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Get a head start on basis reporting to minimize taxable gain

by on
in Small Business Tax Deduction Strategies

Don’t forget that this is the first year that new “basis reporting” rules take effect for securities sales. In some ways, things will be easier for you. You won’t have to search through your records to find the basis of certain investments.

On the other hand, you may discover you’ll have to pay more tax than you initially envisioned.  

Strategy: Be proactive. By planning ahead, you may be able to minimize the taxable gain on a securities sale or increase the tax-deductible loss.

Under IRS regulations issued last year, the onus is still on you to identify shares of securities you intend to sell.

Here’s the whole story: When you sell securities, you may have a taxable gain or loss based on the difference between the sales prices and your basis. Your “basis” is usually the acquisition cost plus certain adjustments such as broker commissions. Also, basis must be adjusted for events like stock splits and mergers.

The resulting capital gain or loss is long term if you’ve held the securities for more than one year. Otherwise, it’s short term. For 2011, net long-term capital gain is taxed at a maximum 15% federal rate (0% for investors in the regular 10% and 15% ordinary income tax brackets).

Previously, financial institutions reported the amount of proceeds received in a securities sale to the IRS, but not the basis of the shares. The IRS has maintained that investors have magnified their tax benefits by manipulating the adjusted basis of securities. The higher the basis, the lower the taxable gain or the higher the tax-deductible loss.  

New rules: Under a 2008 tax law, financial institutions now must submit information returns to the IRS indicating the basis of securities sold, the amount of the sales proceeds and whether a gain or loss is long term or short term. Investors will receive the same information on their 1099s. These new rules phase in over three years, but they generally apply to sales of stocks acquired after Dec. 31, 2010.

What can you do to improve your tax situation? Plenty. Financial institutions are informing investors about the new rules and establishing procedures. Generally, when you plan to sell shares of securities, you will have choices about which “lot” to sell. Different institutions will allow different options, so you must check with your broker. You might choose one of the following:

  1. Designate specified shares of securities that you wish to sell (e.g., the shares with the highest or lowest basis).
  2. Treat the first shares acquired to be the first shares sold. This is the first-in, first-out (FIFO) method.
  3. Treat the shares with the lowest basis to be the first shares sold by specifically identifying those shares as the ones you sold. This is the worst-in, first-out (WIFO) method.
  4. Treat the shares with the highest basis to be the first shares sold by specifically identifying those shares as the ones you sold. This is the highest-in, first-out (HIFO) method.

If you make no selection, the financial institution must use FIFO as the default method. Once a lot is sold, you can’t change the selection after the trading settlement date.

Tip: Be aware that the new rules apply to acquisitions after 2010. So you’ll still have to determine the basis of securities acquired before 2011.

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