When you form a new corporation or contribute property to an existing one, the IRS could technically treat that as a taxable event. You are swapping something you own for stock, and normally that kind of exchange would trigger gain or loss.
But this section allows one or more persons to move property into a corporation solely in exchange for stock of that corporation. They do not recognize gain or loss on the deal. The gain is deferred, not eliminated. It sits inside the stock you received until you eventually sell.
It sounds simple on the surface but has enough moving parts to trip people up. Let us walk through what a Section 351 transaction actually requires, where the 80% threshold matters, and what happens when things go sideways.
For this provision to apply, three conditions have to line up.
First, the transferor (or a group of transferors) must transfer property to a corporation. Services do not count as property here. If you receive shares purely as payment of compensation for work you performed, that portion is treated as taxable income, not a tax-free exchange.
Second, the exchange must be solely for stock in the corporation. Common stock, voting stock, and most types of nonvoting stock all qualify. But nonqualified preferred stock does not get 351 treatment. If the person receives stock plus cash or other property or money (called "boot"), the math changes, which we will cover below.
Third, the transferors must be in control of the corporation immediately after the exchange. This is the control requirement, and meeting the requirements of section 351 depends heavily on it.
Control is defined as the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.
In simpler terms: the person or group doing the contribution must own stock with enough voting power plus enough of each nonvoting class, measured immediately after the transfer. Property transferred to a corporation only qualifies if the contributors collectively clear this bar.
A few things to keep in mind here:
Group contributions count. If three people each move assets in and together they hold the required threshold, the control test is satisfied by the group. The individual contributor does not need to hit 80% alone. As long as the combined group qualifies for section 351, the transaction works.
Timing matters. The control requirement is met only if the contributors own the required stock immediately after the exchange. If someone contributes property but then sells part of their shares right away, that could blow the threshold. A pre-arranged sale can make the whole thing fail.
Services-only contributors do not count. If one person in the group contributes only services (no property or money), they are not factored into the 80% calculation. The remaining property contributors must clear the bar on their own.
For a deeper look at how entity classification works when forming a corporation, that guide covers Form 8832 and the options available.
This provision applies to transfers of property, and the IRS defines property broadly. Cash, equipment, inventory, real estate, intellectual property, and accounts receivable all qualify. Even a promissory note can count as property contributed to the corporation.
What does not qualify? Services. If a shareholder receives stock purely for services rendered, the fair market value of that stock is ordinary income.
There is a workaround, though. If you contribute both property and services, the property portion can still qualify as long as the amount of property is meaningful, not just a token contribution.
One more thing: if the corporation by one or more transfers becomes an investment company as a result of the deal, Section 351 does not apply. This rule prevents people from pooling diversified investments into a corporate wrapper tax-free.
In a clean exchange, the transferor gives property and receives stock. Nothing else changes hands.
But when the contributor receives something in addition to stock, like cash, debt relief, or other property, that extra piece is called "boot." And boot changes things.
If you receive boot, you would recognize gain up to the lesser of the boot received or the total gain built into the property. You cannot recognize a loss on the transfer, even if the property has declined in value. Losses are deferred.
Here is a quick example. Say you transfer property worth $100,000 with an adjusted basis of $60,000 to a corporation and receive stock valued at $85,000 and $15,000 in cash. Your total gain is $40,000. The boot is $15,000. So you report gain of $15,000, which is the lesser of the boot ($15,000) or the total gain ($40,000).
A corporate transferor contributing appreciated assets needs to think carefully about whether any non-stock consideration will trigger a gain that could have been deferred.
When a section 351 transfer goes through tax-free, the basis does not reset to fair market value. It carries over.
The transferor's basis in the stock received in the exchange equals their adjusted basis in the asset contributed, increased by any gain recognized and decreased by boot received. The built-in gain does not disappear. It sits in the stock.
The corporation's basis equals the contributor's old basis in the property, plus any gain recognized. This carryover basis means the corporation inherits the same tax position on that asset.
If you are curious about how these rules interact with S corporation status, our article on S corp elections covers Form 2553 and related planning.
Even when people think they have a clean deal, a few issues can unravel the whole thing.
Failing the 80% bar after the exchange. If the contributors do not hold the required voting power and share percentage immediately after closing, the application of Section 351 falls apart. Pre-arranged sales, redemptions, or stock issuances to other shareholders right after closing can undermine this.
Treating services as property. Contributing services alone does not qualify. And if a services contributor is needed to hit the 80% threshold, the deal falls apart.
Forgetting about liabilities. When liabilities assumed by the corporation exceed the contributor's basis in the property, the excess is treated as gain. This trips up people who contribute debt-heavy real estate or encumbered equipment.
Dilution after closing. The control must exist immediately after the transfer. If the plan involves issuing shares to third parties or if an outsider were to purchase the stock and dilute the group below 80%, the provision 351 is not met and the whole deal becomes a fully reportable exchange.
If you have questions about how qualified small business stock interacts with new incorporations, that piece covers the Section 1202 exclusion.
1. What does Section 351 do? It allows a transferor to contribute property to a corporation in exchange for stock without triggering a tax hit. The gain is deferred, not erased.
2. Who qualifies as a "transferor"? Any person or entity that contributes property (not services) and receives stock in return. A group of transferors can satisfy the control test together.
3. What is the 80% test? Control means holding stock with at least 80 percent of the total combined voting power, plus 80 percent of each class of nonvoting stock, right after the exchange.
4. Does it apply when you start a corporation? Yes. If you incorporate and put in property for 100% of the shares, the control requirement is met by default. It is almost impossible to fail section 351 in a solo incorporation.
5. Can I receive cash along with stock? You can, but the cash is boot. You would report gain up to the lesser of the boot or the total gain in the property. You cannot use this provision to lock in a loss.
6. What happens to the tax basis after a 351 transfer? The contributor's basis in the stock equals their old basis in the property, adjusted for any gain recognized and boot. The corporation takes a carryover basis in the asset.
7. Can services count as "property" for 351 purposes? No. Stock received purely as compensation is ordinary income. If you bring in both property and services, the property portion may still qualify for purposes of determining whether the requirements are met.
8. What if the 80% control requirement is not met? The exchange is treated as a fully reportable event. The contributor would recognize gain or loss based on the difference between the value of the stock and their adjusted basis in what they contributed.
Working through a Section 351 transaction and want to make sure it holds up? Madras Accountancy supports CPA firms across the U.S. with corporate tax structuring and compliance. Get in touch to talk through your situation.
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