Understanding Tax Lots For My Reference

Tax Lots

September 12

2013Understanding the art of selling selectively thereby optimizing Capital Gains and Tax deductions

Domain-Financial Markets

- Author: Bunty Mandhyan (Emp# 457724)- Mail: [email protected]

Table of ContentsWhat are Tax Lots?......................................................................................................................................3

1.) A “Lot”.....................................................................................................................................3

2.) Open Lot..................................................................................................................................3

3.) Closed Lot................................................................................................................................3

4.) Short and Long Term Capital Gains..........................................................................................3

Which Tax Lots should you Sell first?...........................................................................................................4

Cost Basis/Tax Basis................................................................................................................................4

Wash-Sale Rule.......................................................................................................................................4

Cost Basis/Tax Basis Example.................................................................................................................5

Different Cost Basis Methods..................................................................................................................5

1.) What is FIFO cost basis method?.............................................................................................6

2.) What is LIFO cost basis method?.............................................................................................6

3.) What is Specific Share cost basis method?..............................................................................6

4.) What is Average Cost – Cost basis method?............................................................................6

5.) Example of How Cost Basis is calculated..................................................................................7

Corporate Actions and Its impact on Cost Basis Calculations................................................................8

1.) Capital Gains Distributions.......................................................................................................8

2.) Dividends.................................................................................................................................8

3.) Stock Splits.............................................................................................................................11

4.) Rights Issues...........................................................................................................................14

5.) Spin offs and Mergers and Acquisitions.................................................................................15

What are the pointers for Tax Minimization?............................................................................................20

References.................................................................................................................................................21

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What are Tax Lots?

Concept for Tax Lots is used when you are selling shares. You can specify which “lot” of share you would want to sell. This is important from Capital Gains Tax point of view. Selecting appropriate “lot” will help one maximize Capital Gain and minimize Tax deduction.

1.) A “Lot”: A “Lot” is basically a group of shares of a particular company purchased on some Trading date in past. In other words, a “Lot” for a client “C” is basically “N” number of shares of symbol “S” purchased at price/Average Price “P” on Trading Date “T”.

Tax Lots concept is based on different Tax rates on Short Term Capital Gain and Long Term Capital Gain.

A tax lot (commonly referred to as a "lot") is basically a group of shares that are purchased (or sold) together and have the same attributes for tax reporting purposes.

2.) Open Lot: A “lot” that is currently held in your account. For example, shares that have been purchased, but not yet sold would be considered "open". All of the shares of an open lot have the same acquisition date, cost per share and holding period.

3.) Closed Lot: A “lot” that is no longer held in your account. For example, shares that have been purchased and sold would be considered "closed". All of the shares of a closed lot have the same acquisition date, cost per share, closing transaction date, closing price per share and holding period.

4.) Short and Long Term Capital Gains:

Note: In 2011, the (USA) federal income tax rates slots were 10%, 15%, 25%, 28%, 33% and 35%.

Stocks, Bonds, Mutual Funds Tax Bracket of 10% or 15% Tax Bracket of 25% or Higher

Dividends 0% 15%

Short-Term Capital Gains Ordinary tax bracket ordinary tax bracket

Long-Term Capital Gains 0% 15%

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Which Tax Lots should you Sell first?

Determining which Tax Lot to sell first depends largely on Cost Basis aka Tax basis of that Lot.

Cost Basis/Tax Basis

It is equal to the difference between the asset's cost price and the current market value at the time of selling it.

This value is used to determine the capital gain. Your choice of cost basis method can have a significant effect on the computation of capital gains and losses when you sell shares.

Using the correct tax basis is important especially if you reinvested dividends and capital gains distributions instead of taking the earnings in cash. Reinvesting distributions increases the tax basis of your investment, which you must account for in order to report a lower capital gain (and therefore pay less tax). If you don't use the higher tax basis, you could end up paying taxes twice on the reinvested distributions.

Accounting for cost basis reveals the true returns of investments, as high commissions or fees, either from high fee structures or frequent trading, reduce the net returns of any investment.

Wash-Sale Rule

Beware of Wash-Sale rule while computing Cost Basis.

It is an Internal Revenue Service (IRS) rule that prohibits a taxpayer from claiming a loss on the sale or trade of a security.

