
From the U.S. Code Online via GPO Access
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[Laws in effect as of January 2, 2001]
[Document not affected by Public Laws enacted between
  January 2, 2001 and January 28, 2002]
[CITE: 26USC1042]

 
                     TITLE 26--INTERNAL REVENUE CODE
 
                        Subtitle A--Income Taxes
 
                  CHAPTER 1--NORMAL TAXES AND SURTAXES
 
          Subchapter O--Gain or Loss on Disposition of Property
 
                  PART III--COMMON NONTAXABLE EXCHANGES
 
Sec. 1042. Sales of stock to employee stock ownership plans or 
        certain cooperatives
        

(a) Nonrecognition of gain

    If--
        (1) the taxpayer or executor elects in such form as the 
    Secretary may prescribe the application of this section with respect 
    to any sale of qualified securities,
        (2) the taxpayer purchases qualified replacement property within 
    the replacement period, and
        (3) the requirements of subsection (b) are met with respect to 
    such sale,

then the gain (if any) on such sale which would be recognized as long-
term capital gain shall be recognized only to the extent that the amount 
realized on such sale exceeds the cost to the taxpayer of such qualified 
replacement property.

(b) Requirements to qualify for nonrecognition

    A sale of qualified securities meets the requirements of this 
subsection if--

                 (1) Sale to employee organizations

        The qualified securities are sold to--
            (A) an employee stock ownership plan (as defined in section 
        4975(e)(7)), or
            (B) an eligible worker-owned cooperative.

          (2) Plan must hold 30 percent of stock after sale

        The plan or cooperative referred to in paragraph (1) owns (after 
    application of section 318(a)(4)), immediately after the sale, at 
    least 30 percent of--
            (A) each class of outstanding stock of the corporation 
        (other than stock described in section 1504(a)(4)) which issued 
        the qualified securities, or
            (B) the total value of all outstanding stock of the 
        corporation (other than stock described in section 1504(a)(4)).

                   (3) Written statement required

        (A) In general

            The taxpayer files with the Secretary the written statement 
        described in subparagraph (B).

        (B) Statement

            A statement is described in this subparagraph if it is a 
        verified written statement of--
                (i) the employer whose employees are covered by the plan 
            described in paragraph (1), or
                (ii) any authorized officer of the cooperative described 
            in paragraph (l),

        consenting to the application of sections 4978 and 4979A with 
        respect to such employer or cooperative.

                      (4) 3-year holding period

        The taxpayer's holding period with respect to the qualified 
    securities is at least 3 years (determined as of the time of the 
    sale).

(c) Definitions; special rules

    For purposes of this section--

                      (1) Qualified securities

        The term ``qualified securities'' means employer securities (as 
    defined in section 409(l)) which--
            (A) are issued by a domestic C corporation that has no stock 
        outstanding that is readily tradable on an established 
        securities market, and
            (B) were not received by the taxpayer in--
                (i) a distribution from a plan described in section 
            401(a), or
                (ii) a transfer pursuant to an option or other right to 
            acquire stock to which section 83, 422, or 423 applied (or 
            to which section 422 or 424 (as in effect on the day before 
            the date of the enactment of the Revenue Reconciliation Act 
            of 1990) applied).

                (2) Eligible worker-owned cooperative

        The term ``eligible worker-owned cooperative'' means any 
    organization--
            (A) to which part I of subchapter T applies,
            (B) a majority of the membership of which is composed of 
        employees of such organization,
            (C) a majority of the voting stock of which is owned by 
        members,
            (D) a majority of the board of directors of which is elected 
        by the members on the basis of 1 person 1 vote, and
            (E) a majority of the allocated earnings and losses of which 
        are allocated to members on the basis of--
                (i) patronage,
                (ii) capital contributions, or
                (iii) some combination of clauses (i) and (ii).

                       (3) Replacement period

        The term ``replacement period'' means the period which begins 3 
    months before the date on which the sale of qualified securities 
    occurs and which ends 12 months after the date of such sale.

                 (4) Qualified replacement property

        (A) In general

            The term ``qualified replacement property'' means any 
        security issued by a domestic operating corporation which--
                (i) did not, for the taxable year preceding the taxable 
            year in which such security was purchased, have passive 
            investment income (as defined in section 1362(d)(3)(C)) in 
            excess of 25 percent of the gross receipts of such 
            corporation for such preceding taxable year, and
                (ii) is not the corporation which issued the qualified 
            securities which such security is replacing or a member of 
            the same controlled group of corporations (within the 
            meaning of section 1563(a)(1)) as such corporation.

