Basis of shares received in a reorganization.

• Author: Clifton, Diane

Many years ago the IRS ruled in Rev. Rul. 55-355 that a shareholder has to assign tax basis to the shares received in a reorganization by using the average tax basis of the shares given up. Subsequently, the courts and the IRS have gradually given taxpayers more leeway to allocate the basis of shares given up to specific shares received. For example, the courts have given taxpayers the ability to specifically identify the old shares' tax basis to the new shares' tax basis; see Bloch, 148 F2 452 (9th Cir. 1945), and Leonard Osrow, 49 TC 333 (1968), while the IRS issued technical advice (TAM 7946005) that allows taxpayers to trace the basis from the old shares to the new shares. One treatise (Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders, Seventh Ed., Warren, Gotham & Lamont, para. 12.4413] [c]) viewed the old ruling as merely a matter of administrative convenience.

Final Regs.

In 2004, the IRS issued proposed regulations permitting taxpayers to specifically identify the tax basis of shares received in a reorganization when certain criteria are met. The proposed regulations recently became final. Kegs. Sec. 1.358-2 applies to exchanges and distributions of stock and securities occurring after Jan. 22, 2006. Despite this effective date, the fact that Treasury issued the proposed regulations in 2004 suggests that it would accept this new approach for transactions that were in accordance with the final regulations before the effective date.

A specific allocation method for determining the tax basis of shares received in a reorganization may be quite useful when calculating the tax consequences of a future disposition. For example, a taxpayer planning to contribute shares to a qualifying charity would prefer to select the shares with the lowest tax basis because he or she will not pay tax on the appreciation. Or a taxpayer who contemplates giving shares as gifts to family members would prefer to select the shares with the highest tax basis because the donee must use the donor's tax basis for the donated property if it is sold or exchanged at a gain.

Taxpayers who would like to sell shares after a reorganization may prefer to select which blocks to retain and which blocks to sell. Being able to allocate the historic basis among the blocks received gives more control to taxpayers who prefer to make specific identifications.

The proposed regulations outlined the limits and included seven helpful examples. Based on...