Cost Basis: Noncovered & Covered Securities Tax Implications

Getting ready for tax season? It’s time to take a look at cost basis and make sure you’re covered when it comes to correct reporting.

Back in 2001, the U.S. Government Accountability Office (GAO) estimated that 38% of taxpayers who reported a security sale incorrectly reported their taxable gain or loss. Why? Because they used an incorrect cost basis. These miscalculations created an $11 billion tax gap.

Congress included a provision in the Energy Improvement and Extension Act of 2008 that requires 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 equities purchase under dividend reinvestment plans
• January 1, 2014: Fixed-rate debt instruments and options
• January 1, 2016: Variable-rate debt instruments and other complex securities

The heightened reporting requirements are now fully in effect.

Covered and Noncovered Securities

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. 

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

• Covered securities are security purchases made after the effective dates listed above. Brokers must track the purchase date, purchase price, holding period for such securities, and any required adjustments to the cost basis. Covered transactions are classified as short-term (Box A) or long-term (Box D) on Form 8949.
• What is a noncovered security? These are security purchases made prior to the effective dates listed (e.g., January 1, 2011 for equities). If a noncovered transaction is reported on 1099-B, the sale is classified as short-term (Box B) or long-term (Box E) on Form 8949. The proceeds only (no basis) are reported to the IRS by the broker. All other noncovered transactions are classified as short-term (Box C) or long-term (Box F) on Form 8949, and neither the proceeds nor basis are reported to the IRS by the broker.

Next Steps

• Review tax implications with your tax advisor before 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 ensure the best fit for you.
• Review the new elections for debt securities with your tax advisor. Notify your broker or custodian if you plan to make or revoke such elections.

Tracking Cost Basis with GainsKeeper

Computing your taxable gains and losses hinges on adjusted cost basis and holding periods. The GainsKeeper platform helps track your trading capital gains and losses throughout the year by automatically adjusting your cost basis and gains/losses for all trades, wash sales, and corporate actions (such as splits).

You may have noticed changes in the way TD Ameritrade calculates, tracks, and adjusts cost basis for fixed-income securities. Enhancements to GainsKeeper are available to help you comply with federal regulations and report cost basis for options and fixed-income securities acquired on or after January 1, 2016.*

Cost Basis Adjustments 

GainsKeeper will display the fixed-income adjustments to cost basis that brokers are required to make. These include:

• Original issue discount (OID)
• Bond premium
• Market discount
• Acquisition premium

*Please note that not every fixed-income security acquired starting January 1, 2016 will be required to report cost basis; some fixed-income securities will be excluded. For more information, please call a TD Ameritrade Fixed-Income Specialist at 800-934-4445. Watch for additional tools and resources in the Tax Center. Log in to tdameritrade.com > My Account > Tax Center.

This article is an update of the original “Cost Basis: Covered Securities and Tax Implications Explained,” published on January 13, 2014.

TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.