[Federal Register Volume 69, Number 85 (Monday, May 3, 2004)]
[Proposed Rules]
[Pages 24107-24112]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-10009]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-116564-03]
RIN 1545-BC05


Determination of Basis of Stock or Securities Received In 
Exchange for, or With Respect to, Stock or Securities in Certain 
Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations under section 358 
that provide guidance regarding the determination of the basis of stock 
or securities received in exchange for, or with respect to, stock or 
securities in certain transactions. These proposed regulations affect 
shareholders of corporations.

DATES: Written or electronic comments must be received by August 2, 
2004.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-116564-03), Room 5203, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
116564-03), Courier's desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC 20044, or sent electronically, via the IRS 
Internet site at www.irs.gov/regs or via the Federal eRulemaking Portal 
at www.regulations.gov (indicate IRS and REG-116564-03).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Theresa Kolish, Emidio J. Forlini, Jr. or Reginald Mombrun, (202) 622-
7930, concerning submissions of comments, Treena Garrett, (202) 622-
7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    Section 1012 of the Internal Revenue Code (Code) provides that the 
basis of property is generally the cost of such property. Section 
1.1012-1(c) provides that, if shares of stock are sold or transferred 
by a taxpayer who purchased or acquired lots of stock on different 
dates or at different prices, and the lot from which the stock was sold 
or transferred cannot be adequately identified, the stock sold or 
transferred is charged against the earliest of such lots purchased or 
acquired in order to determine the basis of such stock.
    Under this rule, a shareholder has greater flexibility in planning 
the tax consequences of the sale by specifically identifying the shares 
sold. The rules for adequate identification operate differently 
depending on the manner in which the shares are held and actions taken 
by the shareholder. For example, when shares are held through a broker, 
an adequate identification is effected by giving the proper 
instructions to the broker. This rule allows identification without 
regard to the particular shares physically transferred by the broker. 
The rule also allows identification when several lots are represented 
by a single share certificate. However, if a shareholder holds a 
different share certificate for each lot, the identity of the shares is 
determined by the specific certificate sold.
    Section 358(a)(1) generally provides that the basis of property 
received pursuant to an exchange to which section 351, 354, 355, 356, 
or 361 applies is the same as that of the property exchanged, decreased 
by the fair market value of any other property (except money) received 
by the taxpayer, the amount of any money received by the taxpayer, and 
the amount of loss to the taxpayer which was recognized on such 
exchange, and increased by the amount which was treated as a dividend, 
and the amount of gain to the taxpayer which was recognized on such 
exchange (not including any portion of such gain

[[Page 24108]]

