Corporate Tax I, McMahon, Fall 2013
§ 351 Analysis – Even if Boot and/or Liabilities Involved, ALWAYS go through basic 351 Analysis First
I. If 351 does not apply, which means ordinary taxable exchange rules, then:
1. Any person or corp that transfers appreciated or depreciated prop to a Corp ordinarily recognizes a gain or loss if the FMV of the stock and any other prop received is different from the basis the person or corp had in the transferred prop.
a. EXCEPTION: § 267(only applies to losses). If a person transfers depreciated prop to a Corp that he either directly or indirectly owns more than 50% of the value of, then that person will not be allowed to deduct that loss. This rule also applies to transfers b/w two corps that are members of the same controlled group.
Also, if an individual transfers depreciated prop to a corp that his family (brothers and sisters, spouse, parents, grandparents, and children) owns either directly or indirectly more than 50% in value, then that individual will not be allowed to deduct that loss.
i. Unresolved issue here: if a person transfers depreciated prop to a corp in which he does not own more than 50% of before the transfer but owns more than 50% after the transfer, it is uncertain as to whether he will be able to deduct that loss from the exchange of the depreciated prop.
b. EXCEPTION: § 1239(a) for gain on depreciable prop – still will recog gain, but it may be recharacterized. Only applies to sales/exchanges b/w related parties. See Analysis on page 10.
2. Corp never recognizes gain or loss when it exchanges its own stock for prop transferred to the Corp. (Corp’s stock also includes NQPS-so Corp won’t recog gain or loss when it exchange NQPS w/ SH). CORP CAN RECOGNIZE A LOSS IF IT TRANSFERS OTHER PROP TO A SH IN AN EXCHANGE THAT DOESN’T GET §351 TREATMENT, BUT LOOK FOR § 267.
a. EXCEPTION: Corp may have to recognize gain or loss if it transfers other prop to the SH in the exchange, such as “boot” property. This will never apply if Corp transfers “boot” cash to SH bc nobody has basis in cash.
b. EXCEPTION: § 267. If a Corp when exchanging its stock for prop received from a SH also includes “boot” property in the exchange that is depreciated and the exchange is with an individual who owns either directly or indirectly (after applying the 267 stock attribution rules) more than 50% of the outstanding stock of the Corp, then the Corp cannot recognize any loss in exchanging that “boot” property with the SH.
3. Corp will recognize gain on prop besides its stock that it exchanges and will recognize loss on prop besides its stock that it exchanges UNLESS § 267 applies.
4. SH gets a FMV basis in the stock he receives and in any other prop he receives
5. Corp gets a FMV basis in the prop it receives
6. Both SH’s and Corp’s holding period begins on date after exchange (no tacking)
*If SH transfers APPRECIATED PROP to the Corp BUT does not receive anything in exchange, then the following occurs:
1. SH does not recognize any income (doesn’t get a deductible loss either)
2. SH’s basis in the stock of the Corp that he already owns increased by his basis in the transferred prop.
3. SH just keeps holding period that he had in the Corp stock before the transfer
4. Corp recognizes no gain or loss
5. Corp gets SH’s old basis in the prop (probably gets to tack holding period).
II. If SH transfers prop (most likely his own stock in a publicly traded corp) to an “investment company,” then § 351 does not apply, and the transfer is treated like any ol’ taxable exchange. § 351(e).
A. A corp is an “investment company” if the § 351 transaction results, directly or indirectly, in a diversification of the SH transferor’s interest and the transferee Corp is a regulated investment company, a real estate investment trust, or a Corp in which more than 80% of the value of the assets is held in readily marketable stocks or securities or similar transferable interests. § 1.351-1(c).
III. A Shareholder (SH) can only achieve sale treatment (thus no § 351 exchange treatment) if he ONLY receives property other than stock and/or NQPS as defined in § 351(g).
