Excess Principal as Boot Explained
Section 354 allows a shareholder to exchange securities in a reorganization without recognizing gain or loss, but only to the extent the principal amount of the securities received does not exceed the principal amount of the securities surrendered. Section 356 treats the value attributable to any excess principal as “other property” — boot.
Here, D transfers to the Corporation a security with a principal amount of $1,000. In return, D receives 100 shares of common stock and a security with a principal amount of $1,200 and a fair market value of $1,100.
Because D received a $1,200 principal security while surrendering only a $1,000 principal security, $200 of the principal received is excess. Under Treas. Reg. § 1.356-3(c), the amount of other property is not the $200 of excess principal itself but the fair market value of that excess — $183.33 (the $1,100 fair market value multiplied by the $200/$1,200 excess ratio).
The $1,100 of value received in the security breaks into a $916.67 no-excess portion, which is received tax-free as securities, and a $183.33 excess portion, which is boot. That $183.33 is the ceiling for gain recognition under section 356(a).
