A shareholder who sells appreciated property to his closely‑held corporation at an inflated price might think he’s cashing out at capital gains rates while giving the corporation a higher cost basis. But the IRS often recharacterizes such a transfer as a contribution to capital, not a sale.
Burr Oaks Corporation v. Commissioner, 365 F.2d 24 (7th Cir. 1966), cert. denied, 385 U.S. 1007 (1967), is a classic example. Three shareholders bought land for 330,000 in promissory notes. The corporation had only $4,500 of paid‑in capital. The Seventh Circuit held that the transfer was a contribution to capital, not a sale.
Why? The court looked at factors like the thin capitalization of the corporation, the lack of a genuine business purpose for the sale, and the fact that the notes were really a way for the shareholders to extract equity without paying capital gains tax. The court noted that when payment to the transferors depends on the success of an untried, undercapitalized business, a strong inference arises that the transfer is an equity contribution.
The lesson: If you’re going to sell property to your own corporation, make sure the corporation is adequately capitalized, the price is supported by an independent appraisal, and the transaction has a genuine business purpose. Otherwise, the IRS may treat it as a contribution to capital, and you’ll lose both the sale treatment and the stepped‑up basis.
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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