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Question

The one thing I am still not sure of is with regard to your response:

Now the hard part, basis allocation. The basic concept is exactly the way you put it: you take your original cost basis & allocate it between the original company & the spun-off company. You base this on the values of the parent & spin-off on the date of the spin-off.

Do you not work the allocation based on the original cost instead of the values of the parent and spin-off on the date of the spin-off? If not, I have always done it wrong and also never knew about sending the IRS a letter about the spin-off.

Followup To

Question -

How do you figure outthe new cost basis of stock when you have spinoffs? Do you take your original purchase cost and assign it a percentage the company provides and then assign the remainder of the percentage to the spinoff? Does the spinoff have the same buy date as the buy date of the original stock? I take it this inofrmation is needed at the time you decide to sell in order to figure out your tax basis. I find the whole process totally confusing.

Answer -

Hi Lee-

You’re right, it’s totally confusing! This is a big pain in the neck, it’s one of the things I do for my clients. You should see what a mess old AT&T is, I think shareholders have ended up with something like 20 different spin-offs (and spin offs of spin offs) since 1983.

First the easy one — for figuring holding period, the spun off shares have the same purchase date as your original shares. It’s as if you go back to your original purchase and pretend that the company was divided right from the day you bought the original shares.

Now the hard part, basis allocation. The basic concept is exactly the way you put it: you take your original cost basis & allocate it between the original company & the spun-off company. You base this on the values of the parent & spin-off on the date of the spin-off.

Occasionally you need to figure that out from the newspaper or by calling up the company & pestering them for the info. But in every spin off these days the parent company should produce a document describing the basis allocation in detail. You can usually find even some very old spin-off documents (e.g. for AT&T) on the parent company’s web site under Investor Relations or For Investors or whatever the company calls that part of their site.

The document or web page will say something like Mama Company spun off its Kiddie Corp. subsidiary on X/X/2004. Blah blah blah, so allocate your cost basis as follows:

82.34% Mama Company

17.66% Kiddie Corp.

Also there’s usually a written statement that you’re supposed to sign and mail in with your tax return, that essentially says that the spin-off was a nontaxable event under IRS guidance. I have no idea whether the IRS has ever actually taxed someone for not sending in that letter, but it’s the rule.

Are we done yet? Unfortunately no, if you want to be precise about it. Many times in a spin-off there is cash in lieu given for any fractional shares you would have received. Imagine you hold 75 shares in Mama Co. and you’re entitled to one Kiddie Corp share for every 10 Mama shares held. OK, you would get 7.5 shares in Kiddie, but they never do that. Instead you get 7 shares plus some cash equal to the value of 0.5 shares of Kiddie. This is called CIL, Cash In Lieu of fractional shares.

That cash is technically a sale of those 0.5 shares (!) and so if you’re being precise you might have some tiny sale transaction like $5.68 for 0.5 shares of Kiddie Corp. I include this stuff when I document these things for my clients but I suspect that a lot of people just ignore them, because they’re typically such small amounts. Many brokers don’t record these CILs on their 1099-B reports at end of year.

I hope for your sake that you don’t have a lot of these to track because I think it’s a total pain in the neck! Hope the explanation’s helpful.

Answer

Do you not work the allocation based on the original cost instead of the values of the parent and spin-off on the date of the spin-off? If not, I have always done it wrong and also never knew about sending the IRS a letter about the spin-off.

Hmmm — not sure what you’re asking — maybe an example would help — let’s say you bought stock for $10/share, then some years later the company spun off part of the business and their notice said to allocate 80% to parent & 20% to the spin off, those percentages being based on the values at the time the spin-off happened. The basis after that would be $8 for the parent shares and $2 for the spin-off shares.

RE: the IRS letter. it’s not part of every transaction & now that I think about it you might need an acquisition to be involved for that letter to be required. If you didn’t get notice about it it’s probably not an issue — it’s the kind of thing shareholders are informed about in a mailing.