMV of assets held by Newco after the transfers, only 60, the land and equipment, is not considered, "stock or securities". Because 440/500 exceeds 80%, and because the shareholders have diversified their interests, Newco is an investment company.

 

 
 (2) Title 11 or similar case
 A transfer of property of a debtor pursuant to a plan while the
 debtor is under the jurisdiction of a court in a title 11 or
 similar case (within the meaning of section 368(a)(3)(A)), to the
 extent that the stock received in the exchange is used to satisfy
 the indebtedness of such debtor.
 

Section 351(e)(2)

 

Assumptions: X is in bankruptcy court and the transaction was executed pursuant to a plan under the jurisdiction of that court.

 

Treatment: X's transfer of assets to Newco in exchange for all of Newco's stock is not covered by 351. 351(e)(2). This result allows the transaction to be tested under 368(a)(1)(G) instead.

 
 
 (f) Treatment of controlled corporation
 If -
 (1) property is transferred to a corporation (hereinafter in
 this subsection referred to as the ''controlled corporation'') in
 an exchange with respect to which gain or loss is not recognized
 (in whole or in part) to the transferor under this section, and
 (2) such exchange is not in pursuance of a plan of
 reorganization,
 section 311 shall apply to any transfer in such exchange by the
 controlled corporation in the same manner as if such transfer were
 a distribution to which subpart A of part I applies.
 

Section 351(f)

 

 

Treatment: The transaction comes under 351(b). X recognizes the realized gain of 100 on the transfer of land to A in exchange for A's cash, but X does not recognize the realized loss of 50 on the transfer of equipment to B in exchange for B's cash. 351(f). X also does not recognize gain or loss on the transfer of its stock for cash from either A or B. 1032.

 

 
 
 (g) Nonqualified preferred stock not treated as stock
 (1) In general
 In the case of a person who transfers property to a corporation
 and receives nonqualified preferred stock -
 (A) subsection (a) shall not apply to such transferor, and
 (B) if (and only if) the transferor receives stock other than
 nonqualified preferred stock -
 (i) subsection (b) shall apply to such transferor; and
 (ii) such nonqualified preferred stock shall be treated as
 other property for purposes of applying subsection (b).
 

Section 351(g)(1) Ex. 1, (2)(A)(i)

 
 

Assumptions: B can require X to redeem the preferred shares in 5 years for 10.

 

Treatment: B has received nonqualified preferred stock. The preferred stock is nonqualified because B can require X to redeem it. 351(g)(2)(A)(i). Accordingly, that stock is treated as boot. B will recognize gain of 10, the lesser of B's realized gain of 15 or the boot of 10. 351(g)(1)(B). A does not recognize gain. 351(a).

 

 

 

 

Sections 351(g)(1) Ex. 2, (2)(A)(ii), (3)(B)

 

 

Assumptions: Y is required to redeem the X preferred stock in 7 years.

 

Treatment: The stock received by A is nonqualified preferred stock because a "related person" to X is required to redeem that preferred stock. 351(g)(2)(A)(ii). Y is related to X because they are members of the same controlled group. 267(b)(3, (f)(1), 351(g)(3)(B), 1563(a). Because A received only this nonqualified preferred stock from X, neither 351(a) nor (b) apply and A recognizes the entire realized gain of 30. 351(g)(1)(A).

 

 

 

Section 351(g)(1) Ex. 3

 

 

Assumptions: Newco is required to redeem A's preferred stock in 5 years.

 

Treatment: A's preferred stock is nonqualified because Newco is required to redeem that stock. 351(g)(2)(A)(ii). Because A has received just this nonqualified stock, 351(a) and (b) do not apply to A, and A is therefore required to recognize the realized gain of 15. 351(a) applies to B because the transferors of property, A and B, own 100% of Newco following the transfers. The preferred stock is treated as nonqualified for purposes of determining the application of 351(a) and (b) to the recipient of the preferred stock, but that preferred stock is otherwise treated as stock.

 

 (2) Nonqualified preferred stock
 For purposes of paragraph (1) -
 (A) In general
 The term ''nonqualified preferred stock'' means preferred
 stock if -
 (i) the holder of such stock has the right to require the
 issuer or a related person to redeem or purchase the stock,
 

Section 351(g)(1) Ex. 1, (2)(A)(i)

 
 

Assumptions: B can require X to redeem the preferred shares in 5 years for 10.

 

Treatment: B has received nonqualified preferred stock. The preferred stock is nonqualified because B can require X to redeem it. 351(g)(2)(A)(i). Accordingly, that stock is treated as boot. B will recognize gain of 10, the lesser of B's realized gain of 15 or the boot of 10. 351(g)(1)(B). A does not recognize gain. 351(a).

