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A Section 351 exchange generally qualifies for nonrecognition when one or more persons transfer property to a corporation solely for its stock and, immediately afterward, those transferors control the corporation. Control means at least 80% of the total voting power of all voting classes and at least 80% of every other class of stock under IRC §368(c). Cash or other property received with the stock can trigger current gain, liabilities require a separate analysis, and the corporation and each participating person must attach the required factual statement to the return for the exchange year.
The qualification test at a glance
Section 351 is a deferral rule, not a permanent exemption. The transaction must satisfy several requirements at the same time. A failure in one area can change the tax result even when the overall business purpose is to incorporate assets.
| Requirement | What must be established | Why it matters |
|---|---|---|
| Property transfer | One or more persons transfer identified property to a corporation and document ownership, adjusted basis and fair market value. | The statutory rule applies to property transferred to a corporation in exchange for stock. |
| Stock consideration | The intended consideration is stock of the corporation. | An exchange solely for stock can qualify for full nonrecognition; money or other property is potential boot. |
| Immediate control | Immediately after the exchange, the transferor or transferor group owns at least 80% of total voting power and at least 80% of every other stock class. | This is the statutory control test under IRC §368(c). |
| Boot review | Inventory cash, securities, debt instruments and other property received by each transferor. | Section 351(b) can require gain recognition up to the money and fair market value of other property received; it does not recognize a loss. |
| Liability review | List liabilities assumed or taken subject to and test the applicable exceptions and excess-liability rules. | Liabilities are not simply treated as cash or other property under the general boot rule. |
| Reporting | The corporation and each person involved attach the complete statement of facts required by Treasury Regulation §1.351-3. | The statement must accompany the relevant returns for the exchange year. |
IRC §351(a) expresses the core rule: “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.”
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Step 1: Identify the property and establish its tax history
Start with an asset-by-asset schedule rather than a description such as “the business” or “all operating assets.” For every item proposed for contribution, record the legal owner, a description, adjusted tax basis, fair market value, and the stock issued in return. Keep the valuation date consistent with the closing date and preserve the documents supporting both basis and value.
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Build a contribution schedule
- List tangible assets, contractual rights, securities, intellectual property and other property being transferred.
- Identify the person or persons that own each asset immediately before the exchange.
- Record each asset’s adjusted basis and fair market value as of the transfer.
- Map each contribution to the stock issued and to the recipient corporation.
- Flag assets with built-in appreciation or built-in loss for later basis and disposition modeling.
Do not assume that every item used by a business is owned by the person signing the exchange documents. A title, assignment, partnership agreement, loan document or other restriction may affect whether the intended transfer can occur. Contributions involving services, foreign corporations, or other specialized provisions require additional analysis beyond this basic property checklist.
Step 2: Confirm that the intended consideration is stock
For full nonrecognition under Section 351(a), the property is transferred solely for stock of the corporation. Before closing, compare the term sheet, subscription agreement, capitalization table and closing statement. Any amount shown as cash, a note, securities or other property received by a transferor is a potential boot item and should not be hidden in a general “purchase price” figure.
Separate stock from everything else
Prepare a consideration schedule for each transferor. It should state the number and class of shares issued, the value assigned to any nonstock item, and when each item is delivered. A transferor can receive stock and still have current gain because of boot; the presence of boot does not automatically make the entire exchange taxable, but it removes the assumption of complete nonrecognition.
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Step 3: Test the 80% control requirement immediately after closing
The control test is measured immediately after the exchange, not at the start of negotiations and not at a later date when the corporation may have issued additional shares. Under IRC §368(c), the transferor or transferor group must own at least 80% of the combined voting power of all classes entitled to vote and at least 80% of the shares of every other class.
Measure both voting and nonvoting ownership
| Ownership measurement | Minimum immediately after the exchange | Common review question |
|---|---|---|
| Combined voting power | At least 80% of the total voting power of all voting classes | Do the transferors control enough votes after all issued voting shares and voting rights are counted? |
| Each other stock class | At least 80% of the shares in every class that is not part of the voting-power calculation | Does a separate preferred or other nonvoting class leave the transferors below 80%? |
Use the capitalization table that exists immediately after the exchange, including shares issued to nontransferors as part of the same closing. Count classes separately; 80% of total equity is not a substitute for 80% of voting power and 80% of every other class.
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Document the closing capitalization
- List every outstanding class and the number of shares or units in that class immediately before the exchange.
- Add the shares issued for each property contribution and any shares issued to other persons at the closing.
- Calculate the transferor group’s voting percentage across all voting classes.
- Calculate the transferor group’s percentage in each other class.
- Attach the final capitalization table and governing stock terms to the transaction file.
