IRC §351 (Transfer to corporation controlled by transferor) is the foundational nonrecognition provision for INCORPORATING a business or transferring property to an existing controlled corporation. CORE RULE §351(a): no gain or loss recognized when one or more persons transfer PROPERTY to a corporation SOLELY in exchange for STOCK of that corporation IF, IMMEDIATELY AFTER the exchange, those persons are IN CONTROL of the corporation. CONTROL §368(c): ownership of at least 80% of total combined voting power of all voting-stock classes AND at least 80% of total shares of each nonvoting class. KEY TERMS: "PROPERTY" §351(d) includes cash, real estate, equipment, inventory, intangibles, accounts receivable - but does NOT include services rendered (stock received for services is taxable ordinary compensation income §83). "SOLELY in exchange for stock" - if transferor receives anything besides stock (cash, notes, other property = "BOOT"), §351(b) requires gain (not loss) recognition to the lesser of FMV of boot or realized gain; basis and holding period rules adjust. "IMMEDIATELY AFTER" §1.351-1(a)(1) is judged on a flexible step-transaction basis - includes near-simultaneous transfers part of one integrated plan. CONTROL GROUP - multiple transferors may aggregate property contributions to satisfy 80%/80% test collectively. SERVICE PROVIDER PROBLEM: stock received for services is NOT property contribution; service-only shareholders' shares do NOT count toward 80% control unless they ALSO contribute meaningful property (>10% of stock value contributed as property, per Rev. Proc. 77-37 safe harbor). BASIS §358(a)(1): transferor's basis in stock received = adjusted basis of property transferred, MINUS boot/liabilities, PLUS gain recognized. CORPORATION'S BASIS §362(a): substituted basis = transferor's basis PLUS gain recognized; §362(e)(2) loss duplication rule limits stepped-up basis where aggregate built-in loss transferred. LIABILITIES ASSUMED: §357(a) - generally not boot; §357(b) - tax-avoidance liabilities recharacterized as boot; §357(c) - liabilities EXCEEDING aggregate basis recognized as gain. INVESTMENT COMPANY §351(e) - no nonrecognition where transferee is an investment company (mainly stocks/securities); diversification rule. STATEMENT REQUIRED Reg §1.351-3 - both transferor and corporation attach §351 statement to first return.
The trade: Property in, stock out, no current gain or loss - IF the transferors collectively control the corporation immediately after (80% voting + 80% of each nonvoting class per §368(c)).
What counts: Property includes cash, real estate, equipment, intangibles, accounts receivable. Services do NOT - stock for services is ordinary compensation income §83. Service-only shareholders' shares don't help the 80% test.
Boot §351(b): Anything received other than transferee stock (cash, notes, other property). Recognized as gain to the LESSER of boot FMV or realized gain. Losses never recognized.
Liabilities §357: Generally not boot under §357(a). §357(b) tax-avoidance liabilities = boot. §357(c) liabilities ASSUMED in excess of aggregate property basis = gain recognized.
Basis: Transferor takes substituted basis in stock §358(a); corporation takes carryover basis in property §362(a), subject to §362(e)(2) anti-loss-duplication rules. Statement required Reg §1.351-3.
| Element | Detail |
|---|---|
| (1) PROPERTY transferred | §351(a) requires "property"; §351(d) excludes services, indebtedness of transferee corp not evidenced by a security, interest on transferee debt. Property: cash, real estate, equipment, inventory, intangibles (patents, customer lists, goodwill, going concern value), accounts receivable, securities. |
| Services exclusion §351(d)(1) | Stock issued for services rendered = ordinary compensation income to recipient under §83; not property contribution; service shares do NOT count toward 80% control. |
| (2) SOLELY for STOCK of transferee | Stock includes common, preferred (but NOT nonqualified preferred under §351(g)), voting and nonvoting. Excludes: warrants, options, debt instruments, contingent rights. |
| Nonqualified preferred stock §351(g) | Preferred with mandatory redemption, holder put right within 20 years, issuer call where redemption likely, or dividend rate referencing interest rates/commodities - treated as BOOT, not stock |
| (3) CONTROL immediately after §368(c) | Transferors collectively own at least 80% of total combined voting power of all voting-stock classes AND at least 80% of total shares of EACH OTHER class of stock |
| "Immediately after" timing | Reg §1.351-1(a)(1) - mutual interdependence test; near-simultaneous transfers part of one integrated plan aggregate; step-transaction doctrine may apply |
| Multiple transferors | §351(a) "one or more persons" - aggregate contributions; control group must hold 80%/80% in aggregate immediately after |
