[Congressional Bills 105th Congress]
[From the U.S. Government Publishing Office]
[H.R. 1207 Introduced in House (IH)]







105th CONGRESS
  1st Session
                                H. R. 1207

  To amend the Internal Revenue Code of 1986 to provide all taxpayers 
    with a 50 percent deduction for capital gains, to increase the 
  exclusion for gain on qualified small business stock, to index the 
        basis of certain capital assets, and for other purposes.


_______________________________________________________________________


                    IN THE HOUSE OF REPRESENTATIVES

                             March 20, 1997

 Mr. Watkins introduced the following bill; which was referred to the 
                      Committee on Ways and Means

_______________________________________________________________________

                                 A BILL


 
  To amend the Internal Revenue Code of 1986 to provide all taxpayers 
    with a 50 percent deduction for capital gains, to increase the 
  exclusion for gain on qualified small business stock, to index the 
        basis of certain capital assets, and for other purposes.

    Be it enacted by the Senate and House of Representatives of the 
United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

    This Act may be cited as the ``Economic Competitiveness and Growth 
Act''.

SEC. 2. 50 PERCENT CAPITAL GAINS DEDUCTION.

    (a) General Rule.--Section 1201 of the Internal Revenue Code of 
1986 is amended to read as follows:

``SEC. 1201. CAPITAL GAINS DEDUCTION.

