Tax Treatment of Liabilities Assumed by a Corporation IRC 357 - What is Boot? - John R. Dundon II, Enrolled Agent
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Tax Treatment of Liabilities Assumed by a Corporation IRC 357 – What is Boot?

Tax Treatment of Liabilities Assumed by a Corporation IRC 357 – What is Boot?

According to IRC 357(a) if property transferred to a corporation in an IRC 351 nonrecognition transaction is subject to a liability, the assumption of that liability by the corporation generally is not treated as taxable “boot” for purposes of determining the amount of any taxable gain on the transaction.

For example if you transfer computer programs and peripheral devices to a software development corporation in exchange for stock in that corporation with a fair market value of $2,500,000 and immediately after the exchange you control the corporation in question, if the property transferred to the corporation has a fair market value of $4,000,000 and is subject to a development loan of $1,500,000 when the corporation assumes the development loan the transfer of property to the corporation qualifies for Code Sec. 351 nonrecognition treatment. Generally speaking you should not recognize any gain on the Corporation’s assumption of the liability.

The amount of the liability generally is treated as “boot” predominately for  determining your basis in the stock received in the exchange. What this means is that if you transfer property to a corporation in exchange for its stock and also receive money or other property (aka “boot”) in addition to the stock, the transaction may still qualify for nonrecognition treatment under IRC 351. However, the persons receiving money or other property must recognize gain on the boot received in the transaction.

The amount of the gain recognized is restricted to the total of any money received plus the fair market value of any other property received subsequently making it impossible to recognize a loss on the receipt of boot.

Here’s another example if you transfer computer programs and peripheral devices with a fair market value of $1,000,000 and a basis of $200,000 to a software development corporation in exchange for stock with a fair market value of $600,000 plus property with a fair market value of $300,000 plus $100,000 cash and of course you control the corporation after the exchange you subsequently realize a gain of $800,000 ($1,000,000 – $200,000) on the transfer of the property. However you are required to recognize this gain only to the extent of any boot received in the transaction or $400,000 consisting of $300,000 in property plus $100,000 in cash.

In determining the amount of gain recognized for “boot” purposes, each transferred asset is treated as having been separately exchanged without netting total gains and losses. In other words no aggregation as doing so might create the recognition of losses which are specifically disallowed. In applying the asset-by-asset approach you cannot designate specific property to be exchanged for specific stock.

For example in a 351 nonrecognition transaction my wife Cathy transferred $2,000,000 cash to a Corporation in exchange for 20,000 shares of stock. After the transaction she controls the corporation.  Because Cathy did not receive any boot (property or cash) she does not recognize any gain or loss on the transaction.

Similarly my daughter Amelia transferred her art collection to a corporation in exchange for 100,000 shares of stock and $100,000 cash and after the exchange she controlled the corporation. Amelia received $100,000 in cash (aka the “boot”). To determine the recognizable gain, the fair market value of the boot received is allocated to the assets transferred in proportion to their relative fair market values at the time of the transfer.

If a corporation assumes a liability of an individual in an effort to avoid federal income tax or if the corporation’s assumption of the liability is not for a legitimate business purpose, then the total amount of the liability assumed by the corporation is treated as taxable boot or money received for transferring property to the corporation.

If the total assumed liabilities is greater than the total adjusted basis of the property transferred in the exchange, the excess amount generally must be treated as gain from the sale or exchange of an asset under IRC 357(c); as well as Flextronics America v. Comm’r, T.C. Memo. 2010-245.

Certain liabilities are excluded in making this determination. The excluded liabilities include tax deductible payments, as long as the payments did not create an increase in the basis of any property or are for capital expenditures.

So how is “boot” defined in these regards. As I understand it in the most distilled form it is merely money or property received in an exchange or transfer and is generally speaking taxable.