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However, there is a provision in the "deemed sale" statute that requires the seller to recognize gain on a deemed sale "notwithstanding any provision of the Internal Revenue Code".

It's still not quite clear though. I think the intent is clear that it wasn't supposed to be allowed, but the provision in TRA 97 says that the gain must be recognized notwithstanding any other provision of the Code. Sec. 121 provides an exclusion for recognized gain. So, technically, you can still argue that the Sec. 121 exclusion applies, because it isn't a non-recognition provision, it's an exclusion provision.
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