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Nonrecognition Transaction in Taxation

Instructor: Martin Gibbs

Martin has 16 years experience in Human Resources Information Systems and has a PhD in Information Technology Management. He is an adjunct professor of computer science and computer programming.

Sometimes corporate gains or losses are not included in corporate tax filings. This lesson will discuss nonrecognition transactions and treatment of distributions from these transactions.

An Exception to Declaring?

To oversimplify doing your taxes, you could say that's its basically telling the government what you made in income, and what you lost in expenses. In other words, how much did you make, and how much did you have to spend? We know how detailed this can get, with all kinds of categories and lines on the tax forms in order to place all your gains and losses appropriately.

But there are in fact some cases, when a business doesn't have to put a transaction down anywhere on these forms.

Nonrecognition Transactions

Typically a corporation (just like an individual) is required to claim gains or losses on money made/lost during the course of doing business. However, there are some situations in which the gain or loss is not recognized. A nonrecognition transaction is one that is not claimed on corporate tax filings.

For corporate tax, section 361 of the US Tax code defines these types of gains or losses, and the treatment of distributions. It states that no gain or loss is recognized to a corporation if the company is reorganizing and exchanges property (assets) ONLY for stock or securities.

The IRS regulations refer to qualified property: This means shares of stock. This includes stock in the company distributing the shares, or another corporation which is part of the reorganization.

What does this mean in practice?

Example

Let's say that Pretty Good Apps, Inc. is going through a rough time and decides to restructure instead of fold. The board decides to transfer all of its assets to a major shareholder in exchange for all of her stock. As long as the exchange is purely asset-for-stock, then any gains or losses from this transaction are not recognized.

Even if the transfer results in a net loss, this is not recognized. For example, if Company A has assets of $250,000 and exchanges them for stock worth $100,000, they cannot declare a loss on this transaction. The transfer of the qualified property (that is, shares of stock) in exchange for assets can be captured under 361 as a nonrecognition transaction.

Treatment of Distributions

In order for property distribution to be non-recognized for gain/loss, the property needs to be considered qualified. Qualified property, again, is company stock. Let's look at the example of Pretty Good Apps, Inc. again, and add some numbers to the transaction to highlight the qualification under Section 361.

Our sample company, Pretty Good Apps, Inc., has assets of $80,000. In the course of negotiations, both Janet the buyer and the company agree that Janet will get all assets of Pretty Good Apps.

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