Denim Corporation declares a nontaxable dividend payable in rights to subscribe to common stock. One right and $60 entitle the holder to subscribe to one share of stock. One right is issued for every two shares of stock owned. At the date of distribution of the rights, the market value of the stock is $110 per share and the market value of the rights is $55 per right. Lauren owns 300 shares of stock that she purchased two years ago for $9,000. Lauren receives 150 rights, of which she exercises 105 to purchase 105 additional shares. She sells the remaining 45 rights for $2,475. What are the tax consequences of this transaction to Lauren

Since the fair market value of the rights is 15% or more of the value of the old stock, Lauren must allocate her basis in the stock between the stock and the stock rights. Lauren allocates basis as follows:

Fair market value of stock: 300 shares x $110 =  $33,000

Fair market value of rights: 150 rights x $55 =          8,250

                                                                              $41,250

Basis of stock:  $9,000 x $33,000/$41,250 = $7,200

Basis of rights:  $9,000 x $8,250/$41,250 = $1,800

Basis per right:  $1,800 ÷ 150 rights = $12

There is a capital gain on the sale of the rights of $1,935, computed as follows:

Sales price of 45 rights                             $2,475

Less: Basis of 45 rights (45 x $12)     (540)

Long-term capital gain                            $1,935  

Basis of new stock is $7,560, computed as follows:

105 rights x $12                                                    $1,260

Additional consideration ($60 x 105 shares)    6,300

Basis on newly acquired stock                           $7,560

Holding period of the 105 new shares begins on the date of purchase.