Chinese media say family planning officials in Hunan province took the children from poor homes unable to pay fines for having more than one child.
The children were allegedly listed as orphans and adopted by foreigners for fees of about $3,000 (￡1,800) each.
Xinhua news agency said some were now in the US, the Netherlands and Poland.
The reports first appeared in Caixin magazine and caused such outrage that the Hunan provincial government has launched a formal investigation.
A government spokeswoman confirmed to AFP news agency that the investigation began on Monday.
Correspondents say the one-child policy is not always strictly enforced and the worst that violators normally expect is a fine.
However, Caixin reported that when some families in poorer parts of Hunan were unable to pay their fines, authorities would tear down their houses.
Then - about 10 years ago - officials started confiscating their children, it is claimed.
Missing daughterEnforcers from the family planning bureau are said to have listed about 20 children as orphans - many of them from impoverished Longhui county. They then reportedly sent them to welfare centres from where they were put up for international adoption.
Officials in Longhui county allegedly received 1,000 yuan ($155; ￡94) for each child and the welfare agencies received up to $3,000 per child put up for adoption, it said.
One couple said their only child was taken away by mistake while they were working in another city. Migrant worker Yang Libing told Caixin he had since tracked down his daughter, now seven years old and living in the US.
Tens of thousands of Chinese children have been adopted by foreign couples since the one-child policy came into force in the 1980s.
The policy was aimed at curbing China's surging population.
Latest census figures revealed last month showed China's population grew to 1.34 billion people by 2010, with a sharp rise in those over 60.
The figures showed China's population was growing more slowly than in the past.
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