Sec. 354. Exchanges of stock and securities in certain
 reorganizations
 
(a) General rule
 (1) In general
 No gain or loss shall be recognized if stock or securities in a
 corporation a party to a reorganization are, in pursuance of the
 plan of reorganization, exchanged solely for stock or securities
 in such corporation or in another corporation a party to the
 reorganization.
 
 

Sections 368(a)(1)(C) Ex. 1, 354(a)(1) Ex. 1, 358(a)(1) Ex. 7, 361(a) Ex.1, (c)(1) Ex. 2, (c)(4) Ex. 2, 362(b) Ex. 5,

381(a) Ex. 1, (c)(1) Ex. 1, (c)(2) Ex. 3, 1032(a) Ex. 1, 1223(1) Ex. 1, (2) Ex. 1

 

 

Treatment:  The transaction is a C reorganization. 368(a)(1)(C).  T does not recognize gain or loss on the exchange of its assets for P stock.  361(a).  T also does not recognize gain or loss on the distribution of the P voting stock under 361(c)(1) and 336 does not apply to T.  361(c)(4).  P does not recognize gain on the use of its P stock.  1032(a).  A recognizes none of the realized gain of 200 (300 - 100), because A has received solely stock or securities of another party to the reorganization in exchange for stock or securities of a party to the reorganization.  354(a)(1).  A's basis in the stock received will equal 100, A's basis in the T stock surrendered.  358(a)(1).  A's holding period in the P stock will include A's holding period in the T stock.  1223(1).  P's bases in the T assets received will equal T's 200 bases in those assets .  362(b).  P's holding period in those assets will include T's holding period.  1223(2).  P will succeed to certain T attributes, including T's NOL carryover (subject to possible limitations) and T's E&P.  381(a), (c)(1) & (2).

 

 

Sections 354(a)(1) Ex. 2, (2)(B) Ex. 2, (3)(B) Ex. 2

 

 

 

Assumptions:  The FMV of the X bond owned by A included accrued but unpaid interest of 3.  A received the extra cash in exchange for this bond.  When A purchased the bond the accrued but unpaid interest was 1.

 

Treatment:  The transaction is an A reorganization.  368(a)(1)(A).  Neither A nor B exchanged X stock or securities solely for P stock or securities.  Accordingly, 354(a)(1) does not apply to either A or B.  But, 356(a)(1) does apply, which would provide that A and B would recognize any realized gain (but not loss - 356(c)) up to the FMV of boot received.  Because B has a realized loss ( AR of 70 less AB 85) B recognizes neither gain nor loss.  A also has a realized loss overall: AR of 83 - AB 95.  356(a)(1) and (c) would indicate that A would recognize neither gain nor loss.  But, 354(a)(2)(B) overrides this result to the extent that A has received stock, securities or boot attributable to interest accrued since A's ownershipof the bond.  That amount here is 2 and so A has taxable interest income of 2 (354(a)(3)(B)), but otherwise A does not recognize gain or loss.

 

 

 
 (2) Limitation
 (A) Excess principal amount
 Paragraph (1) shall not apply if -
 (i) the principal amount of any such securities received
 exceeds the principal amount of any such securities
 surrendered, or
 
 
 

Sections 354(a)(2)(A)(i) Ex. 1, 356(d)(1) Ex. 1, (d)(2)(A) Ex. 1, (d)(2)(B) Ex. 1

 
 
 

Treatment:  The transaction is an A reorganization.  368(a)(1)(A).  A's treatment would have been dictated by 354 but for the receipt of boot. The boot is the excess principal amount of 5 in the bonds.  354(a)(2)(A)(i).  Because 354 does not apply due to the receipt of boot, 356 applies.  As a general rule, boot ("other property") includes securities.  356(d)(1).  But, boot does not include securities to the extent those securities could be received without recognition of gain.  356(d)(2)(A).  Here, that amount is 10, equal to the principal amount of T bonds surrendered by A.  It is the FMV of the excess principal amount of the P bonds received by A that represents boot here.  356(d)(2)(B).  Here, the excess principal amount and the FMV thereof are both 5 = 15 - 10.  A would therefore recognize any realized gain to the extent of this boot received of 5.

