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For a domestic Section 351 exchange, prepare an asset-by-asset basis and fair-market-value schedule, attach the statement required by Treasury Regulation §1.351-3 to the federal return for the exchange year, and report any recognized gain from money or other property received. A transfer to a foreign corporation may also require Form 926, filed with the income-tax return for the year that includes the transfer date. The correct income-tax line depends on the taxpayer type and the facts; there is no universal Form 1040 line for every Section 351 exchange.
Start by confirming that Section 351 applies
Section 351 is generally a nonrecognition rule. Internal Revenue Code §351(a) provides: “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 (as defined in section 368(c)).” When the requirements are met, the transfer is usually tax-deferred rather than taxable immediately.
Property must be exchanged for stock
Cash, equipment, inventory, real estate, intellectual property and other assets can be property for this purpose. Services are not property. If a person receives stock for performing services, that portion is analyzed under compensation rules rather than Section 351. Separate the service component from any property contribution in the closing documents and tax workpapers.
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The transferor or transferors must control the corporation immediately after the exchange under the Section 368(c) test. In general, that means at least 80 percent of the total voting power and at least 80 percent of each class of nonvoting stock, subject to detailed attribution and transaction-specific rules. Record ownership percentages immediately after the closing, not merely the percentages before the contribution.
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Check for rules that override or modify the normal result
Before preparing the return, identify money or other property received, liabilities assumed or extinguished, transfers to a foreign corporation, built-in-loss property, and any transaction that may fall under another nonrecognition provision. Section 367, Section 362(e)(2), Section 357 liability rules and reorganization provisions can change the result even when the documents describe a contribution for stock.
Build the exchange workpapers before entering the return
The return attachment is supported by a complete schedule for every asset transferred. Do not combine several assets into one unsupported total. The schedule should reconcile the transfer agreement, the corporation’s books and the transferor’s tax basis records.
Asset-by-asset schedule
| Column | What to record |
|---|---|
| Property description | A specific description, such as a parcel, machine, security, patent or inventory category. |
| Acquisition information | Acquisition date and original cost or other starting basis. |
| Adjusted basis immediately before transfer | Basis after depreciation, amortization, distributions, improvements and other adjustments. |
| Fair market value | Value at the transfer date, with valuation support for hard-to-value assets. |
| Stock received | Class, number of shares and stated or agreed value, if provided in the transaction documents. |
| Money or other property received | Cash, notes, securities or any nonstock consideration, shown separately from stock. |
| Liabilities | Each liability assumed, paid or otherwise extinguished, its amount and its business purpose. |
| Resulting basis | The computed basis of the stock and, where relevant, the corporation’s basis in each asset. |
Retain the valuation reports, depreciation schedules, purchase documents and other records that support each entry. Fair market value is relevant even when no immediate gain is recognized, because it is required in the Section 351 statement and can affect built-in-gain and built-in-loss analysis.
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“Boot” means money or other property received in addition to stock. Under Section 351(b), gain is recognized, but only up to the amount of money plus the fair market value of other property received. Show boot separately in the workpapers and identify the asset that produced the recognized gain. The limitation does not turn an otherwise taxable loss into a recognized loss.
Illustrative example: A transferor contributes property with a $100,000 adjusted basis and receives stock plus $20,000 cash. If the transaction otherwise qualifies under Section 351 and no special rule changes the result, the recognized gain cannot exceed $20,000. The actual gain computation still requires the property’s fair market value, liabilities and other consideration to be analyzed.
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Analyze liabilities rather than treating them as automatic boot
A corporation’s assumption of a liability does not by itself make the entire exchange taxable. Preserve the amount, type and purpose of every liability and test the applicable Section 357 rules. Liabilities can affect the transferor’s stock basis, and special issues arise for liabilities that exceed basis, lack a business purpose, or would produce a deduction when paid. Keep debt assumed, debt paid off and debt that remains with the transferor in separate columns.
Compute the transferor’s stock basis
Stock basis normally begins with the transferor’s adjusted basis in the property contributed. It is then adjusted for recognized gain, money or other property received, liabilities and transaction expenses under the applicable basis rules. The computation must be done for the actual exchange, not copied from the corporation’s book value or the stock’s stated value.
Items commonly increasing or decreasing basis
- Start with the adjusted tax basis of each transferred asset.
