7517 / How is a shareholder taxed on the sale or exchange of stock?

Specific circumstances may result in the conversion of what appears to be a long-term capital gain to short-term, short-term capital loss to long-term, capital gain to ordinary income, or the disallowance of a loss. See Q 7507 concerning stripped preferred stock, Q 7616 concerning conversion transactions, and Q 701 concerning sales between related individuals. Also, certain derivative securities transactions may result in a constructive sale (see Q 7617 to Q 7621) with respect to an appreciated stock position, which may result in immediate recognition of gain, and the start of a new holding period. See Q 7525 concerning short sales and Q 7588 concerning futures and forward contracts.

For an explanation of the rollover of gain into specialized small business investment company stock for tax years prior to 2018, see Q 7520.For an explanation of the 50 percent (or 75 percent or 100 percent) exclusion for gain from the sale of qualified small business stock, see Q 7522.

Assuming none of the special rules described above applies, when shares of stock are sold, the amount of gain (or loss) is the difference between the selling price and the shareholder’s tax basis in the shares at the time of sale. If the shares are exchanged for property, or for property and cash, the amount of gain (or loss) is the difference between the fair market value of the property plus the cash received in the exchange and the shareholder’s tax basis.³ But if common stock in a corporation is exchanged for common stock in the same corporation, or if preferred stock is exchanged for preferred stock in the same corporation, gain or loss is generally not recognized unless cash or other property is also received; that is, the exchange is taxed in substantially the same manner as a “like-kind” exchange (noting that these Section 1036 exchanges are different from the generally applicable Section 1031 exchange rules, which now only apply to real estate exchanges post-reform).

The exchange of shares of different corporations and exchanges of common for preferred do not qualify for the general “like-kind” exchange rules, even if the shares are similar in all respects.⁴ The nonrecognition rules of IRC Section 1036 apply to exchanges of common stock for common stock in the same corporation, even though the shares are of a different class and have different voting, preemptive, or dividend rights.⁵ For an explanation of “like-kind” exchanges, see Q 710.

Special rules apply to exchanges of stock made pursuant to a plan of corporate reorganization.⁶ The IRS has released regulations under IRC Section 358 providing guidance regarding the determination of the basis of stock or securities received in exchange for, or with respect to, stock or securities in certain transactions (see Q 692).⁷

If a shareholder’s holdings in a company’s stock were all acquired on the same day and at the same price, the shareholder will have little difficulty in establishing the tax basis and holding period for the shares sold or exchanged. But where the shares were acquired at different times or prices and the shareholder sells less than all of the holdings in the stock, the process becomes more difficult while also becoming more significant. Unless the shareholder can “adequately identify” the lot from which the shares being sold originated, the shares sold will be deemed to have come from the earliest of such lots purchased or acquired (i.e., under a first-in, first-out (FIFO) method).⁸ For an explanation of how lots can be “adequately identified,” see Q 700 and Treasury Regulation Section 1.1012-1.

If the stock sold was acquired on the conversion of a market discount bond, a portion of the sales proceeds may have to be treated as interest income (see Q 7648).