Sec. 351 transfers involving boot and encumbered assets.

• Author: Keller, Brian E.

Under Sec. 351(b)(1), when consideration received in exchange for property transferred in a Sec. 351 transfer includes money or other property (i.e., "boot"), gain is recognized to the extent of the boot's fair market value (FMV). However, Sec. 351 is silent about how to allocate consideration received in an exchange, including boot, among the assets transferred. More importantly, although the IRS has issued guidance on multiple-asset transfers under Sec. 351, it has not addressed multiple-asset transfers involving encumbered assets. Two reasonable interpretations seem possible; the better result depends on the facts.

Rev. Rul. 68-55

In Rev. Rul. 68-55, the Service held that if multiple assets are transferred under Sec. 351, each asset is deemed transferred in exchange for a proportionate share of each category of consideration received (i.e., stock, liability assumption and boot). Because stock or liability assumption received in an exchange is protected under the Sees. 351(a) and 357(a) non-recognition rules, the real effect of Rev. Rul. 68-55 is on the allocation of boot among the multiple assets transferred. Under Sec. 351(b)(2), if boot is allocated to property with a realized loss, such loss would not be recognized. However, according to Sec. 351(b)(1), if it is allocated to property with realized gain, such gain would be recognized to the extent of the allocated boot's FMV.

Rev. Rul. 68-55 strives to provide a balanced approach for determining exactly which consideration is received for each asset transferred. As such, it addresses two concerns: (1) the netting of gains and losses realized in a Sec. 351 transfer involving multiple assets and (2) the arbitrary allocation of consideration among the multiple assets transferred.

For the first issue, the ruling is clear--receipt of boot might simply have no effect if netting were permitted. For the second issue, in the ruling, the IRS rejected the arbitrary allocation of consideration; this position was later reiterated and amplified in Rev. Rul. 85-164. The IRS's reasoning is quite apparent--the arbitrary allocation of consideration, particularly boot, may allow a taxpayer to allocate the boot to shift gain recognition away from gain assets and toward loss assets. Fortunately, in Rev. Rul. 68-55, the Service did not attempt to allocate boot only to gain assets.

Specific Liabilities

Unfortunately, Rev. Kul. 68-55 did not consider the effect if one or more of the assets transferred was encumbered. In...