The rule defines a wash-sale as the sale that occurs when an individual sells or trades a security at a loss and within 30 days before or after this sale, buys a “substantially identical” stock or security, or acquires a contract or option to do so. A wash sale also results if an individual sells a security, and the spouse or a company controlled by the individual buys a substantially equivalent security.

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If the loss is disallowed by the IRS because of the wash sale rule, the taxpayer has to add the loss to the cost of the new stock, which becomes the cost basis for the new stock. For example, consider the case of an investor who purchased 100 shares of Microsoft for $33, sold the shares at $30, and within 30 days bought 100 shares at $32. In this case, while the loss of $300 would be disallowed by the IRS because of the wash sale rule, it can be added to the $3,200 cost of the new purchase. The new cost basis therefore becomes $3,500 for the 100 shares that were purchased the second time, or $35 per share.

Cost Basis/Tax Basis Example

Say you bought 100 shares of a stock for $1,000 last year and you reinvested the $100 of dividends distributed from the company.

The next year, you received $200 in dividends PLUS capital-gains distributions, which you again reinvested.

Since tax law considers these reinvested earnings as paid to you even though you didn't actually have the cash in hand, your adjusted cost basis when the stock is sold should be recorded at $1,300 instead of the original purchase price of $1,000.

Thus, if the sale price is $1,500, the taxable gain would only be $200 ($1,500 - $1,300) instead of $500 ($1,500 - $1,000). If you record the cost basis as $1,000, you'll end up paying more taxes than you have to.

What does the statement – A Security trading at “X” basis means?

If particular commodity say – corn’s futures contract happens to be trading at $3.50, while the current market price of the commodity today is $3.10, there is said to be a $0.40 basis.

Different Cost Basis Methods

For mutual fund shares, there are three common ways to identify the cost basis of the shares that you are selling: FIFO (first-in, first-out), average-cost method and specific-share method.

For stocks, you could use FIFO, LIFO (last-in, first out) or specific shares.

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Note:

All Cost Basis methods must be approved by Internal Revenue Service. You cannot device your own cost basis methodology. You can only use one amongst the existing approved methods.

1.) What is FIFO cost basis method?

FIFO stands for “First In First Out”. Lots with the earliest acquisition date are sold first.

2.) What is LIFO cost basis method?

LIFO stands for “Last In First Out”. Lots with the latest acquisition date are sold first.

3.) What is Specific Share cost basis method?

As the name suggest, this method gives you the most control over the gains and losses you realize by allowing you to select the specific shares you'd like to sell each time you place an order to close a position

4.) What is Average Cost – Cost basis method?

Average Cost – As the name suggests, it calculates the Average Price by dividing the Total Cost by Total number of Shares. Cost basis method is used for Mutual Funds and not for directly-held stocks or bonds. Mutual fund companies select which method they want to use and not the holder of a mutual Fund.

There are two types of Average Price Cost Basis Methods:

Average Cost — Single Category (ACSC) Average Cost — Double Category (ACDC)

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4.A. Average Cost — Single Category (ACSC):

To apply this method, every time you have a dividend reinvestment, you just add the dividend dollar amount to your cumulative cost total and add the number of shares reinvested to your cumulative total shares. Divide the cumulative cost by the cumulative shares for your new average cost per share.

If you sell any shares, subtract the number of shares sold from your cumulative share total and subtract the product of the average cost times the number of shares sold from the cumulative cost total.

As you can see, this method simplifies the accounting a “lot” by putting all the costs in one bucket. However, you still have to identify the holding period of the shares that were sold. This method employs selling of long-term shares first just like FIFO.

So basically here Cost basis is calculated based on the average price paid for all shares held, regardless of holding period. Gains or losses are defined as short-term or long-term based on the assumption that the oldest shares are sold first, even though the average cost is the same for all shares.

4.B. Average Cost — Double Category (ACDC)

With ACDC, the cost basis is calculated based on how long the shares were held. Cost basis is calculated on two average cost figures based on the holding period: one for short-term shares owned less than one year, and one for long-term shares owned more than one year. So basically there will be one “Lot” for shares held over a year (long-term shares) and another total for shares held under 12 months (short-term shares) unlike ACSC where in there is just one lot and one single Average Price.

