IRC 351 Explained: How Section 351 Transfers Work in Corporate Tax

A startup founder contributes $500,000 worth of intellectual property to his new corporation. He expects no immediate tax bill since he's only receiving stock. Six months later, the IRS sends a notice for $85,000 in capital gains tax. His mistake? The transaction failed IRC Section 351 requirements by just 5 percentage points of stock ownership.

Section 351 prevents this exact scenario when applied correctly. This powerful provision allows tax-free property transfers to corporations, but one misstep triggers immediate taxation on all built-in gains.

In this guide, we'll cover the three non-negotiable Section 351 requirements, common compliance failures that cost businesses thousands and how Bizora.ai's advanced tax research platform helps professionals navigate these complex rules with confidence.

What Is IRC 351?

IRC Section 351 allows you to transfer property to a corporation in exchange for stock without recognizing gain or loss immediately. This preserves cash for reinvestment, making it a key tool for capital-intensive businesses. 

Key Requirements for Section 351 Eligibility

To benefit from Section 351, every transfer must meet three core requirements. Missing even one can turn a tax-deferred transfer into a taxable event.

1. Property Transfer

You must contribute property. Qualifying property includes:

• Cash

• Real estate

• Equipment and inventory

• Patents, trade secrets, and other intellectual property

• Goodwill or leaseholds

Services do not qualify as property. Stock received for services is taxed as ordinary income. Avoid combining property and services without separating the stock issued for each. Only stock received for property counts toward the control test. With complex transactions involving multiple asset types, Bizora.ai's AI-powered tax research capabilities help identify these classification issues before they become problems.

2. Solely-for-Stock Exchange

The property must be exchanged exclusively for stock. Anything else is considered boot and triggers gain recognition. Boot includes:

• Cash

• Debt instruments

• Nonqualified preferred stock

• Relief from certain liabilities

Planning tip: If you must receive boot, limit it to your realized gain to minimize tax impact.

3. Control Requirement

Transferors must collectively own at least 80 percent of the total voting power and 80 percent of all other stock classes immediately after the exchange. This prevents abuse of nonrecognition rules.

Example: Two investors contribute assets and receive 75 percent of the stock. A third party could contribute additional property as an accommodating transferor to reach the 80 percent threshold.

Tax Implications of Section 351

Section 351 allows gain or loss deferral, but some scenarios trigger immediate taxation.

Gain and Loss Deferral

When Section 351 requirements are met, you defer gain until the stock is sold. Basis in the new stock generally equals the basis of contributed property, preserving capital for reinvestment.

Receiving Boot

Receiving extra consideration such as cash or nonqualified stock triggers taxable gain only to the extent of that consideration. Planning contributions carefully avoids surprises when boot is involved.

Liability Assumptions

If the corporation assumes liabilities, they usually do not trigger tax unless liabilities exceed your basis or are primarily used to avoid tax. Proper structuring and documentation are essential.

Bizora Labs can track liabilities and provide alerts to ensure your transaction maintains Section 351 compliance.

Section 351 Compliance Checklist

Before the transfer:

• Identify all property and separate from any services

• Calculate total liabilities the corporation will assume

• Verify 80% control immediately after exchange

• Document business purposes for the transaction

• Obtain proper property valuations

During the exchange:

• Issue only qualifying stock (common or qualified preferred)

• Limit or eliminate boot payments

• Execute all transfers simultaneously or as integrated steps

• Maintain detailed transaction records

After the transfer:

• File required tax returns and elections

• Track adjusted basis in received stock

• Monitor ongoing control percentages

• Document any subsequent liability assumptions

Bizora.ai's automated compliance monitoring can track these requirements in real-time, preventing compliance failures before they occur.

Common Pitfalls

• Receiving stock for services instead of property

• Failing the control test

• Prearranged stock dispositions violating control requirements

• Liabilities exceeding property basis

• Transfers to investment companies, which do not qualify for Section 351

• Improper documentation

Proper planning, accurate valuation, and thorough documentation minimize risks and ensure intended deferral benefits.

International and Modern Applications

Cross-Border Transactions

• Section 367 can override Section 351 for contributions to foreign corporations. Exceptions include tainted assets and trade or business rules.

• Anti-inversion rules prevent shifting income out of the U.S. without triggering tax.

• Maintain records of property value, transfer details, and compliance with foreign reporting.

Modern Business Applications

• Startups and Venture Capital: Structure founder equity, preferred stock issuance, and employee stock plans carefully.

• ETF Conversions: Section 351 enables tax-deferred conversion of managed accounts to ETFs. Compliance with investment company rules is critical.

• Intellectual Property Transfers: Intangible assets must meet property and control requirements. Valuation is key.

• Digital Assets: Cryptocurrency contributions qualify as property, but documentation and valuation are required to ensure deferral.

These applications help businesses leverage Section 351 efficiently while maintaining compliance. For real-time monitoring and planning, Bizora Labs can guide cross-border and modern asset transactions.

Key Takeaways

• Core Requirements: Property contribution, stock exchange, and 80 percent control immediately after transfer

• Deferral Benefits: Gain is deferred until stock disposition, preserving capital

• Boot and Liabilities: Extra consideration triggers taxable gain; excess liabilities may require recognition

• Practical Strategies: Separate property from services, use accommodating transferors, coordinate with QSBS and Section 83 rules, maintain documentation

• Common Pitfalls: Misclassifying stock, failing control requirements, prearranged sales, excess liabilities, improper documentation

• Modern Applications: Applies to startups, venture capital, ETFs, intellectual property, digital assets, and cross-border transactions

Mastering Section 351 balances technical rules with strategic planning. Structured correctly, it enables tax-efficient corporate formations and property transfers. Missteps can trigger unexpected taxation. Use tools like Bizora Labs for real-time guidance, reporting, and monitoring to ensure compliance and optimize outcomes.

For detailed IRS guidance, consult IRS Section 351 resources for official rules and examples.