which was treated as a dividend). Section 358(b)(1) provides that, 
under regulations prescribed by the Secretary, the basis determined 
under section 358(a)(1) must be allocated among the properties received 
in the exchange or distribution.
    Section 1.358-2(a)(2) provides that, if as the result of an 
exchange or distribution under section 354, 355, 356, or former 371(b) 
a shareholder who owned stock of only one class before the transaction 
owns stock of two or more classes after the transaction, then the basis 
of all the stock held before the transaction (as adjusted under Sec.  
1.358-1) must be allocated among the stock of all classes (whether or 
not received in the transaction) held immediately after the transaction 
in proportion to the fair market values of the stock of each class. In 
addition, Sec.  1.358-2(a)(3) provides that, if as the result of an 
exchange under section 354, 355, 356, or former 371(b) a security 
holder who owned only securities, all of one class, before the 
transaction, owns securities or stock of more than one class, or owns 
both stock and securities, then the basis of all the securities held 
before the transaction (as adjusted under Sec.  1.358-1) must be 
allocated among all the stock and securities (whether or not received 
in the transaction) held immediately after the transaction in 
proportion to the fair market values of the stock of each class and the 
securities of each class.
    Section 1.358-2(a)(4) provides that, in every case in which, before 
the transactions, a person owned stock of more than one class or 
securities of more than one class or owned both stock and securities, a 
determination must be made, upon the basis of all the facts, of the 
stock or securities received with respect to stock and securities of 
each class held (whether or not surrendered). The allocation described 
in Sec.  1.358-2(a)(2) is separately made as to the stock of each class 
with respect to which there is an exchange or distribution and the 
allocation described in Sec.  1.358-2(a)(3) is separately made with 
respect to the securities of each class, part or all of which are 
surrendered in the exchange.
    Section 1.358-2(a)(5) provides a special rule that applies in cases 
in which a shareholder retains stock or securities pursuant to a plan 
of recapitalization under section 368(a)(1)(E). In those cases, the 
basis of the stock retained remains unchanged.
    When all of the taxpayer's stock in a target corporation is 
transferred in a reorganization in exchange for stock of the acquiring 
corporation or the issuing corporation, it may be difficult to identify 
physically which share of stock of the target corporation was 
surrendered for which share of stock of the acquiring or issuing 
corporation. Questions have arisen regarding whether, for purposes of 
section 1012 and the regulations thereunder, a shareholder that sells 
or transfers shares of stock received in an exchange or distribution to 
which section 354, 355, or 356 applies can identify that share as being 
traceable to a particular lot of exchanged shares and, if so, how such 
an identification can be effected.
    A number of authorities have addressed this issue but have reached 
inconsistent results. For example, in Arrott v. Commissioner, 136 F.2d 
449 (3d Cir. 1943), the court reasoned that the shares surrendered in 
an acquisitive reorganization lost their identity when traded for new 
shares in the reorganization and held that the basis of the shares 
acquired was determined by averaging the basis of the shares exchanged. 
Accord Commissioner v. Bolender, 82 F.2d 591 (7th Cir. 1936); Helvering 
v. Stifel, 75 F.2d 583 (4th Cir. 1935); Commissioner v. Von Gunten, 76 
F.2d 670 (6th Cir. 1935); see also Revenue Ruling 55-355 (1955-1 C.B. 
418).
    On the other hand, other courts have rejected the average basis 
method for determining the basis of stock received in a reorganization. 
For example, in Bloch v. Commissioner, 148 F.2d 452 (9th Cir. 1945), 
the court permitted the basis of blocks of stock received in an 
acquisitive reorganization to be traced to the basis of the surrendered 
stock. The court reasoned that where the shareholder can trace the 
``transmigrations'' of shares of stock, there is no reason the 
shareholder should not be entitled to identify which shares are sold. 
In Kraus v. Commissioner, 88 F.2d 616 (2d Cir. 1937), the court held 
that if a taxpayer acquires a corporation's stock at different times 
and at different prices and exchanges that stock in a recapitalization, 
the bases of that stock are not blended or averaged in computing the 
basis of the acquired stock. See also Osrow v. Commissioner, 49 T.C. 
333 (1968).
    The IRS and Treasury Department have considered whether tracing or 
averaging is the more appropriate method for determining the basis of 
stock received in a reorganization described in section 368 or a 
distribution to which section 355 applies. In view of the carryover 
basis rule of section 358, the IRS and Treasury are not convinced that 
a reorganization is an event that justifies averaging the bases of the 
exchanged blocks of stock. Moreover, the IRS and Treasury Department 
are concerned that averaging the bases of the exchanged blocks of stock 
may inappropriately limit the ability of taxpayers to arrange their 
affairs or may afford opportunities for the avoidance of certain 
provisions of the Code.
    The authorities holding that the basis of shares received in a 
reorganization is determined by the average basis method have reached 
that conclusion on the basis that it is not possible to match shares 
received with shares surrendered. The IRS and Treasury Department do 
not believe that this inability requires the use of the average basis 
method. When stock of one corporation is surrendered in exchange for 
stock of another corporation in a reorganization, the documents 
governing the reorganization will typically identify how many, and what 
class of, shares of the target corporation are being exchanged for how 
many, and what class of, shares of the acquiring or issuing 
corporation. That is, the exchanging shareholder will know that one or 
more shares of the acquiring or issuing corporation are being received 
in exchange for one or more shares of the target corporation. However, 
when the shareholder sells or transfers stock of the acquiring or 
issuing corporation, it may not know which share of stock of the target 
corporation corresponds to a particular share of the acquiring or 
issuing corporation. Although, in some cases, the exchange may present 
obstacles to physical tracing, these obstacles are not materially 
different from those that exist in the absence of a reorganization 
where shares are held through a broker or consolidated in a single 
certificate. Thus, the IRS and Treasury Department believe that it is 
appropriate to permit shareholders to identify the shares of the 
acquiring corporation sold or transferred by reference to the shares 
surrendered in exchange therefor.
    These proposed regulations remove Sec.  1.358-2(a)(2) through (5) 
and (c) and replace these provisions with a more complete set of rules 
for determining the basis of each share or security received in a 
reorganization described in section 368 and a distribution to which 
section 355 applies. These proposed regulations generally provide that 
the basis of each share of stock or security received in an exchange to 
which section 354, 355, or 356 applies will be the same as the basis of 
the share or shares of stock or security or securities exchanged 
therefor. The determination of which share of stock or security is 
received in exchange for, or with respect to, a particular share of 
stock or security will

