Peracchi v. Commissioner

United States Court of Appeals for the Ninth Circuit · 1998 · Corporations

143 F.3d 487 (9th Cir. 1998)

Updated July 31, 2026

corporationstaxsection 351section 357(c)shareholder basisI.R.C. § 351I.R.C. § 357(a)I.R.C. § 357(b)

Facts

Peracchi needed to add capital to his closely held corporation, NAC, so it could comply with Nevada's minimum premium-to-asset ratio for insurance companies. He contributed two parcels of real estate, but the liabilities on those parcels exceeded his basis in the properties by $566,807, which would ordinarily trigger gain under section 357(c). To avoid that result, he also contributed a ten-year promissory note for $1,060,000 bearing 11% interest and argued that the note had basis equal to its face amount. The IRS contended both that the note was not genuine debt and that, even if genuine, it had zero basis in Peracchi's hands.

Issue

Whether a shareholder's own promissory note, contributed to his wholly owned corporation in a section 351 transaction, has basis in the shareholder's hands for purposes of section 357(c). Also, whether Peracchi's note was genuine indebtedness rather than a sham or gift.

Rule

For purposes of section 357(c), a shareholder who contributes to an operating C corporation a valid, unconditional, creditworthy promissory note that is worth approximately its face value and creates a real, non-trivial increase in the shareholder's economic exposure to corporate creditors takes basis in that note equal to its face value. Such a note is genuine debt when the shareholder's legal obligation is not illusory, including where the note bears a market rate, has a fixed term, is enforceable and transferable, and can be reached by third parties such as creditors.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Maya Linwood owns all the stock of Cedar Vale Underwriting, a C corporation operating in Nevada. She transfers encumbered warehouse property to the corporation in a Section 351 exchange; the liabilities exceed her aggregate basis by $280,000, but in the same transaction she also contributes her signed recourse note for $400,000, payable over eight years at a market interest rate, and she is plainly solvent.

How should the note be treated in determining whether Maya must recognize gain under Section 357(c)?

Explanation. The majority held that, in a Section 351 transfer to an operating C corporation, a shareholder's valid, unconditional, creditworthy promissory note that is worth approximately its face value has basis equal to face value for Section 357(c) purposes when it creates a real, non-trivial increase in the shareholder's economic exposure. Because Maya's note is recourse, market-rate, fixed-term, and she is solvent, its basis is aggregated with the basis of the other property transferred.