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8.2 Boot, Section 357 Liabilities in Excess of Basis & Section 1244 Stock
EA Part 2 — Businesses: Free Study Guide 2026 Exam
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1 Chapter 1: Exam Cycle & Preparation
1.1 Current Exam Cycle, Blueprint & Study Decisions
2 Chapter 2: Business Entity Choices & Classification
2.1 Business Structures & Liability: Sole Proprietorship, Partnership, LLC, and Corporation 2.2 Entity Classification & Check-the-Box Rules (Form 8832) 2.3 Classification Elections, Default Rules & the 60-Month Limitation 2.4 EINs, Entity Changes & Closing a Business
3 Chapter 3: Sole Proprietorships
3.1 Schedule C Gross Income & Allowable Business Expenses 3.2 Self-Employment Tax (Schedule SE) & Statutory Employees 3.3 Business Use of Home (Simplified vs. Actual Method)
4 Chapter 4: Partnership Formation & Basis
4.1 Formation & Property Contributions under Section 721 4.2 Partner Liabilities under Section 752 (Recourse vs. Nonrecourse) 4.3 Partnership Tax Year, Accounting Periods & Form 1065 Filing 4.4 Family Partnerships, Gifted Interests & Income Allocations
5 Chapter 5: Partnership Basis & Loss Limitations
5.1 Outside Basis Calculations & Ordering Rules 5.2 Basis, At-Risk (§465) & Passive Loss (§469) Limitations 5.3 Excess Business Losses (§461(l)) & Related-Party Transactions (§707) 5.4 Debt Discharge: Partnership vs. S Corporation
6 Chapter 6: Partnership Operations & Distributions
6.1 Form 1065, Schedule K & Schedule K-1 Separately Stated Items 6.2 Guaranteed Payments vs. Distributive Shares 6.3 Nonliquidating & Liquidating Distributions & Section 751 Hot Assets 6.4 Centralized Partnership Audits, Notices & Opting Out
7 Chapter 7: Partnership Dispositions & Basis Adjustments
7.1 Sale or Exchange of a Partnership Interest 7.2 Optional Basis Adjustments (Section 754, 743(b) & 734(b)) 7.3 Partnership Terminations, Mergers & Divisions
8 Chapter 8: C Corporation Formation & Structure
8.1 Corporate Formation & Section 351 Transfer Requirements 8.2 Boot, Section 357 Liabilities in Excess of Basis & Section 1244 Stock 8.3 Capital Structure: Debt vs. Equity & Section 385 Principles 8.4 Controlled Groups & Closely Held Corporations
9 Chapter 9: C Corporation Operations & E&P
9.1 Form 1120 Gross Income, Corporate Deductions & 21% Flat Tax Rate 9.2 Book-Tax Differences (Schedule M-1 vs. Schedule M-3) 9.3 Current vs. Accumulated Earnings & Profits (E&P) 9.4 Accumulated Earnings & Personal Holding Company Taxes 9.5 Corporate Minimum Tax & Foreign Tax Credits
10 Chapter 10: C Corporation Distributions & Liquidations
10.1 Property Distributions, Dividends & Constructive Distributions 10.2 Stock Redemptions (§302) & Corporate Liquidations (§331/§336)
11 Chapter 11: S Corporation Eligibility & Operations
11.1 S Corporation Requirements & Form 2553 Election Rules 11.2 Election Deadlines, Late Election Relief (Rev. Proc. 2013-30) 11.3 Form 1120-S Operations, Reasonable Compensation & 2% Shareholder Fringes
12 Chapter 12: S Corporation Basis, Distributions & Taxes
12.1 Stock & Debt Basis Calculations, Ordering Rules & Form 7203 12.2 S Corp Distributions, Accumulated Adjustments Account (AAA) & E&P Tiers 12.3 Entity-Level Taxes (BIG §1374 & Passive Income §1375) & Termination
13 Chapter 13: Accounting Periods & Methods
13.1 Tax Years: Calendar, Fiscal, and 52-53 Week Years 13.2 Cash vs. Accrual Method & Section 448 Gross Receipts Test 13.3 Changes in Accounting Method (Form 3115) & Section 481(a) Adjustments 13.4 2025 Domestic Research Expensing & Foreign Research
14 Chapter 14: Business Gross Income & Inventory
14.1 Gross Receipts & Inclusions in Business Gross Income 14.2 Cost of Goods Sold (COGS) & Inventory Valuation (Cost, LCM, FIFO, LIFO) 14.3 Section 263A Uniform Capitalization (UNICAP) & Small Business Exemption
