not a replacement (I. T. 1378), nor was a purchase represented in the acquisition of a similar asset from an affiliated corporation (A. R. M. 142). The purchase of only unimproved real estate was permitted where other real estate had been condemned; the cash received could be held for a reasonable length of time in the form of municipal bonds (I. T. 1617). Property restored by the Government, following the war, and accompanied by a cash indemnity, was permitted to be credited, with the cash received, to a replacement fund (T. B. R. 41); the same treatment was accorded the proceeds, received in 1924, from the sale by the Alien Property Custodian in 1918 of cotton owned by a partnership, provided the sum was reinvested in cotton (I. T. 2073). The replacement of property by property of somewhat larger capacity was held to be a replacement falling under this head (T. B. M. 61; 4 B. T. A. 118), as was also the replacement of one farm lost by the power of eminent domain by another (O. D. 513); on the other hand, the replacement of a tug by barges was not a replacement in kind (O. 914). Compensation for a portion of certain property condemned and for damages to remaining property could be credited direct to the cost of the entire property (I. T. 1787). The redemption and retirement of the Victory 334's on June 15, 1922, was not an involuntary conversion (I. T. 1354).

Use and occupancy insurance when applied to replacement is exempt from tax as income (3 B. T. A. 1009) but not when it covers a loss of profits (3 B. T. A. 283).

An unused portion of a replacement fund set up in 1918 was subject to taxation at 1918 rates, although the replacement was made in 1920; hence, an amended return was required (Sol. Op. 135).

Cost to be carried forward under the 1921 act is stated by the Solicitor of Internal Revenue to be the cost of the new asset and not the old cost less the free cash not taxed. The decision is clearly erroneous (S. M. 2303); the wording of Section 202 (d) (3) of the Act of 1921 is unambiguous.

PROPERTY ACQUIRED BY GIFT, DEVISE, BEQUEST, OR
INHERITANCE, AND TRANSFERS IN TRUST

Under the 1918 act and previous acts gifts were valued, for the purpose of resale, at their fair value at the time of gift or at March 1, 1913, if acquired prior to that date. By

provision in the 1921 law the cost or March 1, 1913, value to the last preceding owner by whom it was not acquired by gift governed in the case of a gift made after December 31, 1920, and the same rule was continued in the 1924 and 1926 acts (Sec. 204 (2), (4); Art. 73; 1593-1594). An attempt to tax gifts to the donor under the estate tax title was defeated in conference before the final passage of the 1921 act, but a tax on gifts was incorporated into the 1924 act and repealed in the 1926 act as of December 31, 1925. In the act of 1894 gifts and inherited property were themselves regarded as income but this point of view has not been held since except as to the income derived therefrom.

Transfers in trust (except trusts created through bequest or devise) are given the same status as gifts. The provision has been effective from December 31, 1920. The principle involved is not hard to find. Before the enactment of the 1921 law, gifts, for example, between husband and wife just before property was sold were a common means of tax evasion. The fair value at the date of gift governed and the selling price was very close to, if not identical with, such fair value. After gifts were legislated against, other legal means of avoiding the tax on sales of property were sought; and the creation of trusts became a popular expedient. Not only is cost limited to cost to the grantor (Sec. 204 (a) (3); Art. 1595) but the earnings of such trusts are taxable to the grantor1 (Sec. 219 (g) and (h); Art. 347). See further on page 303.

Property acquired by devise, bequest, or inheritance, including a material portion of a decedent's property acquired before, but in contemplation of, death, has always been valued under the various income tax laws at its fair market price or value at the time of acquisition which has been held to be value for Federal or state inheritance tax purpose (Art. 1594). The Board of Tax Appeals has held, however, that the fair value at the date of actual distribution 1 See Chapter XXVI.

governs (2 B. T. A. 921). The date of distribution is often a year or more after the date of death.

Property sold shortly after its gift has been regarded as "colorable," i.e., not a bona-fide gift; any profits arising from such sale are held taxable to the donor, and the penalty for fraud may be assessed (S. 1022); the Board of Tax Appeals has held, however, that such gifts were possible under the 1918 law without asserting fraud (3 B. T. A. 780). Gifts as between husband and wife may not be set aside because of the failure to record the change in security ownership on the corporate records or because income was deposited in a joint account (A. R. R. 367). The cost of property held in a trust inter vivos is the cost to the donor (I. T. 1636). Income from properties conveyed to trustees under the 1918 act which could be accumulated or paid to the settlor at his pleasure, was taxable to the settlor. In L. O. 1102 the creator of the trust was required to report only the income paid to him but such income was the yearly balance of income not distributed to others (S. M. 1699). Original cost should attach to securities conveyed to trustees by an individual and subsequently reconveyed to him by his order (I. T. 1994).

