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Articles: New “cost-basis” rules in play

New cost-basis reporting rules being phased in over a two-year period could have a major tax impact.  The changes present both potential opportunities and pitfalls for investors.

Background: Under prior law, you were responsible for providing the cost basis of all securities transactions, although financial institutions often helped out.  This was often difficult to do if you held multiple shares of the same securities and some or all of the shares were acquired a long time ago.  Conversely, you had some flexibility in des ignating which block of shares you were selling at a particular time.  Depending on your situation, you might be able to identify shares that would provide a favorable tax loss or a low-taxed gain.

But the IRS amended the rules in 2008.  Financial institutions are required to report the relevant cost-basis information to investors and to the IRS for “covered securities” acquired after a specific date.  Under the law, the new cost basis reporting rules apply to securities acquired after

  • January  1,  2011,  for  stocks,  American  Depository Receipts (ADRs), real estate investment trusts (REITs) and exchange-traded funds (ETFs) taxed as corporations
  • January 1, 2012, for mutual funds, dividend reinvestment plans (DRPs) and other ETFs
  • January 1, 2013, for all other types of securities (e.g., options, fixed income instruments and debt instru ments).   Update:  This effective date has just been post poned to January 1, 2014.

However, the new reporting rules do not apply to “uncovered securities” acquired prior to these dates. Thus, the new and old rules will co-exist for the foreseeable future.

Another significant change is that the financial institution will use a “default method” if you do not choose one of the other allowable accounting methods at the time of the transaction. Previously, you did not have to make the choice until tax return time.  The default method for stocks acquired after 2010 is the first-in, first-out (FIFO) method.

For example, say that Mary Smith bought 100 shares of Major Corp. stock on March 1, 2011, at $10 a share.  Then she acquired 50 more shares of Major Corp. stock on October 1, 2011 at $15 a share.  Finally, she sold 50 shares of the stock on December 1, 2011, at $16  share.

Under the FIFO method, Mary has a taxable gain of $300 ($16 a share $10 a share x 50 shares).  In contrast, under the LIFO (last-in, first-out) method, her taxable gain would have been only $50 ($16 a share $15 a share x 50 shares).

Final words:  Consult your professional tax and investment advisers concerning the available cost-basis accounting methods and the implications for your situation.


This newsletter/advertisement is produced for our clients, friends and associates through an arrangement with WPI Communications, Inc. for the representatives’ use. Although the editorial content is professionally researched, written and edited, neither our firm nor any of its agents, representatives or associates make any representations regarding the accuracy of the content or its applicability to your situation. The information in this communication is not intended as tax or legal advice. In accordance with IRS Circular 230, the information provided herein may not be relied on for purposes of avoiding any federal tax penalties. Any tax advice contained in the body of this material was not intended or written to be used, and cannot be used, by the recipient for the purpose of 1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or 2) promoting, marketing or recommending to another party any transaction or matter addressed herein. You are encouraged to seek tax or legal advice from an independent advisor.

 

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