A mutual insurance company is owned by its policyholders. A mutual insurance company has no stock. When an insurance company demutualizes, a policyholder's ownership interest is exchanged. The exchange does not cause the policies to change, except for the name. Since you have the same policy as before (nothing about it has changed), your basis in the policy stays the same. Thus, your basis in the resulting stock or cash is deemed to be zero. If you elect to receive cash instead of shares, you are treated as having received shares and sold them for capital gain reportable on Form 1040, Schedule D (PDF), Capital Gains and Losses.

If you received the cash and you held the policy for more than one year as of the date of this demutualization, this cash is treated as a long-term capital gain. If you owned it for a year or less, it is short-term, as discussed in Revenue Ruling 85-164 and Internal Revenue Code Section 1223(1).

For information on how to report this gain, refer to Publication 550 (PDF), Investment Income and Expenses.

If you elected to receive the stock, you are not taxed on the shares until you sell or otherwise dispose of them. As with the cash, the holding period of the stock begins with the purchase of the policy and your starting basis is zero.

Copies of Revenue Rulings are available in one of the local Federal Depositary Libraries in your community. To find the library nearest to you, visit the Governmental Printing Office Locate Federal Depository Libraries website at http://www.gpo.gov/su_docs?locators/findlibs/index.html.

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