5.) Example of How Cost Basis is calculated:

Suppose over a two-year period, you made the following purchases of XYZ stock (you are in the

28% tax bracket):

Tax Lot # Cost Per Share Shares Purchased Current Price Per Shares Gain

1 $50 800 two years ago $75 $25

2 $58 500 nine months ago $75 $17

3 $70 400 six months ago $75 $5

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Now, suppose that you need to sell 800 shares of XYZ and you want to minimize your tax consequence:

Under the FIFO Method Tax Result Taxes Due

Sell 800 shares of tax lot #1

long-term gain of $20,000 (800 shares x $25 gain) $3,000 ($20,000 x 15%)

Assume that your Income Tax bracket is 28%.

User Specific-Shares Method Tax Result Taxes Due

Sell 400 shares of tax lot #3 short-term gain of $2,000 $560 ($2,000 x 28%)

Sell 400 shares of tax lot #1 long-term gain of $10,000 $1,500 ($10,000 x 15%)

Total $2,060

Under the FIFO method, you would sell the first 800 shares that you purchased two years ago, resulting

in a long-term gain of $20,000, with a tax bill of $3,000. On the other hand, if you choose to sell a

specific tax lot instead, you can sell your most expensive shares first (even though they are short term)

and still have a lower tax bill of $2,060.

Corporate Actions and Its impact on Cost Basis Calculations

1.) Capital Gains Distributions: The payment of proceeds prompted by a fund manager's liquidation of underlying stocks and securities in a mutual fund is called Capital gains distribution. In other words, Capital gains distribution occurs when a mutual fund manager liquidates underlying positions that have made gains since they were added to the fund. Capital gains distributions will be taxed as capital gains to the person receiving the distribution just like Cash Dividend that is not reinvested.

2.) Dividends: A dividend is the payment of a portion of a company's profits to its shareholders.

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The dividend can be paid out as cash -- either sent directly to the shareholder or deposited in the shareholder's brokerage account -- or it can be reinvested into the company through the purchase of additional shares.

A dividend can also take the form of additional shares in the company (a stock dividend) which, from the investor's point of view, acts as a stock-split. From the investor's point of view, there is not much difference between a stock split and a stock dividend. In both cases, you end up with more shares that are, individually, worth less (but the total dollar value remains unchanged).

In any event, if the shares are held in a taxable account, the shareholder owes income taxes on the amount received, though the amount depends on whether the dividend is a qualified dividend or not.

Dividends do not lower the cost basis of an investment, either when received in cash or when used to purchase new shares. A stock dividend, however, does adjust cost basis.

2.A.) Cash dividends:

For U.S. taxpayers, according to the IRS, cash dividends do not reduce the basis of a stock purchase. But Cash Dividends are Taxable as per Federal Income/Capital Tax Rules.

For instance, if your company pays an annual dividend of $0.40 and you bought at $30, you do not get to reduce your basis to $29.60.

If you are reinvesting the dividends in a taxable account, then each reinvestment is treated as a new purchase with its own basis.

Here is an example: You buy 100 shares of $20 stock with a commission of $10. Your basis is 100 x $20 + $10 = $2,010. The stock pays a single annual dividend of 5% (the yield when you bought it, or $1 per share). Dividend time rolls around and you receive $100 for the 100 shares, of which you owe Uncle Sam $15, assuming a 15% tax rate. That $100 is reinvested into more shares, but now the price is $25, so it buys 4 shares.

Your basis is NOT $2,110 for 104 shares ($20.2885 / share). (For why not, see below.) You can't use an average basis, even if the original and reinvested prices were identical, because you didn't take commissions into account (which are added to your basis when you buy). Instead your basis is as follows:

Lot1: 100 shares, $2,010 ($20.10 / share)

Lot2: 4 shares, $100 ($25 / share)

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In other words, each purchase has its own basis and this must be tracked. The IRS does not allow basis of shares of stock to be calculated using an average basis. Mutual funds, yes but for Stocks, no.

Now, it comes time to sell the shares you will sell 2 lots:

LOT1: 100 shares will attract long term capital gain

LOT2: 4 shares will attract say short term capital gain if it sold in less than or equal to one year.

2.B.) Stock Dividend:

Suppose you buy 37 shares of a company at $45. Your broker charges you $7.99 in commissions to handle that transaction for you. What is your total cost, or basis?

37 x $45 + $7.99 = $1,672.99. This works out to be $45.216 per share.

