These examples assume the stock portion of the deal is greater than 50% of the total value and the tax authority is the USA.
We'll use a round number that produces a fractional share for this example. Our fictional investor owns 1000 shares of Level 3 Communications (LVLT) with a basis cost of $40.00 per share (qualifying for long term capital gains) for a total cost of $40,000.00. LVLT is bought by Centurylink (CTL) for 1.4286 shares of CTL plus $26.5 per share in cash.
Let’s say the closing market value of CTL is $25.00 per share on the last trading day prior to the merger (late next year). You also received $15.00 "cash in lieu" for fractional shares of LVLT.
What is your cost basis for CTL? First we calculate the total value received:
1000 shares of LVLT receives 1.4286 shares of CTL per share, for a total of 1428.6 shares of CTL. We’ll assume for this example the closing value of CTL was $25.00 per share; a value of $35,715.00 for the stock portion. You also received $26.50 cash for a total cash portion of $26,500.00. Therefore, the total value you received for both cash and stock is $62,215.00.
Your total gain is $22,215, the total value received; $62,215.00 less the original cost of your shares of LVLT or $40,000.00. The shareholder will recognize as gain the lesser of the gain realized or the cash received. Capital gains for this case is $22,215.00. The difference from the cash received is $4,285.00 so your adjusted basis cost is $40,000 minus $4,285 minus $15 (fractional share) or $35,700.00.
What if your cost basis was $30,000 putting your gain at $32,215.00. Now your capital gain is the cash portion or $26,500 and your cost basis for the new shares remain at $30,000.
I ran these examples based on this Calculator.
I am not an accountant so talk to a CPA to verify these methods are acceptable to the IRS.
Have a different opinion? Let me know at firstname.lastname@example.org