        For purposes of clause (i), income which is described in section 
        954(c)(3) (as in effect immediately before the Tax Reform Act of 
        1986) shall not be treated as passive investment income.

        (B) Operating corporation

            For purposes of this paragraph--
            (i) In general

                The term ``operating corporation'' means a corporation 
            more than 50 percent of the assets of which were, at the 
            time the security was purchased or before the close of the 
            replacement period, used in the active conduct of the trade 
            or business.
            (ii) Financial institutions and insurance companies

                The term ``operating corporation'' shall include--
                    (I) any financial institution described in section 
                581, and
                    (II) an insurance company subject to tax under 
                subchapter L.

        (C) Controlling and controlled corporations treated as 1 
                corporation

            (i) In general

                For purposes of applying this paragraph, if--
                    (I) the corporation issuing the security owns stock 
                representing control of 1 or more other corporations,
                    (II) 1 or more other corporations own stock 
                representing control of the corporation issuing the 
                security, or
                    (III) both,

          then all such corporations shall be treated as 1 corporation.
            (ii) Control

                For purposes of clause (i), the term ``control'' has the 
            meaning given such term by section 304(c). In determining 
            control, there shall be disregarded any qualified 
            replacement property of the taxpayer with respect to the 
            section 1042 sale being tested.

        (D) Security defined

            For purposes of this paragraph, the term ``security'' has 
        the meaning given such term by section 165(g)(2), except that 
        such term shall not include any security issued by a government 
        or political subdivision thereof.

                 (5) Securities sold by underwriter

        No sale of securities by an underwriter to an employee stock 
    ownership plan or eligible worker-owned cooperative in the ordinary 
    course of his trade or business as an underwriter, whether or not 
    guaranteed, shall be treated as a sale for purposes of subsection 
    (a).

                    (6) Time for filing election

        An election under subsection (a) shall be filed not later than 
    the last day prescribed by law (including extensions thereof) for 
    filing the return of tax imposed by this chapter for the taxable 
    year in which the sale occurs.

          (7) Section not to apply to gain of C corporation

        Subsection (a) shall not apply to any gain on the sale of any 
    qualified securities which is includible in the gross income of any 
    C corporation.

(d) Basis of qualified replacement property

    The basis of the taxpayer in qualified replacement property 
purchased by the taxpayer during the replacement period shall be reduced 
by the amount of gain not recognized by reason of such purchase and the 
application of subsection (a). If more than one item of qualified 
replacement property is purchased, the basis of each of such items shall 
be reduced by an amount determined by multiplying the total gain not 
recognized by reason of such purchase and the application of subsection 
(a) by a fraction--
        (1) the numerator of which is the cost of such item of property, 
    and
        (2) the denominator of which is the total cost of all such items 
    of property.

Any reduction in basis under this subsection shall not be taken into 
account for purposes of section 1278(a)(2)(A)(ii) (relating to 
definition of market discount).

(e) Recapture of gain on disposition of qualified replacement property

                           (1) In general

        If a taxpayer disposes of any qualified replacement property, 
    then, notwithstanding any other provision of this title, gain (if 
    any) shall be recognized to the extent of the gain which was not 
    recognized under subsection (a) by reason of the acquisition by such 
    taxpayer of such qualified replacement property.

    (2) Special rule for corporations controlled by the taxpayer

        If--
            (A) a corporation issuing qualified replacement property 
        disposes of a substantial portion of its assets other than in 
        the ordinary course of its trade or business, and
            (B) any taxpayer owning stock representing control (within 
        the meaning of section 304(c)) of such corporation at the time 
        of such disposition holds any qualified replacement property of 
        such corporation at such time,

    then the taxpayer shall be treated as having disposed of such 
    qualified replacement property at such time.

             (3) Recapture not to apply in certain cases

        Paragraph (1) shall not apply to any transfer of qualified 
    replacement property--
            (A) in any reorganization (within the meaning of section 
        368) unless the person making the election under subsection 
        (a)(1) owns stock representing control in the acquiring or 
        acquired corporation and such property is substituted basis 
        property in the hands of the transferee,
            (B) by reason of the death of the person making such 
        election,
            (C) by gift, or
            (D) in any transaction to which section 1042(a) applies.

