Par. 4. Section 1.475(a)-2 is added to read as follows:
(a) General rule. If a dealer in securities ceases to be the owner of a security for federal income tax purposes and if the security would have been marked to market under section 475(a) if the dealer's taxable year had ended immediately before the dealer ceases to own it, then (whether or not the security is inventory in the hands of the dealer) the dealer must recognize gain or loss on the security as if it were sold for its fair market value immediately before the dealer ceases to own it, and gain or loss is taken into account at that time. The amount of any gain or loss subsequently realized must be properly adjusted, in the form of a basis adjustment or otherwise, for gain or loss taken into account under this paragraph (a). See Sec. 1.475(b)-4(b) for the rule governing when a security with substituted basis must be identified if it is to be exempted from the application of section 475(a).
(b) Example. The rule of paragraph (a) of this section is illustrated by the following example.
Example.
(i) Facts. D is a dealer in securities within the meaning of section 475(c)(1) and is a member of a consolidated group that uses the calendar year as its taxable year. On February 1, 1995, D acquired for $100 a debt instrument issued by an unrelated party. On June 1, 1995, D sold the debt instrument to another member of the group, M1, for $110, which was the fair market value of the security on that date. D would have been required to mark the debt instrument to market under section 475(a) if its taxable year had ended immediately before it sold the debt instrument to M1.
(ii) Holding. Under paragraph (a) of this section, D marks the debt instrument to market immediately before the sale to M1 and takes into account $10 of gain. The gain is not deferred intercompany gain. As a result, D's basis in the debt instrument increases to $110 immediately before the sale. Accordingly, there is no gain or loss on the sale, and M1's basis in the debt instrument is $110.