    ``(a) General Rule.--If for any taxable year a taxpayer has a net 
capital gain, 50 percent of such gain shall be a deduction from gross 
income.
    ``(b) Estates and Trusts.--In the case of an estate or trust, the 
deduction shall be computed by excluding the portion (if any) of the 
gains for the taxable year from sales or exchanges of capital assets 
which, under sections 652 and 662 (relating to inclusions of amounts in 
gross income of beneficiaries of trusts), is includible by the income 
beneficiaries as gain derived from the sale or exchange of capital 
assets.
    ``(c) Coordination With Treatment of Capital Gain Under Limitation 
on Investment Interest.--For purposes of this section, the net capital 
gain for any taxable year shall be reduced (but not below zero) by the 
amount which the taxpayer takes into account as investment income under 
section 163(d)(4)(B)(iii).
    ``(d) Transitional Rules.--
            ``(1) In general.--In the case of a taxable year which 
        includes January 1, 1997--
                    ``(A) the amount taken into account as the net 
                capital gain under subsection (a) shall not exceed the 
                net capital gain determined by only taking into account 
                gains and losses properly taken into account for the 
                portion of the taxable year on or after January 1, 
                1997, and
                    ``(B) the amount of the net capital gain taken into 
                account in applying section 1(h) for such year shall be 
                reduced by the amount taken into account under 
                subparagraph (A) for such year.
            ``(2) Special rules for pass-through entities.--
                    ``(A) In general.--In applying paragraph (1) with 
                respect to any pass-through entity, the determination 
                of when gains and losses are properly taken into 
                account shall be made at the entity level.
                    ``(B) Pass-through entity defined.--For purposes of 
                subparagraph (A), the term `pass through entity' 
                means--
                            ``(i) a regulated investment company,
                            ``(ii) a real estate investment trust,
                            ``(iii) an S corporation,
                            ``(iv) a partnership,
                            ``(v) an estate or trust, and
                            ``(vi) a common trust fund.''
    (b) Deduction Allowable in Computing Adjusted Gross Income.--
Subsection (a) of section 62 of such Code is amended by inserting after 
paragraph (16) the following new paragraph:
            ``(17) Long-term capital gains.--The deduction allowed by 
        section 1201.''
    (c) Technical and Conforming Changes.--
            (1) Section 1 of such Code is amended by striking 
        subsection (h).
            (2) Section 12 of such Code is amended by striking 
        paragraph (4) and redesignating the following paragraphs 
        accordingly.
            (3)(A) Subsection (a) of section 57 of such Code is amended 
        by striking paragraph (7).
            (B) Subclause (II) of section 53(d)(1)(B)(ii) of such Code 
        is amended by striking ``, (5), and (7)'' and inserting ``and 
        (5)''.
            (4) Paragraph (1) of section 170(e) of such Code is amended 
        by striking ``the amount of gain'' in the material following 
        subparagraph (B)(ii) and inserting ``50 percent of the amount 
        of gain''.
            (5) Paragraph (2) of section 172(d) of such Code is amended 
        to read as follows:
            ``(2) Capital gains and losses.--
                    ``(A) Losses of taxpayers other than 
                corporations.--In the case of a taxpayer other than a 
                corporation, the amount deductible on account of losses 
                from sales or exchanges of capital assets shall not 
                exceed the amount includible on account of gains from 
                sales or exchanges of capital assets.
                    ``(B) Deduction for capital gains.--The deduction 
                under section 1201 shall not be allowed.''
            (6) The last sentence of section 433A(c)(3) of such Code is 
        amended by striking all that follows ``long-term capital 
        gain,'' and inserting ``the deduction under section 1201 shall 
        be taken into account.''
            (7) Paragraph (2) of section 468B(b) of such Code is 
        amended by inserting ``the deduction allowed by section 1201 
        and by'' after ``reduced by''.
            (8) Paragraph (2) of section 527(b) of such Code is hereby 
        repealed.
            (9) Subparagraph (A) of section 641(d)(2) of such Code is 
        amended by striking ``Except as provided in section 1(h), the'' 
        and inserting ``The''.
            (10) Paragraph (4) of section 642(c) of such Code is 
        amended to read as follows:
            ``(4) Adjustments.--To the extent that the amount otherwise 
        allowable as a deduction under this subsection consists of gain 
        from the sale or exchange of capital assets held for more than 
        1 year, proper adjustment shall be made for any deduction 
        allowable to the estate or trust under section 1201 (relating 
        to capital gains deduction). In the case of a trust, the 
        deduction allowed by this subsection shall be subject to 
        section 681 (relating to unrelated business income).''
            (11) The last sentence of section 643(a)(3) of such Code is 
        amended to read as follows: ``The deduction under section 1201 
        (relating to capital gains deduction) shall not be taken into 
        account.''
            (12) Subparagraph (C) of section 643(a)(6) of such Code is 
        amended by inserting ``(i)'' before ``there shall'' and by 
        inserting before the period ``, and (ii) the deduction under 
        section 1201 (relating to capital gains deduction) shall not be 
        taken into account.''
            (13) Paragraph (4) of section 691(c) of such Code is 
        amended by striking ``1(h),''.
            (14) Paragraph (2) of section 801(a) of such Code is hereby 
        repealed.
            (15) Subsection (c) of section 831 of such Code is amended 
        by striking paragraph (1) and redesignating the following 
        paragraphs accordingly.
            (16)(A) Subparagraph (A) of section 852(b)(3) of such Code 
        is amended by striking ``, determined as provided in section 
        1201(a), on'' and inserting ``of 17.5 percent of''.
            (B) Clause (iii) of section 852(b)(3)(D) of such Code is 
        amended--
                    (i) by striking ``65 percent'' and inserting ``82.5 
                percent'', and
                    (ii) by striking ``section 1201(a)'' and 
inserting ``subparagraph (A)''.
            (17) Clause (ii) of section 857(b)(3)(A) of such Code is 
        amended by striking ``determined at the rate provided in 
        section 1201(a) on ``and inserting'' of 17.5 percent of''.
