Stock Spin-Offs Get Unusual Tax Treatment

I have owned 1200 shares of "Company A" stock for
several years. I bought this stock for $26 per share. Last May there was a
spin-off, and I received 600 shares of stock in the new company, "Company B." On
the day of the spin-off, Company A was quoted at $31 per share and the new
company at $17.50 per share. If I should want to sell my shares in the Company B
stock, what would be my acquisition cost for determining capital gain or
loss?

W.H., Indianapolis

Stock spin-offs are interesting animals. They are different from stock splits, where you get more of the same stock you already own. In a spin-off, you get shares of a different stock based on how many shares you own of the original stock. The calculation for determining your "cost" of the new stock is a little complicated. I'll give you a generic example, then we'll apply the rules to your situation.

Say you own 100 shares of stock in a company called Old Company. You bought the stock 10 years ago for $8 per share. The stock now trades for $25 per share. Old Company spins off a new company called New Company and gives its shareholders one share of New Company stock for every four shares they own of Old Company stock. So now you own 100 shares of Old Company, for which you paid $8 per share, and 25 shares of New Company, for which you paid nothing.

Follow these five steps to determining your cost, or basis, in the New Company stock.

Find out how much both the New Company stock and the Old Company stock traded for on the day the New Company stock was issued. If you don't have this information, you can call your public library reference desk and they can look it up for you. For this example, Old Company was trading at $25 on the day New Company was issued. New Company traded at $6 per share. The total value of your holdings on the date New Company was issued is 100 shares times $25 ($2,500) plus 25 shares times $6 ($150), or $2,650.

Figure out what one share of Old Company stock is now worth, in terms of all shares of stock. In this case, one share of Old Company stock is now worth one share of Old Company stock plus ¼ share of New Company Stock. One share of Old Company stock sells for $25 and ¼ share of New Company stock sells for $1.50, so one of your original shares of Old Company stock is now worth $26.50 in Old and New stock. (Are you with me so far? Remember that you received only ¼ share of New Company stock for each share of Old Company stock.)

Determine the percentage of the market value that each stock represents by dividing each stock by the total market value. Old Company's percentage is 25/26.50 or 94.34%. New Company's percentage is 1.50/26.50 or 5.66%.

Apply the percentages you calculated in Step 3 to your basis (your cost) in Old Company stock to determine your new basis in the Old Company stock as well as your basis in the New Company stock. For this example, multiply 94.34% times $8 (your cost of Old Company stock) to arrive at $7.55. That is now your basis in each share of Old Company stock. Multiply 5.66% times $8 to arrive at $.45 for your basis in ¼ share of the New Company stock. A single share of New Company stock, therefore, is 4 times $.45 or $1.80.

Double check your calculations by multiplying the basis amounts you calculated in Step 4 times the total number of shares of stock you own and comparing that to the basis in your original Old Company stock. These two numbers should be the same. The original basis was 100 shares times $8, or $800. The new basis (which should be the same amount) is 100 shares of Old Company at $7.55, or $755, plus 25 shares of New Company at $1.80, or $45. Adding $755 to $45, you get $800.

Now let's apply these steps to your
situation.

Company A traded at $31 and Company B traded at $17.50 on the day of issue.

One share of Company A is now worth one share of Company A plus ½ share of Company B. With Company A trading at $31 and ½ share of Company B trading at $8.75, one former share of Company A is now worth $39.75.

Company A represents 31/39.75 percent, or 78% of the market value, and ½ share of Company B represents 8.75/39.75 percent, or 22% of the total market value.

Your basis in Company A stock is now 78% times $26, the original cost of the stock, or $20.28 per share. Your basis in ½ share of Company B stock is 22% times $26, or $5.72, so your basis in one share of Company B stock is twice this amount, or $11.44.

Your original basis was 1200 shares times $26, or $31,200. To double check the accuracy of these amounts, multiply 1200 shares of Company A times the new basis, $20.28, to arrive at $24,336. Multiply 600 shares of Company B times $11.44 to arrive at $6,864. Add $24,336 to $6,864 to arrive at $31,200, and everything checks out.

If you sell Company B stock, your gain or loss will be determined by subtracting $11.44 from the sales price.

copyright © 2000 Gail Perry - Fun with Taxes

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