A transfer that leaves the contributors with 79% of a relevant class does not satisfy the stated 80% threshold merely because they hold a large economic interest in the corporation. If a planned issuance would reduce control, resolve the capitalization problem before the exchange rather than relying on a later correction.
Step 4: Determine whether several contributors can be counted together
Several persons can be tested as a group when they transfer property as part of one transaction. Their interests may be aggregated for the immediate-control test. The documents should therefore show that the contributions, stock issuances and closing are parts of the same exchange rather than unrelated transfers occurring at different times.
Evidence that the contributions are one transaction
- A coordinated contribution agreement or closing agenda.
- Cross-referenced stock-issuance records showing the same exchange date.
- A unified capitalization table immediately after closing.
- Consistent descriptions of the transferred assets, consideration and ownership in the parties’ records.
Aggregation does not eliminate the need to analyze each person’s property, basis, value, boot and liabilities. It only addresses how the control percentage may be measured when the contributors participate in the same transaction.
Step 5: Inventory and price every item of boot
Boot is money or other property received in addition to stock. Section 351(b) recognizes gain up to the amount of money and the fair market value of other property received. The rule does not recognize a loss. Review the consideration from each transferor’s perspective, because one person’s cash or property receipt does not disappear when another person receives only stock.
Items to check
- Cash paid at closing or shortly afterward as part of the exchange.
- Securities or debt instruments delivered to a transferor.
- Nonstock property distributed with the shares.
- Any side agreement that gives a transferor an asset in addition to the stock described in the main agreement.
For each item, record the amount or fair market value, recipient, delivery date and contractual reason. Compare the total boot with the gain inherent in the contributed property under the applicable basis rules. For example, if a transferor contributes property with $100,000 of value and receives stock plus $8,000 of cash, the cash is a potential current-gain trigger even though the stock portion may otherwise qualify. The recognized gain cannot exceed the applicable boot amount, and the exact computation depends on the transferor’s realized gain and other current-Code rules.
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Step 6: Analyze liabilities as a separate workstream
A corporation’s assumption of a liability is not simply treated as cash or other property under the general Section 351 boot rule. Liability exceptions and excess-liability gain rules require a separate, current-Code analysis. The precise Section 357(c) computation depends on the facts and is not captured by the basic stock-and-boot checklist.
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Liability file to prepare
- List every liability connected with the contributed property.
- Identify the legal obligor before the exchange and the party responsible after closing.
- Record the principal amount, accrued amounts, collateral and any guarantees as of the exchange date.
- Describe whether the corporation assumes the liability, takes property subject to it, or leaves it with the transferor.
- Have a tax professional test the applicable liability exceptions and excess-liability rules before filing.
Do not describe an exchange as “tax-free because the corporation assumed debt.” The assumption may be neutral under one rule and produce gain under another, depending on the liabilities and the transferor’s basis.
Step 7: Prepare the required tax-return statement
IRS Publication 542 states that the corporation and each person involved in a nontaxable exchange must attach the complete statement of facts required by Treasury Regulation §1.351-3 to the return for the year of the exchange. Treat this as a closing deliverable, not an optional narrative prepared only if the IRS asks questions.
Assemble the statement support
- The names and identifying information of the corporation and every participating person.
- A description of each property contribution and the date transferred.
- The adjusted basis and fair market value records used for the exchange.
- The stock class and amount issued to each transferor.
- Cash or other property received by each person.
- Liabilities connected with the property and the treatment agreed at closing.
- The capitalization table demonstrating immediate post-exchange control.
- Copies of the executed agreements and valuation support.
The regulation determines the complete contents of the statement. Use the current version of the regulation and the current return instructions when preparing the filing, and make sure the corporation and every participating person attach consistent information.
What “tax-deferred” means after a successful exchange
Section 351 generally defers recognition; it does not erase built-in gain. The appreciation or other tax history of contributed property remains relevant to the corporation’s and transferor’s future tax results. Stock and asset basis records therefore need to be preserved from the contribution through any later sale, redemption, liquidation or other disposition.
Before closing, model at least two later events: a disposition of the corporation’s contributed property and a disposition of the stock received by the transferor. The model should use the documented adjusted basis, fair market value, stock received, boot and liabilities. A transaction that produces no current gain can still create a substantial tax bill when the property or stock is later sold.
Worked examples of the qualification mechanics
Example 1: Stock only and full control
Alex transfers an investment property to a corporation solely for common stock. Immediately after the exchange, Alex owns 100% of the voting power and 100% of every other class. There is no cash, note, security or other property. The basic Section 351 requirements are satisfied on these facts, so the exchange is generally eligible for nonrecognition, subject to the required statement and any additional provisions that apply to the property or corporation.
