Corporation Capital Contributions (paid-in capital) 351 and 1023 exchanges
Transfers of Property can be technical. Generally, when property is transferred to a corporation in exchange for stock, the transaction is treated as if the property were sold to the corporation at FMV.
• A corporation does not recognize gain or loss when it issues stock in exchange for cash or property. [IRC §1032]
• A shareholder does not recognize gain or loss upon contribution of cash in exchange for corporation stock. A shareholder may recognize gain or loss upon exchange of property for corporation stock.
• When services are performed in exchange for corporation stock, the FMV of the service is taxable compensation. The amount included in income is the shareholder’s basis in the corporation stock received.
Contributions to Corporation Capital by Non-shareholders: The basis of property contributed to a corporation by a non-shareholder is zero.
IRC §351 states "No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control…of the corporation." Non-recognition treatment does not apply to transfers of property to an investment company. Additionally, Cash Is considered property for purposes of Section 351.
With regards to the Stock Control Issue, Under §351, shareholder(s) control the corporation if, immediately after the transfer, they own at least: (1) 80% of the combined voting power of all outstanding voting stock, and (2) 80% of the shares of all other classes of corporation stock, this is not a maybe it is a must.
The Property Must Solely be in Exchange for Stock: Non-recognition of gain under §351 only apply to amounts paid "solely in exchange for stock." If the shareholder receives cash or other property in addition to corporation stock, gain will be recognized up to the amount of cash or FMV of other property received. Additionally, Securities are considered property for purposes of IRC §351.
How Must The Exchange Occur? According to Reg. §1.351-1(a)(1), the phrase "immediately after the exchange" does not necessarily require simultaneous exchanges, as long as the transfers are made pursuant to a predetermined agreement.
Is the Property Subject To Liabilities? Under a Section 351 exchange, if a corporation shareholder contributes property subject to liabilities, the shareholder’s basis in the corporation stock received is reduced by the amount of liability relief. Relief of liabilities is generally not considered in determining gain on the transaction. However, if liabilities exceed the shareholder’s adjusted basis in the property, gain is recognized on the excess, and the shareholder’s basis in the corporation stock is zero. (SEE IRC §357(c))
Technical Know-How: Property or Service? Technical know-how such as trade secrets or processes may be considered property for purposes of Section 351, even though related services are provided. The importance of the services to the principal business purpose is the main factor in making the determination.
Be Sure to Report the Transactions. When a Section 351 transfer occurs, the corporation and the controlling shareholders must attach a statement to their tax returns describing the details of the transaction.
Non-qualified Preferred Stock is Seen as Boot. Preferred stock is non-qualified if the Stockholder has the right to require the issuer or a related person to redeem or purchase the corporation stock; Issuer or a related person is required to redeem or purchase the corporation stock; on the issue date it is more likely than not that the right to redemption will be exercised; or Dividend rate varies with reference to interest rates, commodity prices, or other similar indices. Exceptions apply if the stock must be held for 20 years or more before redemption, or in cases of death, disability or mental incompetence of the owner. Applies to transfers made after 6/8/97.