[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1081-7]

[Page 194-195]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1081-7  Sale of stock or securities received upon exchange by 
members of system group.

    (a) Section 1081(d)(2) provides that to the extent that property 
received upon an exchange by corporations which are members of the same 
system group consists of stock or securities issued by the corporation 
from which such property was received, such stock or securities may, 
under certain specifically described circumstances, be sold to a party 
not a member of the system group, without the recognition of gain or 
loss to the selling corporation. The nonrecognition of gain or loss is 
limited, in the case of stock, to a sale of stock which is preferred as 
to both dividends and assets. The stock or securities must have been 
received upon an exchange with respect to which section 1081(d)(1) 
operated to prevent recognition of gain or loss to any party to the 
exchange. Nonrecognition of gain or loss upon the sale of such stock or 
securities is permitted only if the proceeds derived from the sale are 
applied in retirement or cancellation of stock or securities of the 
selling corporation which were outstanding at the time the exchange was 
made. It is also essential to nonrecognition of gain or loss upon the 
sale that both the sale of the stock or securities and the application 
of the proceeds derived therefrom be made in obedience to an order of 
the Securities and Exchange Commission. If any part of the proceeds 
derived from the sale is not applied in making the required retirement 
or cancellation of stock or securities and if the sale is otherwise 
within the provisions of section 1081 (d)(2), the gain resulting from 
the sale shall be recognized, but in an amount not in excess of the 
proceeds which are not so applied. In any event, if the proceeds derived 
from the sale of the stock or securities exceed the fair market value of 
such stock or securities at the time of the exchange through which they 
were acquired by the selling corporation, the gain resulting from the 
sale is to be recognized to the extent of such excess. Section 1081 
(d)(2) does not provide for the nonrecognition of any gain resulting 
from the retirement of bonds, notes, or other evidences of indebtedness 
for a consideration less than the issuing price thereof. Also, that 
section does not provide for the nonrecognition of gain or loss upon the 
sale of any stock or securities received upon a distribution or 
otherwise than upon an exchange.
    (b) The application of paragraph (a) of this section may be 
illustrated by the following example:

    Example: The X Corporation and the Y Corporation, both of which make 
their income tax returns on a calendar year basis, are members of the 
same system group. As part of an exchange to which section 1081 (d)(1) 
is applicable the Y Corporation on June 1, 1954, issued to the X 
Corporation 1,000 shares of class A stock, preferred as to both 
dividends and assets. The fair market value of such stock at the time of 
issuance was $90,000 and its basis to the X Corporation was $75,000. On 
December 1, 1954, in obedience to an appropriate order of the Securities 
and Exchange Commission, the X Corporation sells all of such stock to 
the public for $100,000 and applies $95,000 of this amount to the 
retirement of its own bonds, which were outstanding on

[[Page 195]]

June 1, 1954. The remaining $5,000 is not used to retire any of the X 
Corporation's stock or securities. Of the total gain of $25,000 realized 
on the disposition of the Y Corporation stock, only $10,000 is 
recognized (the difference between the fair market value of the stock 
when acquired and the amount for which it was sold), since such amount 
is greater than the portion ($5,000) of the proceeds not applied to the 
retirement of the X Corporation's stock or securities. If in this 
example the stock acquired by the X Corporation had not been stock of 
the Y Corporation issued to the X Corporation or if it had been stock 
not preferred as to both dividends and assets, the full amount of the 
gain ($25,000) realized upon its disposition would have been recognized, 
regardless of what was done with the proceeds.