IRC 351 and 358 Shareholder and Corporate Tax Basis

What is the shareholder’s basis in the stock following the transfer?

Pursuant to IRC Sec4on 358, the shareholder’s basis in the corporate stock will equal the basis in the property transferred to the corpora4on, plus any gain that the shareholder recognizes in the transac4on, minus the fair market value of any boot received from the corpora4on. This is known as a “subs4tute basis”. If, however, the property transferred to the corpora4on has a fair market value of less than the shareholder’s basis in the property, IRC Sec4on 362(e) limits the ability of the shareholder and the corpora4on to recognize a loss on the transac4on. In this case, the corpora4on and shareholders can agree on the alloca4on of basis. Further, rather than the shareholder maintaining a basis equal to her basis in the property transferred, the par4es can agree that the basis in the newly acquired stock will equal the fair market value of the property transferred to the corpora4on. In this case, the corpora4on’s basis in the newly acquired property will equal the shareholder’s basis prior to transfer.

• Example: Michelle transfers equipment to the corpora4on in exchange for stock and a $1,000 computer. Her basis in the equipment is $10,000. The $1,000 computer received by Michelle is boot, which she will recognize as gain. Generally, her basis in the stock will be $10,000 ($10,000 basis + $1,000 gain recognized – $1,000 boot received). If the equipment transferred to the corpora4on was worth only $8,000, Michelle cannot recognize the $2,000 loss on the equipment at the 4me of transfer. The shareholder and corpora4on can, however, agree that Michelle will take an $8,000 basis (the FMV of the property) in the stock and the corpora4on’s basis in the property will be $10,000 (the shareholder’s prior basis in the equipment). As such, Michelle takes a lower basis and the corpora4on gets the stepped up basis.

What is the corporation’s basis in the property following the transfer?

Pursuant to IRC Sec4on 358, the corpora4on’s basis in the property following the IRC Sec4on 351 transac4on equals the shareholder’s basis in the contributed property, plus any gain recognized by the shareholder in the transac4on. If the fair market value of the property transferred to the corpora4on is less than the shareholder’s basis in the transferred property, the corpora4on’s basis will equal the fair market value of the stock. As stated above, an excep4on to this rule is where the corpora4on and shareholder agree that the shareholder’s basis in the stock will not be higher than the fair market value of the stock. This effec4vely places the lower basis value on the shareholder. The corpora4on’s basis will then be the shareholder’s basis in the property at the 4me of the transac4on.

• Example: Donna transfers equipment with a basis of $3,000 and a fair market value of $5,000 to the corpora4on in exchange for stock. Assume the transac4on qualifies under IRC Sec4on 351. The corpora4on will take Donna’s basis in the equipment, which is $3,000. If Donna elects to recognize $2,000 in gain, then the corpora4on’s basis in the property would be $5,000. If the fair market value of the equipment at the 4me of transfer is $2,000 (rather than $5,000), the corpora4on would have a $2,000 basis and the shareholder’s basis in the stock received would be her original basis of $3,000. Donna and the corpora4on may agree, however, to allocate the higher basis of $3,000 to the property and Donna will take a basis in the stock equal to the fair market value of the equipment ($2,000).

What happens if the corporation assumes shareholder debt associated with the transferred property?

IRC Sec4on 351 allows for the assump4on by the corpora4on of shareholder debt associated with property transferred to the corpora4on. Pursuant to IRC Sec4on 357, the amount of debt assumed reduces the shareholder’s basis in the property. If, however, the amount of debt assumed by the corpora4on exceeds the shareholder’s basis in the contributed property, the amount of debt above the shareholder’s basis in the property is treated as gain to the shareholder. The corpora4on’s basis in the property is the amount of the assumed debt. A shareholder may lose the benefits of IRC Sec4on 351 if the principle purpose of transferring the property and debt to the corpora4on was tax avoidance rather than a valid business purpose.

Assuming addi4onal debt on property prior to transferring it to the corpora4on is evidence that there was not a valid business purpose. Lastly, if the shareholder also remains responsible for the debt that is jointly assumed by the corpora4on, it will not change the situa4on described above and will not destroy the exemp4on as long as the corpora4on is expected to pay the debt.

  • Example: Winston transfers equipment with a value and a basis of $10,000 to the corpora4on. The equipment is subject to a promissory note owed to the dealer in the amount of $6,000. The corpora4on assumes the debt. Winston’s basis in the newly acquired stock will be $4,000 ($10,000 basis – $6,000 debt assumed). If, however, Winston’s basis in the property is $5,000, he will recognize a gain of $1,000 ($6,000 debt assumed – $5,000 debt shareholder basis). If Winston takes out loans against the property prior to transferring it to the corpora4on, it may be evidence that he was aFemp4ng to avoid the recogni4on of gain and gain may be imputed to him in the transac4on.
  • Note: If the shareholder transfers assets to the corpora4on that secures a debt, but the debt is also secured by property not transferred to the corpora4on, the corpora4on’s basis in the property will be reduced by the value of the non-transferred property securing the debt to the extent of the security interest.

Leave a Comment