What would you do if your rich Uncle Fletch left you all of his stocks when he died? Have a party? Probably, Fletch was pretty loaded. But have you considered the ugly specter of inheritance tax and how it will effect you? You don't know the cost basis of the shares or even if you have a gain or loss. What to do?

Q: I was given a gift of some shares of stock from a relative's estate a few years ago. The company is merging with another and I am receiving a cash payout as a result of the merger. When it comes tax time, on what cost basis do I pay capital gains tax? The original cost of the shares? And what if I don't know what that original cost basis was?

A: First of all, was it a "gift" or did you receive it out of a relative's estate in the form of an "inheritance"? Big difference between the two.

If a gift, your basis (or cost for tax purposes) is the same basis that the donor (i.e., the person who gave you the gift) originally had. So if this is really a gift, you must attempt to trace the cost all the way back to the person who originally owned it and gave it to you. Let's hope that it's not a gift, because arriving at the cost basis could be very difficult.

If an inheritance, you get what is called a stepped up basis for tax purposes. What this means is that your basis (i.e., cost) is established at the fair market value of the stock on the date of death of your relative. The Estate Tax return would disclose the value of the stock at date of death.

If all else fails, call your broker. Give the broker the date of your relative's death and the stock information, and s/he will be able to track the stock, the splits, etc. If you can't find a broker, call the company's shareholder relations department. The company should be able to give you valuation information you need.

However you determine the value at date of death, make sure that you back up your findings with a letter from the broker or the shareholder relations department. You'll need that information just in case the IRS wants to double check (read: audit) your tax return.

- Article 17

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