25 Mar How to find your cost basis for capital-gain taxes
By EVA ROSENBERG
Los Angeles – March 25, 2011 – Taxpayers report billions of dollars’ worth of capital gains each year, and assessing the tax owed on those gains can be a headache.
In 2008, more than 11 million tax returns showed long-term capital gains worth over $530 billion, according to the IRS. And that’s a year when the stock market took a beating. I wonder what that total will be for 2010, when the stock market was in recovery mode?
Taxpayers in the zero to 15% tax brackets may get a windfall — they’ll owe nothing to the IRS on those capital gains. Taxpayers in higher tax brackets will pay no more than 15% on their capital gains. Those terrific rates are still available in 2011 and 2012. Naturally, there are exceptions to those rates for certain sales of real estate (25%), collectibles (28%), and small-business stock (25%).
These rates produce nice surprises when people are working on their 2010 tax returns, expecting big tax bills. Playing around with the numbers, a taxpayer with wages of $25,000 and capital gains of $20,000 would not pay $1 to the IRS on those capital gains. Capital gains of $30,000 would cost $800 (a rate of about 2.7%). Meanwhile, $50,000 in capital gains generates about 11% tax on the capital gains, or about $5,500; $100,000 is taxed at a rate of about 13%; and $1 million costs about 15%. Not bad.
What does this suggest to you? It’s time to do some tax planning for this year and next, to sell off some of those appreciated securities and other assets. Have you tested the numbers on your own portfolio to see how you can benefit? Too often people miss out on tax breaks because they meant to do something, but they were too busy and time ran out.
Remember to take into account your state tax rates when you do this planning. They may not be as favorable.
Are you ready to cash in, but can’t figure out the gains? That should be no problem. After all, the IRS has mandated that financial institutions must issue 1099-Bs (showing proceeds of sales) with the cost basis, not just the amount of the proceeds. This applies to all sales taking place in 2011.
Well, that’s a no-brainer. Or is it? According to Nico Willis, chief executive of NetWorth Services Inc. in Arizona, it’s not that easy. Willis said financial institutions can’t make up the basis out of thin air. They only have the information in their records since the securities were on their books.
Determining the basis of securities that were bought and sold at the institution should be relatively easy. After all, records of transactions and reinvested dividends can be produced. However, you might have made certain elections with respect to your sales, without notifying your brokerage. For instance, if blocks of securities were sold over the years, Willis points out that the institution may not have a record of which block of securities was designated as being sold. You may have opted to sell more recently purchased shares, rather than older shares, to control the amount of gain or loss you needed at the time.
Sophisticated investors, traders and day traders have learned to maintain complex spreadsheets and records of their stock transactions. The large brokerages historically have maintained staff to painstakingly compute the basis history by hand. Time-consuming work.
Casual investors can use a number of tools to help build a good database of their investments. You can set up your own spreadsheet, either on paper or using software. That may not be necessary. Most financial institutions provide online access to your accounts. You no longer need to rely on your broker to keep your information up-to-date. You can enter your transactions and record your own splits and basis adjustments. Some brokerages have integrated Gainskeeper®, a Wolters Kluwer trading tool, into your account. One of the nifty things about Gainskeeper® is that some of the major software providers can import their reports directly into the tax return.
Not a clue
One of the biggest stumbling blocks to selling appreciated assets is that some investors don’t know how to compute their gains. This befuddlement arises for a variety of reasons.
Perhaps the assets were gifted to you and you never knew the basis held by the person who gave them to you. Or you’ve held the assets for decades and have lost the records about the original purchase, splits, reinvestments or other things that might have happened to the stock. Perhaps the original financial institution that you were counting on to have the records no longer exists, or has changed hands.
What do you do? Can’t you simply contact shareholder relations of the company whose stock you own and ask them for the basis of the shares you’re holding? You would think that if you have the physical stock certificates, rather than owning the stock in street name, shareholder relations should be able to look up your account.
But, Willis said, some companies may not have your records. Or they may have records going back only so many years. Many corporations have outsourced these shareholder relations to transfer agents. Transfer agents may be able to help you reconstruct some records. Read more about transfer agents on this SEC page.
If they can’t, you can go online and dig into the history yourself. You can follow the stock from the approximate date or year of purchase to the present. Compute all the splits, reverse splits and reinvested dividends. It helps if you know the original number of shares purchased, and if any shares were sold. (Having the stock certificate in hand is a clue.)
You can look back at old tax returns. Unfortunately, the IRS is not likely to be able to produce copies of tax returns more than 15 or 20 years old. But you can try to get them. You need actual copies. To get copies of tax returns, use Form 4506. Each copy costs $57. While transcripts are free, the transcripts of the tax returns won’t help you. They are not apt to contain the details you need about the reinvested dividends. But it doesn’t hurt to take a look. Use Form 4506-T.
The IRS knows that sometimes you cannot get a perfect answer to the basis issue of older stocks or securities. They expect you to do your best, based on the “prudent man” rule of common law. To protect yourself in these situations, be sure to include a statement with your tax return containing very specific information about how you arrived at your basis. Attach a worksheet explaining your calculations.
Some tax professionals might say that’s overkill. Why is it wise to include it? Because if you are off, and your errors result in a 25% or more reduction in your taxes for the year, the IRS can audit you for up to six years, instead of three years. When you provide full disclosure, even if your understatement is over 25%, the IRS audits are limited to three years.
If you can’t reconstruct the records, Willis’s team may have the answer for you, though the service is not free. NetBasis.com contains over 190 GB of stock history, going back as far as 1925.
Eva Rosenberg is the founder of TaxMama.com and an enrolled agent licensed to represent taxpayers before the IRS. Visit her new website at TaxMama.com.