Once again multiple questions have come into ICLUBcentral support recently concerning the cost basis of stock transferred to a member for a full withdrawal. Though covered here before, it appears a refresher is needed. So here are the basics.
Transferring appreciated stock has tax advantages to both the club and the withdrawing member. The club doesn’t recognize a gain on transfer, and a gain to the member receiving the shares is delayed until the shares are sold. So the withdrawing member has more control over the timing and size of the gains realized.
The holding period for the member receiving transferred shares is the same as the holding period for the club. The period starts on the day the club purchased the shares transferred. This will be reported on the club accounting pro-
gram’s withdrawal report. If multiple blocks of the same company are transferred, each block keeps the same holding period as the club.
For a business partnership, stock received is treated as cash for a member liquidating a partnership interest. For investment partnerships, such as an investment club, stock is treated as property. The member’s adjusted cost basis in the club determines the member’s cost basis in transferred shares (property).
The adjusted cost basis is equal to the member’s paid-in-plus-earnings value on the withdrawal date plus the member’s share of club earnings for the current tax year, up to the withdrawal date. From this sum is subtracted any cash received as part of the withdrawal. The adjusted basis is reported on the withdrawal report.
The club’s cost basis in the transferred shares isn’t considered in this calculation. The club’s cost basis does help determine how the member’s cost basis is allocated among multiple blocks of transferred stock. Because the member’s cost basis in the club determines her cost basis in the shares after transfer, it doesn’t make a difference which blocks the club transfers.
When two or more members are withdrawing and receiving shares of the same company that the club has purchased multiple times, there’s no need to split shares from each block to each withdrawing member to fairly apportion cost basis. The largest advantage to the club is to transfer shares with the lowest cost basis. This makes the process easier on treasurers.
The club’s cost basis does play a role when multiple blocks are transferred. This role is limited to how the member’s adjusted basis in the club is allocated among the multiple blocks. The rules for this allocation can get complex.
Here’s a quick, general summary of the process. The member’s adjusted cost basis in the club is compared with the club’s total cost basis of the shares transferred. If the member’s club basis is greater than the club’s basis in the transferred stocks, an adjustment is made to increase the club’s basis in the transferred shares until the total equals the member’s basis in the club.
If the member’s club basis is less than the club’s basis in the transferred stocks, an adjustment is made to decrease the club’s basis until it equals the member’s basis in the club.
For the curious who would like to know the details of how these adjustments are calculated, refer to Internal Revenue Service Publication 541 — Partnerships. The discussion of cost basis of distributed property begins on page 5 of the document.
It’s possible for members to take out enough cash to bring their adjusted cost basis in the club to zero. If this occurs, the cost basis of all shares received will be zero.
Treasurers can rejoice, as the accounting software does all the calculations. The withdrawal report will itemize the cost basis to the withdrawn member for each block of shares received and report the starting date for the holding period.
Treasurers should remember to distribute a copy of this report to all withdrawing members. Withdrawing members will need this information for their records and for tax purposes.
The per-share cost basis of all blocks remaining in the club don’t change. The total cost basis of a block will change if a portion of the shares in the block are transferred.