(f) Statute of limitations

    If any gain is realized by the taxpayer on the sale or exchange of 
any qualified securities and there is in effect an election under 
subsection (a) with respect to such gain, then--
        (1) the statutory period for the assessment of any deficiency 
    with respect to such gain shall not expire before the expiration of 
    3 years from the date the Secretary is notified by the taxpayer (in 
    such manner as the Secretary may by regulations prescribe) of--
            (A) the taxpayer's cost of purchasing qualified replacement 
        property which the taxpayer claims results in nonrecognition of 
        any part of such gain,
            (B) the taxpayer's intention not to purchase qualified 
        replacement property within the replacement period, or
            (C) a failure to make such purchase within the replacement 
        period, and

        (2) such deficiency may be assessed before the expiration of 
    such 3-year period notwithstanding the provisions of any other law 
    or rule of law which would otherwise prevent such assessment.

(g) Application of section to sales of stock in agricultural refiners 
        and processors to eligible farm cooperatives

                           (1) In general

        This section shall apply to the sale of stock of a qualified 
    refiner or processor to an eligible farmers' cooperative.

                 (2) Qualified refiner or processor

        For purposes of this subsection, the term ``qualified refiner or 
    processor'' means a domestic corporation--
            (A) substantially all of the activities of which consist of 
        the active conduct of the trade or business of refining or 
        processing agricultural or horticultural products, and
            (B) which, during the 1-year period ending on the date of 
        the sale, purchases more than one-half of such products to be 
        refined or processed from--
                (i) farmers who make up the eligible farmers' 
            cooperative which is purchasing stock in the corporation in 
            a transaction to which this subsection is to apply, or
                (ii) such cooperative.

                  (3) Eligible farmers' cooperative

        For purposes of this section, the term ``eligible farmers' 
    cooperative'' means an organization to which part I of subchapter T 
    applies and which is engaged in the marketing of agricultural or 
    horticultural products.

                          (4) Special rules

        In applying this section to a sale to which paragraph (1) 
    applies--
            (A) the eligible farmers' cooperative shall be treated in 
        the same manner as a cooperative described in subsection 
        (b)(1)(B),
            (B) subsection (b)(2) shall be applied by substituting ``100 
        percent'' for ``30 percent'' each place it appears,
            (C) the determination as to whether any stock in the 
        domestic corporation is a qualified security shall be made 
        without regard to whether the stock is an employer security or 
        to subsection (c)(1)(A), and
            (D) paragraphs (2)(D) and (7) of subsection (c) shall not 
        apply.

(Added Pub. L. 98-369, div. A, title V, Sec. 541(a), July 18, 1984, 98 
Stat. 887; amended Pub. L. 99-514, title XVIII, Secs. 1854(a)(1), 
(2)(A), (3)(B), (4), (5)(A), (6)(A), (7), (8)(A), (9)(B), (10), (11), 
(f)(3)(B), 1899A(26), Oct. 22, 1986, 100 Stat. 2872-2878, 2882, 2959; 
Pub. L. 100-647, title I, Sec. 1018(t)(4)(D)-(F), Nov. 10, 1988, 102 
Stat. 3588; Pub. L. 101-239, title VII, Sec. 7303(a), Dec. 19, 1989, 103 
Stat. 2352; Pub. L. 101-508, title XI, Sec. 11801(c)(9)(H), Nov. 5, 
1990, 104 Stat. 1388-526; Pub. L. 104-188, title I, Secs. 1311(b)(3), 
1316(d)(3), 1616(b)(13), 1704(t)(50), Aug. 20, 1996, 110 Stat. 1784, 
1786, 1857, 1890; Pub. L. 105-34, title IX, Sec. 968(a), Aug. 5, 1997, 
111 Stat. 895.)

                       References in Text

    The date of the enactment of the Revenue Reconciliation Act of 1990, 
referred to in subsec. (c)(1)(B)(ii), is the date of enactment of Pub. 
L. 101-508, which was approved Nov. 5, 1990.
    The Tax Reform Act of 1986, referred to in subsec. (c)(4)(A), is 
Pub. L. 99-514, which was approved Oct. 22, 1986.


