Selling an investment typically has tax consequences. To figure out whether you need to report a gain or can claim a loss after you sell, you need to know the cost basis for that investment.
For stocks and bonds, the cost basis is generally your purchase price for the securities, including reinvested dividends or reinvested capital gains distributions, plus additional costs such as the commission or other fees you paid to complete the transaction. This information is usually provided on a confirmation statement sent to you by your brokerage firm after you purchase a security.
You’re responsible for reporting your cost basis information accurately to the IRS, in most cases by filling outForm 8949.
Understanding cost basis could help you steer clear of costly consequences. For example, let’s say you bought a stock investment for $1,000 and sold it for $1,500 two years later. And let’s say the stock paid dividends of $100 in year one and $300 in year two, and you reinvested these dividends, making the adjusted cost basis $1,400. Your taxable gain would be $100 ($1,500 – $1,400) instead of a much higher $500 ($1,500 – $1,000) if you didn’t factor in the reinvested dividends.
While this is a relatively simple example, computing cost basis can get complicated. But you’re not totally on your own—brokerage firms, mutual funds and others are required by law toreport the cost basis of shares purchased by investors.
Brokerage Firm Responsibilities
The IRS provides FAQs about the cost-basis information brokerage firms and other financial institutions must provide. For example, brokerage firms must report cost basis and the type of capital gain (short-term or long-term) on Form1099-B for the sale of stocks, bonds, options and other securities depending upon their purchase date.
Investors should receive a copy of any 1099-B from their brokerage firm by February 15 for the previous tax year. Review this information as soon as you get it. Check that the amount of cost basis your firm reports to the IRS matches your own records—and if the amounts differ, contact the firm immediately.
There may be situations where a firm isn’t required—or able—to provide a cost basis for a sale, such as if the securities you sold were purchased or transferred from one firm to another prior to reporting requirements established in 2008.
If you have questions about what sales are reportable by your brokerage firm, contact your financial professional. Many firms also have a section on their website explaining cost basis and the specific cost-basis information they provide to their customers.
4 Recordkeeping Tips
While brokerage firms have cost-basis reporting obligations, it's still important for you to keep good records of your transactions. Follow these tips:
- Keep an electronic or printed copy of your trade confirmations showing how much you paid for specific shares.
- Keep track of stock dividends or non-dividend distributions you receive, because they may affect the cost basis of your shares.
- If you purchased stock of a company at different times and prices and can adequately identify the shares you sold, their basis is the cost for those specific shares. If you can’t determine exactly which shares you’re selling, tax rules generally require you to calculate a gain or loss as if you’re selling the earliest acquired shares (sometimes referred to as the "first in, first out" method).
- If you received the securities as a gift or through an inheritance, you might have to find out what the fair market value was when it was given to you or the previous owner's adjusted basis.
IRS Publication 550 offers detailed guidance on how to calculate cost basis under different circ*mstances. It's also sound practice to consult with a tax professional when computing and reporting a gain or loss.
The bottom line is that the IRS expects you to maintain records that identify the cost basis of your securities. If you don’t have adequate records, you might have to rely on the cost basis that your brokerage firm reports—or you may be required to treat the cost basis as zero, which could mean owing more in taxes. For this reason, consider checking whether you have cost basis information for securities you want to sell before doing so.
