Navigating the New Broker Reporting Rules
Brokers and mutual fund companies soon will be reporting to the IRS and to you the cost basis of assets sold during the year. You soon will have to make a decision that will affect these reports.
In 2008 Congress passed the requirement, and phased it in. The first reports occur on Form 1099-B in 2012 for 2011 transactions. Reports for different assets begin at different times.
The cost basis of an asset generally is what you paid for it. Other costs, such as brokerage commissions, may be added. When you sell the asset, the gain or loss is the sale price (minus selling expenses) less the cost basis.
There are different ways to compute the basis when you bought the holdings over time and you sell less than your total holdings. You can use the FIFO, or first-in, first-out method. This assumes the first assets you purchased were the first ones you sold. There’s also LIFO, or last-in, first-out, and HIFO, highest-basis-in, first-out. Another method is specific identification. You specify for the sale which shares will be sold but must make the identification by the settlement date of the sale.
The first stage of the new reporting rules is for your brokers or mutual fund companies to ask you to select which of the methods should be your default or standing method. On each trade you can change the default method, but only up to the settlement date for that trade. The tax law requires the same method to be used for all shares of an investment sold during the year.
Don’t select a default method and one will be selected for you. In most cases it will be the FIFO method.
Only the basis of assets you acquired before 2011 aren’t required to be reported, though many brokers and mutual funds have been tracking this information and reporting it to clients for several years. They could choose to include basis for earlier purchases on the 1099s.
Beginning in 2011, acquisitions and subsequent sales of domestic stocks, real estate investment trusts, and foreign stocks must be tracked and reported by brokers. In 2012 the basis will be reported on mutual funds shares as well as on dividend reinvestment plans. Individual bonds and options are tracked and reported beginning in 2013. Partnerships and derivatives other than options are not covered by the law but the IRS is allowed to add them after 2012.
Exchange-Traded Funds (ETFs) are tricky. Many will be considered mutual funds and first be reported in 2012. Others will be considered stocks and reported in 2011.
Because the law is phased in, investors who consolidate different types of holdings in one account may see that only the basis for stocks and REITs is reported in 2011 and mutual funds are added in 2012.
The brokers are required to do more than report cost basis. They have to make adjustments for stock splits, reinvested dividends and distributions, and mergers. They also have to track the basis of assets received by gift or inheritance. The financial companies also must adjust the basis for “wash sales.” A wash sale is when a share is sold at a loss within 30 days of a purchase of the same asset.
These rules apply only to taxable accounts, since basis doesn’t matter in tax-deferred and tax-exempt accounts such as traditional IRAs and Roth IRAs.
Remember the reporting rules apply only to shares purchased when the requirement begins – 2011 for stocks and 2012 for mutual funds. Your broker or mutual fund firm is not required to report the basis of assets purchased before that year, though it can choose to. The basis is reported only when you sell an asset.
The new reporting can make life easier for many taxpayers. They won’t have to go through their records to determine the basis of securities sold. But it also tightens the rules and presents complications. If you choose to sell specific shares, you’ve always been required to specify those shares before the settlement date. Many taxpayers probably fudged that requirement in the past, waiting until preparing their tax returns to decide whether they sold specific shares. In the past you could wait until filing to decide, for example, whether to use the FIFO or LIFO method. It’s not clear what will happen now when your 1099 uses FIFO but at tax return time you decide to report a sale using LIFO. Presumably the IRS will provide a way to explain discrepancies between the 1099 and the tax return.
December 2010. RW