[[Page 24109]]

be made in accordance with the terms of the exchange or distribution.
    If more than one share of stock or security (or a combination of 
shares of stock and securities) is received in exchange for one share 
of stock or security, the basis of the share of stock or security 
surrendered will be allocated to the shares and/or securities received 
based on the fair market value of the shares and/or securities 
received. In addition, if one share of stock or security is received in 
respect of more than one share of stock or security or a fraction of a 
share of stock or security is received, the basis of the shares of 
stock or securities surrendered must be allocated to the shares of 
stock or securities received in a manner that, to the greatest extent 
possible, reflects that a share of stock or security received is 
received in respect of shares of stock or securities acquired on the 
same date and at the same price. Therefore, if a shareholder that 
acquired 2 shares of stock of a target corporation on Date 1 for $2 
each and 2 shares of stock of the target corporation on Date 2 for $3 
each and the shareholder exchanges such shares for 2 shares of the 
acquiring corporation, one share of the acquiring corporation will be 
treated as acquired for the shares of the target corporation acquired 
on Date 1 and the other share will be treated as acquired for the 
shares of the target corporation on Date 2. Accordingly, one share will 
have a basis of $4 and the other share will have a basis of $6. This 
rule avoids, to the greatest extent possible, creating shares or 
securities with split holding periods.
    In the case of an exchange to which both section 351 and section 
354 or section 356 applies, however, these rules do not apply if, in 
connection with the exchange, the shareholder or security holder also 
exchanges property for stock or securities in an exchange to which 
neither section 354 nor 356 applies or liabilities of the shareholder 
or security holder are assumed. This limitation on the application of 
these rules is intended to prevent a conflict between, on the one hand, 
those rules that apply to determine the basis of stock received in an 
exchange to which section 351 applies (including the effect of the 
application of section 357(c)) and, on the other hand, these proposed 
rules.
    In the case of a distribution to which section 355 applies in 
connection with which there is no exchange of shares of stock or 
securities but only the receipt of additional shares of stock or 
securities, these proposed regulations provide that the basis of each 
share of stock or security of the distributing corporation is allocated 
between the share of stock or security of the distributing corporation 
and the share of stock or security received with respect to such share 
of stock or security of the distributing corporation in proportion to 
their fair market values. If one share of stock or security is received 
in respect of more than one share of stock or security or a fraction of 
a share of stock or security is received, the basis of each share of 
stock or security of the distributing corporation must be allocated to 
the shares of stock or securities received in a manner that reflects 
that, to the greatest extent possible, a share of stock or security 
received is received in respect of shares of stock or securities 
acquired on the same date and at the same price.
    The IRS and Treasury Department recognize that, in certain cases, 
the shareholder will not be able to identify which particular share (or 
portion of a share) of stock or security was exchanged for, or received 
with respect to, a particular share (or portion of a share) of stock or 
security. In these cases, the proposed regulations permit the 
shareholder or security holder to designate which share or security was 
received in exchange for, or in respect of, which share or security. 
Such designation, however, must be consistent with the terms of the 
exchange or distribution.
    The designation must be made on or before the first date on which 
the basis of a share or security received is relevant, for example, the 
date on which a share or security received is sold or is transferred in 
an exchange described in section 351 or section 721 or a reorganization 
described in section 368. The designation is binding for purposes of 
determining the Federal tax consequences of subsequent transactions 
involving any share or security received or property received with 
respect to such share or security. If the shareholder fails to make a 
designation, then the shareholder will not be able to identify which 
shares are sold or transferred for purposes of determining the basis of 
property sold or transferred under section 1012 and Sec.  1.1012-1(c) 
and, instead, will be treated as selling or transferring the share 
received in respect of the earliest share purchased or acquired.
    The current regulations under section 358 include references to 
transactions described in former sections 371(b) and 374, which were 
repealed by section 11801(a)(19) of Public Law 101-508 (104 Stat. 1388) 
effective November 5, 1990. To reflect the repeal of these sections, 
these proposed regulations remove the references to sections 371(b) and 
374 as they currently appear in the regulations under section 358.

