Sec. 357. Assumption of liability
 
(a) General rule
 Except as provided in subsections (b) and (c), if -
 (1) the taxpayer receives property which would be permitted to
 be received under section 351 or 361 without the recognition of
 gain if it were the sole consideration, and
 (2) as part of the consideration, another party to the exchange
 assumes a liability of the taxpayer,
 then such assumption shall not be treated as money or other
 property, and shall not prevent the exchange from being within the
 provisions of section 351 or 361, as the case may be.
 

Sections 357(a) Ex. 1, 358(d)(1) Ex. 1

 
 

Treatment: Relief from liabilities is generally treated as though receiving cash and paying off those liabilities. However, in a transaction such as this where 351 would otherwise apply, transferring those liabilities will generally not be treated as the receipt of boot for purposes of applying 351 (357(a)), but will generally be treated as the receipt of boot for purposes of measuring shareholder basis. Accordingly, A will recognize none of A's realized gain and A will have a basis in the Newco stock of 15 (30 + 10 -25). B will recognize gain of 10 because the cash received is still boot. B's basis in the stock will be 30 (50 - 20 + 10 - 10).

 

 

Section 357(a) Ex. 2

 

 

Treatment: X's transfer of its mortgage in the C reorganization will not be treated as though X received cash which would have been treated as the receipt of boot. 357(a).Hence, X does not recognize gain or loss from this transaction. 361.

 

 
 
 
 (b) Tax avoidance purpose
 (1) In general
 If, taking into consideration the nature of the liability and
 the circumstances in the light of which the arrangement for the
 assumption was made, it appears that the principal purpose of the
 taxpayer with respect to the assumption described in subsection
 (a) -
 (A) was a purpose to avoid Federal income tax on the
 exchange, or
 (B) if not such purpose, was not a bona fide business
 purpose,
 then such assumption (in the total amount of the liability
 assumed pursuant to such exchange) shall, for purposes of section
 351 or 361 (as the case may be), be considered as money received
 by the taxpayer on the exchange.
 (2) Burden of proof
 In any suit or proceeding where the burden is on the taxpayer
 to prove such assumption is not to be treated as money received
 by the taxpayer, such burden shall not be considered as sustained
 unless the taxpayer sustains such burden by the clear
 preponderance of the evidence.
 

Sections 357(b), (c)(2)(A)

 
 

Assumptions: A placed the mortgage on the land in order to buy a yacht for personal use and incorporated Newco shortly thereafter.

 

Treatment: The general rule of 357(a) does not apply where it appears that the taxpayer's principal purpose with respect to the assumption was to avoid tax on the exchange or otherwise not for valid business purposes. 357(b). That bad purpose will be found in the present circumstances. 357(b) overrides both 357(a) and 357(c). See 357(a) and (c)(2)(A).

 

 
 
 (c) Liabilities in excess of basis
 (1) In general
 In the case of an exchange -
 (A) to which section 351 applies, or
 (B) to which section 361 applies by reason of a plan of
 reorganization within the meaning of section 368(a)(1)(D)with 
respect to which stock or securities of the corporation to
 which the assets are transferred are distributed in a 
transaction which qualifies under section 355,
 if the sum of the amount of the liabilities assumed exceeds the
 total of the adjusted basis of the property transferred pursuant
 to such exchange, then such excess shall be considered as a gain
 from the sale or exchange of a capital asset or of property
 which is not a capital asset, as the case may be.
 

Sections 357(c)(1), 358(d)(1) Ex. 2

 

Assumptions: A's land was a capital asset held long-term in A's hands. It will be used in Newco's business. Inventory will also be used in Newco's business. The liability is a note payable which was incurred years ago to purchase the assets transferred and there is no tax-avoidance issue associated with this liability.

 

Treatment: The general rule of 357(a) provides that A's relief from the liability will not be treated as boot for purposes of recognizing gain. 357(b) will not override here because there is no tax avoidance purpose and the liability was incurred for valid business purposes. 357(c) will apply because A has transferred assets with total bases of 40, 20 less than the liability. Accordingly, A will recognize gain of 20, 12 long-term capital gain (60 FMV of land/100 total FMV x 20) from the land and 8 ordinary gain (40 FMV of inventory/100 total FMV x 20). Reg. 1.357-2. A's basis in the Newco stock will be 0: 40 AB in assets transferred + 20 gain recognized - 60 boot received (entire note payable transferred is treated as boot for purposes of determining stock basis - 358(d)(1)).