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Example 2: Stock plus cash
Jordan transfers appreciated equipment and receives common stock plus $8,000 in cash. Jordan’s cash receipt is boot. Section 351(b) can require current gain recognition up to the $8,000 of money received, even if Jordan and the corporation otherwise satisfy the property, stock and control requirements. The filing records should show the equipment’s basis and value, the stock issued and the cash paid separately.
Example 3: Several contributors
Alex and Priya contribute property under one coordinated closing. Together they receive 90% of the voting power and at least 80% of every other stock class immediately afterward. Their interests may be aggregated for the control test because the contributions are part of the same transaction. Each person still needs an individual schedule of property, basis, value, stock, boot and liabilities, and each must attach the required statement to the relevant return.
Example 4: Control lost through another class
Three contributors receive 85% of the voting power but only 75% of a separate preferred class issued at the same closing. The voting percentage alone is insufficient. Because the transferor group does not own at least 80% of every other class, the transaction requires a different analysis before it can be treated as qualifying under the basic Section 351 test.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.Section 351 compared with a taxable sale or another restructuring
Choosing a Section 351 contribution is a structuring decision, not merely a form choice. Compare the alternatives using the same facts and the same closing date.
| Decision factor | Section 351 contribution | Taxable sale or different restructuring |
|---|---|---|
| Immediate gain | Generally deferred when the statutory requirements are met; boot can create current gain. | Analyze the immediate gain or loss under the sale or restructuring rules that apply. |
| Ownership and voting control | Transferors must meet the immediate 80% control test. | Ownership can be arranged differently, but the Section 351 control test may not apply. |
| Cash or other property | Inventory as boot; money and other property can trigger gain. | Include all nonstock consideration in the sale or exchange computation. |
| Liabilities | Test liability exceptions and excess-liability rules separately. | Apply the liability rules governing the selected transaction. |
| Stock classes | Review voting power, every other class and possible nonqualified preferred stock issues. | Review the equity and debt terms under the rules governing that structure. |
| Later exit | Preserve basis records because deferred built-in gain can matter on a later disposition. | Model the basis and later tax consequences created at the initial closing. |
| Documentation | Prepare the §1.351-3 factual statement for the corporation and each participating person. | Prepare the agreements and tax reporting required for the chosen alternative. |
Common failure points and how to correct them
The capitalization table is prepared too late
If the final table reveals less than 80% ownership in a voting or other class, recalculate before closing. Do not rely on an informal promise that shares will be transferred later; the test is immediate.
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Reconcile the closing statement, escrow instructions, promissory notes and ancillary agreements. Classify every item delivered to a transferor and have the tax preparer evaluate whether it is boot.
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Liabilities are netted against value without analysis
Show liabilities separately from asset value and stock consideration. Obtain a current analysis of the applicable liability provisions instead of assuming debt relief is tax-neutral.
Preferred terms are treated as cosmetic
Read the complete charter and stock agreement. A separate class or nonqualified preferred-stock feature can affect the Section 351 result even when the headline ownership percentage looks adequate.
The parties file inconsistent statements
Use one controlled transaction schedule for the corporation and all transferors. Differences in asset descriptions, values, dates or stock amounts can undermine the factual statement required by §1.351-3.
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Carry the basis and valuation records into the corporation’s books and each transferor’s stock file. Identify the later sale or disposition that could bring deferred gain into income.
Closing checklist
- Identify every property asset, owner, adjusted basis and fair market value.
- Confirm the corporation is issuing stock as the intended consideration.
- List cash, securities, debt instruments and other property received by each transferor.
- Prepare the immediate post-closing capitalization table.
- Verify at least 80% of total voting power and at least 80% of every other class.
- Document why multiple contributions are part of one transaction if aggregation is needed.
- List liabilities and obtain a separate analysis of the applicable exceptions and excess-liability rules.
- Review preferred-stock and nonqualified preferred-stock issues.
- Assemble the facts required by Treasury Regulation §1.351-3.
- Have the corporation and each participating person attach consistent statements to the exchange-year returns.
- Model later dispositions so the deferred built-in gain and basis consequences are understood.
Primary authorities and limits of the checklist
The controlling framework is IRC §351 and the 80% control definition in IRC §368(c), together with Treasury Regulation §1.351-1 and the reporting requirement in Treasury Regulation §1.351-3. IRS Publications 542 and 544 provide explanatory guidance, including the filing statement and the relevance of Section 351(g). An IRS written determination may help explain an issue but is not precedent for other taxpayers.
Tax results can change with statutory amendments and with provisions involving liabilities, foreign corporations, services, preferred stock and the exact transaction documents. Have a qualified tax professional review the current Code, regulations, return instructions and closing documents before filing.
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