Effective Date

    These regulations are proposed to apply to exchanges and 
distributions of stock or securities occurring after the date these 
regulations are published as final regulations in the Federal Register.

Effect on Other Documents

    These proposed regulations would obsolete Revenue Ruling 55-355 
(1955-1 C.B. 418) for transactions occurring after the date these 
regulations are published as final regulations in the Federal Register.

Special Analysis

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C chapter 5) does not apply to these regulations, and, because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight copies) that are submitted timely to the IRS. Alternatively, 
taxpayers may submit comments electronically via the IRS Internet site 
at www.irs.gov/regs or via the Federal eRulemaking Portal at 
www.regulations.gov. The IRS and Treasury Department request comments 
on the clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing may be scheduled if requested in writing by 
any person who timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place of the hearing will be 
published in the Federal Register.

Drafting Information

    The principal authors of these regulations are Reginald Mombrun, 
Theresa Kolish, and Emidio J. Forlini, Jr. of the Office of the 
Associate Chief Counsel (Corporate), IRS. However, other personnel from 
the IRS and the Treasury Department participated in their development.

[[Page 24110]]

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    1. The authority citation for part 1 is amended by adding an entry 
in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *.
    Section 1.358-2 also issued under 26 U.S.C. 358. * * *
    2. Section 1.358-1 is amended by:
    1. Revising paragraph (a).
    2. Adding paragraph (c).
    The revision and addition read as follows:


Sec.  1.358-1  Basis to distributees.

    (a) In the case of an exchange or distribution to which section 354 
or 355 applies in which, under the law applicable to the year in which 
the exchange is made, only nonrecognition property is received, the sum 
of the basis of all of the stock and securities in the corporation 
whose stock and securities are exchanged or with respect to which the 
distribution is made, held immediately after the transaction, plus the 
basis of all stock and securities received in the transaction shall be 
the same as the basis of all the stock and securities in such 
corporation held immediately before the transaction allocated in the 
manner described in Sec.  1.358-2. In the case of an exchange to which 
section 351 or 361 applies in which, under the law applicable to the 
year in which the exchange was made, only nonrecognition property is 
received, the basis of all the stock and securities received in the 
exchange shall be the same as the basis of all property exchanged 
therefor. If in an exchange or distribution to which section 351, 356, 
or 361 applies both nonrecognition property and ``other property'' are 
received, the basis of all the property except ``other property'' held 
after the transaction shall be determined as described in the preceding 
two sentences decreased by the sum of the money and the fair market 
value of the ``other property'' (as of the date of the transaction) and 
increased by the sum of the amount treated as a dividend (if any) and 
the amount of the gain recognized on the exchange, but the term gain as 
here used does not include any portion of the recognized gain that was 
treated as a dividend. In any case in which a taxpayer transfers 
property with respect to which loss is recognized, such loss shall be 
reflected in determining the basis of the property received in the 
exchange. The basis of the ``other property'' is its fair market value 
as of the date of the transaction. See Sec.  1.460-4(k)(3)(iv)(A) for 
rules relating to stock basis adjustments required where a contract 
accounted for using a long-term contract method of accounting is 
transferred in a transaction described in section 351 or a 
reorganization described in section 368(a)(1)(D) with respect to which 
the requirements of section 355 (or so much of section 356 as relates 
to section 355) are met.
* * * * *
    (c) Effective date. Paragraph (a) of this section applies to 
exchanges or distributions of stock and securities after the date these 
regulations are published as final regulations in the Federal Register. 
Paragraph (b) of this section applies to exchanges or distributions of 
stock and securities after December 31, 1953.
    3. Section 1.358-2 is amended by:
    1. Revising paragraphs (a)(1) and (a)(2).
    2. Removing paragraphs (a)(3), (a)(4), and (a)(5).
    3. Revising paragraphs (b)(1) and (c).
    4. Adding paragraph (d).
    The revisions and addition read as follows:


Sec.  1.358-2  Allocation of basis among nonrecognition property.