            (18) The second sentence of section 871(a)(2) of such Code 
        is amended by striking ``1202'' and inserting ``1201''.
            (19) Paragraph (1) of section 882(a) of such Code is 
        amended by striking ``section 11,55,5A, or 1201(a)'' and 
        inserting ``section 11,55, or 59A''.
            (20)(A) Paragraph (2) of section 904(b) of such Code is 
        amended to read as follows:
            ``(2) Capital gains.--Taxable income from sources outside 
        the United States shall include gain from the sale or exchange 
        of capital assets only to the extent of foreign source capital 
        gain net income.''
            (B) Paragraph (3) of section 904(b) of such Code is amended 
        by striking subparagraphs (B), (D), and (E) and by 
        redesignating subparagraph (C) as subparagraph (B).
            (21)(A) Paragraph (2) of section 1211(b) of such Code is 
        amended to read as follows:
            ``(2) the sum of--
                    ``(A) the excess of the net short-term capital loss 
                over the net long-term capital gain, and
                    ``(B) one-half of the excess of the net long-term 
                capital loss over the net short-term capital gain.''
            (B) So much of paragraph (2) of section 1212(b) of such 
        Code as precedes subparagraph (B) thereof is amended to read as 
        follow:
            ``(2) Special rules.--
                    ``(A) Adjustments.--
                            ``(i) For purposes of determining the 
                        excess referred to in paragraph (1)(A), there 
                        shall be treated as short-term capital gain in 
                        the taxable year an amount equal to the lesser 
                        of--
                                    ``(I) the amount allowed for the 
                                taxable year under paragraph (1) or (2) 
                                of section 1211(b), or
                                    ``(II) the adjusted taxable income 
                                for such taxable year.
                            ``(ii) For purposes of determining the 
                        excess referred to in paragraph (1)(B), there 
                        shall be treated as short-term capital gain in 
                        the taxable year an amount equal to the sum 
                        of--
                                    ``(I) the amount allowed for the 
                                taxable year under paragraph (1) or (2) 
                                of section 1211(b) or the adjusted 
                                taxable income for such taxable year, 
                                whichever is the least, plus.
                                    ``(II) the excess of the amount 
                                described in subclause (I) over the net 
                                short-term capital loss (determined 
                                without regard to this subsection) for 
                                such year.''
            (C) Subsection (b) of section 1212 is amended by adding at 
        the end the following new paragraph:
            ``(3) Transitional rule.--
                    ``(A) In general.--The amount determined under 
                subclause (II) of paragraph (2)(A)(ii) for any taxable 
                year shall be reduced (but not below zero) by the 
                excess of--
                            ``(i) the amount of the unused pre-1998 
                        long-term capital loss for such year, over
                            ``(ii) the sum of the long-term capital 
                        gain and the net short-term capital gain for 
                        such taxable year.
                Section 1211(b)(2)(B) shall be applied without regard 
                to ``one-half of'' with respect to such excess for such 
                taxable year.
                    ``(B) Unused pre-1998 long-term capital loss--For 
                purposes of this paragraph, the term ``unused pre-1998 
                long-term capital loss'' means, with respect to a 
                taxable year, the excess of--
                            ``(i) the amount which under paragraph 
                        (1)(B) (as in effect for taxable years 
                        beginning before January 1, 1998) is treated as 
                        a long-term capital loss for the taxpayer's 
                        first taxable year beginning after December 31, 
                        1997, over
                            ``(ii) the sum of--
                                    ``(I) the aggregate amount 
                                determined under subparagraph (A)(ii) 
                                for all prior taxable years beginning 
                                after December 31, 1997, and
                                    ``(II) the aggregate reductions 
                                under subparagraph (A) for all such 
                                prior taxable years.''
            (22) Subsection (b) of section 1374 of such Code is amended 
        by striking paragraph (4).
            (23) Subsection (b) of section 1381 is amended by striking 
        ``or 1201''.
            (24) Paragraph (1) of section 1402(i) of such Code is 
        amended by inserting ``, and the deduction provided by section 
        1201 shall not apply'' before the period at the end thereof.
            (25) Subsection (e) of section 1445 of such Code is 
        amended--
                    (A) in paragraph (1) by striking ``35 percent (or, 
                to the extent provided in regulations, 28 percent)'' 
                and inserting ``17.5 percent (or, to the extent 
                provided in regulations, 19.8 percent)'', and
                    (B) in paragraph (2) by striking ``35 percent'' and 
                inserting ``17.5 percent''.
            (26) Clause (i) of section 6425(c)(1)(A) of such Code is 
        amended by striking ``or 1201(a)''.
            (27) Clause (i) of section 6655(g)(1)(A) of such Code is 
        amended by striking ``or 1201(a)''.
            (28)(A) The second sentence of section 7518(g)(6)(A) of 
        such Code is amended--
                    (i) by striking ``during a taxable year to which 
                section 1(h) or 1201(a) applies'', and
                    (ii) by striking ``28 percent (34 percent'' and 
                inserting ``19.8 percent (17.5 percent''.
            (B) The second sentence of section 607(h)(6)(A) of the 
        Merchant Marine Act, 1936 is amended--
                    (i) by striking ``during a taxable year to which 
                section 1(h) or 1201(a) of such Code applies'', and
                    (ii) by striking ``28 percent (34 percent'' and 
                inserting ``19.8 percent (17.5 percent''.
            (29) The table of sections for part I of subchapter P of 
        chapter 1 of such Code is amended by striking the item relating 
        to section 1201 and inserting the following:

                              ``Sec. 1201. Capital gains deduction.''
    (d) Effective Dates.--
            (1) In general.--Except as otherwise provided in this 
        subsection, the amendments made by this section apply to 
        taxable years ending after December 31, 1996.
            (2) Repeal of section 1(h).--The amendment made by 
        subsection (c)(1) shall apply to taxable years beginning after 
        January 1, 1997.
            (3) Contributions.--The amendment made by subsection (c)(4) 
        shall apply only to contributions on or after January 1, 1997.
            (4) Use of long-term losses.--The amendments made by 
        subsection (c)(21) shall apply to taxable years beginning after 
        December 31, 1997.
            (5) Withholding.--The amendment made by subsection (c)(25) 
        shall apply only to amounts paid after the date of the 
        enactment of this Act.
            (6) Coordination with prior transition rule.--Any amount 
        treated as long-term capital gain by reason of paragraph (3) of 
        section 1122(h) of the Tax Reform Act of 1986 shall not be 
        taken into account for purposes of applying section 1201 of the 
        Internal Revenue Code of 1986 (as added by this section).

SEC. 3. INCREASED EXCLUSION AND OTHER MODIFICATIONS APPLICABLE TO 
              QUALIFIED SMALL BUSINESS STOCK.

    (a) Increased Exclusion.--
            (1) In general.--Subsection (a) of section 1202 of the 
        Internal Revenue Code of 1986 (50-percent exclusion for gain 
        from certain small business stock) is amended--
                    (A) by striking ``50 percent'' and inserting ``75 
                percent'', and
                    (B) by striking ``50-Percent'' in the heading and 
                inserting ``75-Percent''.
            (2) Conforming amendments.--
                    (A) The heading for section 1202 of such Code is 
                amended by striking ``50-percent'' and inserting ``75-
                percent''.
                    (B) The table of sections for part I of subchapter 
                P of chapter 1 of such Code is amended by striking 
                ``50-percent'' in the item relating to section 1202 and 
                inserting ``75-percent''.
    (b) Reduction in Holding Period.--Subsection (a) of section 1202 of 
such Code is amended by striking ``5 years'' and inserting ``3 years''.
    (c) Exclusion Available to Corporations.--
            (1) In general.--Subsection (a) of section 1202 of such 
        Code is amended by striking ``other than a corporation''.
            (2) Technical amendment.--Subsection (c) of section 1202 of 
        such Code is amended by adding at the end the following new 
        paragraph:
            ``(4) Stock held among members of controlled group not 
        eligible.--Stock of a member of a parent-subsidiary controlled 
        group (as defined in subsection (d)(3)) shall not be treated as 
        qualified small business stock while held by another member of 
        such group.''
    (d) Repeal of Minimum Tax Preference.--
            (1) In general.--Subsection (a) of section 57 of such Code 
        (relating to items of tax preference) is amended by striking 
        paragraph (7).
            (2) Technical amendment.--Subclause (II) of section 
        53(d)(1)(B)(ii) of such Code is amended by striking ``, (5), 
        and (7)'' and inserting ``and (5)''.
    (e) Stock of Larger Businesses Eligible for Exclusion.--
            (1) In general.--Paragraph (1) of section 1202(d) of such 
        Code (defining qualified small business) is amended by striking 
        ``$50,000,000'' each place it appears and inserting 
        ``$100,000,000''.
            (2) Inflation adjustment.--Section 1202(d) of such Code is 
        amended by adding at the end the following:
            ``(4) Inflation adjustment of asset limitation.--In the 
        case of stock issued in any calendar year after 1998, the 
        $100,000,000 amount contained in paragraph (1) shall be 
        increased by an amount equal to--
                    ``(A) such dollar amount, multiplied by
                    ``(B) the cost-of-living adjustment determined 
                under section 1(f)(3) for the calendar year in which 
                the taxable year begins, determined by substituting 
                `calendar year 1997' for `calendar year 1992' in 
                subparagraph (B) thereof.
        If any amount as adjusted under the preceding sentence is not a 
        multiple of $10,000, such amount shall be rounded to the 
        nearest multiple of $10,000.''
    (f) Repeal of Per-Issuer Limitation.--Section 1202 of such Code is 
amended by striking subsection (b).
    (g) Other Modifications.--
            (1) Repeal of working capital limitation.--Section 
        1202(e)(6) of such Code (relating to working capital) is 
        amended--
                    (A) in subparagraph (B), by striking ``2 years'' 
                and inserting ``5 years'', and
                    (B) by striking the last sentence.
            (2) Exception from redemption rules where business 
        purpose.--Section 1202(c)(3) of such Code (relating to certain 
        purchases by corporation of its own stock) is amended by adding 
        at the end the following:
                    ``(D) Waiver where business purpose.--A purchase of 
                stock by the issuing corporation shall be disregarded 
                for purposes of subparagraph (B) if the issuing 
                corporation establishes that there was a business 
                purpose for such purchase and one of the principal 
                purposes of the purchase was not to avoid the 
                limitations of this section.''
    (h) Qualified Trade or Business.--Section 1202(e)(3) of such Code 
(defining qualified trade or business) is amended by inserting ``and'' 
at the end of subparagraph (C), by striking ``, and'' at the end of 
subparagraph (D) and inserting a period, and by striking subparagraph 
(E).
    (i) Effective Dates.--
            (1) In general.--Except as provided in paragraph (2), the 
        amendments made by this section apply to stock issued after the 
        date of enactment of this Act.
            (2) Special rule.--The amendments made by subsections (a), 
        (c), (e), and (f) apply to stock issued after August 10, 1993.

