Figuring out cost basis can be one of the biggest hassles investors face at tax time. But a new Internal Revenue Service reporting requirement should eventually make this tax task easier.
For stocks or bonds, basis generally is the price you paid plus any additional costs, such as commissions and recording or transfer fees. You subtract the asset’s basis from the amount you received on its sale, and that will tell you whether you owe taxes on a capital gain or have a capital loss you can use to reduce your tax bill.
But in some cases, it’s difficult to document an asset’s cost basis. Records are lost. Things such as splits, conversions and dividend reinvestments affect a stock’s value. Tracking such information can be time-consuming and still can produce less-than-accurate results.
That’s a problem not only for investors, but also for the U.S. Treasury. IRS in 2005 estimated the federal government was losing an estimated $11 billion in tax revenues because of inaccurate adjusted cost basis information.
To stem such losses, a new rule requiring brokers and other investment managers to include basis information on Form 1099-B came about, thanks to the Emergency Economic Stabilization Act of 2008, commonly known as the bailout bill.
The new cost basis information will be phased in over three years.
|Investment acquired on or after:|
|Jan. 1, 2011||Jan. 1, 2012||Jan. 1, 2013|
|Type of Security||Stocks||Mutual funds||Bond, options, other|
This filing season, cost basis for some 2011 stock sales will be included on Form 1099-B. The reporting requirement expands to mutual funds with the 2012 tax year. Basis reporting will be fully implemented by 2013, with enhanced reporting on the basis of bonds, options and other investments beginning that year.
Money market funds and tax-deferred accounts, such as individual retirement accounts and other retirement plans, generally are not affected by the reporting changes.
Some get info, others don’t
“It’s not a new form, but there is new information on the form,” says Derrek Klimek, CPA and financial adviser with Rehmann Financial in Grand Rapids, Mich. “In the past, brokers only had to report the sale amount. What is required this 2011 tax year is a report on the underlying basis in the sales of certain stock.”
The key word is “certain.” Don’t be upset if you sold a stock but there’s no basis information on your Form 1099-B. The new requirement only applies to stocks purchased in 2011 and also sold that year.
“Frankly, there aren’t a lot of people doing 2011 sales only,” says CFP Michael Kitces, director of research for Pinnacle Advisory Group, a private wealth management firm in Columbia, Md., and publisher of ” The Kitces Report” newsletter. “You need to have done a lot of transactions and have completed them all in one year (2011). I don’t imagine people are going to have a lot of concerns about their method of accounting for their stock sale.”
But some money managers already have been reporting basis as a customer service. In those cases, brokers are reporting whatever basis information they have even if they are not legally required to report it yet.
“Each custodian is going to be different,” says Klimek. “Nobody really knows until these things start showing up.”
And such confusion as to why some 1099-B forms show basis for investment sales and others don’t will likely continue until the reporting requirements on all types of holdings are fully phased in in 2013.
Mutual funds next
Kitces also offers some cautions for mutual fund investors, who will see basis reporting data on 1099-Bs they receive next year.
Mutual fund owners need to carefully consider which cost method of accounting they want to use. The default basis method for mutual funds is average cost. But that means that one sale of a portion of a fund will affect the basis calculation for all future sales of that fund.
|Average cost.||The shares in the account at the time of the sale are averaged to determine the cost. This includes reinvested dividends and capital gains distributions.|
|First in, first out, or FIFO.||Assets acquired first are sold first.|
|Last in, first out, or LIFO.||Assets acquired last are sold first.|
|Highest in, first out.||Highest-cost shares are sold first.|
|Low cost, first out.||Lowest-cost shares are sold first.|
|Loss/gain utilization.||Evaluates losses and gains, and also strategically selects lots based on the loss/gain in conjunction with the holding period.|
|Specific share or specific lot identification.||Specific shares are selected to sell or exchange at the time of each sale. The selected shares determine the cost basis and holding period.|
“When you have a mutual fund that gets sold with the average cost basis as default, you lock all shares as average cost the first time you make a sale,” says Kitces. “If I own 100 shares of an individual security, each bought on 100 different dates, and sell one share of stock, the only thing I lock in is the actual cost basis of that one share.
“But if I own 100 shares of a mutual fund and sell one share under the average share methodology, I’ve permanently locked all 100 shares forever under average cost,” says Kitces. “For example, I held a mutual fund for 17 years and sold a piece of it in January. I still have 99.9 percent of the fund, but by selling the 0.1 percent I have now tagged my shares as sold under average cost.”
You can make a prospective change for future purchases and sales. Just make the decision, tell your broker or fund custodian what basis method you want, and make sure they report it accordingly.
Despite the short-term transition headaches now, once the basis issues are sorted out, tax filing for investors should be easier.
“Now you’ll have to figure out whether you are you selling the shares being reported on or shares that are not being reported on. It’s a little bit messier in the near term,” says Kitces.
But eventually, every investment will be a covered security, and when you want to know your cost basis, says Kitces, your broker will tell you. And anything that provides some reporting information is better for taxpayers.