Can you avoid § 357(c) gain by contributing your own promissory note to the corporation along with encumbered property? That’s the question in Peracchi v. Commissioner, 143 F.3d 487 (9th Cir. 1998).
Peracchi contributed two parcels of real estate to his wholly‑owned corporation. The properties were subject to liabilities that exceeded his basis by over 1,060,000, arguing that the note had a basis equal to its face amount, which would increase his total basis and eliminate the excess.
The IRS argued the note had zero basis – it cost him nothing to write the note. The Ninth Circuit disagreed, holding that the note did have basis equal to its face amount. Why? Because by contributing the note, Peracchi increased his personal exposure to the corporation’s creditors. If the corporation went bankrupt, creditors could enforce the note. That economic risk justified a basis step‑up.
The dissent called this “sortilege” – magic – creating basis out of nothing. And the case remains controversial. The Tax Court had previously held the opposite in Alderman v. Commissioner, 55 T.C. 662 (1971). And the government continues to challenge such arrangements.
The practical lesson: Don’t rely on contributing your own note to avoid § 357(c) gain. The law is unsettled, and the risk of challenge is high. Instead, try to increase your basis through other means – like contributing cash or other property – before transferring encumbered assets.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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