Cost Basis: Stock Dividends and Stock Rights
Stock dividends and stock rights change the number of shares you own without requiring you to spend additional money. The tax treatment focuses on how your existing cost basis gets reallocated across the new total shares.
Think of it this way: Your total investment stays the same; you just slice it into more (or fewer) pieces. The IRS cares about the size of each slice when you eventually sell.
Stock Dividends (Non-Taxable)
A stock dividend distributes additional shares to existing shareholders. The tax treatment:
- A stock dividend is generally not a taxable event
- The total cost basis stays the same - it just gets spread across more shares
- Per-share cost basis decreases because the same total basis covers more shares
Formula: New cost basis per share = original total cost basis / total number of shares (old + new)
Example:
- Investor owns 100 shares purchased at $50/share (total basis: $5,000)
- Company declares a 10% stock dividend (10 additional shares)
- New total: 110 shares, total basis: still $5,000
- New cost basis per share: $5,000 / 110 = $45.45 per share
The holding period of the new shares is the same as the original shares - it tacks on.
Exam Tip: Gotchas
- Stock dividends are NOT taxable income. They reduce per-share basis instead. The total basis stays exactly the same.
Stock Splits
Stock splits follow the same rules as stock dividends for cost basis purposes:
| Split Type | Effect on Shares | Effect on Per-Share Basis |
|---|---|---|
| 2-for-1 split | Shares double | Basis per share is halved |
| 3-for-1 split | Shares triple | Basis per share divided by 3 |
| Reverse split (1-for-2) | Shares halved | Basis per share doubles |
Example: 200 shares at $40/share basis ($8,000 total). After a 2-for-1 split:
- New shares: 400
- New basis per share: $8,000 / 400 = $20/share
- Total basis: still $8,000
Exam Tip: Gotchas
- Reverse splits increase per-share basis (same total basis, fewer shares). A 1-for-2 reverse split doubles your cost per share.
Stock Rights (Non-Taxable)
When a corporation issues stock rights to existing shareholders, the tax treatment depends on the 15% threshold based on fair market value (FMV):
The 15% Rule:
| FMV of Rights vs. FMV of Stock | Basis Allocation |
|---|---|
| Rights FMV is less than 15% of stock FMV | Rights have zero basis (unless investor elects to allocate) |
| Rights FMV is 15% or more of stock FMV | Investor must allocate basis between stock and rights (based on relative FMVs) |
- If the investor elects to allocate basis when not required (below 15%), the election is irrevocable
What happens to the rights:
| Action | Tax Result |
|---|---|
| Rights exercised | Cost basis of new shares = allocated basis of rights + exercise price |
| Rights expire unexercised | Allocated basis (if any) returns to the original shares. No loss recognized |
| Rights sold | Proceeds minus allocated basis = capital gain or loss |
Exam Tip: Gotchas
- Below 15% = optional allocation, at or above 15% = mandatory. The 15% threshold is the dividing line. Below it, rights have zero basis unless the investor elects to allocate. At or above, allocation is required.
- The election to allocate (when optional) is irrevocable. Once made, the investor cannot reverse it.
- Expired rights with allocated basis do NOT generate a loss. The allocated basis returns to the original shares instead.