Can I create a knock out group?

I created an image of a box rectangle, fill color, gradient to white, round corners, softened edges and beveled edges. I created a 180 flip copy of the image so I now have two images color top gradient to white and bottom up color to white. They are now grouped as one.
I created a duplicate and scaled it down a duplicate and I want to use the top smaller image to knock a hole into the same bottom image like a picture frame.
Not sure how i can do that. Illustrator does not give the same edge options that InDesign does. So I cannot create it in Illustrator and place.
Ideally What I am trying to create is an image /picture frame with the inside properties the same as the outside. The properties that I described above. I would be satisfied with a straight edge inside.
Thanks in advance.
Rich

That is what I wanted to do. The look I wanted was rounded inside and outside picture frame. Gradient top to mid black to white and reverse that for the bottom. Hollow inside with rounded edges.
The problems seems to be creating a knockout with two groups of two images that are grouped. I can now see why that is a problem.
Group one Top image gradient black top to white. Duplicate that and flip 180 now black bottom to white up . Group them. Copy the grouped items and reduce 30% . Overlay them. Create knockout. Can't do because pathfinder options were grayed out.
You can't create a knockout of two groups of grouped items. THe effects are irrelevant.
It was a look that I was looking for I did do it in Illustrator.

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