How to Calculate Adjusted Cost Basis After the KD Spinoff
Learn how to adjust your cost basis after the KD spinoff, ensuring accurate tax reporting and proper allocation of your original investment.
Learn how to adjust your cost basis after the KD spinoff, ensuring accurate tax reporting and proper allocation of your original investment.
When a company undergoes a spinoff, shareholders receive new shares in the spun-off entity while retaining their original holdings. This makes it necessary to determine how to allocate the initial investment between both sets of shares for tax purposes. Getting this right is essential because it affects capital gains calculations when selling any shares.
When a company spins off part of its business, the parent company’s stock price typically drops to reflect the separation. A portion of the company’s assets, revenue, and earnings are now assigned to the new entity. While the total value of your investment remains the same immediately after the spinoff, it is now divided between two stocks.
The stock exchange determines the spun-off company’s opening price based on market demand, while the parent company’s stock price adjusts accordingly. For instance, if a company was trading at $50 per share before the spinoff and the new entity begins trading at $10 per share, the parent company’s stock might open at around $40 per share, assuming no other market factors influence the price.
In the days following the spinoff, stock prices may fluctuate as investors reassess the value of both companies. Some shareholders may sell the new shares if they prefer to hold only the parent company, while others may see the spinoff as an opportunity to invest further.
The tax treatment of spinoff shares depends on whether the distribution qualifies as tax-free under Section 355 of the Internal Revenue Code. If it meets IRS requirements, shareholders do not owe taxes upon receiving the new shares, and their cost basis is split between the parent and spun-off company. If the spinoff is taxable, the fair market value of the distributed shares is treated as a dividend or capital gain, subject to federal and state tax rates.
For a spinoff to be tax-free, the parent company must distribute at least 80% of the new entity’s stock to its shareholders, and the transaction must have a legitimate business purpose beyond tax avoidance. The IRS also evaluates whether the parent retains too much control or if the spinoff is part of a larger plan to sell the new company. If these conditions are not met, the distribution is taxable, and shareholders must report the value of the received shares as income.
If the spinoff is taxable, the cost basis of the new shares is their market value on the distribution date. This means shareholders could owe capital gains tax if the shares appreciate before they are sold. Additionally, if the spinoff includes a cash payment for fractional shares, that payment is treated as a sale and taxed accordingly. Investors should review IRS Form 8937, which companies often release to explain the tax consequences of a spinoff.
After a spinoff, you must determine how to distribute your original cost basis between the parent and the new company. The allocation is based on the relative fair market values of both stocks immediately after the spinoff, typically using their opening prices on the first trading day.
For example, if you originally purchased 100 shares of the parent company for $5,000, giving you a per-share cost basis of $50, and after the spinoff, the parent company trades at $40 per share while the new entity trades at $10 per share, the total combined value per share is still $50. The parent now represents 80% of the total value, and the spun-off company accounts for 20%. Applying these percentages, your new basis would be $40 per share for the parent and $10 per share for the spinoff, maintaining the original $5,000 total.
Brokerage firms often provide adjusted cost basis calculations, but investors should verify these figures against company disclosures or IRS Form 8937. Errors in basis allocation can lead to misreported capital gains and unexpected tax liabilities. If the company issues multiple classes of stock or includes additional distributions, reviewing official documentation is necessary to ensure proper allocation.
Keeping accurate records after a spinoff is necessary for tax compliance and simplifies future transactions. Investors should retain brokerage statements, trade confirmations, and corporate disclosures detailing the distribution. These documents establish the adjusted basis used to calculate capital gains or losses upon selling either security. Without proper documentation, the IRS may require taxpayers to use the default cost basis method, potentially leading to higher taxable gains.
Dividend reinvestment plans (DRIPs) and additional stock purchases further complicate recordkeeping. Each transaction must be recorded separately to track variations in cost basis, especially if shares are acquired at different prices. The IRS requires taxpayers to use either the specific identification method or the first-in, first-out (FIFO) method when selling shares, making it necessary to maintain a detailed log of purchase dates and costs. Using accounting software or a spreadsheet can help organize this information and prevent misreporting.