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 358 substituted basis
Meaning
Computation of tax basis for shareholders receiving stock in an exchange. A section 358 substituted basis ensures that the founder’s historical cost in their property is preserved in their new equity. This rule prevents the immediate taxation of appreciation that occurred prior to the incorporation.
Initial Calculation
Founders start the math by taking the tax basis of the property they contributed to the company. The section 358 substituted basis is then adjusted by adding any gain recognized and subtracting any cash or other property received in the deal. This calculation results in a basis for the stock that mirrors the investment in the original assets.
Asset Allocation
Distribution of the total cost occurs when a founder receives multiple classes of shares or securities. The section 358 substituted basis must be divided among the different types of stock in proportion to their respective fair market values. This step is necessary to determine the gain or loss on a future sale of any specific portion of the holdings.
Disposition Result
Future tax liability is determined by the difference between the sale price and the adjusted cost recorded at formation. Because the section 358 substituted basis keeps the old cost alive, a founder who sells their shares shortly after incorporation will recognize the same gain they would have seen by selling the original property. The tax burden follows the asset through the corporate envelope.