- Add gain recognized in the exchange, including gain recognized because of boot, to the extent the applicable basis rule requires it.
- Subtract money and the fair market value of nonstock property received.
- Analyze liabilities assumed or extinguished under the relevant liability provisions; they can reduce stock basis and can create recognition in particular circumstances.
- Account for qualifying transaction expenses and any basis allocation required by the governing regulations.
Publication 542 also identifies possible adjustments under Section 362(e)(2) for transfers of built-in-loss property. In an applicable transaction, an election may reduce the transferor’s stock basis instead of reducing the corporation’s basis in the contributed property. Document whether the election is available, who makes it and how the elected basis reduction is reflected on both sides of the transaction.
Keep the stock and asset computations consistent
Reconcile the transferor’s stock basis schedule with the corporation’s opening tax basis in each asset. Differences should be explainable by recognized gain, liabilities, boot, transaction costs, elections and other statutory adjustments. A balance-sheet value or an appraisal alone is not a substitute for a tax-basis computation.
Attach the required Section 351 statement
Treasury Regulation §1.351-3(a) requires every significant transferor to include a statement on or with the return for the year of the exchange. The statement must be titled:
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STATEMENT PURSUANT TO §1.351-3(a) BY [INSERT NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A SIGNIFICANT TRANSFEROR
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The records and attachment should identify the transferred property and provide its amount, adjusted basis and fair market value. Include the stock and any other consideration received, together with liabilities assumed or extinguished. Describe facts needed to understand the exchange, including the ownership percentages immediately afterward and any recognized gain or special election that affects basis.
Who attaches it
Publication 542 explains that the corporation and the persons involved in a nontaxable exchange attach the complete statement of facts required by Section 1.351-3 to their returns for the exchange year. The phrase “significant transferor” and the required content come from the regulation, so do not replace the statement with a short note that merely says “Section 351 exchange.”
Use the rules and instructions for the filing year
Attachment mechanics can differ by taxpayer type and filing method. Before filing, check the current regulation, the current return instructions and any electronic-filing requirements for the exchange year. If an attachment is transmitted electronically, retain the generated PDF or other accepted copy with the filed return and workpapers.
Report recognized gain and other consideration on the correct return
There is no single line on Form 1040 that covers every Section 351 exchange. The reporting location depends on whether the transferor is an individual, C corporation, S corporation, partnership, estate or trust, what property was transferred, and whether boot, liabilities or another rule produced recognized income.
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Do not report a deferred exchange as if the stock were sold
When Section 351 applies and no gain is recognized, the transfer is generally documented through the required statement and basis schedules rather than treated as a current sale of the contributed assets. Do not report the stock’s fair market value as immediate income merely because the corporation issued shares.
Report the taxable portion supported by the workpapers
If boot or another rule produces recognized gain, report that amount on the return form and schedule applicable to the taxpayer and property type. The character of the gain can depend on whether the asset was inventory, depreciable business property, a capital asset or another category. Follow the current form instructions rather than assuming that every recognized amount belongs on the same schedule.
Determine whether Form 926 is required for a foreign corporation
A transfer to a foreign corporation requires a separate international filing analysis. A U.S. citizen or resident, domestic corporation, or domestic estate or trust generally files Form 926 for certain transfers of property to a foreign corporation under Section 6038B, Section 367(d) or Section 367(e). The form is filed with the income-tax return for the tax year that includes the transfer date.
Form 926 is not automatic for every foreign transfer
The form has ownership, cash-transfer and other statutory conditions and exceptions. Review the current Form 926 instructions and the transaction’s facts before deciding that a filing is or is not required. A Section 351 label does not eliminate the need to test Section 367 and Section 6038B.
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Information Form 926 requests
The instructions ask the filer to identify the type of nonrecognition transaction, including a Section 351 exchange, and to provide a description of the transfer, the consideration received, fair market value and the characteristics of stock or securities received. Ensure that the Form 926 description agrees with the Section 1.351-3 statement and the asset schedule.