 
 

Sections 357(c)(1)(B) Ex. 1, 358(f), 362(b) Ex. 1

 
 
 

Assumptions: The requirements of 355 and 368(a)(1)(D) are satisfied. Transfer of Widget to Newco includes all assets and liabilities of Widget. No tax avoidance exists - all liabilities were incurred and transferred for bona fide business purposes.

 

Treatment: 357(a) provides as a general rule that P's transfer of liabilities to Newco will not be treated as the receipt of money by P. Also, while 357(c) generally does not apply to reorganizations, it does apply to divisive D reorganizations. Hence, P will recognize gain of 20 on the excess of liabilities transfrred (50) over he basis (30) of assets transferred. 357(c)(2). Because Newco received no stock or securities of P, 358 does not apply to Newco. 358(f). Instead, 362(b) applies. Accordingly, Newco's basis in the assets will be 50, P's basis increased by P's recognized gain (30 + 20).

 

 

Section 357(c)(1)(B) Ex. 2

 

 

 

Assumptions: The transaction is a C reorganization (368(a)(1)(C)). There is no tax avoidance and all liabilities were incurred and transferred for bona fide business purposes.

 

Treatment: 357(a) provides as a general rule that T's transfer of liabilities to Newco will not be treated as the receipt of money by P. Also, 357(c) does not apply because, while it will apply to a divisive D reorganization, this is a C reorganization, not a divisive D.

 

P's basis in the old T assets will equal 150, which was T's basis. 362(b).

 

 

 (2) Exceptions
 Paragraph (1) shall not apply to any exchange -
 (A) to which subsection (b)(1) of this section applies, or
 

Sections 357(b), (c)(2)(A)

 
 

Assumptions: A placed the mortgage on the land in order to buy a yacht for personal use and incorporated Newco shortly thereafter.

 

Treatment: The general rule of 357(a) does not apply where it appears that the taxpayer's principal purpose with respect to the assumption was to avoid tax on the exchange or otherwise not for valid business purposes. 357(b). That bad purpose will be found in the present circumstances. 357(b) overrides both 357(a) and 357(c). See 357(a) and (c)(2)(A).

 
 
 (B) which is pursuant to a plan of reorganization within the
 meaning of section 368(a)(1)(G) where no former shareholder of
 the transferor corporation receives any consideration for his
 stock.
 

Section 357(c)(2)(B) Ex. 1

 
 

Assumptions: P is under the jurisdiction of the U.S. Bankruptcy Court and the transaction is pursuant to a plan approved by the Court. A's interest is eliminated. B's P bond is replaced with 100% of the stock of Newco and C's account receivable is assumed in its entirety by Newco. P will cease to exist following the transaction.

 

Treatment: Even though P transferred liabilities in excess of the adjusted bases of assets transferred, 357(c)(2)(B) contains an exception in the case of a reorganization pursuant to 368(a)(1)(G) where no former shareholder receives consideration for the stock - A receives nothing here.

 
 

Section 357(c)(2)(B) Ex. 2

 
 

Assumptions: P is under the jurisdiction of the U.S. Bankruptcy Court and the transaction is pursuant to a plan approved by that court. A's stock and B's note in P are eliminated, each replaced with Newco stock. C's account receivable is assumed in its entirety by Newco. P will cease to exist following the transaction.

 

Treatment: While 357(c)(1) generally requires recognition of gain on the trnasfer of liabilities in excess of bases of assets transferred in specified transactions, 357(c)(2)(B) contains an exception for G reorganizations. That exception does not apply, however, because A received some consideration for the P stock.

 

 (3) Certain liabilities excluded
 (A) In general
 If a taxpayer transfers, in an exchange to which section 351
 applies, a liability the payment of which either -
 (i) would give rise to a deduction, or
 (ii) would be described in section 736(a),
 then, for purposes of paragraph (1), the amount of such
 liability shall be excluded in determining the amount of
 liabilities assumed.
 

Sections 357(c)(3)(A), 358(d)(2)

 
 

Assumptions: The ABZ partnership transfers the Services business, including the associated assets and liabilities. The liabilities consist of amounts owed to retired partners in liquidation of their partnership interests but not in exchange for their in partnership property. C is a cash basis taxpayer transferring C's interest in a sole-practitioner services business, including the associated assets and accrued but unpaid expenses.

 

Treatment: The liability transferred by ABZ is described in 357(c)(3)(A)(ii), a liability the payment of which would be described in 736(a). The liability transferred by C is described in 357(c)(3)(A)(i), a liability the payment of which would give rise to deduction. As such, these liabilities are ignored for purposes of both 357(c)(1) and 358. 358(d)(2). Accordingly, neither ABZ nor C recognizes any realized gain. ABZ's basis in the Newco stock will be 30 and C's basis in Newco will be 20.

