I'm an investment adviser who owns many HOLDRs for clients. My clients have recently received distributions and/or spinoffs for three HOLDRs: Nortel (NT) from the Telecom HOLDRs (TTH) ; Agilent (A) - Get Report from the Internet Architecture HOLDRs (IAH) and Pharmacia & Upjohn from the Pharmaceuticals (PPH) - Get Report HOLDRs.
I understand the Nortel piece is taxable as a dividend immediately (according to BCE (BCE) - Get Report, which spun it off). I think the other two spinoffs are not taxable events. But calculating the cost basis adjustments for the pieces now outside the HOLDRs and the adjustment of the cost basis of the HOLDR itself is more than I can take. I've spoken about these events to various CPAs and they are also confused. Do you have any information that could help my poor soul? I'll tell you one thing, I won't be buying HOLDRs in taxable accounts any longer -- too much of a pain. -- Stuart Chaussee
As you know, HOLDRs offer ownership in a basket of 20 stocks through a single investment. But the key to understanding the tax issues is to think of HOLDRs as 20 separate stock investments. After all, you can redeem your HOLDRs in 100-share lots, if you want, and get shares of each of the underlying stocks. (Today's
Dear Dagen offers a primer on HOLDRs, if you want to learn more.)
For now, forget the concept of HOLDRs. Pretend you own
20 stocks that happen to be in the same industry. One of your holdings just completed a spinoff, so you need to recalculate its cost basis.
Let's take the recent spinoff of Agilent from
as the example. Let's say you bought one round lot (100 shares) of the Internet Architecture HOLDRs on March 1 for $9,400, based on that day's closing price of 94 per share.
Forgetting the notion of HOLDRs, for the moment, you owned seven shares of H-P (see the Amex site for the
complete breakdown of Internet Architecture HOLDRs holdings) and 19 other Internet hardware and software stocks.
H-P closed at 133 5/8 on March 1, so you indirectly spent $935.38 for your seven H-P shares. That is your cost basis.
According to the terms of the H-P-Agilent spinoff, 21.96% of your H-P basis should be allocated to your new Agilent shares. That means $205.41 ($935.38 x 21.96%) of your H-P cost basis should be allocated to your new Agilent shares. (For really detailed instructions on allocating your H-P cost basis to Agilent, check out Saturday's
Tax Forum .)
Now come back to your HOLDRs investment for a minute. Those Agilent shares are not part of the Internet Architecture HOLDRs. Consider them an addition to your other stock investments outside your HOLDRs portfolio.
Since they are not part of your HOLDRs, your original cost basis for your HOLDRs shares,$9,400, should not include your new Agilent basis. In our example, your HOLDRs basis is now $9,194.59 ($9,400 - $205.41).
I know this is not a very straightforward calculation. But here is a bit of good news:
, creator of the HOLDRs, plans to put a calculator on its site to help you determine your cost basis in these products. No word yet on when it will happen, though, so brush up on your math skills.
For more details on the taxability of the BCE-Nortel spinoff, see this recent
HOLDRs In An IRA
I'm seriously thinking of investing my IRA funds into a few HOLDRs, and I have a few questions: If I don't sell any of the HOLDRs, do I still owe any taxes at the end of the year? Is it like a mutual fund where even if you don't trade, you still might end up paying some taxes? Say I'm ready to retire. Do I have to sell the HOLDRs as one entity or can I just sell some of the stocks within the HOLDRs? This is a bit confusing since a recent Dear Dagen said, "you actually own all the underlying stocks in the portfolio and can redeem HOLDRs shares for the underlying stocks." -- Tushar Dhoraje
If you own the HOLDRs in a tax-deferred account like an IRA, you won't have to worry about year-end taxes. And you won't have Stuart's ongoing cost-basis calculation headache, either.
But don't jump too quickly. This is your retirement money. HOLDRs have been
very volatile. For instance, the
B2B Internet HOLDR
is down 60% since its inception in late February.
But assuming you have other savings, selecting two or three HOLDRs might be a reasonable way to diversify.
Remember, your IRA is a tax-deferred account. You can contribute up to $2,000 each year, pre-tax. You aren't required to start withdrawing from the account until you reach age 70 1/2. At that point, you'll owe ordinary income tax on your cash withdrawals.
While the HOLDRs may make an occasional distribution, if they're in your IRA, who cares? You defer the tax hit on all trading and distributions until you pull cash out of the account later in life.
As you saw in the answer to Stuart's question, when you own HOLDRs, you essentially own the underlying stocks. So when you're ready to start taking cash distributions, your account has a choice: It can sell the HOLDRs as a unit or redeem the HOLDRs for the actual shares. If it's the latter, you'll have approximately 20 stocks in your account, and you can sell whichever shares you choose.
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