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Penalty exposure
The IRS states that failure to comply can result in a penalty generally equal to 10% of the fair market value of the property at the time of transfer, subject to reasonable-cause rules and statutory limits or exceptions. Retain proof of filing and any reasonable-cause analysis if the position is not straightforward.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.Domestic and foreign cases compared
| Issue | Domestic transferee corporation | Foreign transferee corporation |
|---|---|---|
| Core qualification | Property for stock and immediate post-exchange control, subject to boot, liability and other rules. | The same Section 351 analysis, plus potential Section 367 and Section 6038B requirements. |
| Exchange-year attachment | Section 1.351-3 statement for the corporation and involved persons as required by the regulation. | Section 1.351-3 statement plus any required international forms. |
| Additional form | No Form 926 solely because the corporation is domestic. | Form 926 may be required; check its conditions and exceptions. |
| Filing deadline | With the applicable federal return for the exchange year. | Form 926 accompanies the income-tax return for the year including the transfer date. |
| Primary extra risk | Incorrect basis, boot or liability treatment. | Those risks plus international information-reporting penalties and Section 367 consequences. |
Federal reporting workflow
- Collect the closing documents. Obtain the contribution or exchange agreement, stock ledger, board or shareholder approvals, closing statement, liability payoff records and ownership schedule.
- Test Section 351. Confirm that each relevant transfer is property for stock and that the transferors have the required control immediately afterward. Separate any services-for-stock arrangement.
- Identify boot and liabilities. List cash, notes, securities, other property, assumed debt and extinguished debt. Determine whether any amount creates recognized gain or a special liability issue.
- Prepare the asset schedule. Record adjusted basis, fair market value, acquisition information, stock received, nonstock consideration and liabilities for every asset.
- Compute basis. Calculate the transferor’s stock basis and the corporation’s basis in each asset. Test Section 362(e)(2) and document any election.
- Calculate recognized income. Apply the boot limitation and any other recognition rule. Determine the character and return schedule for the taxable amount based on the taxpayer and asset.
- Prepare the Section 1.351-3 statement. Use the required title, identify the significant transferor and include the complete facts, amounts, bases, values and liabilities.
- Check international filing. If the transferee is foreign, review Form 926, Section 367 and Section 6038B conditions, then prepare Form 926 when required.
- Attach and reconcile. Attach the statement and any Form 926 to the current federal return, verify that electronic attachments meet the filing system’s requirements and reconcile every reported amount to the workpapers.
- Retain the file. Keep the signed statement, filed forms, transmission confirmation, valuation support, basis calculations and ownership records with the permanent tax records.
Records to retain
- Contribution or exchange agreement and amendments.
- Board and shareholder approvals and the stock ledger.
- Asset register, acquisition dates, original costs and depreciation or amortization records.
- Fair-market-value appraisals or other valuation support.
- Detailed liability schedule showing amounts, purpose and disposition.
- Ownership percentages immediately after the exchange.
- Stock-basis and corporate-asset-basis computations, including any Section 362(e)(2) election.
- Signed Section 1.351-3 statements and copies of all filed attachments.
- Form 926 and its filing confirmation, when applicable.
Common filing mistakes and how to correct them
Attaching only a purchase agreement
A contract may describe the transaction but omit adjusted basis, fair market value, liabilities and the required statement title. Prepare the complete Section 1.351-3 attachment and retain the contract as supporting evidence.
Using one aggregate basis number
An aggregate figure can conceal different basis, valuation and gain characteristics. Rebuild the schedule by asset and explain every allocation to stock and other consideration.
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Notes, securities and other property are boot even when no cash changes hands. Value and list each item separately and apply the recognized-gain limitation.
Assuming every debt assumption is taxable
Debt treatment is governed by specific liability rules. Identify the debt and its purpose, then analyze whether it affects basis or recognition instead of labeling the entire exchange taxable.
Assuming a foreign exchange needs no extra form
Section 351 treatment does not replace the Section 367 and Section 6038B analysis. Check Form 926 conditions and exceptions for the taxpayer and transfer.
Looking for a universal Form 1040 line
The right line depends on the taxpayer, asset and recognized-income character. Use the current return instructions for the applicable taxpayer rather than forcing the transaction onto a generic capital-gain line.
When professional review is especially important
Obtain advice from a qualified tax professional when the transfer includes a foreign corporation, substantial liabilities, built-in-loss property, intangible assets, services mixed with property, multiple transferors, related-party ownership, or a possible Section 367, Section 362(e)(2) or reorganization issue. Those facts can change both the tax result and the required attachments.
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