When do liabilities assumed trigger gain under Section 357?

Three rules.

Section 357(a): general rule. Liabilities assumed by the corporation are not treated as boot for purposes of computing recognized gain.

Section 357(b): tax avoidance exception. If the principal purpose of the assumption is tax avoidance or there is no bona fide business purpose, all liabilities assumed by the corporation are treated as boot.

Section 357(c): excess liability rule. If the total liabilities assumed exceed the total adjusted basis of all property transferred by the transferor, the excess is recognized as gain.

Worked example for 357(c). Transferor contributes property with basis 30,000 and FMV 150,000. Corporation assumes 50,000 of debt.

• Liabilities assumed: 50,000
• Total basis transferred: 30,000
• Excess: 20,000 — recognized as gain

The transferor reports 20,000 of recognized gain. Stock basis becomes 30,000 minus 50,000 plus 20,000, which equals zero. Stock basis cannot go negative because of the 357(c) recognition.

Note that 357(b) and 357(c) usually don't overlap on the exam. If 357(b) applies, all liabilities are boot under boot mechanics and gain is computed up to the boot. If 357(c) applies, only the excess over basis is gain. Both rules prevent abuse but in different ways.