Pro Rata Boot Allocation Explained
J, an individual, holds 10 shares of Class A stock of Corporation X (basis $30) and 10 shares of Class B stock of Corporation X (basis $90). On Date 3, Corporation Y acquires the assets of Corporation X in a reorganization under section 368(a)(1)(A). Pursuant to the plan, J surrenders all of J’s Corporation X stock in exchange for 10 shares of Corporation Y stock and $100 of cash. Each Class A share, each Class B share, and each Corporation Y share is worth $10, so J receives $100 of Corporation Y stock and $100 of cash for $200 of surrendered stock.
Because the terms of the exchange do not specify that the cash is received for particular Class A or Class B shares, Treas. Reg. § 1.356-1(b) requires the cash to be allocated pro rata by the fair market value of the surrendered shares. J is therefore treated as receiving $50 of Corporation Y stock and $50 of cash for the Class A shares, and $50 of Corporation Y stock and $50 of cash for the Class B shares.
The gain is computed separately for each block. On the Class A shares, J realizes $70 of gain ($100 consideration − $30 basis), $50 of which is recognized under section 356(a) as the lesser of gain realized or boot received. On the Class B shares, J realizes $10 of gain ($100 consideration − $90 basis), all $10 of which is recognized. Assuming the recognized gain is not treated as a dividend under section 356(a)(2), it is treated as gain from the exchange of property.
