New Cost Basis Reporting Rules

For years it has been a question asked by taxpayers and accountants alike.  How much did I pay for that stock?  If you’ve ever sold a stock or a mutual fund you know that you need to report that sale on your tax return.  You also need to report what is called the “cost basis” of that investment.  Put simply, the cost basis is the amount you paid for the investment.  If the sale price is higher than your cost basis then you report a gain which is taxed at capital gains rates.  If the sales price is lower than your basis then you report a loss which can be used to offset other capital gains or up to $3,000 of other income.

Tracking down the price you paid for a certain stock or fund has often turned into a long and difficult search for some taxpayers.  Additionally, the IRS has never had any way to verify your records unless they performed an audit.  A recent study estimated that basis errors were contributing up to $25 billion a year to the “tax gap.”  This loss of tax dollars finally got to be too much for Congress and back in 2008 they mandated new rules for brokers that begin to phase in next year.  For 2011, brokers must begin tracking acquisitions of stocks, real-estate investment trusts and foreign stocks.  Mutual fund tracking won’t be required until 2012 and individual bond and options tracking won’t be required until 2013.

So what does this mean for you?  Well eventually it will mean that reporting sales of investments on your tax return will become much easier.  Of course it will take time for these rules to really have much of an effect because they only apply to sales of investments that were purchased after the date when the tracking rules kick in.  So if you sell a stock in 2011 that you bought in 2010, your broker will not need to report the basis to the IRS but if you purchase a stock in 2011 and then sell it in 2011 it will be reported to the IRS. 

You also might soon be receiving a call or a mailing from your broker asking you to declare a standing order on which shares you would like sold first.  In other words if you have 200 shares of a stock that you bought in 2 blocks of 100 and you sell 100 of them, your broker will need to know which block you are selling.  Some examples of a standing order are FIFO (first in, first out) LIFO (last in, first out) or HIFO (highest basis in, first out).  You can also ask to specify on a case-by-case basis, which might make sense in many situations where you want to either maximize your losses or gains for a particular year for tax purposes.

If you’ve received a request like this from your broker and would like more guidance feel free to contact us. 

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