Dove Corporation declares a nontaxable dividend payable in rights to subscribe t

Question

Dove Corporation declares a nontaxable dividend payable in rights to subscribe to common stock. Each right entitles the holder to purchase one share of stock for $45. One right is issued for every two shares of stock owned. Ann owns 200 shares of stock in Dove that she purchased three years ago for $7,500. At the time of the distribution of the rights, the market value of the common stock is $50 per share, and the market value of the rights is $5 per right. Ann receives 100 rights. She exercises 50 rights and sells the remaining 50 rights three months later for $5.50 per right.

a. Ann must allocate a part of the basis of her original stock in Dove to the rights.

b. If Ann does not allocate a part of the basis of her original stock to the rights, her basis in the new stock is zero.

c. Sale of the rights produces ordinary income to Ann.

d. Ann is not permitted to allocate a part of the basis of her original stock in Dove to the rights.

e. None of the above is correct.

Explanation / Answer

Answer: D

Because the value of the rights is less than 15% of the value of the stock ($500 ÷ $10000 = 5.%, Ann need not allocate any of the cost of the original stock to the rights. The rights have a zero basis and their sale produces a capital gain of $275 (50 × $5.50), which is long term. Basis of the new shares is $2500 (50 × $50).

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.