SEC. 4. ROLLOVER OF GAIN FROM SALE OF QUALIFIED STOCK.

    (a) In General.--Part III of subchapter O of chapter 1 of the 
Internal Revenue Code of 1986 (relating to common nontaxable exchanges) 
is amended by adding at the end the following:

``SEC. 1045. ROLLOVER OF GAIN FROM QUALIFIED SMALL BUSINESS STOCK TO 
              ANOTHER QUALIFIED SMALL BUSINESS STOCK.

    ``(a) Nonrecognition of Gain.--In the case of any sale of qualified 
small business stock with respect to which the taxpayer elects the 
application of this section, eligible gain from such sale shall be 
recognized only to the extent that the amount realized on such sale 
exceeds--
            ``(1) the cost of any qualified small business stock 
        purchased by the taxpayer during the 60-day period beginning on 
        the date of such sale, reduced by
            ``(2) any portion of such cost previously taken into 
        account under this section.
This section shall not apply to any gain which is treated as ordinary 
income for purposes of this title.
    ``(b) Definitions and Special Rules.--For purposes of this 
section--
            ``(1) Qualified small business stock.--The term `qualified 
        small business stock' has the meaning given such term by 
        section 1202(c).
            ``(2) Eligible gain.--The term `eligible gain' means any 
        gain from the sale or exchange of qualified small business 
        stock held for more than 6 months.
            ``(3) Purchase.--A taxpayer shall be treated as having 
        purchased any property if, but for paragraph (4), the 
        unadjusted basis of such property in the hands of the taxpayer 
        would be its cost (within the meaning of section 1012).
            ``(4) Basis adjustments.--If gain from any sale is not 
        recognized by reason of subsection (a), such gain shall be 
        applied to reduce (in the order acquired) the basis for 
        determining gain or loss of any qualified small business stock 
        which is purchased by the taxpayer during the 60-day period 
        described in subsection (a).
    ``(c) Special Rules for Treatment of Replacement Stock.--
            ``(1) Holding period for accrued gain.--For purposes of 
        this chapter, gain from the disposition of any replacement 
        qualified small business stock shall be treated as gain from 
        the sale or exchange of qualified small business stock held 
        more than 6 months to the extent that the amount of such gain 
        does not exceed the amount of the reduction in the basis of 
        such stock by reason of subsection (b)(4).
            ``(2) Tacking of holding period for purposes of deferral.--
        Solely for purposes of applying this section, if any 
        replacement qualified small business stock is disposed of 
        before the taxpayer has held such stock for more than 6 months, 
gain from such stock shall be treated eligible gain for purposes of 
subsection (a).
            ``(3) Replacement qualified small business stock.--For 
        purposes of this subsection, the term `replacement qualified 
        small business stock' means any qualified small business stock 
        the basis of which was reduced under subsection (b)(4).''
    (b) Conforming Amendments.--
            (1) Section 1016(a)(23) of such Code is amended--
                    (A) by striking ``or 1044'' and inserting ``, 1044, 
                or 1045''; and
                    (B) by striking ``or 1044(d)'' and inserting ``, 
                1044(d), or 1045(b)(4)''.
            (2) The table of sections for part III of subchapter O of 
        chapter 1 of such Code is amended by adding at the end the 
        following:

                              ``Sec. 1045. Rollover of gain from 
                                        qualified small business stock 
                                        to another qualified small 
                                        business stock.''
    (c) Effective Date.--The amendments made by this section apply to 
stock sold or exchanged after the date of the enactment of this Act.

SEC. 5. INDEXING OF CERTAIN ASSETS ACQUIRED AFTER DECEMBER 31, 1996, 
              FOR PURPOSES OF DETERMINING GAIN OR LOSS.

    (a) In General.--Part II of subpart O of chapter 1 of the Internal 
Revenue Code of 1986 (relating to basis rules of general application) 
is amended by inserting after section 1021 the following new section:

``SEC. 1022. INDEXING OF CERTAIN ASSETS ACQUIRED AFTER DECEMBER 31, 
              1996, FOR PURPOSES OF DETERMINING GAIN OR LOSS.

