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8.1 Corporate Formation & Section 351 Transfer Requirements
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
8.1 Corporate Formation & Section 351 Transfer Requirements
Key Takeaways Explain This Topic AI
IRC §351(a) provides mandatory nonrecognition of gain or loss when one or more persons transfer property to a corporation solely in exchange for stock and immediately after the exchange possess 80% control under IRC §368(c).
Control requires owning at least 80% of total combined voting power of all classes of voting stock AND at least 80% of the total number of shares of each class of nonvoting stock.
Services are specifically excluded from the definition of property under §351(d)(1); stock received for services generates immediate ordinary compensation income under §61 and §83 equal to fair market value.
A service contributor cannot count toward the 80% control group unless they also transfer more than nominal property (Rev. Proc. 77-37 safe harbor: property FMV must equal at least 10% of the value of stock already owned or received for services).
The shareholder receives a substituted basis in stock under §358 (transferred basis + gain recognized - boot received - liabilities assumed), while the corporation inherits a carryover basis in property under §362(a), with holding period tacking under §1223 for capital and §1231 assets.
Last updated: October 2026
Corporate Formation & Section 351 Transfer Requirements
When entrepreneurs organize a corporation or incorporate an existing business, the general realization rule of Internal Revenue Code (IRC) Section 1001 would ordinarily treat the exchange of appreciated assets for corporate stock as a fully taxable sale. However, Congress enacted IRC §351 to prevent the tax code from impeding business formation and structural reorganization. Section 351 reflects the underlying tax principle of continuity of investment : changing the legal form in which property is held—from individual ownership or partnership form to corporate equity—does not represent a cashing-in of the taxpayer's economic investment.
Corporate formation under Section 351 is a core area of corporate taxation on SEE Part 2. Candidates must master the three statutory requirements for nonrecognition, understand how services alter control calculations under IRS revenue procedures, and compute shareholder stock basis (§358) and corporate asset basis (§362(a)) with surgical accuracy.
The Three Statutory Requirements of IRC §351(a)
Under IRC §351(a) , no gain or loss is recognized if one or more persons transfer property to a corporation solely in exchange for stock of such corporation and immediately after the exchange such person or persons are in control of the corporation (as defined in IRC §368(c) ). Transferors (One or More Persons)
- │
- ├── Contributes: Qualifying "Property"
- │
- └── Receives: "Solely Corporate Stock"
- │
- ▼
- Immediately After Exchange: Transferor Group Owns ≥ 80% Control (§368(c))
- │
- └── Result: Mandatory Nonrecognition (§351(a)) ──> Realized Gain/Loss Deferred
This nonrecognition treatment is mandatory , not elective. If all statutory criteria are satisfied, neither the transferor shareholders nor the transferee corporation can choose to recognize gain or loss.
Requirement 1: Transfer of "Property"
To qualify under Section 351, the transferor must transfer property . The Internal Revenue Code does not provide an exhaustive statutory definition of property for §351, but the courts and IRS rulings have established comprehensive parameters:
Qualifying Property: Cash (U.S. currency and foreign currency), real estate, tangible personal property (machinery, vehicles, inventory, office equipment), and intangible personal property (patents, copyrights, trademarks, secret formulas, trade secrets, goodwill, and customer lists). Cash-method accounts receivable also qualify as property.
Statutory Exclusions from Property (IRC §351(d)):
Services (§351(d)(1)): Stock issued for past, present, or future services rendered to or for the benefit of the issuing corporation is not issued in return for property.
Short-Term Indebtedness (§351(d)(2)): Indebtedness of the transferee corporation that is not evidenced by a "security" (e.g., an open accounts payable or unsecured short-term promissory note) does not qualify as property.
Accrued Interest (§351(d)(3)): Corporate indebtedness that resulted in accrued interest on or after the beginning of the transferor's holding period is excluded.
Requirement 2: Solely in Exchange for Stock
The transferor must receive stock of the transferee corporation. The following equity instruments qualify as stock:
- Voting common stock
- Nonvoting common stock
- Qualified preferred stock (voting or nonvoting)
Instruments That Do NOT Qualify as Stock:
Corporate Debt & Securities: Following the Revenue Reconciliation Act of 1989, corporate debt securities (bonds, debentures, long-term notes) no longer qualify as nonrecognition property under §351. Debt received by a transferor is treated as taxable boot .
Stock Rights, Options, and Warrants: Under Treas. Reg. §1.351-1(a)(1), stock rights and stock purchase warrants do not constitute stock.