 

 
 (ii) the issuer or a related person is required to redeem
 or purchase such stock,
 

Sections 351(g)(1) Ex. 2, (2)(A)(ii), (3)(B)

 

 

Assumptions: Y is required to redeem the X preferred stock in 7 years.

 

Treatment: The stock received by A is nonqualified preferred stock because a "related person" to X is required to redeem that preferred stock. 351(g)(2)(A)(ii). Y is related to X because they are members of the same controlled group. 267(b)(3, (f)(1), 351(g)(3)(B), 1563(a). Because A received only this nonqualified preferred stock from X, neither 351(a) nor (b) apply and A recognizes the entire realized gain of 30. 351(g)(1)(A).

 

 (iii) the issuer or a related person has the right to
 redeem or purchase the stock and, as of the issue date, it is
 more likely than not that such right will be exercised, or
 

Section 351(g)(2)(A)(iii)

 
 

Assumptions: The Class A preferred will pay an annual dividend of 6% (which rate is reasonable for a company such as Newco). Newco can redeem the stock for 1.20/share. The Class B preferred wil pay an annual dividend of 6% for the first 5 years, 12% thereafter. After 5 years, Newco can redeem the stock at 1/share.

 

Treatment: The Class A preferred is not nonqualified because, even though Newco has the right to redeem, it is not more likely than not that it will do so. 351(g)(2)(A)(iii). The Class B preferred is nonqualified because, even though Newco has the right to redeem, it is not more likely than not that it will do so. 351(g)(2)(A)(iii). The Class B preferred is nonqualified because the doubling of the dividend rate in 5 years together with the reasonable redemption price of 1/share makes redemption more likely than not.

 

 (iv) the dividend rate on such stock varies in whole or in
 part (directly or indirectly) with reference to interest
 rates, commodity prices, or other similar indices.
 

Section 351(g)(2)(A)(iv)

 

 

Assumptions: The Class A preferred pays a dividend every quarter equal to the average prime rate for the quarter plus 2%. The Class B preferred pays a dividend every quarter equal to any net positive increase in the price of a barrel of crude oil for the quarter. Class C preferred pays a quarterly dividend equal to 1.75%. All of the preferred classes can be (but need not be) redeemed by Newco for 120% of their face amount.

 

Treatment: Classes A and B preferred are nonqualified while Class C is not. Class A is nonqualified because it has a dividend rate which varies based on interest rates. Class B is nonqualified because its dividend rate is a function of commodity prices (hence, its value moves more like the commodity than preferred stock). Class C is garden variety preferred.

 
 
 (B) Limitations
 Clauses (i), (ii), and (iii) of subparagraph (A) shall apply
 only if the right or obligation referred to therein may be
 exercised within the 20-year period beginning on the issue date
 of such stock and such right or obligation is not subject to a
 contingency which, as of the issue date, makes remote the
 likelihood of the redemption or purchase.
 

Section 351(g)(2)(B) Ex. 1

 

 

Assumptions: The preferred stock provides an annual dividend of 7% (a rate reasonable for a company such as Newco). After 25 years, Newco is required to redeem the preferred stock.

 

Treatment: While a requirement that the issuer (or a related person) redeem preferred stock normally taints the stock as nonqualified (351(g)(2)(A)(ii)) this is not so for an obligation exercised more than 20 years from issuance. 351(g)(2)(B).

 

 

 

Section 351(g)(2)(B) Ex. 2

 

 

Assumptions: The terms of the preferred stock allows A to require Newco to redeem the stock if the rate of inflation exceeds 25% measured over any 2 consecutive year period, a possibility that is remote.

 

Treatment: The preferred stock is not nonqualified because, while A can require Newco to redeem the stock, such obligation is subject to a contingency which makes the likelihood of redemption remote. 351(g)(2)(B).

 

 (C) Exceptions for certain rights or obligations
 (i) In general
 A right or obligation shall not be treated as described in
 clause (i), (ii), or (iii) of subparagraph (A) if -
 (I) it may be exercised only upon the death, disability,
 or mental incompetency of the holder, or
 

Section 351(g)(2)(C)(i)(I)

 
 

Assumptions: A (or A's estate) can require Newco to redeem the preferred stock, but only if A dies, or becomes disabled or incompetent.

 

Treatment: While the provision that A can require Newco to redeem the preferred stock would generally make that stock nonqualified (351(g)(2)(A)(i)), an exception applies because A can exercise that requirement only upon A's death, disability or incompetence. 351(g)(2)(C)(i)(I).