    ``(a) General Rule.--
            ``(1) Indexed basis substituted for adjusted basis.--Except 
        as otherwise provided in this subsection, if an indexed asset 
        which has been held for more than 3 years is sold or otherwise 
        disposed of, for purposes of this title the indexed basis of 
        the asset shall be substituted for its adjusted basis.
            ``(2) Except for depreciation, etc.--The deductions for 
        depreciation, depletion, and amortization shall be determined 
        without regard to the application of paragraph (1) to the 
        taxpayer or any other person.
    ``(b) Indexed Asset.--
            ``(1) In general.--For purposes of this section, the term 
        `indexed asset' means--
                    ``(A) common stock in a C corporation (other than a 
                foreign corporation), and
                    ``(B) tangible property,
        which is a capital asset or property used in the trade or 
        business (as defined in section 1231(b)).
            ``(2) Stock in certain foreign corporations included.--For 
        purposes of this section--
                    ``(A) In general.--The term `indexed asset' 
                includes common stock in a foreign corporation which is 
                regularly traded on an established securities market.
                    ``(B) Exception.--Subparagraph (A) shall not apply 
                to--
                            ``(i) stock of a foreign investment company 
                        (within the meaning of section 1246(b)),
                            ``(ii) stock in a passive foreign 
                        investment company (as defined in section 
                        1296),
                            ``(iii) stock in a foreign corporation held 
                        by a United States person who meets the 
                        requirements of section 1248(a)(2), and
                            ``(iv) stock in a foreign personal holding 
                        company (as defined in section 552).
                    ``(C) Treatment of american depository receipts.--
                An American depository receipt for common stock in a 
                foreign corporation shall be treated as common stock in 
                such corporation.
    ``(c) Indexed Basis.--For purposes of this section--
            ``(1) General rule.--The indexed basis for any asset is--
                    ``(A) the adjusted basis of the asset, increased by
                    ``(B) the applicable inflation adjustment.
            ``(2) Applicable inflation adjustment.--The applicable 
        inflation adjustment for any asset is an amount equal to--
                    ``(A) the adjusted basis of the asset, multiplied 
                by
                    ``(B) the percentage (if any) by which--
                            ``(i) the gross domestic product deflator 
                        for the last calendar quarter ending before the 
                        asset is disposed of, exceeds
                            ``(ii) the gross domestic product deflator 
                        for the last calendar quarter ending before the 
                        asset was acquired by the taxpayer.
                The percentage under subparagraph (B) shall be rounded 
                to the nearest one-tenth of 1 percentage point.
            ``(3) Gross domestic product deflator.--The gross domestic 
        product deflator for any calendar quarter is the implicit price 
        deflator for the gross domestic product for such quarter (as 
        shown in the last revision thereof released by the Secretary of 
        Commerce before the close of the following calendar quarter).
    ``(d) Suspension of Holding Period Where Diminished Risk of Loss; 
Treatment of Short Sales.--
            ``(1) In general.--If the taxpayer (or a related person) 
        enters into any transaction which substantially reduces the 
        risk of loss from holding any asset, such asset shall not be 
        treated as an indexed asset for the period of such reduced 
        risk.
            ``(2) Short sales.--
                    ``(A) In general.--In the case of a short sale of 
                an indexed asset with a short sale period in excess of 
                3 years, for purposes of this title, the amount 
                realized shall be an amount equal to the amount 
                realized (determined without regard to this paragraph) 
                increased by the applicable inflation adjustment. In 
                applying subsection (c)(2) for purposes of the 
                preceding sentence, the date on which the property is 
                sold short shall be treated as the date of acquisition 
                and the closing date for the sale shall be treated as 
                the date of disposition.
                    ``(B) Short sale period.--For purposes of 
                subparagraph (A), the short sale period begins on the 
                day that the property is sold and ends on the closing 
                date for the sale.
    ``(e) Treatment of Regulated Investment Companies and Real Estate 
Investment Trusts.--
            ``(1) Adjustment at entity level.--
                    ``(A) In general.--Except as provided in 
                subparagraph (B), the adjustment under subsection (a) 
                shall be allowed to any qualified investment entity 
                (including for purposes of determining the earnings and 
                profits of such entity).
                    ``(B) Exception for qualification purposes.--This 
                section shall not apply for purposes of sections 851(b) 
                and 856(c).
            ``(2) Adjustments to interests held in entity.--
                    ``(A) Regulated investment companies.--Stock in a 
                regulated investment company (within the meaning of 
                section 851) shall be an indexed asset for any calendar 
                quarter in the same ratio as--
                            ``(i) the average of the fair market values 
                        of the indexed assets held by such company at 
                        the close of each month during such quarter, 
                        bears to
                            ``(ii) the average of the fair market 
                        values of all assets held by such company at 
                        the close of each such month.
                    ``(B) Real estate investment trusts.--Stock in a 
                real estate investment trust (within the meaning of 
                section 856) shall be an indexed asset for any calendar 
                quarter in the same ratio as--
                            ``(i) the fair market value of the indexed 
                        assets held by such trust at the close of such 
                        quarter, bears to
                            ``(ii) the fair market value of all assets 
                        held by such trust at the close of such 
                        quarter.
                    ``(C) Ratio of 80 percent or more.--If the ratio 
                for any calendar quarter determined under subparagraph 
