If you sold stock or mutual fund shares in 2012, the Form 1099-B
provided by your mutual fund company or brokerage may have a new
look. A new IRS rule requires financial-services firms to track the
cost basis of their customers' shares in stocks, funds and other
investments. Your cost basis is the price you paid for your shares,
plus any reinvested dividends, capital-gains distributions, sales
commissions and transaction fees. When you sell shares, your cost
basis determines the amount of your taxable gain or tax-saving
The requirement is being phased in gradually. For stocks, the
new rule affects shares purchased on or after January 1, 2011; for
mutual funds and most exchange-traded funds, it's limited to shares
purchased on or after January 1, 2012. The requirement will be
expanded to include bonds and other investments purchased in 2014.
Securities in retirement accounts and other tax-deferred
instruments won't be affected.
QUIZ: Is It Tax Deductible?
Many financial-services firms have voluntarily provided
cost-basis information to their customers for years, but they
weren't required to share it with the IRS. Now the feds will get
the same report you do. If those cost-basis numbers don't match
what you report on your tax return, you'll probably hear from
Cutting through the confusion. When it comes time to report the
sale of shares of a stock or mutual fund, you'll no longer have to
hunt through old documents to figure out how much you paid for the
shares. The new disclosure rule could also help you avoid past
costly mistakes. For example, fund investors often forgot to
include reinvested dividends when they calculated their basis. That
resulted in dividends being taxed twice--first when they were paid
out and reinvested, and later when they were included in the
proceeds of the sale.
In the short term, though, the new rule is likely to cause a lot
of confusion. Most long-term investors with taxable accounts will
have two types of securities: covered shares, which are subject to
the new rules, and uncovered shares, which were purchased before
the rules took effect (and for which you may still need to search
through your files to establish a basis). If you sold shares in a
fund you purchased before 2012 that included dividends and capital
gains reinvested in 2012, you could end up with both covered and
uncovered shares in the same investment.
Taxpayers, or their preparers, will have to distinguish between
covered and uncovered shares on their tax returns by filling out
separate Form 8949s for the two types of securities. Then they can
use the information from these forms to complete Schedule D.
Choosing a method. You may have already received a notice from
your brokerage or mutual fund firm asking you to select a preferred
cost-basis method. The notice typically explains the firm's default
accounting method, along with a description of other options
offered by the company.
For most investors, the method known as specific share
identification offers the most flexibility and potential tax
savings. You could sell the shares for which you paid the highest
price, thus generating the lowest possible tax bill.
You have two other choices: First-in, first-out, or FIFO, lets
you sell shares in the order in which you purchased them. Average
cost instructs the company to add up everything you've invested in
the fund and divide the total by the number of shares you own to
come up with your cost basis. Both methods are straightforward and
require less record keeping than specific share identification, but
they're not necessarily the most tax-efficient. For example, if the
price of your shares has increased significantly since you bought
them, using the FIFO method would unload the lowest-priced shares,
thereby increasing your taxable capital gain.
For most mutual fund companies, the default method for investors
who don't make a selection is average cost; for stocks, it's
usually FIFO. If you prefer another method, you need to be
proactive--especially because once you have used the average-cost
method to sell covered shares in a particular fund, you lock in
that basis for any remaining shares in the fund.