    (a) Allocation of basis in exchanges or distributions to which 
section 354, 355, or 356 applies. (1) As used in this paragraph the 
term stock means stock which is not ``other property'' under section 
356. The term securities means securities (including, where 
appropriate, fractional parts of securities) which are not ``other 
property'' under section 356.
    (2)(i) If a shareholder or security holder surrenders a share of 
stock or a security in an exchange under the terms of section 354, 355, 
or 356, the basis of each share of stock or security received in the 
exchange shall be the same as the basis of the allocable portion of the 
share or shares of stock or security or securities exchanged therefor 
(as adjusted under Sec.  1.358-1). If more than one share of stock or 
security is received in exchange for one share of stock or one 
security, the basis of the share of stock or security surrendered shall 
be allocated to the shares of stock or securities received in the 
exchange in proportion to the fair market value of the shares of stock 
or securities received. If one share of stock or security is received 
in respect of more than one share of stock or security or a fraction of 
a share of stock or security is received, the basis of the shares of 
stock or securities surrendered must be allocated to the shares of 
stock or securities received in a manner that reflects, to the greatest 
extent possible, that a share of stock or security received is received 
in respect of shares of stock or securities acquired on the same date 
and at the same price.
    (ii) If a shareholder or security holder receives one or more 
shares of stock or one or more securities in a distribution under the 
terms of section 355 (or so much of section 356 as relates to section 
355) and does not surrender any shares of stock or securities in 
connection with the distribution, the basis of each share of stock or 
security of the distributing corporation (as defined in Sec.  1.355-
1(b)), as adjusted under Sec.  1.358-1, shall be allocated between the 
share of stock or security of the distributing corporation with respect 
to which the distribution is made and the share or shares of stock or 
security or securities (or allocable portions thereof) received with 
respect to the share of stock or security of the distributing 
corporation in proportion to their fair market values. If one share of 
stock or security is received in respect of more than one share of 
stock or security or a fraction of a share of stock or security is 
received, the basis of each share of stock or security of the 
distributing corporation must be allocated to the shares of stock or 
securities received in a manner that reflects that, to the greatest 
extent possible, a share of stock or security received is received in 
respect of shares of stock or securities acquired on the same date and 
at the same price.
    (iii) If a shareholder or security holder that purchased or 
acquired shares of stock or securities in a corporation on different 
dates or at different prices exchanges such shares of stock or 
securities under the terms of section 354, 355, or 356, or receives a 
distribution of shares of stock or securities under the terms of 
section 355, and the shareholder or security holder is not able to 
identify which particular share of stock or security (or portion of a 
share of stock or security) is received in exchange for, or with 
respect to, a particular share of stock or security, the shareholder or 
security holder may designate which share of stock or security is 
received in exchange for, or with respect to, a particular share of 
stock or security, provided that such designation is consistent with 
the terms of the exchange or distribution. The designation must be made 
on or before the first date on which the basis of a share of stock or 
security received is relevant. The basis of the shares or

[[Page 24111]]

securities received, for example, is relevant when such shares or 
securities are sold or otherwise transferred. The designation will be 
binding for purposes of determining the Federal tax consequences of any 
sale or transfer of, or distribution with respect to, the shares or 
securities received. If the shareholder fails to make a designation, 
then the shareholder will not be able to identify which shares are sold 
or transferred for purposes of determining the basis of property sold 
or transferred under section 1012 and Sec.  1.1012-1(c) and, instead, 
will be treated as selling or transferring the share received in 
respect of the earliest share purchased or acquired.
    (iv) Paragraphs (a)(2)(i) through (iii) of this section shall not 
apply to determine the basis of a share of stock or security received 
by a shareholder or security holder in an exchange described in both 
section 351 and section 354 or section 356, if, in connection with the 
exchange, the shareholder or security holder exchanges property for 
stock or securities in an exchange to which neither section 354 nor 356 
applies or liabilities of the shareholder or security holder are 
assumed.
    (b) Allocation of basis in exchanges to which section 351 or 361 
applies. (1) As used in this paragraph (b), the term stock refers only 
to stock which is not ``other property'' under section 351 or 361 and 
the term securities refers only to securities which are not ``other 
property'' under section 351 or 361.
* * * * *
    (c) Examples. The application of paragraphs (a) and (b) of this 
section is illustrated by the following examples:

