Section 354 would ordinarily let a shareholder exchange stock in a reorganization without recognizing gain or loss. When the shareholder also receives money or other property (“boot”) that could not be received tax-free, section 356 steps in: realized gain is recognized, but only up to the fair market value of the boot received.
Here A (an individual or a corporation) surrenders one share of Corp stock with an adjusted basis of 85. In return A receives one share of stock worth 100, cash of 25, and other property with a fair market value of 50 — total consideration of 175. Subtracting the 85 basis in the surrendered share yields 90 of realized gain.
Because the stock itself is permitted to be received tax-free, the recognized gain is limited to the boot: 25 cash plus 50 of other property, or 75. That 75 is the ceiling on recognition even though 90 was realized.
Under section 356(a)(2), when the exchange has the effect of a dividend, the recognized gain is treated as a dividend to the extent of the shareholder’s ratable share of the distributing corporation’s earnings and profits accumulated after February 28, 1913. That share is 30, so 30 of the 75 is a taxable dividend and the remaining 45 is treated as gain from the exchange of property.
