The crackdown has begun: No more basis fudging.
Convinced that taxpayers were overstating the costs of stocks they sold—and thus understating the capital gains—the Internal Revenue Service got a law passed that requires brokers to squeal on their clients. For any stock you bought after Jan. 1, 2011, the IRS will know your cost basis. “Basis,” in tax lingo, is the cost of an asset, adjusted up or down for things like reinvested dividends or the effects of corporate spin-offs.
But what about stocks you acquired before 2011? The onus is on you to keep good records. If you have no evidence to the contrary, the IRS is entitled to assume that your cost was zero and the entire proceeds are taxable as a capital gain.
You also have, of course, a legal obligation to follow all the rules when you fill out Schedule D, the list of gains and losses attached to your 1040 tax return. This in itself is a challenge. The instructions for the form used to be two pages long, but that was before the tax simplification act of 1986. Now it runs to 14 pages.
Don’t panic. Here are six ways to survive the basis nightmare.
Hire some help. Let’s suppose you bought 100 shares of AT&T in 1980 for $5,188. A tangle of split-ups and mergers leaves you holding ten different securities today. How is the original cost basis apportioned to the pieces?
To solve puzzles like this, basis calculation outfits have sprung up. For most taxpayers the best way to get access to their data is subscribe to BasisPro, a service maintained by the Dutch firm Wolters Kluwer. Another service is Netbasis, offered by the Phoenix, Ariz. firm NetWorth Services.
Both of these cost-reconstruction services can handle reinvested dividends—very useful for mutual funds. Both enable you to work backward—useful if you know current share count and when you got in (for example, when a relative died) but not much else.
Donate the stock. For long-term holdings donated to charity, the basis is irrelevant. You ignore the gain and claim a deduction for the current market value.
Give the stock to a low-bracket relative. Youngsters with no other investment income pay no tax this year on long-term capital gains below $1,900. If you have a $1,500 stock position of unknown cost that you want to get rid of, transfer it to your 4-year-old and ask her if she’s interested in selling it. She can cavalierly report the cost at $0 and still pay no tax.
Construct an archive. Your broker probably has cost data going back five or ten years. If you have positions antedating these computerized records, paw through your old brokerage statements while you can still find them and put the trade slips in a safe place.
Check the investor relations department. Let’s say your grandma in Fayetteville bought shares of Wal-Mart Stores at the initial offering and later gave some to you. You now have 20,480 shares and want to sell. What’s your basis? The company’s website shows a split history. Working backward, you can deduce that your position started out as ten shares with a basis of $165.
Hang in there. This is a particularly good choice for anyone whose grandmother lived next door to Sam Walton and invested in his company. Why realize a $1 million gain if you don’t have to? Leave appreciated assets in your estate and your heirs will get a free ride on capital gain taxes.