 

 (II) in the case of a right or obligation to redeem or
 purchase stock transferred in connection with the
 performance of services for the issuer or a related person
 (and which represents reasonable compensation), it may be
 exercised only upon the holder's separation from service
 from the issuer or a related person.
 (ii) Exception
 Clause (i)(I) shall not apply if the stock relinquished in
 the exchange, or the stock acquired in the exchange is in -
 (I) a corporation if any class of stock in such
 corporation or a related party is readily tradable on an
 established securities market or otherwise, or
 

Section 351(g)(2)(C)(ii)(I)

 
 

Assumptions: A is 70 years old. A (or A's estate) can require Newco to purchase the preferred stock for 35 if A dies or becomes disabled or incompetent, a possibility that has more than a remote chance of occurring.

 

Treatment: The Newco preferred stock issued to A is nonqualified. The holder has the right to require the issuer to redeem the stock - that stock would therefore generally be nonqualified. 351(g)(2)(A)(i). While 351(g)(2)(C)(i)(I) provides an exception if the right can only be exercised upon death, disability or incompetency, 351(g)(2)(C)(ii)(I) provides an exception to that exception where the stock acquired is in a corporation if any class of stock in such corporation (Newco) or a related party (P) is readily tradable, as is true here.

 
 
 (II) any other corporation if such exchange is part of a
 transaction or series of transactions in which such
 corporation is to become a corporation described in
 subclause (I).
 

Section 351(g)(2)(C)(ii)(II)

 
 

Assumptions: A is 70 years old. A (or A's estate) can require Newco to purchase the preferred stock for 35 if A dies or becomes disabled or incompetent, a possibility that has more than a remote chance of occurring.

 

Treatment: The Newco preferred stock issued to A is nonqualified. The holder has the right to require the issuer to redeem the stock - that stock would therefore generally be nonqualified. 351(g)(2)(A)(i). While 351(g)(2)(C)(i)(I) provides an exception if the right can only be exercised upon death, disability or incompetency, 351(g)(2)(C)(ii)(II) provides an exception to that exception where the stock is acquired in a corporation as part of a transaction or series of transactions where such corporation will have a class of stock that is readily tradable.

 
 
 (3) Definitions
 For purposes of this subsection -
 (A) Preferred stock
 The term ''preferred stock'' means stock which is limited and
 preferred as to dividends and does not participate in corporate
 growth to any significant extent. Stock shall not be treated
 as participating in corporate growth to any significant extent
 unless there is a real and meaningful likelihood of the 
shareholder actually participating in the earnings and growth
 of the corporation. If there is not a real and meaningful likelihood 
that dividends beyond any limitation or preference will actually be 
paid, the possibility of such payments will be disregarded in 
determining whether stock is limited and preferred as to dividends.
 

Section 351(g)(3)(A)

 
 

Assumptions: Both classes of preferred are to be redeemed in 10 years. Class A preferred is garden variety preferred: limited and preferred as to dividends which are set a flat rate. Class B preferred has a dividend which is currently set at the rate of the Class A but will increase in proportion to the increase in dividends attributable to the common shares, an event which is deemed likely to happen.

 

Treatment: The Class A preferred is nonqualified preferred stock. The Class B preferred is not. Only "preferred stock" can be nonqualified preferred stock, and the term "preferred stock" is defined to exclude stock that participates in corproate growth to any significant extent. 351(g)(3)(A).

 

 
 
 (B) Related person
 A person shall be treated as related to another person if
 they bear a relationship to such other person described in
 section 267(b) or 707(b).
 

Sections 351(g)(1) Ex. 2, (2)(A)(ii), (3)(B)

 

 

Assumptions: Y is required to redeem the X preferred stock in 7 years.

 

Treatment: The stock received by A is nonqualified preferred stock because a "related person" to X is required to redeem that preferred stock. 351(g)(2)(A)(ii). Y is related to X because they are members of the same controlled group. 267(b)(3, (f)(1), 351(g)(3)(B), 1563(a). Because A received only this nonqualified preferred stock from X, neither 351(a) nor (b) apply and A recognizes the entire realized gain of 30. 351(g)(1)(A).

 

 (4) Regulations
 The Secretary may prescribe such regulations as may be
 necessary or appropriate to carry out the purposes of this
 subsection and sections 354(a)(2)(C), 355(a)(3)(D), and 356(e).
 The Secretary may also prescribe regulations, consistent with the
 treatment under this subsection and such sections, for the
 treatment of nonqualified preferred stock under other provisions
 of this title.
 (h) Cross references
 (1) For special rule where another party to the exchange
 assumes a liability, (FOOTNOTE 1) see section 357.
 (FOOTNOTE 1) So in original. Probably should be followed by a
 comma.
 (2) For the basis of stock or property received in an
 exchange to which this section applies, see sections 358 and
 362.
 (3) For special rule in the case of an exchange described in
 this section but which results in a gift, see section 2501 and
 following.
 (4) For special rule in the case of an exchange described in
 this section but which has the effect of the payment of
 compensation by the corporation or by a transferor, see section
 61(a)(1).
 (5) For coordination of this section with section 304, see
 section 304(b)(3).