Effects of dividends and spin-offs on stock.

Example: J's grandfather died in January 1993, leaving each of his grandchildren 100 shares of Sears stock he had acquired two years earlier. J is considering selling this stock to pay for his daughter's first year of college.

J prepares the following list of the stock's relevant information

1. J's grandfather purchased 100 shares of Sears for $30 per share in 1991.

2. J's grandfather died in January 1993; for estate tax purposes, the Sears' stock was valued at $40 per share.

3. Sears spun off Dean Witter to shareholders of record on June 28, 1993; each shareholder received 0.39031 shares of Dean Witter common stock for each share of Sears owned.

4. Sears announced a stock dividend of Allstate Stock to Sears shareholders of record on June 30, 1995; each shareholder received 0.927035 shares of Allstate for each share of Sears owned.

5. Dean Witter announced a 100% stock dividend on Jan. 17, 1997.

6. In June 1997, Dean Witter and Morgan Stanley announced a name change to Morgan Stanley Dean Witter, Discover & Co.

7. J's brokerage statement now includes 78 shares of Morgan Stanley, 100 shares of Sears and 92 shares of Allstate.

The basis of property received from a decedent is normally the fair market value (FMV) at the date of the decedent's death (Sec. 1014(a)). Because J's bequest had appreciated in value from $3,000 at the time of purchase by his grandfather to $4,000 at the time of his grandfather's death, it followed the normal rule; thus, J's basis in the 100 shares of Sears is $4,000. The holding period of property received from a decedent is always long-term, and the actual holding period of either the decedent or the heirs is disregarded (Sec. 1223(11)).

The IRS ruled that Sears' distribution of Dean Witter stock in 1993 qualified as tax-free under Sec. 355, with the Sears shareholders not recognizing gain. However, J's brokerage statement indicated that he had received $1.10 for a partial share. While the cash received by a Sears shareholder in lieu of any fractional share distribution was to be treated as the sale of such fractional share, J had not bothered with this immaterial capital gain or loss on his 1993 return. However, to properly determine gains or losses, it was mandatory to determine the basis for the Dean Witter shares and the fractional shares. J's original Sears stock basis of $4,000 had to be allocated between the Sears stock and the Dean Witter stock based on relative FMVs on the date of the Dean Witter distribution: