A taxpayer’s relief from indebtedness is generally a taxable event. However, where Section 351 applies to a contribution of assets to a corporation for stock, the corporation’s assumption of liabilities may or may not be taxable under Section 357.

Section 357(a) states assumptions of indebtedness pursuant to a Section 351 transaction generally do not trigger gain. However, subsections (b) and (c) have important exceptions. Subsection 357(b)(1) provides where transfers are made either to avoid Federal income tax on the exchange or with no bona fide business purpose, the taxpayer is treated as if it received cash equal to the assumed debt. Section 357(b)(2) provides the burden is on the taxpayer to prove by the clear preponderance of the evidence that Section 357(b)(1) should not apply.

Section 357(c) provides in Section 351 transactions and certain Section 355 transactions, gain is realized to the extent the liabilities assumed by the corporation exceed the total of the adjusted basis of the property transferred to the corporation. Such excess is taxable as gain from the sale or exchange of the assets transferred. That means the type gain depends on the holding period and character of the assets, with the proportion based on the relative fair market values of the assets. See Reg. § 1.357-2. Section 357(c) often surprises taxpayers because it requires a comparison of the amount of the liabilities to the basis of the assets rather than the fair market value of the assets.

John G. Hodnette is an attorney with Fox Rothschild, LLP in Charlotte.

March 13, 2025/by TAX