In response to a reader's question in January, I showed how to calculate the cost basis of shares of stock redeemed from Merrill Lynch's Internet HOLDRs (HHH:Amex. - news).

It was a complex exercise -- too complex for most people, I think. Back then, I wrote that Merrill was working on a service to make it easier to figure out your cost basis, and it's finally here. Merrill's long-awaited HOLDRs Web site is up, and has a cost-basis calculator.

I put it to the test, and while it definitely works, it still dumps a lot of numbers on you with little explanation or description. So let's walk through it together, and I'll try to shed some light as we go.

First the Basics

As you probably know by now, HOLDRs (short for Holding Company Depositary Receipts) offer ownership in a basket of 20 stocks through a single investment. What makes these securities different from other exchange-traded indices is that you have the option of redeeming HOLDRs in 100-share lots for the underlying stocks. (For more basics on HOLDRs, check out this Dear Dagen.)

Once you redeem those shares, you must determine your cost basis in each one. Cost basis is a fancy term for what you paid for a security. When you sell that stock, the difference between the sales price and your cost basis is your taxable gain (or loss).

Let's Crunch Some Numbers

On to the calculator. Let's say you were overzealous and bought shares of the Internet Architecture HOLDRs (IAH:Amex - news) on Feb. 25, opening day. We'll assume you paid $91 a share (HOLDRs are sold in minimum 100-share lots) and a $29.95 commission for the trade.

You must input this information in the HOLDRs calculator on a per-share basis. So enter $91 as the share price, and 30 cents as the per-share commission, as well as the date of your purchase.

Hit "calculate" and you get a big chart that details the number of shares you own of each stock in the HOLDR, the closing price of those shares the day you bought them and percentage of each HOLDRs share represented by each stock. All that helps you determine your cost basis.

Here's an excerpt for the top holding in the Internet Architecture HOLDRs, Cisco Systems (CSCO:Nasdaq - news):

Company	Ticker	Shares Owned	Closing Price	Weighting	Cost Basis
Cisco	(CSCO:Nasdaq - news)	26.00	66.38	19.09%	$67.05

According to the calculator, your Cisco cost basis is $67.05. But what does that number represent, and what do you do with that information?

The $67.05 represents your cost for each share of Cisco in the HOLDR. (It would be nice if they just told you that.) How did the calculator arrive at that number?

In this example, on Feb. 25 Cisco represented 19.09% of the Internet Architecture HOLDRs. Remember, the weightings are based on the stocks' closing prices, so they change daily.

Your cost basis in each share of the Holdrs is $91.30 (share price plus commission). But you bought a 100-share lot, so multiply by 100, and your cost basis in the lot is $9,130.

Now apply that day's weighting for Cisco 19.09%, to your HOLDRs cost basis. Approximately $1,743 ($9,130 x 19.09%) is allocated to your total Cisco holding. The calculator also tells you that you own 26 shares of Cisco, so you need to divide $1,743 by 26. That gives you a cost basis of $67.05 for each share of Cisco in your HOLDRs.

If you were thinking of redeeming your HOLDRs and selling your Cisco shares, you would now know that your cost basis in each share is $67.05. If you sold on Friday for around $63, you'd take a loss.

Beware of Spinoffs

Of the 11 Holdrs currently trading, six contain stocks involved in spinoffs. That presents an even more complicated cost-basis calculation. Remember, a company spun off from a stock in a HOLDR does not go back into the HOLDR. It ends up in your personal account. You must then allocate a piece of your original cost basis in the HOLDR to that new spun-off stock. So your HOLDR basis would decrease accordingly.

In the case of the Internet Architecture HOLDRs, there have been spinoffs from two stocks in the portfolio. They are listed separately at the bottom of the chart under "Distributed Securities." Aglient (A:NYSE - news) was spun off from Hewlett-Packard (HWP:NYSE - news) and Palm (PALM:Amex - news) was spun off from 3Com (COMS:Nasdaq - news). So a piece of your original $9,130 HOLDRs cost basis must be apportioned to your new Agilent and Palm shares.

Fortunately, the calculator does this work for you. Here's something to note: In the case of Agilent, you received 2.67 shares for each H-P share in your HOLDRs, according to the calculator. But that 0.67 share was not deposited into your account. As with most spinoffs, you get cash for fractional shares. So while your basis in each whole share is $72.61, according to the calculator, your basis in that 0.67 share is $48.65 ($72.61 x 0.67). The total basis then for the remaining two whole Agilent shares in your account is $145.22 ($72.61 x 2).

After the spinoffs, your adjusted cost basis in the Internet Architecture Holdrs now is $8,743, or $87.43 a share. The calculator notes this at the bottom of the screen. These same calculations hold for fractional shares of other spun-off companies as well.

For more on spinoffs within HOLDRs, see this previous Tax Forum.