Section 354 permits a shareholder to exchange stock or 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 governs what happens when a shareholder receives “other property” — boot — along with the permitted stock or securities.
In this example, Shareholder A, an individual, transfers 100 shares of common stock to the Corporation. In return, A receives 100 shares of common stock and a security with a principal amount of $1,000 and a fair market value of $990.
Because A surrendered no securities in the exchange, the entire principal amount of the security received is treated as other property. Under Treas. Reg. § 1.356-3(c), the amount of other property is the fair market value of the security — $990 — not its face or principal amount.
That $990 of boot is the ceiling for gain recognition under section 356(a): any realized gain is recognized only up to the fair market value of the security received by A.
When a shareholder receives securities but surrenders none, the securities are “other property” under section 356 and are not received tax-free like stock.
The amount of other property is the $990 fair market value of the security received by A — not its $1,000 principal amount.
Section 354 shelters securities only up to the principal amount of securities surrendered; because A surrendered no securities, the full security received is boot.
Any gain A realizes on the exchange is recognized only to the extent of the $990 of boot received, mirroring the section 356(a)(1) limitation.