| Pre-existing corporation | §351 works for new and existing corporations; control measured after the transfer regardless of corporation's pre-existing ownership |
| Stock issuance to new investor concurrent | If new investor receives stock in same plan, transferor group's control percentage may drop below 80% - destroys §351 if not careful |
| Loss not recognized either | §351 is nonrecognition - both gain AND loss deferred; basis preserves loss for later recognition on disposition |
| Control Test Element | Detail |
|---|---|
| Voting stock test | Transferors must own 80% of total combined voting power of all classes of stock entitled to vote |
| Nonvoting stock test | Transferors must own 80% of total number of shares of EACH OTHER class (not aggregated across classes) |
| "Vertical" test per class | Each nonvoting class tested separately; failing 80% on any single nonvoting class breaks control |
| Attribution | §368(c) does NOT apply §318 attribution; each transferor counted individually; family/entity ownership generally not attributed |
| Treasury stock | Not outstanding for purposes of 80% test; only outstanding shares count |
| Group transferors | Multiple transferors aggregated only if all are "persons" who transferred property and received stock in same transaction |
| Failure consequences | If control fails, ENTIRE transfer is taxable; not partial - all gain recognized at FMV minus basis |
| Concurrent third-party issuance | Stock issued to third-party investor in same plan dilutes transferor control; can destroy 80% test |
| Service-only shareholders | Stock for services not property; service-only shares don't count toward transferor group's 80%; Rev. Proc. 77-37 safe harbor: service shareholder must contribute property >10% of FMV of stock received |
| "Accommodation" property transfer | Small property transfer by service provider purely to qualify - IRS may disregard if not "more than nominal" |
| Boot Element | Detail |
|---|---|
| Definition | Anything received in exchange other than stock of transferee corporation - cash, notes, debt instruments, other property |
| Gain recognition | §351(b) - gain recognized to the LESSER of (i) FMV of boot received OR (ii) realized gain on the exchange |
| Loss never recognized | §351(b)(2) - loss never recognized even when boot received; loss carries forward in basis |
| Character of gain | Same as character of property transferred - capital, ordinary, §1245, §1250 recapture; allocation pro rata |
| Allocation rules | If multiple assets transferred with mixed character, boot allocated proportionally based on FMV; gain computed per asset |
| Nonqualified preferred stock §351(g) | Specified preferred features = treated as boot, not stock |
| Securities and debt instruments | Securities of transferee corp received in exchange = boot per §351(a) "solely for stock"; pre-2001 rule allowed securities as nonrecognition |
| Basis adjustment §358(a)(1) | Stock basis = property basis MINUS FMV of boot received PLUS gain recognized |
| Boot received takes FMV basis | Boot received takes its own basis = FMV at distribution |
| Holding period | Stock receives tacked holding period from property if capital asset / §1231; boot received starts new holding period |
Facts: Anna and Frank form Newco, Inc. in 2026. Anna contributes:
- Manufacturing equipment: basis $50,000, FMV $200,000
- Cash: $50,000
Frank contributes:
- Patent portfolio: basis $10,000, FMV $250,000
In exchange, each receives 500 shares of Newco common stock (1,000 total outstanding). Sarah (CTO) also receives 100 shares of restricted stock for services rendered.
§351 control analysis:
Sarah's 100 shares for services - NOT property contribution; do NOT count toward control group
Newco total outstanding: 1,100 shares
Anna + Frank own: 1,000 / 1,100 = 90.9%
90.9% > 80% threshold → §351 CONTROL satisfied → nonrecognition for Anna and Frank
Anna's transfer:
Property transferred: $50K equipment + $50K cash = $100,000 total basis
FMV of property: $200K + $50K = $250,000
Stock received: 500 shares Newco
No boot received → no gain recognition
Anna's basis in 500 shares: $100,000 (substituted basis §358(a)(1))
Newco's basis in equipment: $50,000 (carryover §362(a)); in cash: $50,000
Anna's holding period in stock: tacked from equipment (capital asset)
Frank's transfer:
Property: patent basis $10,000, FMV $250,000 (built-in gain $240,000)
Stock received: 500 shares Newco
No boot → no gain recognition
Frank's basis in 500 shares: $10,000
Newco's basis in patent: $10,000 (carryover)
Built-in gain $240K preserved at corporate level
Sarah's stock for services:
NOT a §351 transfer; treated under §83
Sarah recognizes ordinary compensation income on 100 shares at FMV
If FMV per share = $500 (matching Anna/Frank stock value), Sarah includes $50,000 ordinary income
Sarah should file §83(b) election within 30 days if shares subject to vesting
Newco gets §83(h) deduction matching Sarah's income inclusion
What if Frank also received $50,000 cash boot:
Frank's realized gain: $250K FMV minus $10K basis = $240,000
Boot received: $50,000
§351(b) gain recognized: LESSER of $50,000 boot OR $240,000 realized = $50,000 recognized
Frank's basis in 500 shares: $10,000 - $50,000 + $50,000 = $10,000
$240,000 - $50,000 = $190,000 built-in gain preserved in stock
Character: patent is §1221 capital asset → $50,000 long-term capital gain (if 1-year holding)
Newco basis in patent (with boot):
§362(a) - carryover basis $10,000 PLUS gain recognized by transferor $50,000 = $60,000
| §357 Element | Detail |
|---|---|
| General rule §357(a) | Corporation's assumption of transferor's liabilities NOT treated as boot - despite providing equivalent value to transferor |
| Tax-avoidance liabilities §357(b) | If principal purpose of liability assumption was tax avoidance OR not bona fide business purpose, ALL assumed liabilities treated as boot - large potential trap |
| Liabilities exceeding basis §357(c) | If aggregate liabilities assumed EXCEEDS aggregate adjusted basis of property transferred, the EXCESS is GAIN RECOGNIZED (capital or ordinary per character of underlying assets) |
| §357(c)(1) gain recognition | Cannot be deferred; cash-method service businesses with high receivables (no basis) often trip this when incorporating |
| Exception §357(c)(3) - deductible liabilities | Liabilities that would give rise to deduction when paid (e.g., accounts payable for cash-basis taxpayer) excluded from §357(c) computation |
| Aggregation across transferors | §357(c) computed PER TRANSFEROR, not aggregated across transferor group |
| Recourse vs nonrecourse | Generally treated equivalently for §357; substance over form |
| Strategy: contribute additional basis | Transferor can contribute cash or higher-basis property to bring aggregate basis above liabilities and avoid §357(c) gain |
| Basis effect §358(d) | Liabilities assumed reduce transferor's stock basis dollar-for-dollar |
| Conversion of partnership to corp | Common §357(c) trap - cash-basis partnership with receivables (zero basis) plus payables; structure carefully to avoid gain recognition |
| Basis Element | Detail |
|---|---|
| Transferor's stock basis §358(a)(1) | Substituted basis = adjusted basis of property MINUS FMV of boot/liabilities assumed PLUS gain recognized to transferor |
| Transferor's boot basis §358(a)(2) | FMV at distribution date |
| Corporation's property basis §362(a) | Carryover basis = transferor's basis PLUS gain recognized by transferor |
| §362(e)(2) anti-loss-duplication | Where aggregate built-in losses > aggregate built-in gains, corporation's basis in built-in-loss property reduced to FMV (stepped DOWN) - or transferor can elect to step DOWN stock basis instead under §362(e)(2)(C) |
| Loss duplication purpose | Prevents duplicating loss at both transferor and corporation levels; one loss only |
| §362(e)(2)(C) basis-shift election | Transferor and corporation jointly elect to reduce stock basis (preserving full asset basis at corp level); election irrevocable |
| Holding period §1223(1) | Transferor's stock holding period = tacked from property holding period IF property is capital asset or §1231 property; otherwise starts new |
| Corporation's holding period §1223(2) | Tacked from transferor |
| Multiple-asset transfer | If both capital and ordinary property contributed, stock receives blended/split holding period based on FMV allocation |
| Statement Reg §1.351-3 | Both transferor and corporation attach §351 statement to first return: description of property, FMV, basis, stock received, etc. |
Stock issued for services is not a property contribution and does NOT count toward 80% test. Practitioner who lets a service founder receive equity at formation without proper property contribution can break §351 control and turn the entire deal taxable. Rev. Proc. 77-37 safe harbor: service shareholder should also contribute property >10% of FMV of stock received.
Stock issued to a new outside investor in the same plan dilutes the transferor group's control. Practitioner forming a corporation and simultaneously raising equity from a VC must carefully time and structure - if VC takes >20% at formation, §351 control fails.
Liabilities assumed in excess of aggregate property basis = gain recognized §357(c). Common trap on cash-basis service business incorporation (high receivables with zero basis + payables). Cure by contributing additional cash/high-basis property.
§357(c)(3) excludes cash-basis payables (would be deductible when paid) from the §357(c) liabilities-over-basis computation. Practitioner including all payables in the §357(c) test overstates gain recognition.
§351 nonrecognition does NOT apply if transferee is an "investment company" - corp with >80% of assets in stocks, securities, money, certain derivatives - PLUS the transaction results in diversification of transferors' interests. Practitioner contributing portfolio assets to a holding corp can inadvertently trigger §351(e).