 

 
 
 (ii) any such securities are received and no such
 securities are surrendered.
 
 

Sections 354(a)(2)(A)(ii), 356(d)(2)(B) Ex. 2

 
 
 
 

Treatment:  A has a realized gain of 60 = 100 AR - 40 AB.  But for the receipt of boot, 354(a)(1) would apply to A.  The boot here is the P bond received by A - where securities in a party to a reorganization are received but no such securities are surrendered, 354(a)(1) does not apply.  354(a)(2)(A)(ii).  356 instead applies.  Boot ("other property") includes the FMV of the principal amount of securities received over the principal amount of securities surrendered, and where no securities are surrendered, the entire principal amount of securities received is treated as the excess.  356(d)(2)(B).  Because FMV = face here, the boot equals 20.  And so, of A's realized gain of 60, A will recognize 20.  A will have a basis in the P stock of 40 = AB 40 in T + gain recognized of 20 less boot received of 20.  358(a)(1).  A will have a FMV basis of 20 in the P bond.  358(a)(2).

 

 
 
 (B) Property attributable to accrued interest
 Neither paragraph (1) nor so much of section 356 as relates
 to paragraph (1) shall apply to the extent that any stock
 (including nonqualified preferred stock, as defined in section
 351(g)(2)), securities, or other property received is
 attributable to interest which has accrued on securities on or
 after the beginning of the holder's holding period.
 

Sections 354(a)(2)(B) Ex. 1, (3)(B) Ex. 1

 

 

 

Assumptions:  The X bond owned by A had a face of 10 and its FMV of 13 includes accrued but unpaid interest of 3.  When A purchased this bond, the accrued but unpaid interest was 1.

 

Treatment:  The transaction is an A reorganization.  368(a)(1)(A).  A and B have exchanged stock and securities solely for stock and, accordingly, 354(a)(1)(A) applies.  This provision would dictate that A and B recognize neither gain nor loss.  Nonetheless, 354(a)(2)(B) overrides this result as to A.  A has received 2 shares of P stock with a FMV of 2 attributable to interest accrued since A acquired the X bond.  Hence, A will have taxable interest income of 2.  354(a)(3)(B).  A will not recognize any other gain or loss, including any stock received for the $1 interest accrued prior to A's holding of the bond.

 

 
 
 (C) Nonqualified preferred stock
 (i) In general
 Nonqualified preferred stock (as defined in section
 351(g)(2)) received in exchange for stock other than
 nonqualified preferred stock (as so defined) shall not be
 treated as stock or securities.
 
 

Sections 354(a)(2)(C)(i) Ex. 1, 356(e)(1) Ex. 1, (e)(2) Ex. 1

 
 
 
 

Assumptions:  Both the T preferred and the P preferred contains clauses allowing A to require the issuer to redeem on demand such stock at face, which such amount is equal between the T and P stock. 

 

Treatment:  The transaction is an A reorganization.  368(a)(1)(A).  Both the T and P preferred stock is considered nonqualified preferred stock ("NQPS")  because the holder can require the issuer to redeem the stock.  351(g)(2)(A)(i).  While NQPS received in exchange for stock is generally considered boot, (354(a)(2)(C)(i) & 356(e)(1)), this rule does not apply when NQPS is received for other NQPS.  354(a)(2)(C)(i), 356(e)(2).  Accordingly, the P preferred stock is treated as stock for purposes of 354, and A does not recognize gain or loss from the transaction.

 

 

Sections 354(a)(2)(C)(i) Ex. 2, 356(e)(1) Ex. 2, (e)(2) Ex. 2

 

 
 
 

Assumptions:  Both the T preferred and the P preferred contains clauses allowing A to require the issuer to redeem on demand such stock at face, which amount equals the indicated FMV.

 

Treatment:  The transaction is an A reorganization.  368(a)(1)(A).  Both the T and P preferred stock is considered nonqualified preferred stock ("NQPS") because the holder can require the issuer to redeem the stock.  351(g)(2)(A)(i).  NQPS received in exchange for stock is considered boot except to the extent received for other NQPS.  354(a)(2)(C)(i), 356(e)(1) & (2).  Here, A received 20 FMV of P NQPS in exchange for T NQPS.  This amount will therefore be considered stock.  The remaining 10 of P NQPS will be considered boot received by A.  Hence, of A's gain realized of 25 ((90 + 30) - (80 + 15)), only 10 is recognized.

