Cost basis is the price that you paid to purchase a security plus any additional costs such as a broker’s commission. When you sell a security, your tax liability is determined by the cost and sales price of that security. If you sell a security for more than the cost that you paid for, the difference will be taxed as a capital gain. The reporting method of your cost basis will default to FIFO, which stands for “First In, First Out”. Any shares that you bought first will be sold first.
New Cost Basis Legislation
The Emergency Economic Stabilization Act of 2008 requires broker dealers to track and report cost basis to the IRS in three phases over three tax years. Starting January 1, 2011, Firstrade is responsible for tracking and reporting both your cost basis and sales proceeds for securities covered by the new legislation. The changes to how cost basis is tracked give you a more comprehensive and accurate evaluation of your cost basis, and will help you simplify your annual tax filings. Because these changes could impact the cost basis which is used to calculate your gains and losses, it's very important for you to understand these reporting changes as well as how they will apply to you.
Reporting changes will be in place in three phases over three tax years:
- 2011: Equity securities
- 2012: Mutual funds and dividend reinvestment plan shares
- 2014: Debt securities, options and all other financial instruments.
- The first phase of the cost basis legislation went into effect on January 1, 2011. The securities affected by this first phase of the legislation are equities purchased or acquired on or after January 1, 2011 and include US issued and non-US issued stock. NOTE: Tax Lots that are marked Uncovered will not be reported to the IRS or on your 1099-B.
- The second phase of the cost basis legislation goes into effect on January 1, 2012. The securities affected by phase two of the legislation are mutual funds, ETFs, unit investment trusts, real estate investment trusts, dividend reinvestment plans, limited partnerships and all other regulated investment companies.
- The third phase of the cost basis legislation goes into effect on January 1, 2014. The securities affected by phase three of the legislation are options, fixed income (bonds) and all other securities.
Covered and Non-covered securities
- Covered securities refer to the securities for which Firstrade is responsible for tracking and reporting cost basis information to IRS. This includes:
- Securities acquired on or after Jan. 1, 2011
- Mutual funds and dividend reinvestment plan shares acquired on or after Jan. 1, 2012
- Debt securities, options and other securities acquired on or after Jan. 1, 2014
- Equities: Jan. 1, 2011
- Mutual funds, DRIPs, ETFs: Jan. 1, 2012
- Options, and all other securities: Jan. 1, 2014
Cost Basis FAQs:
What are the latest cost basis reporting requirements?
Congress passed the Emergency Economic Stabilization Act on October 3, 2008, which requires firms like Firstrade to report adjusted cost basis for taxable accounts to the IRS via Form 1099-B beginning in 2011. The final ruling was issued by the IRS on October 12, 2010. You can gain access to the final regulation, as well as other helpful information, under the "Cost Basis Reporting on Securities Sales" section located via the following link:http://www.irs.gov/taxpros/article/0,,id=225080,00.html
What does cost basis mean?
Cost basis is the original purchase price you paid for an investment. Adjusted cost basis is the original cost basis and any adjustments due to wash sales, corporate actions, and any other transactions that affect cost basis.
When will the various phases take affect and what is covered?
Covered under the legislation:
- Equities purchased or acquired on or after January 1, 2011
- Mutual funds, DRIPs and all other Registered Investment Companies purchased or acquired on or after January 1, 2012
- Options, Bonds, and all other securities purchased or acquired on or after January 1, 2014
What are non-covered securities?
Non-covered securities are those securities acquired before these dates:
- Equities: January 1, 2011
- Mutual funds, DRIPs, ETFs: January 1, 2012
- Options, and all other securities: January 1, 2014
Will the securities I purchased before January 1, 2011 be affected by the new legislation?
Securities acquired before January 1, 2011 are not covered by the new legislation, therefore, Firstrade is not required to report the gain/loss, cost basis and holding period to the IRS on Form 1099 when these securities are sold.
Will your responsibility for filing capital gains and losses on a Schedule D change?
No, taxpayers will still be responsible for reporting capital gains and losses on Schedule D based on an aggregate view of all holdings across all of their accounts that have the same social security number or tax ID.
How will you be notified about the cost basis on a transaction?
The following message appears on confirmations: "COST BASIS ELECTION FOR SECURITIES The default tax relief method used for tax reporting is First-In-First-Out (FIFO). Please contact your broker if you wish to change the default tax-relief method for your account or specify different tax lots for liquidation."
How is a tax lot defined?
- A tax lot is a grouping of a security that has the same price and trade date. In most cases, a trade represents a tax lot.
- As lots are sold or short sell lots are covered, the system will break up the lots if the amount of shares being sold or covered does not equal the existing lots they are matching to.
For example: A customer owns a 300 share lot of a stock. The customer sells 200 shares of that stock. The 300 share lot will be broken into a 200 share lot, which will be matched based on the customer's instructions or the default of FIFO, and a 100 share lot will continue to show as open for the account.
What is wash sale and what are its components?
- The wash sale rule only applies to transactions for the exact same security (CUSIP #).
- A transaction to sell or buy-to-cover is identified as a wash sale if the replacement shares are bought or sold short within 30 days before or after the sell or buy-to-cover. The wash sale loss is added to the basis of the replacement shares.
- Replacement shares are created by the buy or short-sell transaction that occurs within 30 days before or 30 days after a sell or buy-to-cover transaction that had resulted in a realized loss.
- Disallowed loss is the amount of the realized loss from the sell or buy-to-cover that is applied to the replacement buy or short-sell transaction.
- The basis adjustment is important as it preserves the benefit of the disallowed loss. You'll receive that benefit on a future sell of the replacement stock.
- The sale of replacement shares can result in a wash sale. The same window of 30 days before and 30 days after applies to the replacement shares.
Wash Sale: If the customer sells 200 shares at a loss but has bought the same security within 30 days before or 30 days after the sell, then the sale is a wash sale. If the buy was for 100 shares, only the loss on 100 of the 200 share sale is disallowed and applied to the replacement shares. The customer is allowed a loss on the other 100 shares.
Wash Sale/Short Sell: If the customer has a buy-to-cover 200 shares at a loss but has a short sale of the same security within 30 days before or 30 days after the buy-to-cover, then the buy-to-cover is subject to wash sale treatment. If the short sale was for 100 shares, only the loss on 100 of the 200 share buy-to-cover is disallowed and applied to the replacement shares. The customer is allowed a loss on the other 100 shares.
How will you know if a security will have cost basis information reported or not?
Only covered securities will have cost basis information reported on the 1099-B.
What is the deadline for reporting cost basis?
- 1099-B forms will be provided by February 15.
- The taxpayer filing deadline has not changed.
- If an adjustment to basis is made by the issuer after the reporting deadline to transactions already reported on the 1099-B, Firstrade will issue an adjusted 1099-B.