7511 / What is the tax basis of warrants or other stock rights received in a nontaxable stock dividend distribution from the issuing corporation?

If a shareholder acquires stock warrants or other stock rights of the distributing corporation in a nontaxable stock dividend distribution (see Q 7509) and either exercises or sells the warrants or rights, the tax basis in the “old” shares with respect to which the distribution of warrants or rights was made is generally reallocated (in the same manner as discussed in Q 7510 for stock dividends) between the old shares and the warrants or rights, in proportion to the fair market values of each on the date of distribution (not the declaration or record date). But if the fair market value of the warrants or rights is less than 15 percent of the fair market value of the “old” stock, the tax basis of the warrants will automatically be zero, unless the shareholder makes an irrevocable election to reallocate the basis of the old stock with respect to which the warrants or rights were distributed to all warrants or other rights received in the distribution.¹ Despite this, it has been held that where the subscription rights became valueless and the subscriptions received were refunded, no adjustment to the shareholders’ basis was required.²