For a split (like 3:2 or 2:1 or 3:1), you increase the number of shares by the split factor, which necessarily reduces the per share cost basis. Suppose that stock you purchased above splits 3:1. Your new basis would be $1,672.99 / 111 shares = $15.072 per share, now. (But your total basis, $1,672.99, remains the same.)

In this situation, your basis is adjusted downward depending on the amount of new stock received and the original basis of the stock originally owned. For instance, for a 20% stock dividend, if you had 2 LOTS say LOT1: 100 shares at $30 and LOT2: 200 shares at $40, your new basis for both these LOTS would be – LOT1: $25 for 120 shares ($3,000/120) and LOT2: $33.33 for 240 shares ($8,000/240).

Unless you receive cash in lieu of fractional shares of stock, neither stock splits nor stock dividends are taxable events to you until you sell the stock. However, you do need to keep track of the new basis for your shares

2.C.) Return of capital

At times, especially for large one-time dividends, part of the cash paid to the shareholder is a "dividend" and part is "return of capital." The former is treated as a cash dividend and is taxable in the year in which it is paid.

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The return of capital, on the other hand, is not taxable. Instead, it actually lowers the basis of your shares. This is the only part of a "dividend" that does this.

For instance, if you own 100 shares at a basis of $2,010, as noted above, and the company pays a $5 dividend which includes $2 of return of capital, the basis for those shares will be reduced by $200 ($2 x 100 shares) to $1,810.

However, the IRS is not giving up on its taxes. It will get its cut when it comes time to sell the shares by increasing the total capital gain. To illustrate, suppose you sell those 100 shares at $25 each with a $10 commission. Net Capital Gain would be $2,490.

Without the return of capital, the gain would be $2,490 - $2,010 = $480.

With the return of capital, the gain would be $2,490 - $1,810 = $680 (there's that $200 that you got returned showing up as an increase in the capital gain realized).

If the return of capital actually reduces the basis to below $0, then the basis becomes $0 and the difference is immediately taxable. For instance, if the basis for those 100 shares is $150, then the $200 return of capital would reduce the basis to $0 and $50 would be taxable that year.

3.) Stock Splits:

From Shareholders perspective, Stock Split and Dividend as Stock has exactly the same impact on Tax implications.

Form Company’s perspective, in a true stock split, the company technically calls in all of its outstanding shares and issues new shares totaling more than it called in. For instance, if there are 1 million shares outstanding and the company declares a 3-for-2 stock split (3 Share for every 2 shares you own i.e. every 2 shares you own would become 3 shares), it calls in all 1 million shares and then issues 1.5 million(1 million * 3/2). The effect to the stock's par value (Stock Par Value is the carrying value of each share of stock found on the balance sheet) is to change it by the inverse of the split ratio. For this example, the par value would be 67% of the original par value. The total amount of dollars in the par value account remains unchanged.

I have explained the “Even LOT” logic in Stock Dividends. Same logic applies here too for “Even LOT” in Stock Split.

Let’s consider a Stock Split example resulting in Fractional Shares and how it impacts our Cost Basis.


Fractional Shares result in “Odd Lots”.

What are Odd Lots and Even Lots?

When the number of shares in a LOT is a fractional number then that LOT is termed as an ODD LOT. A LOT with whole number of shares in it is termed as an EVEN LOT.

But, Shares cannot be a fractional number like say 1.5 shares. So the fractional shares, say produced in a Stock Split process, are sold by the company and proceeds are thereby transferred to the share holder as Capital gain. Irrespective of Odd or Even Lots that resulted from a stock split Cost Basis per share and Tax calculations would get impacted.

Example of a Stock Split resulting in ODD LOT :

You own 55 shares of ABC Corp. stock. You bought these shares two years ago for $125 per share.

You also paid $20 in commission for the purchase, which would make your total cost basis in these shares $6,895.00 (55 shares X $125 per share, plus $20).

This year, the Board of Directors of ABC Corp. decided to declare a 3-for-2(3 Share for every 2 shares you own) stock dividend. The board declared that each shareholder would receive 0.5 new shares of ABC stock for every share currently owned.

Since you own 55 shares of stock currently, how many shares will you own after the split?

The math works like this: Take your 55 shares * 0.5 = 27.5. Add those 27.5 shares to your original 55 shares, and you now have 82.5 shares of ABC.

