How Are Proceeds From Sale of Stock Rights Taxed?

When a company issues stock rights, it grants existing shareholders the opportunity to purchase additional shares of stock, often at a price below the current market value. A shareholder who receives these rights has three choices: sell them to another investor, exercise them to buy the new stock, or let them expire unused. The tax treatment of these rights depends on which path the shareholder chooses, and this article focuses on the tax implications that arise when a shareholder sells their stock rights.

Determining the Tax Basis of Stock Rights

The first step in determining the tax consequences is to establish the cost basis of the stock rights. In many cases, the basis is zero. This occurs if the fair market value (FMV) of the rights is less than 15% of the stock’s FMV on the distribution date, a guideline known as the “15% rule.” When this rule applies, the basis is automatically $0, and the entire amount received from a subsequent sale is treated as a capital gain.

A shareholder has the option to make an election even if the 15% rule applies. They can choose to allocate a portion of the basis from their original stock to the newly received rights. This election requires the shareholder to attach a formal statement to their tax return for the year the rights were received, and this choice becomes permanent once made.

If the fair market value of the rights is 15% or more of the stock’s value, the shareholder must allocate basis. The basis of the rights is found by multiplying the original stock’s basis by a fraction: the FMV of the rights divided by the combined FMV of the rights and the stock. For example, if stock with a basis of $1,000 has an FMV of $1,800 and the rights have an FMV of $200, the allocated basis to the rights would be $100.

Calculating and Reporting the Gain or Loss

The taxable gain or loss from a sale is the difference between the total proceeds received and the tax basis of the rights. If the basis was determined to be zero, the entire sale proceeds constitute a capital gain. If basis was allocated, that amount is subtracted from the proceeds to find the gain or loss.

The character of the gain or loss depends on the holding period of the original stock. The holding period for the stock rights is considered to have begun on the same day the shareholder acquired the underlying stock. If the original stock was held for more than one year before the rights were sold, the gain or loss is long-term. If held for one year or less, the gain is short-term.

This transaction must be reported to the IRS on Form 8949, Sales and Other Dispositions of Capital Assets. The taxpayer will need to provide a description of the property, the date the original stock was acquired, and the date the rights were sold. The form also requires the sales proceeds and the cost basis, and the totals are then carried over to Schedule D (Capital Gains and Losses).

Tax Consequences of Other Outcomes

If a shareholder exercises the rights to purchase new stock, the action itself is not a taxable event and no gain or loss is recognized. The tax basis of the newly acquired stock is the sum of the subscription price paid and the basis of the rights that were exercised. This basis could be zero or the amount that was allocated from the original stock.

The holding period for the new shares acquired through exercising rights begins on the date the rights are exercised. This is a separate holding period from the original stock. This new period will determine whether a future sale of these shares results in a short-term or long-term capital gain or loss.

If the rights are neither sold nor exercised, they will eventually expire. If a basis was allocated to the rights, the shareholder can recognize a capital loss equal to that basis for the tax year in which the rights expire. However, if the basis of the rights was zero, no loss can be claimed as there is no basis to recover.