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Heed the new cost basis rules

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in Small Business Tax,Small Business Tax Deduction Strategies

Do you notice anything different on your 1099-Bs this year? For the first time, securities brokers must provide cost basis information for “covered securities.”

Strategy: Use new Form 8949, Sales and Other Dispositions of Capital Assets, to report your securities transactions from 2011. Then you must summarize the information on Schedule D.

These changes result from recent legislation that phases in new cost basis reporting rules over a three-year period.

Here’s the whole story: Previously, it was your responsibility to provide the IRS with the cost basis of any securities you sold during the year. But it was often difficult, if not impossible, to find the vital information for securities acquired long ago. On the other hand, you had some leeway in claiming which shares were actually sold if you held multiple shares of the same security.

Emergency Economic Stabilization Act

New rules included in the Emergency Economic Stabilization Act, which phase in over three years, end the guesswork. The 2008 law changes require brokers to report the cost basis information on Form 1099-B, but only for securities acquired after a specific date. The new cost basis reporting rules are effective for securities acquired on or after:

  • Jan. 1, 2011, for stocks, American Depository Receipts (ADRs), real estate investment trusts (REITs) and exchange-traded funds (ETFs) taxed as corporations;
  • Jan. 1, 2012, for mutual funds (including most ETFs) and dividend reinvestment plans (DRPs); and
  • Jan. 1, 2013, for all other remaining securities (e.g., options, fixed income instruments and debt instruments).

If you did not select a cost basis method that identifies the shares of covered securities you sell, your broker will use a default method. The default for stocks acquired after 2010 is the first-in, first-out (FIFO) method.

Example: You bought 100 shares of Uno Corp. stock on Feb. 1, 2011, at $10 a share. Then you bought another 50 shares of Uno on July 1, 2011, at $15 a share. Finally, you sold 50 shares of Uno on Dec. 1, 2011, at $18 a share.

Under the FIFO method, you have a taxable gain of $400 ($18 a share – $10 a share x 50 shares). If you had identified the shares you sold as coming from the last batch of shares you bought (the ones you acquired on July 1), your taxable gain is only $150 ($18 a share – $15 a share x 50 shares).

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