New Net Cost Basis Calculations:

Same as Stock Dividend example, you simply take your original cost basis and divide it by the total number of shares you now have (both new and old) to arrive at your new "per-share" cost basis.

But wait, we have a fractional share of 0.5 in 82.5 that you own.

Remember that companies will not issue fractions of shares (dividend reinvestment plans and Mutual Funds being the exception to the rule). Instead, the company will purchase that fractional share from you at the Fair Market Value (FMV) of the stock on the date your new shares are issued.


Fair Market Value (FMV):

By Definition: The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.

For Publicly Traded Stock: On Transaction day, the fair market value is calculated as the Average of high and the low price for the day for that stock. If there is no trading that day, averages from just before and just after the target day are used instead.

At the end of the year, the company will send you IRS Form 1099B, which will report this sale to Uncle Sammy and to you.

So let's now assume that the ABC Corp. issued you an additional 27 whole shares, sold off your fractional share at FMV of say $90 per share, and sent you a check for $45.00 (proceeds from selling the half share).

You now have the "sale" end of the Stock Split transaction accounted for, but what is your cost basis in this half share?

The theory is the same as we discussed above – simply spread your entire original cost basis over all of your shares (including the fractional shares too). Since your original cost basis is $6,985.00, and after the split you had a total of 82.5 shares, your cost basis per share is $84.67 (total cost basis of $6,985.00 divided by 82.5 shares).

So, your new per-share cost basis is $84.67. So, your half-a-share will have a cost basis of $42.33.

So what is my Capital Gain for the Fractional Share Sell Trade?

You received your check from the ABC Company for $45.00, representing the sale of the fractional share.

Your cost basis for that half share would be $42.33.

Hence, your gain on the sale would be $2.67 ($45.00 minus $42.33).


But, remember that your holding period for this share reaches all the way back to your original purchase date (Which was 2 years back). Hence, your capital gain here even for this fractional share qualifies it as a long-term capital gain on this fractional share sale.

So, let's double-check our math and see where we stand with our remaining shares. We now have 82 total shares. The total cost basis for those shares is $6,942.67 (original cost basis of $6,985.00 minus the cost basis for the fractional share that was sold i.e. $42.33). Just like before, calculate the per-share cost by dividing your total cost basis (now $6942.67) by your total number of shares (now 82), and you arrive at a per-share basis of $84.67. Since this is exactly the same amount we arrived at when we completed the first computation. This confirms that your math was done correctly.

Always remember, Fractional Shares are always purchased back from you by the company issuing them. You will never hold Fractional Shares. But Fractional Shares must be accounted for when calculating your Cost Basis and while filling your Tax Returns.

NOTE: Following Topics on “Right Issues” and “Spin offs and Mergers and Acquisitions” are fairly complicated. Below are just brief insights on them. Yet, attempt has been made to deliver an introduction to these profound areas.

4.) Rights Issues:

A rights issue is an issue of rights to buy additional securities in a company made to the company's existing security holders. When the rights are for equity securities, such as shares, in a public company, it is a way to raise capital under a seasoned equity offering. Rights issues are sometimes carried out as a shelf offering. With the issued rights, existing security-holders have the privilege to buy a specified number of new securities from the firm at a specified price within a specified time. In a public company, a rights issue is a form of public offering (different from most other types of public offering, where shares are issued to the general public).

Rights issues may be particularly useful for closed-end companies, which cannot retain earnings, because they distribute essentially all of their realized income and capital gains each year; therefore,


they raise additional capital through rights offerings. As equity issues are generally preferable to debt issues from the company's viewpoint, companies usually opt for a rights issue when they have problems raising equity capital from the general public and choose to ask their existing shareholders to buy more shares

Example:

Mr. A had 100 shares of company X at a total investment of $40,000, assuming that he purchased the shares at $400 per share and that the stock price did not change between the purchase date and the date at which the rights were issued.

Assuming a 1:1 subscription rights issue at an offer price of $200, Mr. A will be notified by a broker dealer that he has the option to subscribe for an additional 100 shares of common stock of the company at the offer price.

Now, if he exercises his option, he would have to pay an additional $20,000 (100 * 200) in order to acquire the shares, thus effectively bringing his average cost of acquisition for the 200 shares to $300 per share ((40,000+20,000)/200=300). Although the price on the stock markets should reflect a new price of $300 (see below), the investor is actually not making any profit nor any loss.