    Example 1. (i) Facts. F, an individual, acquired 20 shares of 
Corporation N stock on Date 1 for $3 each and 10 shares of 
Corporation N stock on Date 2 for $6 each. On Date 3, Corporation O 
acquires the assets of Corporation N in a reorganization under 
section 368(a)(1)(A). Pursuant to the terms of the plan of 
reorganization, F receives 2 shares of Corporation O stock for each 
share of Corporation N stock. Therefore, F receives 60 shares of 
Corporation O stock. Pursuant to section 354, F recognizes no gain 
or loss on the exchange. F is not able to identify which shares of 
Corporation O stock are received in exchange for each share of 
Corporation N stock.
    (ii) Analysis. Under paragraph (a)(2) of this section, F has 40 
shares of Corporation O each of which has a basis of $1.50 and is 
treated as having been acquired on Date 1 and 20 shares of 
Corporation O each of which has a basis of $3 and is treated as 
having been acquired on Date 2. On or before the date on which the 
basis of a share of Corporation O stock received becomes relevant, F 
may designate which of the shares of Corporation O have a basis of 
$1.50 and which have a basis of $3.
    Example 2. (i) Facts. The facts are the same as in Example 1, 
except that instead of receiving 2 shares of Corporation O stock for 
each share of Corporation N stock, F receives 1\1/2\ shares of 
Corporation O stock for each share of Corporation N stock. 
Therefore, F receives 45 shares of Corporation O stock. Again, F is 
not able to identify which shares (or portions of shares) of 
Corporation O stock are received in exchange for each share of 
Corporation N stock.
    (ii) Analysis. Under paragraph (a)(2) of this section, F has 30 
shares of Corporation O each of which has a basis of $2 and is 
treated as having been acquired on Date 1 and 15 shares of 
Corporation O each of which has a basis of $4 and is treated as 
having been acquired on Date 2. On or before the date on which the 
basis of a share of Corporation O stock received becomes relevant, F 
may designate which of the shares of Corporation O have a basis of 
$2 and which have a basis of $4.
    Example 3. (i) Facts. E, an individual, purchased 20 shares of 
Class A stock of Corporation P on Date 1 for $3 per share and 10 
shares of Class B stock of Corporation P on Date 2 for $3 per share. 
On Date 3, E exchanges each share of Class A stock for one share of 
new Class C stock and one share of new Class D stock in a 
reorganization under section 368(a)(1)(E). Pursuant to section 354, 
E recognizes no gain or loss on the exchange. On the date of the 
exchange, the fair market value of each share of Class A stock is 
$6, the fair market value of each share of Class C stock is $2, and 
the fair market value of each share of Class D stock is $4. E is not 
able to identify which shares of Class C and Class D stock of 
Corporation P are received in exchange for each share of Class A 
stock of Corporation P.
    (ii) Analysis. Under paragraph (a)(2) of this section, because E 
receives one share of Class C stock and one share of Class D stock 
for each share of Class A stock, the basis of each share of Class A 
stock surrendered is allocated to one share of Class C stock and one 
share of Class D stock in proportion to their fair market values. 
Therefore, $1 of the basis of each share of Class A stock is 
allocated to each share of Class C stock and $2 of the basis of each 
share of Class A stock is allocated to each share of Class D stock. 
E's basis in each share of Class B stock remains $3.
    Example 4. (i) Facts. G, an individual, purchased 10 shares of 
Corporation Q stock on Date 1 for $2 per share and 10 shares of 
Corporation Q stock on Date 2 for $5 per share. On Date 3, 
Corporation R acquires the stock of Corporation Q in a 
reorganization under section 368(a)(1)(B). Pursuant to the terms of 
the reorganization, G receives one share of Corporation R stock for 
every 2 shares of Corporation Q stock. Pursuant to section 354, G 
recognizes no gain or loss on the exchange. G is not able to 
identify which portion of each share of Corporation R stock is 
received in exchange for each share of Corporation Q stock.
    (ii) Analysis. Under paragraph (a)(2) of this section, G has 5 
shares of Corporation R each of which has a basis of $4 and is 
treated as having been acquired on Date 1 and 5 shares of 
Corporation R each of which has a basis of $10 and is treated as 