§351(g) - preferred stock with mandatory redemption, holder put within 20 years, issuer call where redemption likely, or interest-rate-linked dividends is treated as BOOT, not stock. Practitioner issuing preferred without checking §351(g) features can inadvertently trigger gain recognition.
§351(b)(2) - loss is NEVER recognized in a §351 exchange, even when boot received. Practitioner expecting to recognize loss via partial-boot structure is wrong; loss preserved in stock basis.
If aggregate built-in losses exceed aggregate built-in gains, §362(e)(2) reduces corporation's basis in loss property to FMV - eliminating duplicated loss. Transferor can elect §362(e)(2)(C) to step DOWN stock basis instead, preserving full asset basis. Practitioner ignoring §362(e)(2) misstates basis on both sides.
"Immediately after" judged on integrated-plan basis; near-simultaneous transfers can be aggregated. Practitioner separating transactions in time without genuine business purpose may have steps collapsed - changing control percentage and breaking §351.
Reg §1.351-3 - both transferor and corporation must attach a §351 statement to their first return: property description, FMV, basis, stock received, liabilities assumed, etc. Practitioner omitting the statement creates audit exposure.
§1223(1) tacks holding period only for capital and §1231 property. Inventory and other ordinary-character property starts a new holding period on stock received. Practitioner applying tacking to all property miscalculates LTCG on later stock sale.
§351 works for transfers to existing corps, but transferors must control corp immediately after. Practitioner transferring property to a 60%-owned existing subsidiary may fail control test even with a "controlled" entity.
§357(b) treats ALL assumed liabilities as boot if any liability had tax-avoidance principal purpose. Practitioner allowing transferor to dump tax-motivated liabilities into corporation can blow up entire §351 transfer.
Inventory is property under §351 but its character flows through for gain recognition and stock holding period. Practitioner not segregating ordinary-character assets misallocates boot gain character.
Self-created goodwill, going concern value, customer lists ARE "property" for §351 purposes if associated with active trade or business. Valuation often disputed; document with appraisal at formation.
§1245/§1250 recapture potential preserved in transferor stock basis and corporation property basis; recapture eventually recognized on disposition. Practitioner overlooking recapture potential miscalculates long-term tax exposure.
Primary authority: IRC §351 (Transfer to corporation controlled by transferor). §351(a) (general rule - nonrecognition). §351(b) (boot - gain to lesser of boot FMV or realized gain; loss never recognized). §351(c) (special rule for subsidiary stock distributions). §351(d) (items not treated as property - services, indebtedness of transferee, interest). §351(e) (investment company exception). §351(f) (treatment of installment obligations). §351(g) (nonqualified preferred stock as boot). §351(h) (cross references). §357 (assumption of liability). §357(a) (general rule - not boot). §357(b) (tax-avoidance purpose). §357(c) (liabilities in excess of basis - gain recognized). §357(c)(3) (deductible liabilities exception - accounts payable). §358 (basis to distributees). §358(a)(1) (substituted basis to transferor). §358(a)(2) (basis of boot). §358(d) (liabilities reduce stock basis). §362 (basis to corporations). §362(a) (carryover basis in property received). §362(e)(2) (anti-loss-duplication - basis reduction for built-in-loss property). §362(e)(2)(C) (transferor election to reduce stock basis instead). §368(c) (control definition - 80% voting + 80% each nonvoting class). §1223 (holding period). §1223(1) (transferor's stock - tacked if capital or §1231). §1223(2) (corporation's property - tacked). §83 (property transferred in connection with services). §83(h) (employer deduction). §1221 (capital asset). §1245 (depreciation recapture). §1250 (real property recapture). §1366 (S corporation pass-through). §1361 (S corporation election). §1202 (qualified small business stock - original-issue requirement). §7701 (definitions). Reg §1.351-1 through §1.351-3. Reg §1.351-1(a) (transferor and control group). Reg §1.351-1(b) (control test). Reg §1.351-1(c)(1) (investment company). Reg §1.351-3 (statement requirement). Reg §1.358-1, -2, -6 (basis). Reg §1.362-1 (corporation's basis). Reg §1.362-4 (loss duplication). Reg §1.368-1(b) (continuity of interest doctrine analog). Rev. Proc. 77-37 (10% safe harbor for service-shareholder property contribution). Rev. Rul. 68-55 (allocation of boot among multiple assets). Rev. Rul. 83-34 (§351 step-transaction analysis). Rev. Rul. 84-111 (partnership-to-corporation conversion). Commissioner v. Court Holding Co., 324 U.S. 331 (1945) (step transaction). Form 1120 (corporate tax return). Form 7004 (extension).