In many cases, the stock purchase right (which acts as an option) can be traded at an exchange.

5.) Spin offs and Mergers and Acquisitions:

5.A.) Spin-Offs: It is the creation of an independent company through the sale or distribution of new

shares of an existing business/division of a parent company. A spinoff is a type of divestiture. Businesses

wishing to “streamline” their operations often sell less productive or unrelated subsidiary businesses as

spinoffs. The spun-off companies are expected to be worth more as independent entities than as parts

of a larger business.

Determining Cost Basis for Spin-Offs:

Consider a Parent Company “Parent” spin-off into two public listed companies say - “Parent”

and “Child”.


The first step is to figure out how much of what you paid for original single entity “Parent” is attributed

to “Parent” and how much to “Child”.

There are many methods to do this and no single standard. One method is to take the closing share

prices of each stock and come up with an allocation.

Say “Parent” closed at $22.20 on the first trading day after “Child” was split off. That same trade day,

“Child” closed at $50.58. The value of the two stocks together was $72.78.

That means that “Parent” shares account for 30.5% of your cost basis, since $22.20 divided by $72.78 is

30.5%. Similarly, “Child” shares accounts for 69.5% of the cost basis, or $50.58 divided by $72.78.

Next, you need to know your original cost basis in single entity “Parent”. Let's say you bought 100 shares

of single entity “Parent” for $70 a share before the spinoff. To figure your cost basis in “Parent” after the

spinoff, multiply $70 by the allocation factor of 30.5%, or $21.35 a share. To figure your cost basis in

“Child”, multiply your original Altria cost basis of $70 by the allocation factor of 69.5%, or $48.65.

5.B.) Mergers: The combining of two or more companies, generally by offering the stockholders of

one company securities in the acquiring company in exchange for the surrender of their stock. It is

basically when two companies become one. This decision is usually mutual between both firms

5.C.) Acquisitions: A corporate action in which a company buys most, if not all, of the target

company's ownership stakes in order to assume control of the target firm. Acquisitions are often made

as part of a company's growth strategy whereby it is more beneficial to take over an existing firm's

operations and niche compared to expanding on its own. Acquisitions are often paid in cash, the

acquiring company's stock or a combination of both

Acquisitions can be either friendly or hostile. Friendly acquisitions occur when the target firm

expresses its agreement to be acquired, whereas hostile acquisitions don't have the same agreement

from the target firm and the acquiring firm needs to actively purchase large stakes of the target

company in order to have a majority stake.


In either case, the acquiring company often offers a premium on the market price of the target

company's shares in order to entice shareholders to sell. For example, News Corp.'s bid to acquire Dow

Jones was equal to a 65% premium over the stock's market price.

5.D.) Example On Mergers:

Say in a Merger where you received stock in a new company plus some cash. The cash part is called

"cash to boot".

There are many ways in which a merger can be taxed. One way is by Normal "cash to boot" rules

Normal "cash to boot" rules :

The usual "cash to boot" rule is that you only recognize gain on cash and stock mergers to the extent of

the "boot" that you received, so that you don't have to pay capital gains tax on non-cash income

First we calculate the Total Economic Value (also called "consideration") received:

You bought 100 shares of Company “C” for $24.00

So total Cost Basis is $2,400.00

Company “C” was bought by Company “A” for .501 shares of “A” plus $22.00 cash to boot PER SHARE of

“C”.

The closing market value of “A” was $72.51 per share on the last trading day prior to the merger.

What is your cost basis for stocks of “A”?

100 shares of “C” receive .501 shares of “A” per share.

This means a total of 50.1 shares of “A”. Since the last market value of “A” was $72.51 per share, this

represents economic value of $3632.751 for the stock portion.


You also received $22.00 cash to boot on 100 shares. So, total cash portion of $2,200.00.

Therefore, the Total Economic Value you received for both cash and stock was $5832.751 ($3632.751 +

$2,200.00).

Your Total True Economic Gain is $3432.751 (Total Economic Value received of $5832.751 less the

original cost of your shares of “C”, $2,400.00).

However, you only received $2,200.00 of your gain in cash, so you only report capital gains on your tax

return of $2,200.00 for this transaction.

What do you do with the rest of your gain, the $1232.751 difference between the True Economic Gain

of $3432.751 and the $2,200.00 taxable capital gain?