15 Chapter 15: General Business Deductions & Limits
15.1 Ordinary & Necessary Business Expenses (§162) & Disallowances 15.2 Business Meals, Gifts & Travel 15.3 Vehicle Expenses, Mileage & Substantiation 15.4 Business Interest Expense Limitation (§163(j)) & Business Taxes
16 Chapter 16: Business Losses & Net Operating Losses
16.1 Net Operating Losses (NOLs) 80% Taxable Income Cap & Carryforward Rules 16.2 Business Casualty, Theft & Disaster Losses 16.3 Business vs. Nonbusiness Bad Debts (Direct Write-Off Method §166)
17 Chapter 17: Section 199A Qualified Business Income Deduction
17.1 Section 199A Overview: 20% Deduction & Qualified Trades or Businesses 17.2 Specified Service Trades or Businesses (SSTBs) & Threshold Phase-Outs 17.3 W-2 Wage & UBIA Limitations Calculation & Aggregation Rules
18 Chapter 18: Depreciation Principles & MACRS
18.1 Depreciable Property, Cost Basis & Capitalization vs. Repair Regulations 18.2 MACRS Property Classes (3, 5, 7, 15, 27.5, 39-Year) & Depreciation Methods 18.3 Depreciation Conventions: Half-Year, Mid-Quarter (40% Rule) & Mid-Month
19 Chapter 19: Section 179 Expensing & Bonus Depreciation
19.1 Section 179 Expensing: $2.5M Limit, $4M Phase-Out & Taxable Income Limitation 19.2 2025 Bifurcated Bonus Depreciation: Pre-Jan 20 (40%) vs. Post-Jan 19 (100% OBBBA) 19.3 Listed Property Rules, >50% Business Use & Section 280F Luxury Auto Limits
20 Chapter 20: Amortization & Intangible Assets
20.1 Section 197 Intangibles & 15-Year Straight-Line Amortization 20.2 Start-Up (§195) & Organizational (§248/§709) Expenditures: $5,000 Rule & 180-Month Amortization 20.3 Depletion: Cost Depletion vs. Percentage Depletion for Natural Resources
21 Chapter 21: Business Property Dispositions & Recapture
21.1 Sale of Business Property & Reporting on Form 4797 21.2 Section 1231 Netting Process & 5-Year Lookback Recapture Rule 21.3 Section 1245 (Full Personal Property Recapture) & Section 1250 / Unrecaptured §1250 Gain
22 Chapter 22: Like-Kind Exchanges & Involuntary Conversions
22.1 Section 1031 Like-Kind Exchanges (Real Property Only, 45-Day/180-Day Deadlines) 22.2 Boot Recognition & Basis Calculation for Replacement Property 22.3 Section 1033 Involuntary Conversions & Replacement Periods
23 Chapter 23: Business Tax Credits
23.1 General Business Credit (Form 3800), Net Income Tax Limit & Carryback/Carryforward 23.2 Key Business Tax Credits: Research Credit (§41), WOTC (§51), Small Employer Health (§45R)
24 Chapter 24: Worker Classification & Information Reporting
24.1 Employee vs. Independent Contractor: Common Law Control & Form SS-8 24.2 Section 530 Relief Requirements & Consequences of Misclassification 24.3 Information Returns: Form 1099-NEC vs. 1099-MISC, Form W-2/W-3 & Backup Withholding
25 Chapter 25: Employment Taxes & Compliance
25.1 Form 941 (Quarterly Payroll Tax Return) & Federal Income Tax / FICA Withholding 25.2 Federal Unemployment Tax (Form 940) & State Unemployment Credit 25.3 Payroll Tax Deposit Schedules (Monthly vs. Semi-Weekly, $100K Rule) & Trust Fund Penalty (§6672)
26 Chapter 26: Fiduciary Income Taxation (Trusts & Estates)
26.1 Principles of Fiduciary Income Taxation & Form 1041 Filing Requirements 26.2 Fiduciary Tax Years, Exemptions & Estimated Payments 26.3 Simple and Complex Trusts, Tiers & Distribution Timing 26.4 DNI Computation & Fiduciary Expense Allocation 26.5 Income Distribution Deduction & Schedule K-1 (Form 1041) Flow-Through 26.6 Foreign Trusts, Grantor Control & Abusive Schemes
27 Chapter 27: Tax-Exempt Organizations & Farm Taxation
27.1 Recognition of Tax Exemption (Form 1023/1024) & §501(c)(3) Standards 27.2 Maintaining Exemption, Political Activity & Excess Benefits 27.3 Form 990 Series Annual Returns & Unrelated Business Taxable Income (UBTI / Form 990-T) 27.4 Unrelated Business Income & Debt-Financed Property 27.5 Farm Income, Schedule F & Conservation Costs 27.6 Farm Income Averaging & Conservation Deductions 27.7 Farm Disaster Elections & Livestock Replacement 27.8 Farm Rentals, Estimated Tax & Farm Depreciation