                               Amendments

    1997--Subsec. (g). Pub. L. 105-34 added subsec. (g).
    1996--Subsec. (c)(1)(A). Pub. L. 104-188, Sec. 1316(d)(3), 
substituted ``domestic C corporation'' for ``domestic corporation''.
    Subsec. (c)(1)(B)(ii). Pub. L. 104-188, Sec. 1704(t)(50), provided 
that section 11801(c)(9)(H) of Pub. L. 101-508 shall be applied as if 
``section 1042(c)(1)(B)'' appeared instead of ``section 1042(c)(2)(B)''. 
See 1990 Amendment note below.
    Subsec. (c)(4)(A)(i). Pub. L. 104-188, Sec. 1311(b)(3), substituted 
``section 1362(d)(3)(C)'' for ``section 1362(d)(3)(D)''.
    Subsec. (c)(4)(B)(ii)(I). Pub. L. 104-188, Sec. 1616(b)(13), struck 
out ``or 593'' after ``section 581''.
    1990--Subsec. (c)(1)(B)(ii). Pub. L. 101-508, which directed the 
amendment of subsec. (c)(2)(B)(ii) by substituting ``section 83, 422, or 
423 applied (or to which section 422 or 424 (as in effect on the day 
before the date of the enactment of the Revenue Reconciliation Act of 
1990) applied)'' for ``section 83, 422, 422A, 423, or 424 applies'', was 
executed to subsec. (c)(1)(B)(ii). See 1996 Amendment note above.
    1989--Subsec. (b)(4). Pub. L. 101-239 added par. (4).
    1988--Subsec. (b)(3), (4). Pub. L. 100-647, Sec. 1018(t)(4)(F), made 
technical correction to Pub. L. 99-514, Sec. 1854(a)(3)(B), see 1986 
Amendment notes below.
    Subsec. (c)(4)(A). Pub. L. 100-647, Sec. 1018(t)(4)(D), inserted 
``(as in effect immediately before the Tax Reform Act of 1986)'' after 
``section 954(c)(3)'' in last sentence.
    Subsec. (c)(4)(B)(i). Pub. L. 100-647, Sec. 1018(t)(4)(E), 
substituted ``replacement period'' for ``placement period''.
    1986--Pub. L. 99-514, Sec. 1854(a)(11), which directed that 
``employee'' be inserted before ``stock'' in section catchline was 
executed by making the insertion before ``stock'' the second time that 
term appears as the probable intent of Congress.
    Subsec. (a). Pub. L. 99-514, Sec. 1854(a)(1), substituted ``the 
taxpayer or executor elects in such form as the Secretary may 
prescribe'' for ``the taxpayer elects'' in par. (1) and inserted ``which 
would be recognized as long-term capital gain'' in concluding 
provisions.
    Subsec. (b)(2). Pub. L. 99-514, Sec. 1854(a)(2)(A), substituted 
``Plan must hold'' for ``Employees must own'' in heading and amended 
text generally. Prior to amendment, par. (2) read as follows: ``The plan 
or cooperative referred to in paragraph (1) owns, immediately after the 
sale, at least 30 percent of the total value of the employer securities 
(within the meaning of section 409(l)) outstanding as of such time.''
    Subsec. (b)(3). Pub. L. 99-514, Sec. 1854(a)(3)(B), as amended by 
Pub. L. 100-647, Sec. 1018(t)(4)(F), redesignated par. (4) as (3) and 
struck out former par. (3) which related to plans maintained for benefit 
of employees.
    Subsec. (b)(3)(B). Pub. L. 99-514, Sec. 1854(f)(3)(B), amended 
subpar. (B) similar to amendment by section 1854(a)(9)(B) of Pub. L. 99-
514, inserting reference to section 4979A.
    Pub. L. 99-514, Sec. 1854(a)(9)(B), substituted ``sections 4978 and 
4979A'' for ``section 4978(a)''.
    Subsec. (b)(4). Pub. L. 99-514, Sec. 1854(a)(3)(B), as amended by 
Pub. L. 100-647, Sec. 1018(t)(4)(F), redesignated par. (4) as (3).
    Subsec. (c). Pub. L. 99-514, Sec. 1899A(26), substituted ``this 
section--'' for ``this section.--'' in introductory provision.
    Subsec. (c)(1). Pub. L. 99-514, Sec. 1854(a)(4), substituted ``stock 
outstanding that is'' for ``securities outstanding that are'' in subpar. 
(A), redesignated subpar. (C) as (B), and struck out former subpar. (B) 
which read as follows: ``at the time of the sale described in subsection 
(a)(1), have been held by the taxpayer for more than 1 year, and''.
    Subsec. (c)(4). Pub. L. 99-514, Sec. 1854(a)(5)(A), amended par. (4) 
generally. Prior to amendment, par. (4) read as follows: ``The term 
`qualified replacement property' means any securities (as defined in 
section 165(g)(2)) issued by a domestic corporation which does not, for 
the taxable year in which such stock is issued, have passive investment 
income (as defined in section 1362(d)(3)(D)) that exceeds 25 percent of 
the gross receipts of such corporation for such taxable year.''
    Subsec. (c)(5). Pub. L. 99-514, Sec. 1854(a)(10), substituted 
``sold'' for ``acquired'' in heading, and in text substituted ``sale of 
securities'' for ``acquisition of securities'' and inserted ``to an 
employee stock ownership plan or eligible worker-owned cooperative''.
    Subsec. (c)(7). Pub. L. 99-514, Sec. 1854(a)(6)(A), added par. (7).
    Subsec. (d). Pub. L. 99-514, Sec. 1854(a)(7), inserted last 
sentence.
    Subsecs. (e), (f). Pub. L. 99-514, Sec. 1854(a)(8)(A), added subsec. 
(e) and redesignated former subsec. (e) as (f).