You subtract it from the market value of your new shares of “A”, for a cost basis of $2,400.00

($3632.751 less $1232.751).

Your cost basis for 50.1 shares of “A” is $2,400.00.

However, the 0.1 fractional shares are not issued by “A” but are instead paid to you as $7.251 "Cash in

Lieu" of fractional shares (.1 times $72.51).

You account for these as follows:

Cost Basis for 0.1 Share = 0.1 * 2,400.00 / 50.1 = $4.79

Capital Gain on sale of 0.1 fractional Share is = $7.251 cash in lieu received less $4.79 cost = $2.461

Your cost basis for the 50 remaining shares of “A” is $2395.21 ($2,400.00 less $4.79 which was cost of

the fractional shares sold.)


Note that the IRS regulations do not specify a required method to determine the market value of the

new shares received. You can use the market value of the opening, average, or closing price on the day

before the merger or the day of the merger. Some taxpayers even use the "volume weighted average

price."

In all of the above cases (Spin-offs and Mergers and Acquisitions), instructions to calculate Cost Basis in

these scenarios are not standardized by IRS. However, you'll get them from the companies involved in

the spin-off, split-up, or purchase and no other place. When these transactions take place, the legal and

accounting folks get together and create a formula that you must follow to allocate your basis in the old

and new shares. The only way you can correctly allocate your stock basis is to follow the formula issued

by the company.


What are the pointers for Tax Minimization?

1. Track securities by tax lot. If you keep accurate accounting (cost basis info) of all your

purchases, you can sell your highest cost positions first as seen in the example above.

2. Avoid short-term gains. In many cases, it's best to sell your long-term positions first, however;

check your tax lots - it sometimes makes sense to sell the newer position for a lower capital

gain.

3. Avoid high-turnover funds and stocks. High turnover in your portfolio will generate

commissions, transaction costs and higher tax liabilities. If you're going to do a lot of trading,

make sure that every buy and sell decision is worth it from a tax perspective.

4. Sell your losers. Harvest your losses on your positions to use the loss to offset gains; don't be

afraid to generate losses that carry forward for future years.

The Bottom Line:

As you have seen, there are many different methods of determining your gain or loss on the sale of a

particular security. Although first-in, first-out might be the easiest method to calculate and track, it

might not always be the most tax advantageous. If you do take advantage of the specific-shares method,

make sure you receive a written confirmation from your broker or custodian acknowledging your selling

instructions. You must determine the method that works best for you and stick with it


References

Websites:

http://en.wikipedia.org/ and www.google.com/http://www.investopedia.com/http://www.costbasis.com/http://www.smartinmoney.com/http://www.fool.com/http://wiki.fool.com/

Detailed Reference Sites for Individual Topics:

http://en.wikipedia.org/wiki/Corporate_actionhttp://en.wikipedia.org/wiki/Cost_basishttp://en.wikipedia.org/wiki/Rights_issuehttp://www.investopedia.com/articles/03/081303.asphttp://www.investopedia.com/articles/investing/062713/investing-stock-rights-and-warrants.asphttp://www.investopedia.com/ask/answers/06/mutualfundcostbasis.asphttp://www.investopedia.com/terms/a/averagecostbasismethod.asphttp://www.investopedia.com/terms/s/short-term-gain.asphttp://www.costbasis.com/mutualfds/averagecostsingle.htmlhttp://www.costbasis.com/stkchanges/cashtoboot.htmlhttp://www.costbasis.com/stkchanges/stockrights.htmlhttp://www.costbasis.com/stocks/cashtoboot.htmlhttp://www.smartinmoney.com/securities/understanding-cost-basishttp://wiki.fool.com/Dividendhttp://wiki.fool.com/How_Is_the_Fair_Market_Value_of_Stock_Determined%3Fhttp://www.fool.com/personal-finance/taxes/how-to-calculate-a-holding-period.aspxhttp://www.fool.com/school/taxes/1999/taxes990319.htmhttp://www.fool.com/school/taxes/1999/taxes990319.htmhttp://budgeting.thenest.com/can-use-average-cost-basis-selling-stocks-26196.htmlhttps://scs.fidelity.com/webxpress/help/topics/learn_account_cost_basis.shtmlhttps://us.etrade.com/e/t/estation/help?id=1930000000#what9


Author: Bunty Mandhyan (Emp# 457724)

Mail: [email protected]; [email protected]

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