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A Section 351 exchange can defer gain when property is transferred to a corporation solely for stock and the transferors control the corporation immediately afterward. The result changes when the corporation assumes liabilities, when stock is issued for services, or when the 80% control test is not met. The key questions are what each person transferred, which obligations the corporation assumed, whether liabilities exceed the transferred property’s adjusted basis, and how the transaction changes stock and corporate asset basis.
What Section 351 does
Section 351(a) generally provides nonrecognition: no gain or loss is recognized when one or more persons transfer property to a corporation solely in exchange for stock and those transferors are in control immediately after the exchange. The Internal Revenue Service describes “control” by reference to Section 368(c). The rule is a deferral provision, not an exemption. Built-in gain generally remains embedded in the stock and the corporation’s assets through the basis rules.
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Three conditions drive the analysis:
- Property: Each relevant transferor must contribute property. Services are analyzed separately.
- Solely for stock: Cash, other property, or certain liability effects can create recognized gain even when the exchange otherwise qualifies.
- Immediate control: The contributing transferors, taken together where appropriate, must satisfy both 80% tests immediately after the exchange.
The Internal Revenue Service cautions that the Internal Revenue Code must be read with Treasury regulations and court decisions. Whether a particular formation, recapitalization, or contribution qualifies depends on the documents, asset bases, ownership rights, liability terms, and transaction sequence.
How the 80% control test works
Two separate 80% measurements
Section 368(c) control requires ownership of at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock. Both measurements must be met. Passing the voting test alone is not enough.
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| Control measurement | What must be owned immediately after the exchange | Common issue to verify |
|---|---|---|
| Voting power | At least 80% of the combined voting power of all voting classes | Different voting rights, voting agreements, and newly issued shares |
| Share count | At least 80% of the total number of shares of every other class | Nonvoting common or preferred shares and classes with separate rights |
“Immediately after” refers to the ownership position at the relevant exchange, not an informal intention to obtain control later. A service provider or another investor receiving shares in the same transaction can affect the denominator and therefore the 80% calculation. Count the shares and rights actually issued under the governing documents.
Group control
Section 351 allows one or more persons to transfer property in the same exchange. The control analysis generally considers the contributing transferors as a group, so an individual who contributes less than 80% can participate if the property contributors collectively satisfy both 80% tests immediately afterward. The ownership schedule should identify each transferor, the classes issued, voting rights, and the resulting percentages.
Control checklist
- List every class outstanding immediately after the exchange.
- Record the number of shares issued to each property contributor and to anyone receiving stock for services or another reason.
- Calculate combined voting power for all voting classes.
- Calculate the share count for all other classes.
- Confirm that the property contributors, considered under the transaction’s ownership structure, reach at least 80% in both calculations.
- Save the capitalization table, charter, stock-rights documents, and closing records supporting the calculation.
Why services are different from property
Stock for services is not stock issued for property
Treasury regulation text reproduced in Internal Revenue Service guidance states: “Stock will not be treated as issued for property if it is issued for services rendered or to be rendered to or for the benefit of the issuing corporation.” Stock issued for services therefore does not receive the same Section 351 property treatment as stock issued for contributed assets.
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Repair common Windows errors and clear accumulated junk for a smoother, more stable PC - no reinstall needed.Free scan · no reinstallA person who receives shares for performing work, consulting, organizing the business, or promising future services generally has a compensation transaction for that portion. The timing and amount of income, withholding, employment-tax treatment, and the recipient’s stock basis can depend on the applicable compensation and equity rules. Section 351 should not be used to label labor as property.
Mixed property-and-services transactions
Many incorporations contain both contributions and services. Allocate the exchange between the two components instead of treating the entire issuance as a single property transfer. The property portion is tested under Section 351; the services portion is analyzed under the compensation rules. The allocation should be supported by contemporaneous agreements, asset values, service descriptions, and the number and value of shares attributable to each component.
