Quick Answer
A spinoff distributes shares of a subsidiary to existing shareholders as a dividend, at no cost to them. The shareholder's original cost basis splits between parent and subsidiary based on their relative fair market values right after the distribution, and the parent's holding period tacks on to the new shares. It is not free stock; it is a reallocation of basis already paid.
Now that you understand shareholder rights, including dividends, you can see how corporations sometimes distribute entire business units to shareholders through this specific type of distribution.
What Is a Spinoff?
- A spinoff occurs when a corporation distributes shares of a subsidiary to its existing shareholders as a dividend
- Shareholders receive shares in the new company at no cost: there is no cash outlay
- After the spinoff, the shareholder owns stock in two separate companies instead of one
- The original company's stock price typically adjusts downward to reflect the value of the spun-off entity
Why companies spin off divisions:
- Unlock hidden value in a subsidiary
- Allow each business to focus on its core operations
- Improve market valuation by eliminating conglomerate discount
How Is Cost Basis Allocated Between the Two Companies?
When a shareholder receives spinoff shares, their original cost basis in the parent company is split between the two companies.
The rule: Cost basis is allocated based on relative fair market values (FMV) immediately after the distribution.
Example:
- You own 100 shares of Parent Corp with a cost basis of $10,000
- Parent spins off Subsidiary Corp
- After the spinoff: Parent trades at $70/share (FMV = $7,000), Subsidiary trades at $30/share (FMV = $3,000)
- Relative FMV: Parent = 70%, Subsidiary = 30%
| Company | FMV | % of Total | Allocated Basis |
|---|---|---|---|
| Parent Corp | $7,000 | 70% | $7,000 |
| Subsidiary Corp | $3,000 | 30% | $3,000 |
| Total | $10,000 | 100% | $10,000 |
Your total basis stays the same ($10,000); it's just divided between two holdings.
Exam Tip: Gotchas
In a spinoff, the shareholder's original cost basis is SPLIT between the two companies based on relative fair market values. A shareholder does NOT get a "free" zero-cost-basis stock. The basis from the parent is reallocated proportionally.
What Makes a Spinoff Tax-Free?
- Tax-free spinoffs qualify under the Internal Revenue Code (IRC) tax-free spinoff provision; shareholders recognize no gain or loss at the time of distribution
- The holding period of the spinoff shares includes (tacks onto) the holding period of the original parent shares
- This means if you held the parent stock for 2 years before the spinoff, the subsidiary shares also have a 2-year holding period from day one
Requirements for tax-free treatment:
- The parent must distribute at least 80% of the subsidiary's stock
- Both the parent and subsidiary must be engaged in an active trade or business for at least 5 years prior
- The spinoff cannot be used primarily as a device for distributing earnings
Exam Tip: Gotchas
- The holding period of the parent TACKS ON to the spinoff shares. If you held the parent for 2 years, the subsidiary shares are also long-term from day one.
- No gain or loss is recognized at the time of a qualifying tax-free spinoff. Tax consequences are deferred until the shares are eventually sold.
What Should You Check on Exam Day?
- A spinoff splits the original cost basis by relative fair market value; it does not create a zero-cost-basis holding.
- The parent's holding period tacks on to the subsidiary shares from day one.
- Qualifying for tax-free treatment requires distributing at least 80% of the subsidiary, an active trade or business on both sides for at least five years, and a purpose other than distributing earnings.