Cost Basis Reporting – Are You Ready?
It’s well known that gains realized from owning stocks and other property are subject to income tax. The simple formula for reporting the gain on a tax return is the proceeds (price for which you sold the stock) less the cost basis and any expenses you incurred in the transaction (commissions or other fees). But sometimes completing that calculation is easier said than done. Having the wrong figures can have a detrimental effect on your wallet (or the IRS intruding into your life).
Keep in mind that when it comes to income taxes, nothing is simple. There are exceptions to almost everything, even when it seems simple. Be sure to not assume anything and discuss all the details with your tax advisor. We’re going to use stocks as the property for this discussion.
Determining the proceeds of the sale is fairly easy: the amount received on the sale. The simplest definition of cost basis is what you paid for it. Good record keeping is essential in knowing your basis. But what if something has happened to the records? How do you determine your basis?
If you use a broker they will most likely have records of past transactions. If they do not have the amount the security was purchased for (which is possible if you’ve changed brokers since acquiring the stock), they may at least have the date. Always double-check your broker’s statements to ensure accuracy or to fill in missing information. If you know only the date of purchase, there are Internet sites where you can look up historical stock prices (an example is finance.yahoo.com). This site’s data automatically adjusts the price for things like stock splits, which will save you the hassle of computing those changes on your own.
But what happens if you do not have a buy date, either because you performed multiple purchases or because the shares were a gift or inheritance? In those cases there are special cost basis rules that apply.
In the case of purchasing multiple shares of the same stock over the years, the default method used by the IRS is called “first in, first out”. Like the name implies, the first shares purchased get reported as sold first. As those shares are used up, then move on to the next lot. The IRS does not allow you to manipulate the gains or losses by picking shares to report as sold based on their cost (there is a way to avoid first-in, first-out, but it requires advance planning and documentation).
If you inherited stock from someone determining your basis can be relatively easy. Just because you inherited the stock from a relative does not mean you also inherited their basis in the stock. Your tax basis is determined based on the date of death. Simply take the average of the high and low on that day and you’ve got your basis.
A gift of stock does not work the same way as an inheritance. In the case of a gift you DO receive the donor’s cost basis. An exception to this is if the stock’s value is less on the gift date than when purchased. This can create a situation where a lot of work is required if the generous person has not kept good records.
If you need help with calculating the basis in your investments, contact us and we will help.
Greg Tanner – is a Tax Principal at Wertz & Company, LLP, a Professional Services Firm located in Orange County, CA that specializes in working with entrepreneurs along their journey to success.