Updated July 28, 2026. Quick answer: §1042(c)(4) requires a security of a domestic operating corporation — defined as one “more than 50 percent of the assets of which were … used in the active conduct of the trade or business” — whose prior-year passive investment income did not exceed 25% of gross receipts. Treasuries, mutual funds, ETFs and index funds all fail.
What qualifies and what does not
| Instrument | Qualifies? |
|---|---|
| Stock or bonds of a domestic operating corporation | Yes |
| U.S. Treasury securities | No — not a corporation |
| Mutual funds, ETFs, index funds | No — the fund is not an operating corporation |
| Foreign corporation securities | No — must be domestic |
| Securities of the company you just sold, or a controlled-group member | No — expressly excluded |
This is the constraint that ruins the plan after the fact. A seller who has just deferred a very large gain naturally wants to sit in Treasuries or a diversified fund while deciding what to do. Doing that fails the test and the deferral is lost. The replacement has to be selected before the fifteen-month window closes, and it has to be individual operating-company securities.
Why the market solved this with a specific instrument
The standard answer is long-dated floating-rate notes issued by large domestic operating companies — instruments that exist substantially because of this provision. That is a genuine market response to a statutory constraint, and it is worth understanding that you are buying a tax structure rather than an investment thesis.
Sources
IRC §453(a), (c), (d), (i); §453A(b), (c) and (d); Temp. Reg. §15a.453-1(c) and (d); §1060(a) and Treas. Reg. §1.1060-1(c) and (e); the asset classes at Treas. Reg. §1.338-6(b) as reproduced in the Instructions for Form 8594; §1042(a), (b), (c); §1202(a)(1) and (c)(1); §6621(a)(2). All read July 2026.
This states what the cited authority says. It is not tax advice, and retirement-plan design turns on facts about your business and your other entities that no page can see. Every dollar limit referenced here is indexed and changes annually.