Cost Basis Allocation in a Spin-Off

When you own shares in a company and it spins off a subsidiary, you end up with shares in both the original company and the new one, but you haven't sold anything and haven't received cash — so there's no new purchase price to record. Tax rules solve this by requiring the original cost basis to be allocated between the two stocks based on their relative fair market values right after the spin-off, rather than treating the new shares as free.

For example, suppose you originally bought parent-company shares for $10,000. On the first day of trading after the spin-off, the parent stock's market value represents 80% of the combined value of parent-plus-spinco, and the new spinco represents the remaining 20%. Your $10,000 basis is then split $8,000 to the parent shares and $2,000 to the spinco shares, each keeping the original purchase date for holding-period purposes. If you later sell the spinco shares for $3,500, your taxable gain is $1,500, not the full $3,500 — the allocated basis, not zero, is what a broker or tax preparer needs.

Companies typically publish the exact allocation ratio in an IRS-compliant tax memo shortly after the spin-off closes; using the wrong ratio, or forgetting to allocate at all, is a common source of overstated capital gains.