Understanding cap gains for a stock swap

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Q. I owned Reynolds tobacco stock and it was recently sold to British American Tobacco (BTI). I received both BTI stock plus a big portion in cash. How does one handle this takeover on their 2017 taxes? Is the value of the BTI stock plus the cash taxable this year or just the cash portion?
— Investor

A. The merger of Reynolds American, Inc. (RAI) into British American Tobacco, PLC (BAT) is a taxable event for RAI shareholders.

When filing their 2017 income tax returns, taxpayers will be required to report the capital gain from the transaction.

The capital gain is equal to the total proceeds, less the cost basis which is the initial price paid for the RAI stock, said Lauren Mazzella Landolfi, a certified public accountant with Wilkin & Guttenplan in East Brunswick.

In this transaction, she said, the total proceeds are equal to the cash received plus the fair market value of the BAT stock received.

“Each RAI shareholder received $29.44 of cash and 0.526 of a BAT share per one share of RAI exchanged,” Landolfi said. “The per share value of the BAT stock received is $69.25 – the closing price of the stock immediately prior to the merger effective date.”

Landolfi offered this example: Assume the taxpayer owned 100 shares of RAI with a cost basis of $10 per share.

The total proceeds received upon the merger are $6,587 (Cash: 100 * 29.44 = $2,944 + BAT shares: 100 * 0.526 * $69.25 = $3,643). The taxpayer’s cost basis is $1,000 (100 * $10). The result is a capital gain of $5,587 ($6,587 – $1,000).

Landolfi said capital gains are taxed based on the length of time the investment was held.

“If the RAI stock was held for one year or less there is no preferential tax treatment,” she said. “Ordinary income tax rates will apply to short term capital gains.”

If the RIA stock was held for longer than a year, you will benefit from reduced long term capital gains tax rates which are 0, 15 or 20 percent, she said.

“The long term capital gains rates you are subject to will be based on your regular tax bracket – low income taxpayers will enjoy the benefit of the low rates while high income taxpayers will be subject to the maximum rate,” Landolfi said. “Certain taxpayers will also be subject to the 3.8 percent Medicare surtax regardless of the holding period.”

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