6.10 Setting up Closely Held Corporations

Tax-free exchange rules facilitate the organization of a corporation. When you transfer property to a corporation that you control solely in exchange for corporate stock in that corporation (but not nonqualified preferred stock), no gain or loss is recognized on the transfer. For control, you alone or together with other transferors (such as partners, where a partnership is being incorporated) must own at least 80% of the combined voting power of the corporation and 80% of all other classes of stock immediately after the transfer to the corporation. If you receive securities in addition to stock, the securities are treated as taxable “boot.” The corporation takes your basis in the property, and your basis in the stock received in the exchange is the same as your basis in the property. Gain not recognized on the organization of the corporation may be taxed when you sell your stock, or the corporation disposes of the property.

Caution

Consider Taxable Transfer

Before making a property transfer to a closely held corporation, consult an accountant or an attorney on the tax consequences. There may be instances when you have potential losses or you desire the corporation to take a stepped-up basis that would make tax-free treatment undesirable.

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Transfer of liabilities.

When assets subject to liabilities are transferred to the corporation, the liability assumed by the corporation is not treated as taxable “boot,” but your stock basis is reduced by the amount of liability. The transfer of liabilities may be taxable when the transfer is part of a tax avoidance scheme, or the liabilities exceed the basis of the property transferred to the corporation.