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| Transaction component | Section 351 treatment | What to document |
|---|---|---|
| Equipment, cash, inventory, intellectual property, or other property | Potentially qualifying property contribution, subject to control and other requirements | Ownership, adjusted basis, value, transfer instrument, and shares issued |
| Past or future services | Not treated as property for Section 351; analyze as compensation | Service agreement, duties, vesting or payment terms, and share allocation |
| One issuance covering both | Separate the property and service portions before testing nonrecognition | Valuation and a defensible allocation between components |
Illustration
Assume a founder transfers equipment with an adjusted basis of $40,000 and also agrees to provide management services. The corporation issues shares with an agreed total value of $100,000, of which $70,000 is attributable to the equipment and $30,000 to the services. The $70,000 property exchange is tested under Section 351. The $30,000 service portion is not property for that purpose and must be analyzed as compensation. If the service shares dilute the property contributors below either 80% threshold, the control test must be recalculated using the post-issuance capitalization table.
How assumed liabilities fit into a Section 351 exchange
General rule under Section 357(a)
When a corporation assumes a transferor’s liability as part of an otherwise qualifying Section 351 exchange, Section 357(a) generally provides that the assumption is not treated as money or other property received. The assumption therefore ordinarily does not, by itself, prevent nonrecognition.
That rule applies to a liability the corporation actually assumes or takes subject to under the transaction documents. Identify whether each obligation is transferred, assumed, left with the transferor, or secured by property but not assumed. The legal wording matters; do not use a single “debt assumed” number without reviewing the loan, lease, tax, employee, and contingent-obligation documents.
Section 357(b): a purpose-based exception
Section 357(b) is an anti-abuse exception. IRS technical guidance states that an assumption can be treated as money when its principal purpose is federal tax avoidance or, absent that purpose, when the arrangement lacks a bona fide business purpose. If Section 357(b) applies, the liability assumption can produce recognized gain under the general boot rules even though the transaction is otherwise structured as a contribution.
This is a facts-and-circumstances inquiry, separate from the numerical Section 357(c) test. A business should be able to explain why the corporation assumed the obligation: for example, because the liability finances an operating asset, is necessary to continue a business, or is part of an ordinary restructuring. A tax result alone is not a business purpose.
Section 357(c): liabilities greater than basis
Section 357(c) creates a separate mechanical gain rule. When liabilities assumed exceed the total adjusted basis of the property transferred, the excess is generally recognized as gain from the sale or exchange of the transferred property. This can apply even when there is no tax-avoidance purpose and the transaction has a genuine business purpose.
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| Adjusted basis of property transferred | Liabilities assumed | Potential Section 357(c) gain |
|---|---|---|
| $80,000 | $110,000 | $30,000 excess, generally recognized as gain |
| $150,000 | $120,000 | No Section 357(c) excess on these figures |
The table is an illustration, not a determination of the character or amount of gain in a real transaction. The computation uses the applicable adjusted bases and the liabilities treated as assumed under the governing regulations. A 2025 IRS proposed-regulation discussion provides additional rules for measuring recourse and nonrecourse liabilities for Sections 357 and 358. Because proposed regulations can change before finalization, confirm the rules effective for the transaction’s tax year.
Recourse and nonrecourse obligations
Measure each liability under the applicable regulations rather than assuming its face amount is always the relevant figure. Recourse debt, nonrecourse debt, guarantees, and contingent obligations can require different analysis. The 2025 proposed-regulation discussion is especially relevant to how liability amounts are determined for Section 357 and stock-basis computations. Keep a schedule showing the creditor, legal obligor, recourse status, principal or measured amount, and whether the corporation assumed or merely took property subject to the obligation.
Basis after the exchange
Transferor’s basis in stock: Section 358
The transferor’s basis in stock received is generally determined under Section 358. Start with the adjusted basis of the property transferred, then apply the statutory adjustments for recognized gain or loss, money or other property received, and liability rules. Liability-related reductions required by Section 358(d) and the applicable regulations can reduce stock basis even when the liability assumption does not itself trigger current gain under Section 357(a).
Because Section 358 adjustments are transaction-specific, maintain an asset-by-asset schedule. Separate property exchanged for stock from property treated as boot, identify any recognized gain, and record liabilities that remain with the transferor versus those assumed by the corporation. The resulting stock basis is important when the shareholder later sells, redeems, or exchanges the stock.
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Corporation’s basis in transferred assets: Section 362(a)
Under Section 362(a), the corporation generally receives a carryover basis in contributed property, subject to increases for gain recognized by the transferor and the statute’s other adjustments. The corporation does not generally receive a fresh fair-market-value basis merely because the assets are worth more than the transferor’s basis.