 

 
 
 (ii) Recapitalizations of family-owned corporations
 (I) In general
 Clause (i) shall not apply in the case of a
 recapitalization under section 368(a)(1)(E) of a
 family-owned corporation.
 (II) Family-owned corporation
 For purposes of this clause, except as provided in
 regulations, the term ''family-owned corporation'' means
 any corporation which is described in clause (i) of section
 447(d)(2)(C) throughout the 8-year period beginning on the
 date which is 5 years before the date of the
 recapitalization. For purposes of the preceding sentence,
 stock shall not be treated as owned by a family member
 during any period described in section 355(d)(6)(B).
 (III) Extension of statute of limitations
 The statutory period for the assessment of any deficiency
 attributable to a corporation failing to be a family-owned
 corporation shall not expire before the expiration of 3
 years after the date the Secretary is notified by the
 corporation (in such manner as the Secretary may prescribe)
 of such failure, and such deficiency may be assessed before
 the expiration of such 3-year period notwithstanding the
 provisions of any other law or rule of law which would
 otherwise prevent such assessment.
 
 

Section 354(a)(2)(C)(ii) Ex. 1

 
 
 

Assumptions:  A and B are parent and child to each other.  They have each owned and will continue to own their stock for at least 3 more years.  The preferred stock received by A contains a clause allowing A to demand that X redeem the stock at its current FMV.

 

Treatment:  The transaction is a recapitalization reorganization.  368(a)(1)(E).  The preferred stock received by A is nonqualified preferred stock ("NQPS").  351(g)(2).  While receiving NQPS is generally treated as the receipt of boot (354(a)(2)(C)(i)), 354(a)(2)(C)(ii) contains an exception for recapitalizations of family-owned corporations.  To qualify under this exception, the corporation must be a family-owned corporation for the 8 year period beginning 5 years prior to the recapitalization.  Because at least 50% of the X stock is owned by members of the same family, X is a family-owned corporation.  447(d)(2)(C)(i).  Because this condition is satisfied continuously for at least 5 years prior to and 3 years following the recapitalization, the condition of 354(a)(2)(C)(ii)(II) is satisfied and, accordingly, the NQPS received by A is not considered boot even though received for stock other than NQPS.

 
 

Section 354(a)(2)(C)(ii) Ex. 2

 
 
 

Assumptions:  A and B are parent and child to each other.  They have each owned their common stock for 6 years prior to the recapitalization (transaction 1) which occurs today.  B will continue to own B's common stock for at least 3 additional years.  In 2 years, A sells the preferred stock received today to a third party.  The preferred stock is nonvoting and contains a clause allowing the holder to demand that X redeem the stock at its current FMV.

 

Treatment:  The transaction is a recapitalization reorganization.  368(a)(1)(E).  The preferred stock received is nonqualified preferred stock ("NQPS").  351(g)(2).  While receiving NQPS is generally treated as the receipt of boot (354(a)(2)(C)(i)), 354(a)(2)(C)(ii) contains an exception for recapitalizations of family-owned corporations.  To qualify under this exception, the corporation must be a family-owned corporation for the 8 year period beginning 5 years prior to the recapitalization.  A family-owned corporation is generally one in which voting stock having at least 50% of the voting power and at least 50% of each non-voting class of stock is owned by members of a family.  447(d)(2)(C)(i).  This requirement is met at the time of the recapitalization, but not as of 2 years later when A sells the preferred stock.  Hence, the 354(a)(2)(C)(ii) exception does not apply, and the NQPS received by A today is boot and, therefore, A will recognize realized gain today.  Because the triggering event occurs 2 years from now, A will need to file an amended tax return for the year of the recapitalization.  The statute of limitations for the current year will not expire until 3 years after the corporation notifies the IRS of the failure to satisfy 354(a)(2)(C)(ii).  354(a)(2)(C)(ii)(III).

