Pink 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 $25 . One right is issued for every two shares of stock owned. Jack owns 100 shares of stock in Pink, which he purchased three years ago for $3,000 . At the time of the distribution, the value of the stock is $45 per share and the value
of the rights is $2 per share. Jack receives 50 rights. He exercises 25 rights and sells the remaining 25 rights three months later for $2.50 per right.
a. Jack must allocate a part of the basis of his original stock in Pink to the rights.
b. If Jack does not allocate a part of the basis of his original stock to the rights, his basis in the new stock is zero.
c. Sale of the rights produces ordinary income to Jack of $62.50.
d. If Jack does not allocate a part of the basis of his original stock to the rights, his basis in the new stock is $625.
e. None of the above.
d
RATIONALE: Because the value of the rights is less than 15% of the value of the stock ($100 ÷ $4,500 = 2.22%), Jack 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 $62.50 (25 × $2.50), which is long term. Basis of the new shares is $625 (25 × $25).
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