28 Chapter 28: Business Records, Reporting & ACA
28.1 Financial Statements, Records & Owner Transactions 28.2 Filing Extensions, International Forms & Cash Reporting 28.3 ACA Employer Size, Coverage & Reporting
29 Chapter 29: Employer & Self-Employed Retirement Plans
29.1 Qualified Plans, 401(k) Limits & Nondiscrimination 29.2 SEPs, Self-Employed Contributions & Owner Compensation 29.3 SIMPLE IRAs & Small-Employer Contribution Choices 29.4 Plan Reporting, Loans & Prohibited Transactions
30 Chapter 30: Rental Property & Passive Activities
30.1 Rental Income, Expenses & Conversion Basis 30.2 Rental Losses, Active Participation & Real Estate Professionals 30.3 Vacation Homes, Personal Days & Rental Allocations
8.2 Boot, Section 357 Liabilities in Excess of Basis & Section 1244 Stock
Key Takeaways Explain This Topic AI
Receipt of boot under IRC §351(b) triggers recognized gain equal to the lesser of realized gain or the fair market value of boot received; loss is strictly disallowed and never recognized under Section 351.
Under IRC §357(a), corporate assumption of shareholder liabilities is generally not treated as taxable boot for gain recognition, but it reduces the shareholder's stock basis under §358(d).
If a liability assumption has a tax avoidance purpose or lacks a bona fide business purpose under §357(b), ALL liabilities assumed from that transferor in the exchange are tainted and treated as cash boot.
Under IRC §357(c), if the sum of liabilities assumed exceeds the total adjusted basis of all properties transferred by a shareholder, the excess is taxable gain; however, deductible liabilities like cash-basis accounts payable are excluded under §357(c)(3).
IRC §1244 permits original individual shareholders to treat losses on qualifying small business stock as ordinary loss up to $50,000 per year ($100,000 MFJ), with excess losses treated as capital loss.
Last updated: October 2026
Boot, Section 357 Liabilities in Excess of Basis & Section 1244 Stock
While corporate formation under IRC §351 is designed as a nonrecognition regime, real-world incorporations frequently involve non-stock consideration (boot) or encumbered property. When a shareholder receives cash, short-term promissory notes, or other property alongside corporate stock, the transaction becomes partially taxable. Similarly, when a corporation assumes shareholder debt, specific anti-abuse and mechanical statutory safeguards under IRC §357 dictate whether the assumption triggers immediate taxable gain.
Finally, because new corporate ventures entail substantial financial risk, Congress enacted IRC §1244 to incentivize investment in small business corporations. Section 1244 provides tax relief by recharacterizing capital losses as ordinary loss deductions if the business falters.
Receipt of Boot under IRC §351(b)
If an exchange satisfies the property and 80% control requirements of Section 351, but the transferor receives property other than corporate stock, the non-qualifying consideration is classified as boot .
What Constitutes Boot?
- Cash and cash equivalents
- Corporate debt instruments (promissory notes, debentures, bonds)
- Real or personal property other than the transferee corporation's stock
- Nonqualified preferred stock under IRC §351(g)
- Securities and stock warrants
- Gain Recognition Rule: IRC §351(b)(1)
When boot is received, the transferor shareholder must recognize gain equal to the lesser of :
The realized gain on the exchange (FMV of all stock and boot received minus adjusted basis of property transferred); OR
The fair market value of boot received (including cash).
