IRC Section 351 Compliance When Exchanging Unvalued Intellectual Property
Tax nonrecognition under Section 351 requires transferring legal title of intangible property rather than services or nonexclusive rights to a controlled corporation.
carryover basis Section 362
Meaning
Asset transfers to a controlled corporation preserve the historical cost of the property to prevent the immediate recognition of gain. The carryover basis section 362 ensures that the corporation takes the same basis in the asset that the transferor had. It operates as a deferral mechanism to avoid an immediate tax liability.
The rule applies specifically to transfers under corporate formation statutes.
Historical Value
The cost history of an asset follows the property into the new entity. Under the carryover basis section 362, the corporation records the asset at its original purchase price minus any depreciation already taken by the founder. This prevents the tax basis from being reset to the current market value upon transfer.
If a founder transfers a patent with a zero basis, the corporation must also record a zero basis. This continuity ensures that the gain inherent in the asset remains within the tax system. The corporation eventually recognizes this gain when it sells the asset to a third party.
It maintains the integrity of the tax record across different corporate forms.
Cost Preservation
Keeping the original cost basis prevents the creation of artificial losses or the elimination of legitimate gains. The carryover basis section 362 locks the tax attributes of the asset in place at the moment of exchange. This preserves the potential tax liability for the future.
Liability Offset
Adjustments to this value occur if the transferor recognizes a gain during the exchange. The carryover basis section 362 allows the corporation to increase its basis by the amount of gain recognized by the founder. This prevents the same economic gain from being taxed twice.
It creates a correspondence between the founder’s tax return and the company’s books.