 

 
 
 (B) Exception
 Subparagraph (A) shall not apply to any liability to the
 extent that the incurrence of the liability resulted in the
 creation of, or an increase in, the basis of any property.
 

Section 357(c)(3)(B)

 
 

Adopted from Senate Report No. 1263 95th Cong., 2d Sess. 185 (1978)

 

Assumptions: A, a cash-basis taxpayer, purchased small tools for 30. This cost would have deducted if paid. Instead, A gets a temporary basis of 30 until A pays the cost. Before this happens, however, A transfers the tools, the associated liability, another liability of 10 and accounts receivable from services of 90.

 

Treatment: 357(c) generally requires A to recognize a gain of 10, the excess of liabilities transferred (40) over bases of assets transferred (30). 357(c)(3)(A) provides an exception for liabilities where, as here, the payment of those liabilities would give rise to a deduction. But, in an exception, to an exception, 357(c)(3)(B) , liabilities are not excluded if a creation or increase in asset basis resulted from the incurrence of the liability. A recognizes a gain of 10, which also equals the excess of liabilities, other than from the purchase of the small tools, over the bases of assets other than small tools.

 

 (d) Determination of amount of liability assumed
 (1) In general
 For purposes of this section, section 358(d), section 358(h),
 section 361(b)(3), section 362(d), section 368(a)(1)(C), 
and section 368(a)(2)(B), except as provided in regulations -
 (A) a recourse liability (or portion thereof) shall be
 treated as having been assumed if, as determined on the basis
 of all facts and circumstances, the transferee has agreed to,
 and is expected to, satisfy such liability (or portion),
 whether or not the transferor has been relieved of such
 liability; and
 (B) except to the extent provided in paragraph (2), a
 nonrecourse liability shall be treated as having been assumed
 by the transferee of any asset subject to such liability.
 

Section 357(d)(1)

 
 

Assumptions: Both mortgages were placed on the respective parcels of land and transferred to Newco for bona fide business purposes and not for tax-avoidance. The mortgage on the land transferred by A is a recourse loan. Newco has agreed with A to make all payments due on the mortgage, but A retains personal liability to the lender if Newco does not pay. B is named on the mortgage securing the land transferred by B, but the loan is nonrecourse.

 

Treatment: Both mortgages are treated as assumed by Newco: A's mortgage because even though A remains potentially liable, Newco has agreed to satisfy the liability (357(d)(1)(A)); B's mortgage is nonrecourse and the collateral has been transferred to Newco (357(d)(1)(B)). Accordingly, A and B recognize gains of 10 and 7, respectively, and they each have a basis of 0 in the Newco stock. 358(d)(1).

 
 
 (2) Exception for nonrecourse liability
 The amount of the nonrecourse liability treated as described in
 paragraph (1)(B) shall be reduced by the lesser of -
 (A) the amount of such liability which an owner of other
 assets not transferred to the transferee and also subject to
 such liability has agreed with the transferee to, and is
 expected to, satisfy; or
 (B) the fair market value of such other assets (determined
 without regard to section 7701(g)).
 

Section 357(d)(2)

 
 

Assumptions: The land transferred to Newco is a parcel subdivided from other parcels which A continues to own. The parcels retained by A have a FMV (ignoring 7701(g)) of 210. All of the parcels (i.e., that transferred to Newco and those retained by A) are and will continue to be subject to the same nonrecourse mortgage of 250. Newco and A have agreed that Newco has responsibility for paying 30 of that mortgage, while A is responsible for 220.

 

Treatment: While 357(d)(1)(B) provides generally that the nonrecourse liability is treated as assumed by Newco, the amount is limited by 357(d)(2). The nonrecourse liability deemed assumed by Newco is the full amount (250) minus the lesser of (A) the amount A has agreed to pay, 220, or (B) the FMV of the parcels retained by A, 210. Hence, the assumed liability is deemed to be 40, and A therefore recognizes a gain of 18 (40 - 22). If the FMV of A's retained parcels was, for example, 224 instead of 210, the lesser of (A) or (B) would be the 220 amount that A agreed to pay and, hence, the assumed liability would be deemed to be 30 and A would recognize a gain of 8 (30 - 22).

 

 
 
 (3) Regulations
 The Secretary shall prescribe such regulations as may be
 necessary to carry out the purposes of this subsection and
 section 362(d). The Secretary may also prescribe regulations
 which provide that the manner in which a liability is treated as
 assumed under this subsection is applied, where appropriate,
 elsewhere in this title.