                    Effective Date of 1997 Amendment

    Section 968(b) of Pub. L. 105-34 provided that: ``The amendment made 
by this section [amending this section] shall apply to sales after 
December 31, 1997.''


                    Effective Date of 1996 Amendment

    Amendment by section 1316(d)(3) of Pub. L. 104-188 applicable to 
taxable years beginning after Dec. 31, 1997, see section 1316(f) of Pub. 
L. 104-188, set out as a note under section 170 of this title.
    Amendment by section 1311(b)(3) of Pub. L. 104-188 applicable to 
taxable years beginning after Dec. 31, 1996, see section 1317(a) of Pub. 
L. 104-188, set out as a note under section 641 of this title.
    Amendment by section 1616(b)(13) of Pub. L. 104-188 applicable to 
taxable years beginning after Dec. 31, 1995, see section 1616(c) of Pub. 
L. 104-188, set out as a note under section 593 of this title.


                    Effective Date of 1989 Amendment

    Section 7303(b) of Pub. L. 101-239 provided that: ``The amendment 
made by this section [amending this section] shall apply to sales after 
July 10, 1989.''


                    Effective Date of 1988 Amendment

    Amendment by Pub. L. 100-647 effective, except as otherwise 
provided, as if included in the provision of the Tax Reform Act of 1986, 
Pub. L. 99-514, to which such amendment relates, see section 1019(a) of 
Pub. L. 100-647, set out as a note under section 1 of this title.


                    Effective Date of 1986 Amendment

    Amendment by section 1854(a)(1), (2)(A), (4), (5)(A), (7), (10), 
(11) of Pub. L. 99-514 effective, except as otherwise provided, as if 
included in the provisions of the Tax Reform Act of 1984, Pub. L. 98-
369, div. A, to which such amendment relates, see section 1881 of Pub. 
L. 99-514, set out as a note under section 48 of this title.
    Amendment by section 1854(a)(3)(B) of Pub. L. 99-514 applicable to 
sales of securities after Oct. 22, 1986, except that a taxpayer or 
executor may elect to have section 1042(b)(3) of the Internal Revenue 
Code of 1954 (as in effect before the amendment by section 1854(a)(3)(B) 
of Pub. L. 99-514) apply to sales before Oct. 22, 1986, as if section 
1042(b)(3) included the last sentence of section 409(n)(1) of this title 
(as added by section 1854(a)(3)(A) of Pub. L. 99-514), see section 
1854(a)(3)(C) of Pub. L. 99-514, as amended, set out as a note under 
section 409 of this title.
    Section 1854(a)(6)(B)-(D) of Pub. L. 99-514 provided that:
    ``(B) The amendment made by subparagraph (A) [amending this section] 
shall apply to sales after March 28, 1985, except that such amendment 
shall not apply to sales made before July 1, 1985, if made pursuant to a 
binding contract in effect on March 28, 1985, and at all times 
thereafter.
    ``(C) The amendment made by subparagraph (A) shall not apply to any 
sale occurring on December 20, 1985, with respect to which--
        ``(i) a commitment letter was issued by a bank on October 31, 
    1984, and
        ``(ii) a final purchase agreement was entered into on November 
    5, 1985.
    ``(D) In the case of a sale on September 27, 1985, with respect to 
which a preliminary commitment letter was issued by a bank on April 10, 
1985, and with respect to which a commitment letter was issued by a bank 
on June 28, 1985, the amendment made by subparagraph (A) shall apply but 
such sale shall be treated as having occurred on September 27, 1986.''
    Section 1854(a)(8)(B) of Pub. L. 99-514 provided that: ``The 
amendment made by subparagraph (A) [amending this section] shall apply 
to dispositions after the date of the enactment of this Act [Oct. 22, 
1986], in taxable years ending after such date.''
    Amendment by section 1854(a)(9)(B) of Pub. L. 99-514 applicable to 
sales of securities after Oct. 22, 1986, see section 1854(a)(9)(D) of 
Pub. L. 99-514, set out as an Effective Date note under section 4979A of 
this title.
    Amendment by section 1854(f)(3)(B) of Pub. L. 99-514 effective Oct. 
22, 1986, see section 1854(f)(4)(A) of Pub. L. 99-514, set out as a note 
under section 409 of this title.


