Reg. § 1.306-3 Section 306 stock defined.
(a) For the purpose of subchapter C, chapter 1 of the code, the term section stock means stock which meets the requirements of section . Any class of stock distributed to a shareholder in a transaction in which no amount is includible in the income of the shareholder or no gain or loss is recognized may be section stock, if a distribution of money by the distributing corporation in lieu of such stock would have been a dividend in whole or in part. However, except as provided in section , if no part of a distribution of money by the distributing corporation in lieu of such stock would have been a dividend, the stock distributed will not constitute section stock.
(b) For the purpose of section , rights to acquire stock shall be treated as stock. Such rights shall not be section stock if no part of the distribution would have been a dividend if money had been distributed in lieu of the rights. When stock is acquired by the exercise of rights which are treated at section stock, the stock acquired is section stock. Upon the disposition of such stock (other than by redemption or within the exceptions listed in section ), the proceeds received from the disposition shall be treated as ordinary income to the extent that the fair market value of the stock rights, on the date distributed to the shareholder, would have been a dividend to the shareholder had the distributing corporation distributed cash in lieu of stock rights. Any excess of the amount realized over the sum of the amount treated as ordinary income plus the adjusted basis of the stock, shall be treated as gain from the sale of the stock.
(c) Section provides that section stock is any stock (other than common issued with respect to common) distributed to the shareholder selling or otherwise disposing thereof if, under section (relating to distributions of stock and stock rights) any part of the distribution was not included in the gross income of the distributee.
(d) Section includes in the definition of section stock any stock except common stock, which is received by a shareholder in connection with a reorganization under section or in a distribution or exchange under section (or so much of section as relates to section ) provided the effect of the transaction is substantially the same as the receipt of a stock dividend, or the stock is received in exchange for section stock. If, in a transaction to which section is applicable, a shareholder exchanges section stock for stock and money or other property, the entire amount of such money and of the fair market value of the other property (not limited to the gain recognized) shall be treated as a distribution of property to which section applies. Common stock received in exchange for section stock in a recapitalization shall not be considered section stock. Ordinarily, section stock includes stock which is not common stock received in pursuance of a plan of reorganization (within the meaning of section ) or received in a distribution or exchange to which section (or so much of section as relates to section ) applies if cash received in lieu of such stock would have been treated as a dividend under section or would have been treated as a distribution to which section applies by virtue of section or section . The application of the preceding sentence is illustrated by the following examples:
Example 1. Corporation A, having only common stock outstanding, is merged in a statutory merger (qualifying as a reorganization under section ) with Corporation B. Pursuant to such merger, the shareholders of Corporation A received both common and preferred stock in Corporation B. The preferred stock received by such shareholders is section stock.
Example 2. X and Y each own one-half of the 2,000 outstanding shares of preferred stock and one-half of the 2,000 outstanding shares of common stock of Corporation C. Pursuant to a reorganization within the meaning of section (recapitalization) each shareholder exchanges his preferred stock for preferred stock of a new issue which is not substantially different from the preferred stock previously held. Unless the preferred stock exchanged was itself section stock the preferred stock received is not section stock.
(e) Section includes in the definition of section stock any stock (except as provided in section ) the basis of which in the hands of the person disposing of such stock, is determined by reference to section stock held by such shareholder or any other person. Under this paragraph common stock can be section stock. Thus, if a person owning section stock in Corporation A transfers it to Corporation B which is controlled by him in exchange for common stock of Corporation B in a transaction to which section is applicable, the common stock so received by him would be section stock and subject to the provisions of section on its disposition. In addition, the section stock transferred is section stock in the hands of Corporation B, the transferee. Section stock transferred by gift remains section stock in the hands of the donee. Stock received in exchange for section stock under section (relating to exchange of stock for stock in the same corporation) or under so much of section as relates to section becomes section stock and acquires, for purposes of section , the characteristics of the section stock exchanged. The entire amount of the fair market value of the other property received in such transaction shall be considered as received upon a disposition (other than a redemption) to which section applies. Section stock ceases to be so classified if the basis of such stock is determined by reference to its fair market value on the date of the decedent-stockholder's death under section or the optional valuation date under section . Section stock continues to be so classified if the basis of such stock is determined under section .
(f) If section stock which was distributed with respect to common stock is exchanged for common stock in the same corporation (whether or not such exchange is pursuant to a conversion privilege contained in section stock), such common stock shall not be section stock. This paragraph applies to exchanges not coming within the purview of section . Common stock which is convertible into stock other than common stock or into property, shall not be considered common stock. It is immaterial whether the conversion privilege is contained in the stock or in some type of collateral agreement.
(g) If there is a substantial change in the terms and conditions of any stock, then, for the purpose of this section—
(1) The fair market value of such stock shall be the fair market value at the time of distribution or the fair market value at the time of such change, whichever is higher;
(2) Such stock's ratable share of the amount which would have been a dividend if money had been distributed in lieu of stock shall be determined by reference to the time of distribution or by reference to the time of such change, whichever ratable share is higher; and
(3) Section shall be inapplicable if there would have been a dividend to any extent if money had been distributed in lieu of the stock either at the time of the distribution or at the time of such change.
(h) When section stock is disposed of, the amount treated under section as ordinary income, for the purposes of part I, subchapter N, chapter 1 of the Code, be treated as derived from the same source as would have been the source if money had been received from the corporation as a dividend at the time of the distribution of such stock. If the amount is determined to be derived from sources within the United States, the amount shall be considered to be fixed or determinable annual or periodic gains, profits, and income within the meaning of section or section , relating, respectively, to the tax on nonresident alien individuals and on foreign corporations not engaged in business in the United States.
(i) Section shall be inapplicable to stock received before June 22, 1954, and to stock received on or after June 22, 1954, in transactions subject to the provisions of the Internal Revenue Code of 1939.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7281, 38 FR 18540, July 12, 1973; T.D. 7556, 43 FR 34128, Aug. 3, 1978; T.D. 9811, 82 FR 6237, Jan. 19, 2017]