                (A) or (B) would (but for this subparagraph) be 80 
                percent or more, such ratio for such quarter shall be 
                100 percent.
                    ``(D) Ratio of 20 percent or less.--If the ratio 
                for any calendar quarter determined under subparagraph 
                (A) or (B) would (but for this subparagraph) be 20 
                percent or less, such ratio for such quarter shall be 
                zero.
                    ``(E) Look-through of partnerships.--For purposes 
                of this paragraph, a qualified investment entity which 
                holds a partnership interest shall be treated (in lieu 
                of holding a partnership interest) as holding its 
                proportionate share of the assets held by the 
                partnership.
            ``(3) Treatment of return of capital distributions.--Except 
        as otherwise provided by the Secretary, a distribution with 
        respect to stock in a qualified investment entity which is not 
        a dividend and which results in a reduction in the adjusted 
        basis of such stock shall be treated as allocable to stock 
        acquired by the taxpayer in the order in which such stock was 
        acquired.
            ``(4) Qualified investment entity.--For purposes of this 
        subsection, the term `qualified investment entity' means--
                    ``(A) a regulated investment company (within the 
                meaning of section 851), and
                    ``(B) a real estate investment trust (within the 
                meaning of section 856).
    ``(f) Other Pass-Through Entities.--
            ``(1) Partnerships.--
                    ``(A) In general.--In the case of a partnership, 
                the adjustment made under subsection (a) at the 
                partnership level shall be passed through to the 
                partners.
                    ``(B) Special rule in the case of section 754 
                elections.--In the case of a transfer of an interest in 
                a partnership with respect to which the election 
                provided in section 754 is in effect--
                            ``(i) the adjustment under section 
                        743(b)(1) shall, with respect to the transferor 
                        partner, be treated as a sale of the 
                        partnership assets for purposes of applying 
                        this section, and
                            ``(ii) with respect to the transferee 
                        partner, the partnership's holding period for 
                        purposes of this section in such assets shall 
                        be treated as beginning on the date of such 
                        adjustment.
            ``(2) S corporations.--In the case of an S corporation, the 
        adjustment made under subsection (a) at the corporate level 
        shall be passed through to the shareholders.
            ``(3) Common trust funds.--In the case of a common trust 
        fund, the adjustment made under subsection (a) at the trust 
        level shall be passed through to the participants.
    ``(g) Dispositions Between Related Persons.--
            ``(1) In general.--This section shall not apply to any sale 
        or other disposition of property between related persons except 
        to the extent that the basis of such property in the hands of 
        the transferee is a substituted basis.
            ``(2) Related persons defined.--For purposes of this 
        section, the term `related persons' means--
                    ``(A) persons bearing a relationship set forth in 
                section 267(b), and
                    ``(B) persons treated as single employer under 
                subsection (b) or (c) of section 414.
    ``(h) Transfers To Increase Indexing Adjustment.--If any person 
transfers cash, debt, or any other property to another person and the 
principal purpose of such transfer is to secure or increase an 
adjustment under subsection (a), the Secretary may disallow part of all 
of such adjustment or increase.
    ``(i) Special Rules.--For purposes of this section--
            ``(1) Treatment of improvements, etc.--If there is 
an addition to the adjusted basis of any tangible property or of any 
stock in a corporation during the taxable year by reason of an 
improvement to such property or a contribution to capital of such 
corporation--
                    ``(A) such addition shall never be taken into 
                account under subsection (c)(1)(A) if the aggregate 
                amount thereof during the taxable year with respect to 
                such property or stock is less than $1,000, and
                    ``(B) such addition shall be treated as a separate 
                asset acquired at the close of such taxable year if the 
                aggregate amount thereof during the taxable year with 
                respect to such property or stock is $1,000 or more.
        A rule similar to the rule of the preceding sentence shall 
        apply to any other portion of an asset to the extent that 
        separate treatment of such portion is appropriate to carry out 
        the purposes of this section.
            ``(2) Assets which are not indexed assets throughout 
        holding period.--The applicable inflation ratio shall be 
        appropriately reduced for periods during which the asset was 
        not an indexed asset.
            ``(3) Treatment of certain distributions.--A distribution 
        with respect to stock in a corporation which is not a dividend 
        shall be treated as a disposition.
            ``(4) Section cannot increase ordinary loss.--To the extent 
        that (but for this paragraph) this section would create or 
        increase a net ordinary loss to which section 1231(a)(2) 
        applies or an ordinary loss to which any other provision of 
        this title applies, such provision shall not apply. The 
        taxpayer shall be treated as having a long-term capital loss in 
        an amount equal to the amount of the ordinary loss to which the 
        preceding sentence applies.
            ``(5) Acquisition date where there has been prior 
        application of subsection (a)(1) with respect to the 
        taxpayer.--If there has been a prior application of subsection 
        (a)(1) to an asset while such asset was held by the taxpayer, 
        the date of acquisition of such asset by the taxpayer shall be 
        treated as not earlier than the date of the most recent such 
        prior application.
            ``(6) Collapsible corporations.--The application of section 
        341(a) (relating to collapsible corporations) shall be 
        determined without regard to this section.
    ``(j) Regulations.--The Secretary shall prescribe such regulations 
as may be necessary or appropriate to carry out the purposes of this 
section.''
    (b) Clerical Amendment.--The table of sections for part II of 
subchapter O of chapter 1 is amended by inserting after the item 
relating to section 1021 the following new item:

