How New Cost Basis Reporting Rules Affect Investors

Due to changes enacted in the federal tax law by the 2008 Emergency Economic Stabilization Act new cost basis reporting rules went into effect on January 1, 2011. The result is that all investment providers will be required to start tracking each customer’s cost basis and holding period for securities purchased or acquired. When you sell a stock the financial institution is required to report your cost basis and your proceeds on IRS Form 1099-B. The reason for this change is that previously the IRS had to rely on the customer to report their cost basis and resulting gain or loss which often resulted in inaccurate reporting.

You may have noticed that your broker has included more information about your cost basis in your brokerage account overview. I have noticed that Zecco and ShareBuilder.com both now show the average cost basis. It is nice to be able to see at a quick glance the average price I paid for a stock and what my gain or loss would be.

Under the new rules if a customer sells less than his or her entire position of a security in an account, a broker must report a customer’s adjusted basis in the security using the first-in, first-out (FIFO) method, unless the customer provides the broker an adequate and timely identification of the shares or units the customer wants to sell. The pitfall here is that if you don’t notify the broker and the FIFO method is used it will likely result in a higher tax bill.

On the plus side the rules will make it easier to determine your cost basis. If you reinvest dividends it can be difficult to determine your cost basis. You can go to a financial calculator site that has tools such as an investment calculator, mortgage calculator, and such and find a cost basis calculator to determine your cost basis but it is much easier to have the broker do it for you.

Since I don’t sell often and when I do I usually sell my entire position the new rules will not have much affect on me. You do need to be aware of the rules when you sell though to make certain you don’t pay more taxes than necessary.

9 Responses to “How New Cost Basis Reporting Rules Affect Investors”

  1. Aunt Bird February 21, 2012 at 9:18 pm #

    This is good article.
    Thanks for sharing.

  2. Netbasis February 21, 2012 at 10:11 am #

    It’s nice that brokers are including more info moving forward, but you still are on your own when finding the cost basis of anything prior to this year. Which is a real nightmare if you’ve purchased the same stock over a few years. The penalties for incorrect reporting are very strict under this new regulation, for you and your tax preparer. Also, it’s 3 business days/72 hours to notify your broker about what sales methodology you want to use.

    • Andy Hough February 21, 2012 at 1:40 pm #

      You could play it safe and just use the FIFO method as long as you still know the cost basis of your first shares. I can see how this would be a nightmare for people who have made multiple purchases of a stock over the years though.

  3. JP@Novel Investor February 19, 2012 at 1:27 pm #

    These same rule changes went into affect for mutual funds, ETFs and stocks purchased through DRIPs for 2012.

    • Andy Hough February 20, 2012 at 3:16 pm #

      Yes, I probably should have put in the three-step implementation of the rules but I wanted to keep the post simple.

  4. Beating Broke February 16, 2012 at 12:20 am #

    I really like that they’ll be doing this from now on. In the past, when I was more money challenged, I bought and sold stocks on several occasions. Luckily, I never got audited for those, because I generally had terrible records and I’m sure the cost basis was not very accurate.

    • Andy Hough February 17, 2012 at 3:30 pm #

      Yeah, it would suck to get audited and have to pay penalties due to an innocent mistake. That should be less of a concern now.

  5. Evan @ Smartwealth February 15, 2012 at 8:03 pm #

    Ha I did just notice my broker including much more detail, it threw me off at first, it took a lot longer for me to enter my stock information than it normally does.

    • Andy Hough February 17, 2012 at 3:31 pm #

      I like the extra detail. It makes it much easier to see how my stock is doing since I bought it.