Structuring a Tax-free Incorporation

When forming a corporate entity, one method of capitalization is through a tax-free (actually, taxdeferred) exchange. Properly transferring property to a corporation delays the recognition of any gain on that property until a taxable event occurs (e.g., sale of the property or stock of the corporation, or liquidation of the corporation).

Generally, the transfer of assets and liabilities to a newly formed corporation solely in exchange for stock does not result in recognition of gain or loss by the transferor/ shareholder or transferee/corporation. The nonrecognition of gain or loss is mandatory rather than elective.

There are four requirements for a tax-free incorporation:

  1. Property must be transferred to the corporation by one or more persons (including individuals, trusts, estates, partnerships, associations, companies, or corporations).
  2. The transfer must be solely in exchange for the stock of the corporation.
  3. The persons making the transfer, taken as a group, must own at least 80% of the transferee corporation immediately following the exchange.
  4. The transfer of property to the corporation must be for a business purpose.

The IRS has proposed, but not finalized, a fifth requirement that the property have net value; i.e., the property's value exceeds any debt on the property.

Property transferred to the corporation can include items such as cash, fixed assets, corporate stock, partnership or LLC interests, oil and gas interests, goodwill, and patents. However, property cannot include services rendered or to be rendered. Stock does not include securities (debt obligations), stock warrants or rights, or nonqualified preferred stock. If any shareholder receives property other than stock in exchange for property transferred to the corporation, a taxable gain may need to be recognized by that shareholder.

Please contact us if you have questions concerning a tax-free incorporation or a related matter.

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This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein. © 2014