Nonqualified Preferred Stock (NQPS): Under IRC §351(g) , preferred stock that includes certain debt-like features (e.g., the holder has the right to require the issuer to redeem it, or the issuer is required to redeem it within 20 years) is treated as taxable boot rather than qualifying stock.
Requirement 3: "Control" Immediately After the Exchange (IRC §368(c))
The transferors—as an aggregated group—must possess control of the corporation immediately after the exchange. Control is defined strictly under IRC §368(c) and requires satisfying both prongs of a two-part test:
Ownership of at least 80% of the total combined voting power of all classes of stock entitled to vote; AND
Ownership of at least 80% of the total number of shares of each class of nonvoting stock (Rev. Rul. 59-259 requires 80% ownership of every separate class of nonvoting stock, not merely 80% in the aggregate). IRC §368(c) Control Test:
- ├── Prong 1: ≥ 80% of Total Combined Voting Power (All Voting Classes)
- └── Prong 2: ≥ 80% of Total Number of Shares of EVERY Nonvoting Class
Important
The 80% control test does not require each individual transferor to acquire 80%. Rather, it evaluates the transferor group collectively . All persons who transfer property as part of a single coordinated plan or transaction are pooled together to measure whether the group owns at least 80% immediately after the transfers.
Stock Received for Services: Taxation & Control Group Impact
When an individual receives corporate stock in exchange for labor, technical services, or management, the tax consequences depend on whether they contribute property in addition to services.
1. Pure Service Contributor
If a taxpayer receives stock solely in exchange for services rendered (e.g., legal counsel, architectural drawings, or promotional work):
Tax Treatment: Under IRC §61 and IRC §83 , the service provider recognizes ordinary compensation income equal to the fair market value (FMV) of the stock received in the year it becomes substantially vested (or immediately if not subject to a substantial risk of forfeiture).
Control Group Exclusion: The pure service provider is not a property transferor . Consequently, zero percent (0%) of their stock counts toward the 80% control requirement under §368(c).
Impact on Other Transferors: If the property transferors do not independently own at least 80% of the stock after accounting for the shares issued to the service provider, the entire transaction fails Section 351, causing all property transferors to recognize gain on their appreciated contributions.
2. Dual Contributor (Property Plus Services) and Rev. Proc. 77-37
If an individual transfers both qualifying property and services in exchange for corporate stock, can their shares count toward the 80% control test?
General Rule: Under Treas. Reg. §1.351-1(a)(1)(ii), if a person transfers property of relatively small value compared to the value of the stock already owned or to be received for services, and the primary purpose of the transfer is to qualify the exchanges of other persons under §351, that person will not be treated as a transferor.
IRS Safe Harbor (Rev. Proc. 77-37 §3.07): For IRS advance ruling purposes, property transferred is not considered of relatively small value if the fair market value of the property transferred is equal to at least 10% of the fair market value of the stock and securities already owned (or to be received for services) by such person.
Mechanics of the Safe Harbor: When the 10% threshold is satisfied, all of that shareholder's stock (both the stock received for property and the stock received for services) counts toward satisfying the 80% control test for the transferor group. However, the shareholder must still recognize ordinary income on the value of the stock received for services under §83!
Contributor Status Ordinary Income Recognized? Counts Toward 80% Control?
- Property Only No (§351 nonrecognition) Yes: 100% of shares count
- Services Only Yes: Ordinary income = FMV of stock No: 0% of shares count
Property + Services (< 10% FMV) Yes: Ordinary income on service shares No: Deemed nominal under Treas. Reg. §1.351-1
Property + Services (≥ 10% FMV) Yes: Ordinary income on service shares Yes: 100% of shares count toward group control
Shareholder's Stock Basis Calculation (IRC §358)
Under IRC §358(a)(1) , the shareholder receives a substituted basis in the stock received. This substituted basis preserves the deferred pre-contribution gain or loss so that it will be recognized upon a subsequent taxable sale of the stock.
The Section 358 Stock Basis Formula Stock Basis = Adjusted Basis of Property Transferred + Cash Contributed + Gain Recognized by Transferor Shareholder − Fair Market Value of Boot Received − Cash Boot Received − Liabilities Assumed by Corporation (Section 358(d)) \begin{aligned}
- \text{Stock Basis} = & \quad \text{Adjusted Basis of Property Transferred} \\
- & + \text{Cash Contributed} \\
- & + \text{Gain Recognized by Transferor Shareholder} \\
- & - \text{Fair Market Value of Boot Received} \\
- & - \text{Cash Boot Received} \\
- & - \text{Liabilities Assumed by Corporation (Section 358(d))}
\end{aligned} Stock Basis = Adjusted Basis of Property Transferred + Cash Contributed + Gain Recognized by Transferor Shareholder − Fair Market Value of Boot Received − Cash Boot Received − Liabilities Assumed by Corporation (Section 358(d))
If the shareholder receives multiple classes of stock (e.g., voting common and nonvoting preferred), the aggregate basis calculated above is allocated among the classes in proportion to their relative fair market values (Treas. Reg. §1.358-2).
