Saturday, 08 October 2011 13:25 Last Updated on Saturday, 29 October 2011 16:01
By Erin Baehr
Published in the Pocono Record, October 4, 2011
One of the more uncomfortable conversations for a tax professional to have with a client comes at the point during a tax preparation meeting when the client produces a Form 1099-B, reflecting the sale of an investment. No one wants to be the bearer of the bad news that the client will need to go home and search through old files not only for the date and cost of the purchase, but for all the statements showing dividend and capital gain reinvestments too. Digging up that old information can be a lot of work for taxpayers. But take heart, the Internal Revenue Service feels your pain and wants to help.
As part of the 2008 Emergency Economic Stabilization Act, the burden of reporting cost basis- the amount paid for an investment- begins to shift from the taxpayer to brokerage houses. While this will ultimately make reporting the sale of an investment on your tax return easier, the IRS has its own motive for the change. The IRS is looking for lost tax revenue warns Timothy J. Hegarty, CPA in Stroudsburg. The new rules “will make it easier for the investor to know what the basis is, for the tax professional to know, and especially for the IRS to know.” The federal government loses billions each year in tax revenue from underreported capital gains, and is hoping to close that gap. Why is the cost basis important? When the sale of a mutual fund, stock, or other security is reported on the tax return, Schedule D requires not only the gross proceeds from the sale, but also the cost of that investment. The difference is your capital gain or loss. It follows then that the higher your basis, the smaller your gain.
From the taxpayer’s point of view, it is important to find and report every bit of that basis. There is more that goes into a cost basis than just your original purchase price; any dividends or capital gains you reinvested are considered part of your basis too. You may also have purchased your investment on various dates; all of those purchases go into your basis. If your stock has split at some point during your holding period, you’ll need to make adjustments for that as well. Your account statements may already show a basis, as a courtesy, but this has been provided for informational purposes only, and not provided to the IRS. This is problematic from the IRS’s point of view, because absent an audit, they largely must take the taxpayer’s word for it.
With the new law in effect since January 1, 2011, we can all relax now, right? Not so fast. The reporting requirements for brokerage companies are phased in over a three year period, and only apply to new purchases, or “covered” securities in IRS-speak. For 2011, the covered securities are equities- stock, real estate investment trusts, and exchange traded funds. Mutual funds and dividend reinvestment plan shares are phased in January 1, 2012, and bonds and options, January 1, 2013. Remember, these new regulations only apply to securities purchased or acquired (by gift or inheritance for example) after those dates. According to Hegarty, “while the burden of assurance is now shifting to the brokerage house, on pre-2011 assets, the burden still rests very heavily with the taxpayer.” He advises continuing to keep impeccable records, saving statements and confirmations. “You need to be able to support your position.”
Brokerage companies are not required to report basis on uncovered securities, but may choose to do so. It is possible then, to have some investments with basis reported and some without. Since the ultimate responsibility for the accuracy of the basis reported still lies with you as the taxpayer, it is in your best interest to match your records with your brokerage before a sale. “Now is the time to make sure your records match your broker’s records. If there is a difference between what the broker reports and what you report, you may get correspondence from the IRS,” says Hegarty.
What if you own stock and have no statements and no idea what your cost basis is? John Discepoli, CPA, owner of Discepoli Financial Planning, LLC in Glendale, Ohio, offers this tip: “I use www.finance.yahoo.com for historical quotes on stocks and funds. They go back as far as provided for by the entity, fund or stock. That’s as far back as 1962 for General Electric and 1970 for Proctor and Gamble for instance. Stock splits complicate matters - and are disclosed on Yahoo.” As an alternative, for a price, services like www.netbasis.com or www.gainskeeper.com can do the research for you.
Determining cost basis is not the only question when selling a security. When selling only part of an investment holding, and when that holding has been acquired over time, you may choose which method to use in determining which shares were sold. For instance, if you purchased a hundred shares of Ford stock in 2006 for $8 a share, a hundred in 2008 for $4 a share, and a hundred in 2010 for $11 a share, then sold a hundred shares in 2011 for $10 a share, depending on the method chosen you could have a $200 gain, a $600 gain, or a $100 loss. Which would be better for you tax-wise depends on your particular circumstances for that year. For instance, if you are in the 10 or 15% marginal tax bracket this year, you may prefer to take the larger gain, as taxpayers in those brackets have a 0% capital gains tax. On the other hand, if you are in a higher tax bracket, you may prefer to take the loss to offset your income.
There are several methods allowed by the IRS to determine your tax lot. The most common is FIFO, or “first in, first out.” Just like it sounds, using this method, you would be considered to have sold the stock purchased in 2006, with a $200 gain. With the average cost method, the cost per share would be considered to be the average of all the prices, or $10.33, giving you a small loss. “Specific identification” allows you specify which of the shares you sold. If you are looking for the largest gain, you would specify that you sold the shares purchased in 2008. You may specify conditions such as highest cost, longest term; lowest cost, shortest term; or last in, first out for instance.
According to Hegarty, “in the past, you could determine which method to use when you filed your tax return.” With the new rules, you must now decide at the time of the sale, and no later than when the trade settles. “Once the trade settles, you cannot change the method.” Taxpayers need to be more proactive about selling now, Hegarty says. “If you are making a sale of some significance, you should talk to a tax professional before selling” in order to optimize the tax consequences.