IV. REMEMBER: CORP NEVER RECOGNIZES GAIN OR LOSS IN A 351 TRANSACTION UNLESS IT DISTRIBUTES APPRECIATED “BOOT.”
How to satisfy 351 (Steps 1-3) – STOCK ATTRIB RULES DO NOT APPLY
1. Is there an identifiable group of person in controls immediately after the exchange? If yes, keep going with test. If no, then default sale/exchange rules.
a. Control means that transferor(s) must own at least 80% of voting stock AND at least 80% of the total number (not value) of all other shares of all other classes of nonvoting stock. §351 – §368 – §351(g). Thus, must separate each class of nonvoting stock into its own group, and the transferor group must at least 80% of each group of the nonvoting stock (determined by number of shares, not by value). Rev. Rul. 59-259.
i. Even if stock is labeled “PREFERRED voting stock,” it is still voting stock; thus, that “PREFERRED voting stock gets lumped in w/ the rest of the voting, and the transferor SHs must still own 80% or more of ALL the voting stock.
ii. NQPS counts as stock for purposes of 80% test; so, SH must also control at least 80% of NQPS after a transfer, assuming of course there is NQPS outstanding, which there may not be.
iii. There are planning opps here: if you have a lot of built-in-loss prop so you don’t want 351 to apply, you may want to give one SH who is only transferring services a different class of stock all by himself so the 80% test of ALL shares of ALL classes of stock is not met.
iv. What is Meant by Voting Power? Rev. Rul. 62-234 suggests that “control” means the % of the board of directors that the transferor group can elect. Thus, it is possible that a transferor group who only owns 75/100 of the voting shares after transferring prop to the Corp but that class of stock the transferor group owns allows the group to elect 80% of the board may still qualify for nonrecog treatment under 351. However, this Rev. Rul. Has not been cited by anybody since 1962; so, it would be risky to rely on it. Prob #3(c) on p. 17 of PB
b. SH can own a percentage before and then add a percentage later to get to 80% threshold. Stock ownership before transfer counts for the 80% test.
c. REMEMBER: STOCK ATTRIBUTION RULES OF 318 AND 267 DO NOT APPLY FOR PURPOSES OF 351. DON’T APPLY STOCK ATTRIBUTION RULES AFTER THE TRANSFER.
c. If a group, the members of group must have a common plan. You don’t have to have a simultaneous exchange by all the SHs to satisfy the “immediately after” requirement, but the SHs should have a common plan and proceed in an expeditious and orderly manner in executing that plan. §1.351-1(a)(1).
d. Look out for situations where SH transfers both prop and services in exchange for stock:
i. If SH transfers only services, then SH’s number of shares owned not counted for purposes of the at least 80% test. Thus, if SH transfers only services, and he receives more than 20% of the stock in the Corp, then 351 will not apply to the Corp Formation or contribution.
A. However, under §1.83-1(a)(1), if the stock received in exchange for servs is subject to a “substantial risk of forfeiture,” then the serv provider is not treated as owning the stock. Thus, there is uncertainty as to whether this language in 1.83-1(a)(1) applies to 351 exchanges. If it does, then the serv provider does not technically own the stock that she received for servs; thus, the Corp would still own the stock and the stock shares would not be included in the total number of shares outstanding, which makes it more likely that the other SHs still own all the stock or at least 80% of the stock. On the other hand, if the language in 1.83-1(a)(1) does not apply to 351 exchanges, then the serv provider is considered to own the stock, which means her stock will be counted as part of the total number of shares outstanding, and if she received that stock only for servs, then the transferor group will be considered as not owning the serv provider’s stock, which will likely blow the 351 nonrecognition.
ii. If SH transfers both prop and services, then SH’S total number of shares counted as part of “control group” for purposes of the 80% test as long as SH satisfies 10% safe harbor rule in Rev. Proc. 77-37.
ii. If SH transfers both prop and services, figure what proportion of the total FMV value of the stock received for both prop and services is compensation for services rendered for purposes of seeing if transfer by SH is an Accommodation transfer (see directly below).