Transferee Corporation's Property Basis (IRC §362(a))
Under IRC §362(a) , the transferee corporation takes a carryover basis in the property received from the transferor shareholder.
The Section 362(a) Asset Basis Formula Corporation’s Property Basis = Transferor Shareholder’s Adjusted Basis + Gain Recognized by Shareholder \text{Corporation's Property Basis} = \text{Transferor Shareholder's Adjusted Basis} + \text{Gain Recognized by Shareholder} Corporation’s Property Basis = Transferor Shareholder’s Adjusted Basis + Gain Recognized by Shareholder
Notice the symmetry: if the shareholder recognizes no gain under §351(a), the corporation steps directly into the shareholder's shoes and takes an identical basis in the property.
Section 362(e)(2) Net Built-in Loss Limitation
To prevent the "double deduction" of losses (once by the corporation through depreciation or asset sale, and once by the shareholder upon selling the stock), IRC §362(e)(2) applies when the aggregate adjusted bases of properties transferred by a shareholder exceed their aggregate fair market value immediately after the transfer:
General Rule: The corporation's aggregate basis in the contributed assets is stepped down to their aggregate fair market value, with the step-down allocated proportionately to built-in loss assets.
Election to Reduce Stock Basis (§362(e)(2)(C)): The shareholder and corporation may make a joint election on their tax returns to preserve the corporation's higher carryover basis in the assets and instead reduce the shareholder's stock basis down to FMV.
Holding Period Tacking Rules (IRC §1223)
Holding periods determine whether gains or losses on future dispositions are classified as long-term (held > 1 year) or short-term:
1. Shareholder's Holding Period in Stock (IRC §1223(1))
Tacking Allowed: The holding period of the stock received includes (tacks) the shareholder's holding period in the contributed property only if the contributed property was a capital asset (IRC §1221) or Section 1231 asset (depreciable business property or real property held > 1 year).
No Tacking (Begins Day After Exchange): If the contributed property was an ordinary income asset (inventory, cash, or unrealized accounts receivable), or if the stock was received for services, tacking is disallowed. The holding period begins on the day after the exchange.
Split Holding Period: If a shareholder contributes a combination of capital/§1231 assets and ordinary assets, each individual share of stock has a split (fragmented) holding period allocated in proportion to the relative fair market values of the contributed properties.
2. Corporation's Holding Period in Property (IRC §1223(2))
The corporation's holding period in the received property always tacks the transferor's holding period, regardless of the nature of the property (capital, §1231, or ordinary income property).
Comprehensive Worked Formation Scenario
Facts: On March 1, 2025, Alex and Beatrice organize Apex Solutions Inc., a new domestic C corporation. Apex issues 100 shares of voting common stock:
Alex transfers commercial equipment held for 3 years: adjusted tax basis of $45,000, fair market value of $80,000. In exchange, Alex receives 80 shares of Apex voting stock (FMV $80,000).
Beatrice transfers $20,000 in cash. In exchange, Beatrice receives 20 shares of Apex voting stock (FMV $20,000).
Analysis:
Control Test (§368(c)): Alex and Beatrice are both property transferors (cash is property). Together, they own 100 out of 100 shares (100% control), which easily exceeds the 80% requirement. Section 351 applies.
Alex's Tax Consequences:
- Realized Gain: $80,000 FMV - $45,000 basis = $35,000
- Recognized Gain: $0 (§351(a) nonrecognition)
- Alex's Stock Basis (§358): $45,000 (substituted basis of equipment)
- Alex's Holding Period: Tacks the 3-year holding period of the equipment (§1231 property)
Beatrice's Tax Consequences:
- Realized & Recognized Gain: $0
- Beatrice's Stock Basis (§358): $20,000 (cash contributed)
- Beatrice's Holding Period: Begins on March 2, 2025 (day after exchange)
Apex Corporation's Tax Consequences:
- Apex recognizes $0 gain on issuing stock (§1032)
- Apex's Inside Basis in Equipment (§362(a)): $45,000 (carryover basis)
- Apex's Inside Basis in Cash: $20,000
- Apex's Holding Period in Equipment: Tacks Alex's 3-year holding period