Recognized Gain = min ( Realized Gain , FMV of Boot Received ) \text{Recognized Gain} = \min(\text{Realized Gain}, \text{FMV of Boot Received}) Recognized Gain = min ( Realized Gain , FMV of Boot Received )
Absolute Disallowance of Loss: IRC §351(b)(2)
Under IRC §351(b)(2) , no loss is recognized in a Section 351 exchange, even if the shareholder receives boot. Realized losses are completely deferred and absorbed into the substituted stock basis.
Warning
Never recognize a loss on a Section 351 transaction on the EA exam. Even if a taxpayer transfers loss property and receives cash boot, the loss is disallowed under §351(b)(2).
Character and Allocation of Recognized Gain (Rev. Rul. 68-55)
When a shareholder transfers multiple assets in exchange for stock and boot, the IRS requires an asset-by-asset allocation under Rev. Rul. 68-55 :
The total consideration (stock and boot) is allocated among the contributed assets in proportion to their relative fair market values.
Realized gain or loss is computed separately for each asset.
Boot is allocated to each asset based on relative FMV. Recognized gain for each asset equals the lesser of that asset's realized gain or allocated boot.
The character of recognized gain (ordinary income, Section 1231 gain, or capital gain) is determined by the character of the specific asset, including depreciation recapture under IRC §1245 or §1250 .
Corporate Assumption of Liabilities: IRC §357
When an ongoing business is incorporated, the corporation almost invariably assumes existing liabilities, such as mortgages, equipment loans, and operational accounts payable. The tax treatment of these assumed liabilities is governed by IRC §357 .
1. General Rule: IRC §357(a)
Under IRC §357(a) , the corporation's assumption of a liability is not treated as money or boot received by the shareholder for purposes of recognizing gain under §351. The exchange remains tax-free.
However, under IRC §358(d) , the assumed liability is treated as cash received by the shareholder solely for the purpose of computing stock basis . Consequently, liabilities assumed reduce the shareholder's stock basis dollar-for-dollar.
Stock Basis = Adjusted Basis of Property − Liabilities Assumed \text{Stock Basis} = \text{Adjusted Basis of Property} - \text{Liabilities Assumed} Stock Basis = Adjusted Basis of Property − Liabilities Assumed
2. Tax Avoidance Exception: IRC §357(b)
Congress enacted IRC §357(b) to prevent abusive pre-incorporation borrowing. If, taking into consideration the nature of the liability and the circumstances under which it was arranged, the shareholder's principal purpose regarding the assumption was:
- To avoid federal income tax on the exchange; OR
- Was not a bona fide business purpose ;
then ALL liabilities assumed from that shareholder in the exchange are treated as taxable cash boot .
Caution
Section 357(b) is an "all-or-nothing" rule. If a shareholder transfers $200,000 of legitimate business debt and $10,000 of personal credit card debt without a business purpose, the entire $210,000 of liabilities is treated as cash boot under §357(b), triggering gain up to realized gain.
3. Liabilities in Excess of Basis: IRC §357(c)
Under IRC §357(c)(1) , if the sum of liabilities assumed by the corporation exceeds the total adjusted basis of all properties transferred by that shareholder, the excess must be recognized as taxable gain .
Taxable Gain under Section 357(c) = Total Liabilities Assumed − Total Adjusted Basis of Contributed Property \text{Taxable Gain under Section 357(c)} = \text{Total Liabilities Assumed} - \text{Total Adjusted Basis of Contributed Property} Taxable Gain under Section 357(c) = Total Liabilities Assumed − Total Adjusted Basis of Contributed Property
Aggregation Rule: Section 357(c) applies on a shareholder-by-shareholder basis. A shareholder aggregates the adjusted tax bases of all assets they contribute to compare against the total liabilities assumed from them.
Basis Result: When §357(c) gain is recognized, the shareholder's stock basis becomes $0 (Basis = Original Basis + Gain Recognized - Debt Relief = Basis + (Debt - Basis) - Debt = $0).
4. Deductible Liabilities Exclusion: IRC §357(c)(3)
Under IRC §357(c)(3) , liabilities that would give rise to a tax deduction when paid are excluded from the §357(c) excess-liability calculation. Common examples include:
- Accounts payable of a cash-method taxpayer
- Accrued trade expenses (unpaid wages, interest, rent of a cash-basis business)
These liabilities do not trigger gain under §357(c) and do not reduce stock basis under §358(d). This exclusion ensures cash-basis sole proprietors with zero-basis receivables and substantial payables can incorporate without catastrophic phantom income.