The corporate records should preserve the transferor’s historic basis, holding period where relevant, depreciation or amortization history, and any recognized-gain adjustment. A low carryover basis can produce future corporate gain when the corporation sells an appreciated asset, while a liability assumption may affect the shareholder’s stock basis and the Section 357 analysis separately.
Illustrative basis sequence
Suppose a shareholder contributes land with a $60,000 adjusted basis and the corporation issues only stock while assuming a $40,000 mortgage. If Section 351 and Section 357(a) apply and no other boot or recognized gain exists, the corporation generally takes a carryover basis in the land, subject to Section 362(a). The shareholder’s stock basis is then computed under Section 358, including the required liability-related adjustment. If the mortgage were $90,000 instead, the $30,000 excess over the $60,000 aggregate basis would raise a Section 357(c) gain issue before the stock-basis computation is finalized.
Comparing common transaction patterns
| Feature | Property-for-stock exchange | Property plus services | Property with assumed liabilities |
|---|---|---|---|
| What is transferred? | Property | Property and services, allocated separately | Property and specified obligations |
| Control test | Property contributors must satisfy both 80% tests immediately after | Recalculate ownership after service shares are issued | Same 80% tests; debt does not replace the ownership analysis |
| Primary tax risk | Failure of property, stock-only, or control requirements | Service shares treated as compensation, plus possible dilution | Section 357(b) purpose exception or Section 357(c) excess-liability gain |
| Basis work | Sections 358 and 362 carryover framework | Separate stock and compensation basis consequences | Sections 358 and 362 plus liability measurement |
A practical review procedure
- Map the transaction. List every transferor, asset, service commitment, share class, share recipient, liability, and closing date.
- Classify each contribution. Mark each item as property, service, money, or a liability-related item. Do not combine labor with contributed assets.
- Determine adjusted bases. Use tax basis rather than book value or an informal estimate, and document the basis of each transferred asset.
- Build the post-closing capitalization table. Include voting and nonvoting classes, preferred rights, service shares, and any other issuance occurring as part of the plan.
- Run both 80% calculations. Test voting power and total shares of other classes independently.
- Inventory liabilities. For each obligation, identify the legal obligor, recourse or nonrecourse status, amount measured under applicable rules, and whether the corporation assumed it.
- Test Section 357(b). Record the commercial reason for each assumption and assess whether any principal purpose was federal tax avoidance or whether a bona fide business purpose is absent.
- Test Section 357(c). Compare liabilities treated as assumed with the aggregate adjusted basis of the transferred property. Any excess is a potential recognized gain.
- Compute basis. Apply Section 358 to the shareholder’s stock and Section 362(a) to the corporation’s assets, including recognized-gain and liability adjustments.
- Retain evidence. Keep contribution agreements, loan documents, valuations, service contracts, capitalization tables, basis schedules, and board approvals with the tax file.
Frequent mistakes and how to correct them
Calling services “property”
Labor, consulting, and promises to work are not property for the Section 351 issuance rule. Correct the analysis by allocating service shares and reporting the compensation component under the applicable rules.
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An ownership schedule can show 80% voting power while failing the 80% share-count test for other classes. Calculate both tests using the actual class rights.
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Assuming every debt assumption is tax-free
Section 357(a) is the general rule, not a blanket result. Check the Section 357(b) purpose exception and the Section 357(c) excess-liability rule independently.
Using book basis or fair value in the Section 357(c) test
The comparison is to adjusted tax basis, not financial-statement carrying value or current market value. Reconstruct basis from tax records before calculating the excess.
Ignoring proposed-rule changes
Liability-measurement details can change as regulations move from proposed to final form. Verify the law and effective dates that apply to the filing year.
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When professional review is warranted
Obtain advice from a Section 351 tax adviser or corporate-formation tax counsel before closing when the transaction includes substantial debt, nonrecourse financing, contingent obligations, service equity, multiple stock classes, or a control percentage close to 80%. A tax professional can reconcile the legal documents with the basis schedules and determine whether recognized gain, compensation income, withholding, or reporting obligations arise.
No short checklist can guarantee qualification. The controlling facts include the actual asset bases, liability documents, stock rights, services, ownership percentages, business purpose, and sequence of the steps.
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