The basis of value of property acquired by a remainderman, in which he had a vested interest since devise, was the value at date of death (O. D. 694 and Sol. Op. 35). The same rule attaches to the valuation of securities acquired through the termination of a trust created by a testator and the distribution of the corpus (I. T. 1165). If only a contingent interest exists, the value to be taken in case of subsequent sale is that at the death of the life tenant (0. D. 727); and a person with a contingent interest cannot deduct a loss of the property when destroyed by fire (S. M. 4640). The sale of an inheritance interest in the estate of a living person was considered income in its entirety (I. T. 1466).

A homestead was to be taken at its fair value at the date of entry plus improvement costs but not including the fee paid to the Government (O. D. 386), and may be taken only by the original entryman (O. D. 601); if entry was made prior to March 1, 1913, but patent thereafter obtained, the property could be regarded as having been acquired prior to that date (O. 880). A mineral grant was a purchase and not a gift (A. R. R. 2516).

VII

SALES AND EXCHANGES: STOCKS AND BONDS— RIGHTS MISCELLANEOUS

Sale and exchange of stocks and bonds. Cost per share necessary. Effect of stock dividend. Effect of other dividends. Bonus stock. Stock and other property acquired in reorganization. Stock acquired through a corporate organization. Split of original basic value. Other exchanges of stock. Wash sales. Sale of rights. Miscellaneous sales and exchanges.

SALES and exchanges of stocks and bonds, principally stocks, offer more difficulties to the layman than any other subject in Federal income taxes. With the enactment of each new law the complications have increased until, in the 1926 act, there would seem to be but few possible cases which the law does not cover. Most of these difficulties are occasioned by corporate reorganizations wherein stockholders, more or less involuntarily, receive other securities, and sometimes cash, in exchange for their old holdings. It is not the involuntary character of the transfer, however, that gives a tax-free status to reorganization transactions but rather the fact that only the form of ownership has changed and that profits, if any, are bound up in the evidences of ownership. In most reorganizations no real conversion takes place.

A discussion of securities involves at once the whole subject of reorganizations, and dividends also. It is impossible, in fact, to treat adequately any one of these three topics without considering in some detail the other two. In this chapter the primary emphasis is laid on cost to the security-holder and a general summary of transactions from which he derives taxable income. The nature of these taxable transactions is further developed in Chapters VIII and IX.

COST PER SHARE NECESSARY

1

Each block of stock or bonds owned by an individual or corporation must be regarded as a separate piece of property having a definite and ascertainable cost or March 1, 1913, value. If a portion of a block of stock or bonds is sold, a proportionate amount of the cost should be allocated to each share or bond. Sales of a portion of a block cannot be credited to the unabsorbed cost of the balance of the block except as noted below, nor can averaged costs be used even though sanctioned by good accounting (Art. 39). Losses through a decline in market prices (i.e., paper losses) are realized for tax purposes only when an actual sale is made. The exception is the dealer in securities, in whose hands stocks and bonds are merchandise, subject, if he elects, to the rule of cost or market, whichever is lower. The cost of worthless securities, however, may be claimed as a deduction, provided they cannot be sold and their worthlessness can otherwise be proved (Art. 144).

Where it is impossible to identify stock certificates or bonds with particular purchases, sales are regarded as proceeding from the earliest purchase or purchases. This was a rule upheld in Towne v. McElligott (274 Fed., 960; T. D. 3252). Such cases arise where the stock certificates or bonds have become merged through consolidation of certificates and exchanges in reorganizations. The necessary details relating to securities may be obtained frequently from corporate records or from vendors. Nearly all dealers in securities maintain records of deliveries to customers.

These rules are fundamental and apply to all laws.

EFFECT OF STOCK DIVIDEND

An ordinary stock dividend, not being taxable (Art. 1548), has the effect of distributing the cost of the original

1 A "block" means a single purchase, represented by one or more certificates or bonds. The distinction in the use of the terms share, certificate, and block should be noted.