                              ``Sec. 1022. Indexing of certain assets 
                                        acquired after December 31, 
                                        1996, for purposes of 
                                        determining gain or loss.''
    (c) Effective Date.--
            (1) In general.--The amendments made by this section shall 
        apply to the disposition of any property the holding period of 
        which begins after December 31, 1996.
            (2) Certain transactions between related persons.--The 
        amendments made by this section shall not apply to the 
        disposition of any property acquired after December 31, 1996, 
        from a related person (as defined in section 1022(g)(2) of the 
        Internal Revenue Code of 1986, as added by this section) if--
                    (A) such property was so acquired for a price less 
                than the property's fair market value, and
                    (B) the amendments made by this section did not 
                apply to such property in the hands of such related 
                person.
    (d) Election To Recognize Gain on Assets Held on January 1, 1997.--
For purposes of the Internal Revenue Code of 1986--
            (1) In general.--A taxpayer may elect to treat--
                    (A) any readily tradable stock (which is an indexed 
                asset) held by such taxpayer on January 1, 1997, and 
                not sold before the next business day after such date, 
as having been sold on such next business day for an amount equal to 
its closing market price on such next business day (and as having been 
reacquired on such next business day for an amount equal to such 
closing market price), and
                    (B) any other indexed asset held by the taxpayer on 
                January 1, 1997, as having been sold on such date for 
                an amount equal to its fair market value on such date 
                (and as having been reacquired on such date for an 
                amount equal to such fair market value).
            (2) Treatment of gain or loss.--
                    (A) Any gain resulting from an election under 
                paragraph (1) shall be treated as received or accrued 
                on the date the asset is treated as sold under 
                paragraph (1) and shall be recognized notwithstanding 
                any provision of the Internal Revenue Code of 1986.
                    (B) Any loss resulting from an election under 
                paragraph (1) shall not be allowed for any taxable 
                year.
            (3) Election.--An election under paragraph (1) shall be 
        made in such manner as the Secretary may prescribe and shall 
        specify the assets for which such election is made. Such an 
        election, once made with respect to any asset, shall be 
        irrevocable.
            (4) Readily tradable stock.--For purposes of this 
        subsection, the term ``readily tradable stock'' means any stock 
        which, as of January 1, 1997, is readily tradable on an 
        established securities market or otherwise.
    (e) Treatment of Principal Residences.--Property held and used by 
the taxpayer on January 1, 1997, as his principal residence (within the 
meaning of section 1034 of the Internal Revenue Code of 1986) shall be 
treated--
            (1) for purposes of subsection (c)(1) of this section and 
        section 1022 of such Code, as having a holding period which 
        begins on January 1, 1997, and
            (2) for purposes of section 1022(c)(2)(B)(ii) of such Code, 
        as having been acquired on January 1, 1997.
Subsection (d) shall not apply to property to which this subsection 
applies.
                                 <all>