Early Unpriced Software Transfers Under Section 351 Non Recognition Rules
Section 351 defers taxable gain when unpriced software property transfers for equity if contributors retain eighty percent control immediately after exchange.
Section 351 non recognition
Meaning
Deferral of taxable gain on property transfers to a controlled entity. A section 351 non recognition event allows founders to exchange assets for stock without immediate tax consequences. This provision facilitates the transition from individual ownership to a corporate structure.
Control Requirement
Majority ownership must be established immediately after the exchange for the deferral to hold. A section 351 non recognition claim requires that the group of transferors owns at least eighty percent of the total voting power and eighty percent of all other classes of stock. If the founders fail to meet this threshold, the entire exchange becomes a taxable event based on the market value of the assets.
Boot Exception
Receipt of any consideration other than stock triggers the recognition of gain for the transferor. While section 351 non recognition covers the stock portion of the deal, the inclusion of cash or debt securities results in a taxable amount. This taxable portion is limited to the lesser of the gain realized or the amount of the extra consideration received.
Holding Period
Tax status of the original assets carries over to the new shares held by the founder. Under section 351 non recognition, the time the founder held the property before the transfer is added to the holding period of the stock. This tacking of time determines whether a future sale of the shares qualifies for long term capital gains treatment.