[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2002]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.852-10]

[Page 29-30]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1--INCOME TAXES--Table of Contents
 
Sec. 1.852-10  Distributions in redemption of interests in unit investment trusts.

    (a) In general. In computing that part of the excess of its net 
long-term capital gain over net short-term capital loss on which it must 
pay a capital gains tax, a regulated investment company is allowed under 
section 852(b)(3)(A)(ii) a deduction for dividends paid (as defined in 
section 561) determined with reference to capital gains dividends only. 
Section 561(b) provides that in determining the deduction for dividends 
paid, the rules provided in section 562 are applicable. Section 562(c) 
(relating to preferential dividends) provides that the amount of any 
distribution shall not be considered as a dividend unless such 
distribution is pro-rata, with no preference to any share of stock as 
compared with other shares of the same class except to the extent that 
the former is entitled to such preference.
    (b) Redemption distributions made by unit investment trust--(1) In 
general. Where a unit investment trust (as defined in paragraph (c) of 
this section) liquidates part of its portfolio represented by shares in 
a management company in order to make a distribution to a holder of an 
interest in the trust in redemption of part or all of such interest, and 
by so doing, the trust realizes net long-term capital gain, that portion 
of the distribution by the trust which is equal to the amount of the net 
long-term capital gain realized by the trust on the liquidation of the 
shares in the management company will not be considered a preferential 
dividend under section 562(c). For example, where the entire amount of 
net long-term capital gain realized by the trust on such a liquidation 
is distributed to the redeeming interest holder, the trust will be 
allowed the entire amount of net long-term capital gain so realized in 
determining

[[Page 30]]

the deduction under section 852(b)(3)(A)(ii) for dividends paid 
determined with reference to capital gains dividends only. This 
paragraph and section 852(d) shall apply only with respect to the 
capital gain net income (net capital gain for taxable years beginning 
before January 1, 1977) realized by the trust which is attributable to a 
redemption by a holder of an interest in such trust. Such dividend may 
be designated as a capital gain dividend by a written notice to the 
certificate holder. Such designation should clearly indicate to the 
holder that the holder's gain or loss on the redemption of the 
certificate may differ from such designated amount, depending upon the 
holder's basis for the redeemed certificate, and that the holder's own 
records are to be used in computing the holder's gain or loss on the 
redemption of the certificate.
    (2) Example. The application of the provisions of this paragraph may 
be illustrated by the following example:

    Example. B entered into a periodic payment plan contract with X as 
custodian and Z as plan sponsor under which he purchased a plan 
certificate of X. Under this contract, upon B's demand, X must redeem 
B's certificate at a price substantially equal to the value of the 
number of shares in Y, a management company, which are credited to B's 
account by X in connection with the unit investment trust. Except for a 
small amount of cash which X is holding to satisfy liabilities and to 
invest for other plan certificate holders, all of the assets held by X 
in connection with the trust consist of shares in Y. Pursuant to the 
terms of the periodic payment plan contract, 100 shares of Y are 
credited to B's account. Both X and Y have elected to be treated as 
regulated investment companies. On March 1, 1965, B notified X that he 
wished to have his entire interest in the unit investment trust 
redeemed. In order to redeem B's interest, X caused Y to redeem 100 
shares of Y which X held. At the time of redemption, each share of Y had 
a value of $15. X then distributed the $1,500 to B. X's basis for each 
of the Y shares which was redeemed was $10. Therefore, X realized a 
long-term capital gain of $500 ($5x100 shares) which is attributable to 
the redemption by B of his interest in the trust. Under section 852(d), 
the $500 capital gain distributed to B will not be considered a 
preferential dividend. Therefore, X is allowed a deduction of $500 under 
section 852(b)(3)(A)(ii) for dividends paid determined with reference to 
capital gains dividends only, with the result that X will not pay a 
capital gains tax with respect to such amount.

    (c) Definition of unit investment trust. A unit investment trust to 
which paragraph (a) of this section refers is a business arrangement 
which--
    (1) Is registered under the Investment Company Act of 1940 as a unit 
investment trust;
    (2) Issues periodic payment plan certificates (as defined in such 
Act);
    (3) Possesses, as substantially all of its assets, securities issued 
by a management company (as defined in such Act);
    (4) Qualifies as a regulated investment company under section 851; 
and
    (5) Complies with the requirements provided for by section 852(a).

Paragraph (a) of this section does not apply to a unit investment trust 
described in section 851(f)(1) and paragraph (d) of Sec. 1.851-7.

[T.D. 6921, 32 FR 8755, June 20, 1967, as amended by T.D. 7187, 37 FR 
13527, July 6, 1972; T.D. 7728, 45 FR 72650, Nov. 3, 1980]