Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

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What adjustment must be made to the cost basis if an investor receives a stock dividend?

The cost basis is increased
The cost basis remains the same
The cost basis is decreased
The cost basis must be adjusted

The correct answer is: The cost basis must be adjusted

When an investor receives a stock dividend, the cost basis of the original shares must be adjusted to reflect the increase in the number of shares owned. A stock dividend typically results in receiving additional shares based on the proportion of ownership, which means the investor now has more shares but the overall value of their investment remains the same. To calculate the new cost basis per share, the total cost basis of the original investment is divided by the total number of shares after the dividend. This adjustment is necessary to maintain the investor's overall investment value. Therefore, while the total investment remains the same, the cost basis allocated to each share is adjusted downwards. This understanding is essential for accurate reporting of capital gains or losses when the shares are eventually sold. The adjustment ensures compliance with tax regulations, as it accurately reflects the true investment cost after receiving additional shares from a stock dividend.