 

Section 354(a)(2)(C)(ii) Ex. 3

 
 
 
 

Assumptions:  A and B are parent and child to each other.  They have owned their common stock in X for the past 6 years and will continue to own their stock (common and preferred) for at least 2 years following today's recapitalization.  But, for 2 years from today A grants an option to acquire all of A's preferred stock.  The preferred stock is nonvoting and allows the holder to require X to redeem the stock at its FMV.

 

Treatment:  The transaction is a recapitalization reorganization.  368(a)(1)(E).  The preferred stock received by A is nonqualified preferred stock ("NQPS").  351(g)(2).  While receiving NQPS is generally not treated as the receipt of boot (354(a)(2)(C)(i)), 354(a)(2)(C)(ii) contains an exception for recapitalizations of family-owned corporations.  To qualify under this exception, the corporation must be a family-owned corporation for the 8 year period beginning 5 years prior to the recapitalization.  A family-owned corporation is generally one in which voting stock having at least 50% of each non-voting class of stock is owned by members of a family.  447(d)(2)(C)(i).  A and B are members of a family and the requirement is met as of the time of the recapitalization.  The requirement would also be met for the 3 years following the recapitalization but for the fact that A has optioned A's preferred stock.  In measuring the requisite ownership period you do not include any time in which there is a substantial diminution of risk by virtue of, inter alia, an option.  354(a)(2)(C)(ii)(II) & 355(d)(6)(B).  Therefore, as of the date of the option, the family is not considered to own at least 50% of each non-voting class of stock, the 8 year requirement is therefore not met, the 354(a)(2)(C)(ii) exception does not apply and all of the NQPS received by A today is considered boot received today.

 

 
 
 (3) Cross references
 (A) For treatment of the exchange if any property is received
 which is not permitted to be received under this subsection
 (including nonqualified preferred stock and an excess principal
 amount of securities received over securities surrendered, but
 not including property to which paragraph (2)(B) applies), see
 section 356.
 

Sections 356(a)(1) Ex. 1, (a)(2) Ex. 1, 354(a)(3)(A)

 
 
 

Treatment:  A has a realized gain of 1,325,000, AR of 1,750,000 (1,000,000 P stock + 750,000 cash) less AB of 425,000.  Because this transaction is an A reorganization, 354 would apply but for A's receipt of boot.  356 therefore applies.  354(a)(3)(A).  As a result, A recognizes the realized gain to the extent of boot received by A.  356(a)(1).  Hence, of the realized gain of 1,325,000, A recognizes 750,000.  This gain will be treated as a dividend if the transaction (exchange) has the effect of a dividend.  This test is determined by treating A as having hypothetically received an additional 7,500 shares of P stock (i.e., stock worth 750,000) instead of cash, and then had those shares redeemed by P in exchange for cash of 750,000.  Clark v. CIR, 489 US 726 (1989).  Principally due to A's clear minority position in P, this hypothetical redemption would be treated, hypothetically, as a sale or exchange, not a distribution.  Accordingly, A's gain will be treated not as a dividend but as though in exchange for the stock, likely long-term capital gain.

 

 
 
 (B) For treatment of accrued interest in the case of an
 exchange described in paragraph (2)(B), see section 61.
 
 

Sections 354(a)(2)(B) Ex. 1, (3)(B) Ex. 1

 

 

 

Assumptions:  The X bond owned by A had a face of 10 and its FMV of 13 includes accrued but unpaid interest of 3.  When A purchased this bond, the accrued but unpaid interest was 1.

 

Treatment:  The transaction is an A reorganization.  368(a)(1)(A).  A and B have exchanged stock and securities solely for stock and, accordingly, 354(a)(1)(A) applies.  This provision would dictate that A and B recognize neither gain nor loss.  Nonetheless, 354(a)(2)(B) overrides this result as to A.  A has received 2 shares of P stock with a FMV of 2 attributable to interest accrued since A acquired the X bond.  Hence, A will have taxable interest income of 2.  354(a)(3)(B).  A will not recognize any other gain or loss, including any stock received for the $1 interest accrued prior to A's holding of the bond.

