[Code of Federal Regulations]
[Title 26, Volume 4]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.304-2]

[Page 20-21]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.304-2  Acquisition by related corporation (other than subsidiary).

    (a) If a corporation, in return for property, acquires stock of 
another corporation from one or more persons, and the person or persons 
from whom the stock was acquired were in control of both such 
corporations before the acquisition, then such property shall be treated 
as received in redemption of stock of the acquiring corporation. The 
stock received by the acquiring corporation shall be treated as a 
contribution to the capital of such corporation. See section 362(a) for 
determination of the basis of such stock. The transferor's basis for his 
stock in the acquiring corporation shall be increased by the basis of 
the stock surrendered by him. (But see below in this paragraph for 
subsequent reductions of basis in certain cases.) As to each person 
transferring stock, the amount received shall be treated as a 
distribution of property under section 302(d), unless as to such person 
such amount is to be treated as received in exchange for the stock under 
the terms of section 302(a) or section 303. In applying section 302(b), 
reference shall be had to the shareholder's ownership of stock in the 
issuing corporation and not to his ownership of stock in the acquiring 
corporation (except for purposes of applying section 318(a)). In 
determining control and applying section 302(b), section 318(a) 
(relating to the constructive ownership of stock) shall be applied 
without regard to the 50-percent limitation contained in section 
318(a)(2)(C) and (3)(C). A series of redemptions referred to in section 
302(b)(2)(D) shall include acquisitions by either of the corporations of 
stock of the other and stock redemptions by both corporations. If 
section 302(d) applies to the surrender of stock by a shareholder, his 
basis for his stock in the acquiring corporation after the transaction 
(increased as stated above in this paragraph) shall not be decreased 
except as provided in section 301. If section 302(d) does not apply, the 
property received shall be treated as received in a distribution in 
payment in exchange for stock of the acquiring corporation under section 
302(a), which stock has a basis equal to the amount by which the 
shareholder's basis for his stock in the acquiring corporation was 
increased on account of the contribution to capital as provided for 
above in this paragraph. Accordingly, such amount shall be applied in 
reduction of the shareholder's basis for his stock in the acquiring 
corporation. Thus, the basis of each share of the shareholder's stock in 
the acquiring corporation will be the same as

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the basis of such share before the entire transaction. The holding 
period of the stock which is considered to have been redeemed shall be 
the same as the holding period of the stock actually surrendered.
    (b) In any case in which two or more persons, in the aggregate, 
control two corporations, section 304(a)(1) will apply to sales by such 
persons of stock in either corporation to the other (whether or not made 
simultaneously) provided the sales by each of such persons are related 
to each other. The determination of whether the sales are related to 
each other shall be dependent upon the facts and circumstances 
surrounding all of the sales. For this purpose, the fact that the sales 
may occur during a period of one or more years (such as in the case of a 
series of sales by persons who together control each of such 
corporations immediately prior to the first of such sales and 
immediately subsequent to the last of such sales) shall be disregarded, 
provided the other facts and circumstances indicate related 
transactions.
    (c) The application of section 304(a)(1) may be illustrated by the 
following examples:

    Example (1). Corporation X and corporation Y each have outstanding 
200 shares of common stock. One-half of the stock of each corporation is 
owned by an individual, A, and one-half by another individual, B, who is 
unrelated to A. On or after August 31, 1964, A sells 30 shares of 
corporation X stock to corporation Y for $50,000, such stock having an 
adjusted basis of $10,000 to A. After the sale, A is considered as 
owning corporation X stock as follows: (i) 70 shares directly, and (ii) 
15 shares constructively, since by virtue of his 50-percent ownership of 
Y he constructively owns 50 percent of the 30 shares owned directly by 
Y. Since A's percentage of ownership of X's voting stock after the sale 
(85 out of 200 shares, or 42.5%) is not less than 80 percent of his 
percentage of ownership of X's voting stock before the sale (100 out of 
200 shares, or 50%), the transfer is not ``substantially 
disproportionate'' as to him as provided in section 302(b)(2). Under 
these facts, and assuming that section 302(b)(1) is not applicable, the 
entire $50,000 is treated as a dividend to A to the extent of the 
earnings and profits of corporation Y. The basis of the corporation X 
stock to corporation Y is $10,000, its adjusted basis to A. The amount 
of $10,000 is added to the basis of the stock of corporation Y in the 
hands of A.
    Example (2). The facts are the same as in Example (1) except that A 
sells 80 shares of corporation X stock to corporation Y, and the sale 
occurs before August 31, 1964. After the sale, A is considered as owning 
corporation X stock as follows: (i) 20 shares directly, and (ii) 90 
shares indirectly, since by virtue of his 50-percent ownership of Y he 
constructively owns 50 percent of the 80 shares owned directly by Y and 
50 percent of the 100 shares attributed to Y because they are owned by 
Y's stockholder, B. Since after the sale A owns a total of more than 50 
percent of the voting power of all of the outstanding stock of X (110 
out of 200 shares, or 55%), the transfer is not ``substantially 
disproportionate'' as to him as provided in section 302(b)(2).
    Example (3). Corporation X and corporation Y each have outstanding 
100 shares of common stock. A, an individual, owns one-half the stock of 
corporation X, and C owns one-half the stock of corporation Y. A, B, and 
C are unrelated. A sells 30 shares of the stock of corporation X to 
corporation Y for $50,000, such stock having an adjusted basis of 
$10,000 to him. After the sale, A is considered as owning 35 shares of 
the stock of corporation X (20 shares directly and 15 constructively 
because one-half of the 30 shares owned by corporation Y are attributed 
to him). Since before the sale he owned 50 percent of the stock of 
corporation X and after the sale he owned directly and constructively 
only 35 percent of such stock, the redemption is substantially 
disproportionate as to him pursuant to the provisions of section 
302(b)(2). He, therefore, realizes a gain of $40,000 ($50,000 minus 
$10,000). If the stock surrendered is a capital asset, such gain is 
long-term or short-term capital gain depending on the period of time 
that such stock was held. The basis to A for the stock of corporation Y 
is not changed as a result of the entire transaction. The basis to 
corporation Y for the stock of corporation X is $50,000, i.e., the basis 
of the transferor ($10,000), increased in the amount of gain recognized 
to the transferor ($40,000) on the transfer.
    Example (4). Corporation X and corporation Y each have outstanding 
100 shares of common stock. H, an individual, W, his wife, S, his son, 
and G, his grandson, each own 25 shares of stock of each corporation. H 
sells all of his 25 shares of stock of corporation X to corporation Y. 
Since both before and after the transaction H owned directly and 
constructively 100 percent of the stock of corporation X, and assuming 
that section 302(b)(1) is not applicable, the amount received by him for 
his stock of corporation X is treated as a dividend to him to the extent 
of the earnings and profits of corporation Y.

[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR 
11997, Aug. 23, 1968]

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