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What is non-taxable stock rights?

Asked Nov 19, 2011, 08:01 PM — 3 Answers
Hi, could any experts please help explain to me what is meant by the term "non-taxable stock rights"? If it is non-taxable, then when is it taxable? And what is it used for? Or if you please give some examples. I'm taking this advanced accounting class, and I'm having trouble grasping it in this chapter.

I've gooled it but I'm quite at a lost. I still don't understand it even after reading about it at http://www.costbasis.com/stockchanges/stockrights.html.

I would very much appreciate all the help that is offered.

Thank You.

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ebaines's Avatar
ebaines Posts: 10,033, Reputation: 5529
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#2

Nov 28, 2011, 10:22 AM
It's a non-taxable event when the stock is distributed, but it serves to dilute the cost basis of the shares you already own. Hence when you sell the shares you use a lower cost basis and consequently pay more in capital gains.

Example: you buy 100 shares of company stock at $10/share, for a total cost of $1000. Then the company declares a 5% stock dividend, which is a tax-free stock right. You now have an additional 5 shares, for a total of 105 shares. The new cost basis of each share is $1000/105 = $9.52. Later when you sell these shares if the stock still sells at $10/share you will have to report a gain. So in effect the stock dividend ultimately gets taxed at capital gains rates rather than cash dividend rates.
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sos07's Avatar
sos07 Posts: 14, Reputation: 1
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#3

Jun 27, 2012, 11:27 PM
Thank You, ebaines. That was a good example. I understand now.
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ebaines's Avatar
ebaines Posts: 10,033, Reputation: 5529
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#4

Jun 28, 2012, 05:43 AM
You're welcome - and welcome back to AMHD!
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