having been acquired on Date 2. On or before the date on which the 
basis of a share of Corporation R stock received becomes relevant, G 
may designate which of the shares of Corporation R have a basis of 
$4 and which have a basis of $10.
    Example 5. (i) Facts. The facts are the same as in Example 4, 
except that, in addition to transferring the stock of Corporation Q 
to Corporation R, G transfers land to Corporation R. In addition, 
after the transaction, G owns stock of Corporation R satisfying the 
requirements of section 368(c). G's transfer of the Corporation Q 
stock to Corporation R is an exchange described in sections 351 and 
354. G's transfer of land to Corporation R is an exchange described 
in section 351.
    (ii) Analysis. Pursuant to paragraph (a)(2)(iv) of this section, 
because neither section 354 nor section 356 applies to the transfer 
of land to Corporation R, the rules of paragraphs (a)(2)(i) through 
(iii) of this section do not apply to determine G's basis in the 
Corporation R stock received in the transaction.
    Example 6. (i) Facts. H, an individual, purchased 10 shares of 
Corporation T stock on Date 1 for $3 per share and 10 shares of 
Corporation T stock on Date 2 for $6 per share. On Date 3, 
Corporation V, a newly formed, wholly owned subsidiary of 
Corporation U, merges with and into Corporation T with Corporation T 
surviving. As part of the plan of merger, H receives one share of 
Corporation U stock for each share of Corporation T stock. In 
connection with the transaction, Corporation U assumes a liability 
of H. In addition, after the transaction, H owns stock of 
Corporation U satisfying the requirements of section 368(c). H's 
transfer of the Corporation T stock to Corporation U is an exchange 
described in sections 351 and 354.
    (ii) Analysis. Pursuant to paragraph (a)(2)(iv) of this section, 
because, in connection with the transfer of the Corporation T stock 
to Corporation U, Corporation U assumed a liability of H, the rules 
of paragraphs (a)(2)(i) through (iii) of this section do not apply 
to determine H's basis in the Corporation U stock received in the 
transaction.
    Example 7. (i) Facts. J, an individual, purchased 5 shares of 
Corporation X stock for $4 per share on Date 1 and 5 shares of 
Corporation X stock for $8 per share on Date 2. Corporation X owns 
all of the outstanding stock of Corporation Y. The fair market value 
of the stock of Corporation X, excluding the stock of Corporation Y, 
is $900. The fair market value of the stock of Corporation Y is 
$900. In a distribution to which section 355 applies, Corporation X 
distributes all of the stock of Corporation Y pro rata to its 
shareholders. No stock of Corporation X is surrendered in connection 
with the distribution. In the distribution, J receives 2 shares of 
Corporation Y stock with respect to each share of Corporation X 
stock. Pursuant to section 355, J recognizes no gain or loss on the 
receipt of the shares of Corporation Y stock. J is not able to 
identify which share of Corporation Y stock is received in respect 
of each share of Corporation X stock.
    (ii) Analysis. Under paragraph (a)(2) of this section, because J 
receives 2 shares of

[[Page 24112]]

Corporation Y stock with respect to each share of Corporation X 
stock, the basis of each share of Corporation X stock is allocated 
between such share of Corporation X stock and two shares of 
Corporation Y stock in proportion to the fair market value of those 
shares. Therefore, each of the 5 shares of Corporation X stock 
acquired on Date 1 will have a basis of $2 and each of the 10 shares 
of Corporation Y stock received with respect to those shares will 
have a basis of $1. In addition, each of the 5 shares of Corporation 
X stock acquired on Date 2 will have a basis of $4 and each of the 
10 shares of Corporation Y stock received with respect to those 
shares will have a basis of $2. On or before the date on which the 
basis of a share of Corporation Y stock received becomes relevant, H 
may designate which of the shares of Corporation Y have a basis of 
$1 and which have a basis of $2.

    (d) Effective date. This section applies to exchanges or 
distributions of stock and securities after the date these regulations 
are published as final regulations in the Federal Register.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-10009 Filed 4-30-04; 8:45 am]
BILLING CODE 4830-01-P