30.7 Convertible Stocks and Bonds

You realize no gain or loss when you convert a bond into stock, or preferred stock into common stock of the same corporation, provided the conversion privilege was allowed by the bond or preferred stock certificate.

Holding period.

Stock acquired through the conversion of bonds or preferred stock takes the same holding period as the securities exchanged. However, where the new stock is acquired partly for cash and partly by tax-free exchange, each new share of stock has a split holding period. The portion of each new share allocable to the ownership of the converted bonds (or preferred stock) includes the holding period of the bonds (or preferred stock). The portion of the new stock allocable to the cash purchase takes a holding period beginning with the day after acquisition of the stock.

Basis.

Securities acquired through the conversion of bonds or preferred stock into common take the same basis as the securities exchanged. Where there is a partial cash payment, the basis of the portion of the stock attributable to the cash is the amount of cash paid; see Examples 1 and 2 below.

If you paid a premium for a convertible bond, you may not amortize the amount of the premium that is attributable to the conversion feature.

EXAMPLES
1. On January 5, you paid $100 for a bond of A Co. Your holding period for the bond begins on January 6 (5.9). The bond provides that the holder may receive one share of A Co. common stock upon surrender of the bond and the payment of $50. On October 19, you convert the bond to stock on payment of $50. For tax purposes, you realize no gain or loss upon the conversion regardless of whether the fair market value of the stock is more or less than $150 on the date of the conversion. The basis and holding period for the stock is as follows: $100 basis for the portion attributed to the ownership of the bond with the holding period beginning January 6; and $50 basis attributed to the cash payment with the holding period for this portion beginning October 20.
2. Same facts as in the above Example, but you acquired the bond on January 5 through the exercise of rights on that date. Since the holding period for the bond includes the date of exercise of the rights (5.10), the portion of the stock allocable to the bond takes a holding period beginning on January 5.
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