Section 357 Provision Triggering Event Tax Consequence Impact on Stock Basis
§357(a) General Rule Standard business debt assumed No gain recognized; not treated as boot Reduces stock basis dollar-for-dollar under §358(d)
§357(b) Anti-Abuse Tax avoidance purpose or lacks business purpose ALL liabilities assumed are treated as cash boot Gain recognized up to realized gain; stock basis adjusted
§357(c) Excess Debt Total debt assumed > aggregate adjusted basis Excess debt recognized as taxable gain Stock basis is reduced to exactly $0
§357(c)(3) Deductible Debt Cash-method accounts payable Excluded from §357(c); no gain Does NOT reduce stock basis under §358(d)
Section 1244 Small Business Stock
Stock in a corporation is ordinarily a capital asset under IRC §1221. Under general tax principles, a loss on the sale, exchange, or worthlessness of corporate stock is a capital loss , subject to the stringent $3,000 annual deduction limit against ordinary income under IRC §1211(b) .
To encourage investment in small operating companies, IRC §1244 allows eligible shareholders to treat losses on qualifying stock as ordinary loss deductions .
Annual Statutory Loss Caps
Single / Head of Household / MFS: Up to $50,000 of ordinary loss per year.
Married Filing Jointly: Up to $100,000 of ordinary loss per year (even if only one spouse owned the stock).
Excess Losses: Any loss in excess of the annual $50,000 / $100,000 ceiling is treated as a capital loss , subject to standard capital loss rules ($3,000 annual ordinary income offset with indefinite carryforward).
Qualification Requirements for Section 1244 Stock
To qualify for Section 1244 treatment, the stock must meet all of the following requirements:
Eligible Taxpayers (Original Issuee Rule): Only individuals and partnerships who were the original issuees of the stock can claim Section 1244 ordinary loss treatment. If stock is acquired by purchase from another shareholder, gift, inheritance, or distribution from a partnership, Section 1244 status is permanently lost.
Small Business Corporation ($1,000,000 Capital Ceiling): At the time the stock was issued, the aggregate amount of money and other property received by the corporation for stock, as a contribution to capital, and as paid-in surplus cannot exceed $1,000,000 .
Active Business Test: For the 5 most recent tax years ending before the date the loss is sustained (or for the period of the corporation's existence if shorter), the corporation must have derived more than 50% of its aggregate gross receipts from sources other than royalties, rents, dividends, interest, annuities, and sales/exchanges of stock or securities (passive investment test).
Common or Preferred Stock: The stock may be voting or nonvoting, common or preferred (prior to 1984, only common qualified; current law allows preferred stock).
Special Basis Limitation for Contributed Property (IRC §1244(d)(1))
If a shareholder contributes property with a tax basis in excess of fair market value (built-in loss property) to a corporation in a §351 exchange for §1244 stock:
For computing the Section 1244 ordinary loss , the stock's basis is reduced to the fair market value of the property at the time of contribution.
Any loss attributable to the pre-contribution built-in loss remains a capital loss .
- Comprehensive Worked Numerical Examples
- Example 1: Section 351(b) Boot Calculation
Facts: Marcus transfers a commercial building (adjusted tax basis $60,000, FMV $150,000) to Vertex Corp. for 80% of Vertex stock (FMV $120,000) plus $30,000 cash boot.
Realized Gain: Total consideration ($120,000 stock + $30,000 cash = $150,000) minus Basis ($60,000) = $90,000 .
Recognized Gain (§351(b)): Lesser of Realized Gain ($90,000) or Boot Received ($30,000) = $30,000 .
Marcus's Stock Basis (§358): Basis: $60,000 (basis) + $30,000 (gain recognized) - $30,000 (boot received) = $60,000
Vertex Corp.'s Inside Basis in Building (§362(a)): Basis: $60,000 (carryover basis) + $30,000 (gain recognized) = $90,000
Example 2: Section 357(c) Liabilities in Excess of Basis
Facts: Samantha incorporates her sole proprietorship, transferring business assets with an aggregate adjusted basis of $70,000 (FMV $140,000) and liabilities of $100,000 (equipment loans) which the corporation assumes. Samantha receives 100% of the corporate stock.
Section 357(c) Gain: Liabilities assumed ($100,000) minus Total Basis ($70,000) = $30,000 Taxable Gain .