Cost Basis: Covered Securities and Tax Implications Explained

It’s time to run down the changes we will see this tax filing season and what to expect in 2014 and beyond.

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It’s time to run down the changes we will see this tax filing season and what to expect in 2014 and beyond.

In 2001, the U.S. Government Accountability Office estimated that 38% of taxpayers reporting a security sale incorrectly reported their taxable gain or loss due to an incorrect cost basis, creating an $11 billion tax gap.

Congress included a provision in the Energy Improvement and Extension Act of 2008 requiring brokers to report the cost basis of certain securities to the IRS and taxpayers when a sale occurred. The reporting requirements were rolled out in phases:

  • January 1, 2011: Equities

  • January 1, 2012: Mutual Funds and Dividend Reinvestment Plans

  • January 1, 2014: Fixed-Rate Debt Instruments and Options

  • January 1, 2016: Variable-Rate Debt Instruments and Other Complex Securities

Now, 12-plus years later, we are nearing the final stages of the heightened reporting requirements.

A Work In Progress

Since 2011, sales and dispositions of property are reported on Schedule D and detailed on Form 8949. Six classification buckets are required for sale and disposition transaction details. 

 SHORT TERMLONG TERM
Box A – CoveredBasis reported to IRS
Basis reported on 1099-B
Basis reported to IRS
Basis reported on 1099-B
Box B – Non-coveredBasis NOT reported to IRS
Basis reported on 1099-B
Basis NOT reported to IRS
Basis reported on 1099-B
Box A – CoveredBasis NOT reported to IRS
Basis NOT reported on 1099-B
Basis NOT reported to IRS
Basis NOT reported on 1099-B
 

Understanding the difference between covered securities and non-covered securities is vital for cost basis reporting. A few highlights:


    • Covered securities are security purchases made after the effective dates listed previously. Brokers must track purchase date, purchase price, and holding period for such securities. Covered transactions are classified as short-term or long-term on Form 8949, Box A.
    • Non-covered, or uncovered, securities are security purchases made prior to the effective dates listed (e.g., January 1, 2011, for equities). If a non-covered transaction is reported on 1099-B, the sale is classified as short-term or long-term on Form 8949, Box B. All other non-covered transactions are classified as short-term or long-term on Form 8949, Box C.

    Steps For Now

    • Review tax implications with your tax advisor prior to executing transactions involving security sales.

    • Review your lot selection method (e.g., first-in, first-out for equities or average-cost for mutual funds) to assure a best fit for you.

    • Review the new elections for debt securities with your tax advisor. Notify your broker/custodian whether you plan to make or revoke such elections.

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