A Denver tax attorney and business attorney at The McGuire Law Firm can assist clients with the formation and structure of corporations. The article below outlines the tax implications when contributing property to a corporation in exchange for stock.
Many business owners inquire as to their gain or loss recognition when contributing property to a corporation in exchange for stock, as well as the implications to the corporations. While certain business transactions may require the recognition of gain or loss, it is possible for gain or loss to be avoided.
In general, a corporation does not recognize gain or loss upon the issuance or sale of its own stock under IRC Section 1032. Although, IRC Section 1001 treats the transfer of property for stock in a corporation as a sale where gain or loss is recognized under IRC Section 1002, IRC Section 351 may be able to avoid this gain recognition.
For IRC Section 351 to apply one or more persons must transfer property to a corporation; the transfer must be solely in exchange for stock in such corporation; and, the transferors must control the corporation immediately after the transfer and “control” is defined as 80% or more under IRC Section 368(e). If Section 351 does not apply, gain or loss will be recognized under Section 1001. Furthermore, Section 351 is mandatory and not an election.
The statute does not define “property” but “property” includes cash as well as tangible and intangible property. Regarding intangible property, if the property has value separate and apart from the existence of the business, it is considered property. It is important to note that services are not considered property; however, the stock issued for the performance of services does not necessarily cause the transfer to fail to qualify as a Section 351 transfer. Under such circumstances the person receiving the stock for the performance of services is not counted or considered when the 80% control requirement is calculated.
If non-qualified preferred stock is issued by the corporation, this non-qualified preferred stock is treated as “boot” for purposes of gain when received in exchange for property that is transferred to a controlled corporation.
The Receipt of “Boot”
If a shareholder (transferor) receives money or property in addition to the stock, this money or property is considered “boot.” If a shareholder does receive boot through the transaction, gain is recognized at the lesser amount of the realized gain or the boot received. The receipt of a short term note or certain stock rights and warranties would be considered boot, but debt is not considered boot although it would lower basis.
This article has been prepared by John McGuire. John is a business attorney and tax attorney working with individuals and businesses regarding issues from taxation and contracts to the formation and sale of business entities. Contact a tax attorney and business attorney at The McGuire Law Firm to assist you with the formation and structure of business entities as well as the tax implications to the business & business owners.
You can schedule a free consultation with a small business attorney in Denver by contacting The McGuire Law Firm. John@jmtaxlaw.com