 

 

Sections 354(a)(1) Ex. 2, (2)(B) Ex. 2, (3)(B) Ex. 2

 

 

 

Assumptions:  The FMV of the X bond owned by A included accrued but unpaid interest of 3.  A received the extra cash in exchange for this bond.  When A purchased the bond the accrued but unpaid interest was 1.

 

Treatment:  The transaction is an A reorganization.  368(a)(1)(A).  Neither A nor B exchanged X stock or securities solely for P stock or securities.  Accordingly, 354(a)(1) does not apply to either A or B.  But, 356(a)(1) does apply, which would provide that A and B would recognize any realized gain (but not loss - 356(c)) up to the FMV of boot received.  Because B has a realized loss ( AR of 70 less AB 85) B recognizes neither gain nor loss.  A also has a realized loss overall: AR of 83 - AB 95.  356(a)(1) and (c) would indicate that A would recognize neither gain nor loss.  But, 354(a)(2)(B) overrides this result to the extent that A has received stock, securities or boot attributable to interest accrued since A's ownershipof the bond.  That amount here is 2 and so A has taxable interest income of 2 (354(a)(3)(B)), but otherwise A does not recognize gain or loss.

 

 

 
 
 (b) Exception
 (1) In general
 Subsection (a) shall not apply to an exchange in pursuance of a
 plan of reorganization within the meaning of subparagraph (D) or
 (G) of section 368(a)(1), unless -
 (A) the corporation to which the assets are transferred
 acquires substantially all of the assets of the transferor of
 such assets; and
 (B) the stock, securities, and other properties received by
 such transferor, as well as the other properties of such
 transferor, are distributed in pursuance of the plan of
 reorganization.
 (2) Cross reference
 For special rules for certain exchanges in pursuance of plans
 of reorganization within the meaning of subparagraph (D) or (G)
 of section 368(a)(1), see section 355.
 

Sections 354(b) Ex. 1, 368(a)(1)(D) Ex. 3

 
 
 
 

Assumptions:  The transaction is not a disguised dividend.

 

Treatment:  The transaction is a non-divisive D reorganization, 368(a)(1)(D), by virtue of qualifying under 356(a).  The transaction would have qualified under 354(a) but for the receipt of cash, and so it qualifies under 356.   In order to qualify under 354(a), the transaction must satisfy 354(b).  X acquired substantially all of P's assets, having acquired all of P's operating assets, thus satisfying 354(b)(1)(A).  By liquidating, P satisfies 354(b)(1)(B).  The main point of 354(b) is to distinguish non-divisive D and G reorganizations from divisive D and G reorganizations which must qualify under 355 (or 356 by way of 355).  See, 355(b)(2).

 

Section 354(b) Ex. 2

 

 

 

Treatment:  The transaction does not satisfy 354(b) and therefore does not qualify under 354(a), even though such transaction might qualify as a D reorganization under 368(a)(1)(D).  It does not qualify under 354(b) both because Newco does not acquire substantially all of P's assets, 354(b)(1)(A), and because P does not distribute all of its assets, 354(b)(1)(B).  For it to qualify as a D reorganization, P must satisfy the requirements of 355, which is the main point of 354(b).  354(b)(2).

 

 

 

 
 
 (c) Certain railroad reorganizations
 Notwithstanding any other provision of this subchapter,
 subsection (a)(1) (and so much of section 356 as relates to this
 section) shall apply with respect to a plan of reorganization
 (whether or not a reorganization within the meaning of section
 368(a)) for a railroad confirmed under section 1173 of title 11 of
 the United States Code, as being in the public interest.
 

Section 354(c)

 
 
 
 

Assumptions:  The transaction qualifies as a reorganization of a railroad confirmed under 1173 of Title 11.

 

Treatment:  None of the 368 definitions of reorganization are satisfied here.  The transaction is not a B reorganization because Railroad shareholders received more than solely stock of P.  Nonetheless, but for the receipt of boot, the transaction would qualify under 354(a)(1) even though not a reorganization under 368 because the transaction is a railroad reorganization confirmed under 1173 of Title 11.  354(c).  Because of the receipt of boot, 356 will apply to the historic Railroad shareholders.