The IRS Has New Rules For Investors

In the past, you might have your securities in street name in a brokerage account and you never told the broker your cost basis in the securities. Sometimes, you might have inherited some of the securities and received a new cost basis or received some shares as a gift, where you would either use the date of death value or the donor’s cost basis respectively as your cost. When you would sell the stock, the brokerage company would issue a Form 1099 to you with a list of the stocks sold and the sale prices. You would then list each of those on your tax returns and provide the date that you purchased (or received) the shares and your cost on them.

As a result, there was no way to determine if you used the correct cost basis on your tax return, short of an audit of your return, where you had to produce the backup to show what your cost was based upon for each stock or bond sold. Congress thought that this must be a loophole and estimated that the federal coffers might pick up an additional $25 billion of taxes as a result. Of course, this presupposes that you would either use the wrong cost innocently or on purpose—where the estimate comes from is anyone’s guess.

Now, as a result in the change of the law, investment providers, such as brokerage firms must track customers’ cost bases and report them to the IRS on a Form 1099 in the year that the investment is sold. This change in the law is effective beginning in 2011 for stocks, REIT’s and foreign stocks. The effective date for mutual funds and dividend reinvestment accounts is January 1, 2012. Most exchange traded funds fall under the 2012 rule. For individual bonds and options, the law is effective on January 1, 2013. At the moment, most partnerships and derivatives are not covered by the law.

The brokerage company will provide basis information for investments that were purchased after the date of the effective date of the law. They will track events such as splits, reinvested dividends and mergers on the stock purchased by them, which impact the cost basis. You may have to tell the broker which CUSIP you may want to sell, as if you fail to let them know, the law chooses for you, usually first in—first out, which may result in a higher taxable gain.

It may be a good idea to give your broker copies of documents to show your cost on every issue in the brokerage account, even those that were not purchased through them. This will give you the information on the cost basis that you will need to make your decision on when to sell the investment and what taxable gain might ensue.

Denice Gierach is a lawyer and owner of The Gierach Law Firm in Naperville. She is a certified public accountant and has a master’s degree in management.