e. Look out for Accommodation Transfers: Rev. Proc. 77-37. If the property that the SH transfers is NOT WORTH (according to FMV) at least 10% of the FMV of the stock that the SH is going to receive for services rendered or that the SH already owns, then that SH’s shares will not be counted when determining if the “control group” meets the “at least 80% test.” Thus, if shares not counted, 351 probably will not apply, so transaction treated like ordinary taxable exchange. (see rules for when 351 does not apply.) ALSO APPLIES WHEN ONE SH SIMPLY TRANSFERS PROP TO HELP ANOTHER SH GET NONRECOGNITION TREATMENT. IN THIS SCENARIO, SH MUST TRANSFER PROP HAVING A FMV OF AT LEAST 10% OF THE FMV OF THE STOCK HE ALREADY OWNS. IF NOT 10%, THEN NO § 351 TREATMENT.
i. Even if SH does not satisfy 10% safe harbor in Rev. Proc. 77-37 when transferring prop and services to the Corp, the stock can still qualify as part of the “control group” stock if SH can show that his primary purpose for transferring the prop in ques
effect on whether or not 351 applies b/c it is now considered a completely separate future transaction.
ii. If there is an underwriter in the question and it receives stock, then it must recognize service income equal to the FMV of the stock received. §83.
iii. If an underwriter is involved in issuing stock to the public, the underwriter is seen as simply a conduit, and the capital received by the underwriter by the public when the public buys the stock is looked at as if the public transferred cash straight to the newly formed Corp. Thus, the underwriter is disregarded for this purpose. §1.351- 1(a)(3). Therefore, if the SHs formed the Corp and at the time of formation, already had a binding agreement in place for the underwriter to sell stock to the public, then the formation and the public stock sale would be viewed as one transaction. Thus, the main SHs and the public would be the “control group” that would have to 80% or more of the Corp stock in order to qualify under §351.
iii. For the most part, view each transaction separately to see if satisfies the requirements of §351.
iv. Rev. Rul. 84-111: Pship transfers assets to its newly formed Corp, and it receives 100% of the Corp stock in return. The Pship liquidates and transfers the Corp stock to the Pners in proportion to their Pship interests. § 351 will apply here.
v. Rev. Rul. 83-34: If a Parent Corp owns 80% or more of its sub 1 and transfers assets to that sub 1 solely in exchange for more shares of sub 1. Then sub 1 transfers the assets it just received from its Parent to sub 2, which is a newly formed corp that sub 1 will own 80% of. An unrelated corp will own the remaining 20%. Both transaction qualify as § 351 transactions. (i.e. Rev. Rul. 83-34 is good for 2 drops).
v. Rev. Rul. 2003-51 – § 351 applies here; thus, nonrecognition
A. If SH receives stock in a §351 nonrecognition transaction and pursuant to a pre-arranged plan, transfer that stock to another in a NONTAXABLE TRANSACTION (such as another, subsequent §351 exchange), that will not prevent the transaction in which the SH first received the stock from still being classified as a §351 nonrecognition event.
B. Even though the W transferred the Z stock it received in the §351 transaction immediately after pursuant to a pre-arranged plan, § 351 still applied b/c the end result (nonrecognition) in this case could have been accomplished without W transferring the Z stock immediately after it received it. W simply could have transferred its business A assets to Y in exchange for stock at the same time X transferred $30k in cash to Y in exchange for stock. This would have qualified as a § 351 transaction. Then, Y Corp could have simply transferred the Business A assets and the $30k to Z Corp in exchange for all of the Z stock. This would have qualified as a §351 transaction. In the end, W and X would end up owing Y Corp, which would own Z Corp in turn. See Prob #2(b) on Trump on p. 14 b/c Rev. Rul. 2003-51 applies there – As long as SH keeps the “exchanged” basis throughout the course of these various transactions, §351 should apply.
