Section 354 lets a shareholder exchange stock or securities in a corporate reorganization without recognizing gain or loss. Securities, however, are only sheltered to the extent the principal amount of the securities received does not exceed the principal amount of the securities surrendered. Section 356 and Treas. Reg. § 1.356-3(c) treat any such excess principal as “other property” — boot.
Here, Shareholder C surrenders a security with a principal amount of $1,000 to the Corporation. In return, C receives 100 shares of common stock and a new security with a principal amount of $900.
Because the $900 principal amount of the security received does not exceed the $1,000 principal amount of the security surrendered, there is no excess principal. Under the regulation, no part of the security received is treated as other property.
The result is a fully tax-free exchange: the 100 shares of common stock qualify as stock received in a reorganization, and the $900 security is protected by the security C gave up. C recognizes no gain because there is no boot.
Boot from securities turns on principal amount: the securities received are “other property” only to the extent their principal exceeds the principal of the securities surrendered.
C surrendered $1,000 of principal and received only $900 of principal, so there is no excess principal and no part of the security received is boot.
The 100 shares of common stock C receives are stock permitted to be received tax-free under section 354, entirely apart from the securities analysis.
With no boot in the exchange, section 356(a) has nothing to tax and C recognizes no gain on the surrender of the $1,000 security.