                             Effective Date

    Section 541(c) of Pub. L. 98-369 provided that: ``The amendments 
made by this section [enacting this section and amending sections 1016 
and 1223 of this title] shall apply to sales of securities in taxable 
years beginning after the date of enactment of this Act [July 18, 
1984].''


                            Savings Provision

    For provisions that nothing in amendment by Pub. L. 101-508 be 
construed to affect treatment of certain transactions occurring, 
property acquired, or items of income, loss, deduction, or credit taken 
into account prior to Nov. 5, 1990, for purposes of determining 
liability for tax for periods ending after Nov. 5, 1990, see section 
11821(b) of Pub. L. 101-508, set out as a note under section 29 of this 
title.


                             Line Item Veto

    Section 968 of Pub. L. 105-34, amending this section and enacting 
provisions set out as a note above, was subject to line item veto by the 
President, Cancellation No. 97-2, signed Aug. 11, 1997, 62 F.R. 43267, 
Aug. 12, 1997. For decision holding line item veto unconstitutional, see 
Clinton v. City of New York, 524 U.S. 417, 118 S.Ct. 2091, 141 L.Ed.2d 
393 (1998).


           Plan Amendments Not Required Until January 1, 1989

    For provisions directing that if any amendments made by subtitle A 
or subtitle C of title XI [Secs. 1101-1147 and 1171-1177] or title XVIII 
[Secs. 1800-1899A] of Pub. L. 99-514 require an amendment to any plan, 
such plan amendment shall not be required to be made before the first 
plan year beginning on or after Jan. 1, 1989, see section 1140 of Pub. 
L. 99-514, as amended, set out as a note under section 401 of this 
title.


Ownership of Stock Options as Ownership of Stock; Employee Ownership of 
                            Stock After Sale

    Section 1854(a)(2)(B) of Pub. L. 99-514 provided that:
    ``(i) The requirement that section 1042(b) of the Internal Revenue 
Code of 1954 [now 1986] shall be applied with regard to section 
318(a)(4) of such Code shall apply to sales after May 6, 1986.
    ``(ii) In the case of sales after July 18, 1984, and before the date 
of the enactment of this Act [Oct. 22, 1986], paragraph (2) of section 
1042(b) of such Code shall apply as if it read as follows:
        `` `(2) Employees must own 30 percent of stock after sale.--The 
    plan or cooperative referred to in paragraph (1) owns, immediately 
    after the sale, at least 30 percent of the employer securities or 30 
    percent of the value of employer securities (within the meaning of 
    section 409(1)) outstanding at the time of sale.' ''


                Replacement Period for Certain Securities

    Section 1854(a)(5)(B) of Pub. L. 99-514 provided that: ``If--
        ``(i) before January 1, 1987, the taxpayer acquired any security 
    (as defined in section 165(g)(2) of the Internal Revenue Code of 
    1954 [now 1986]) issued by a domestic corporation or by any State or 
    political subdivision thereof,
        ``(ii) the taxpayer treated such security as qualified 
    replacement property for purposes of section 1042 of such Code, and
        ``(iii) such property does not meet the requirements of section 
    1042(c)(4) of such Code (as amended by subparagraph (A)),
then, with respect to so much of any gain which the taxpayer treated as 
not recognized under section 1042(a) by reason of the acquisition of 
such property, the replacement period for purposes of such section shall 
not expire before January 1, 1987.''

                  Section Referred to in Other Sections

    This section is referred to in sections 409, 1016, 1223, 4978, 4979A 
of this title.
