Section 351 and Partnerships
Section 351 of the Internal Revenue Code generally provides for the non-recognition of gain or loss when property is transferred to a corporation in exchange for stock in such corporation, provided that the transferors are in control of the corporation immediately after the exchange (https://www.irs.gov/pub/irs-drop/rr-03-51.pdf). This non-recognition treatment also applies to partnerships that transfer their assets to a corporation in exchange for stock (https://www.bluej.com/resources/rev-rul-80-323).
Partnership Recognition
Under Section 351, partnerships generally recognize no gain or loss on the transfer of their assets to a corporation in exchange for the corporation’s stock and assumption of the partnership’s liabilities (https://www.irs.gov/pub/irs-drop/rr-03-51.pdf). This non-recognition treatment is available even if the partnership distributes the stock received to its partners, provided that the partnership terminates within the taxable year of the transfer (https://www.thetaxadviser.com/issues/2007/aug/transferstoinvestmentcompaniespitfallsofsecs351and721.html).
Liabilities and Gain Recognition
If the sum of the liabilities assumed by the corporation and the liabilities to which the property is subject exceeds the transferor’s adjusted basis of the property transferred, then the excess may be considered as gain from the sale or exchange of a capital asset or property that is not a capital asset (https://www.irs.gov/pub/irs-drop/rr-03-51.pdf). This gain recognition rule applies to both individual and partnership transfers under Section 351.
Limited Partner Liabilities
In the case of a transfer of a limited partnership interest in a Section 351 exchange, each transferring limited partner’s share of partnership nonrecourse liabilities is considered a liability to which the partnership interest is subject (https://www.bluej.com/resources/rev-rul-80-323). Consequently, each limited partner may recognize gain to the extent that their share of nonrecourse partnership liabilities exceeds the adjusted basis of the interest transferred.
FAQs
1. What is Section 351?
Section 351 of the Internal Revenue Code generally provides for the non-recognition of gain or loss when property is transferred to a corporation in exchange for stock in such corporation, provided that the transferors are in control of the corporation immediately after the exchange.
2. Does Section 351 apply to partnerships?
Yes, Section 351 also applies to partnerships that transfer their assets to a corporation in exchange for stock.
3. Do partnerships recognize gain or loss on a Section 351 exchange?
Generally, partnerships do not recognize gain or loss on a Section 351 exchange. However, if the sum of the liabilities assumed by the corporation and the liabilities to which the property is subject exceeds the partnership’s adjusted basis in the property transferred, then the excess may be considered as gain from the sale or exchange of a capital asset or property that is not a capital asset.
4. What happens if a partnership distributes the stock received in a Section 351 exchange to its partners?
If a partnership distributes the stock received in a Section 351 exchange to its partners, the partnership will not recognize gain or loss on the distribution, provided that the partnership terminates within the taxable year of the transfer.
5. How are nonrecourse liabilities treated in a Section 351 exchange involving a limited partnership interest?
In the case of a transfer of a limited partnership interest in a Section 351 exchange, each transferring limited partner’s share of partnership nonrecourse liabilities is considered a liability to which the partnership interest is subject. Consequently, each limited partner may recognize gain to the extent that their share of nonrecourse partnership liabilities exceeds the adjusted basis of the interest transferred.
6. What are the benefits of using a Section 351 exchange for partnerships?
Section 351 exchanges can be beneficial for partnerships because they allow partnerships to transfer their assets to a corporation without recognizing gain or loss. This can be useful for a variety of reasons, such as consolidating operations, raising capital, or changing the legal structure of the business.
7. What are the potential drawbacks of using a Section 351 exchange for partnerships?
One potential drawback of using a Section 351 exchange for partnerships is that the partnership may be required to recognize gain if the sum of the liabilities assumed by the corporation and the liabilities to which the property is subject exceeds the partnership’s adjusted basis in the property transferred. Another potential drawback is that the partnership may lose its pass-through tax status if the corporation is not a qualified subchapter S corporation.
8. When should partnerships consider using a Section 351 exchange?
Partnerships should consider using a Section 351 exchange when they are looking to transfer their assets to a corporation without recognizing gain or loss. This can be useful for a variety of reasons, such as consolidating operations, raising capital, or changing the legal structure of the business. However, partnerships should carefully consider the potential benefits and drawbacks of using a Section 351 exchange before making a decision.