As 2017 came to a close, many investors made last minute choices regarding the sale and purchase of various securities. From tax loss harvesting to rebalancing and profit taking after the prolonged market rally, the record keeping associated with the execution of taxable transactions in non-retirement accounts is usually pretty simple. That’s because in 2011, a new rule required investment custodians or brokers to report the adjusted cost basis and whether any gain or loss on a sale is classified as short-term or long-term from the sale of "covered securities" on Form 1099-B, thus easing the burden placed on investors. Despite this rule, it is often inevitable that an investor either sells securities that were purchased prior to 2011 or sells shares acquired through other means that are missing cost basis information.
Despite the fact that it is not necessarily uncommon for some taxpayers to be missing cost basis information, it is important to remember that it is ultimately your responsibility to keep careful records. According to Christine Darcy, CPA at Darcy & Connolly CPAs in Spring Lake Heights, NJ, “Taxpayers should keep in mind that the IRS expects you to keep and maintain records that identify the cost basis of your securities. We recommend taxpayers hold onto trade confirmations and also keep track of reinvested stock dividends.”
So, what exactly should a taxpayer do when they are missing cost basis information? First, it’s important to understand that cost basis reconnaissance can be a time-consuming process, which is why it may be a good idea to get started on the process well in advance of the tax filing deadline. A great place to start is usually with the last known investment firm or transfer agent. While they may have to access their own archives, it may be possible to locate the information you are looking for by tracing the purchase back to the original firm the security was purchased through.
Alternatively, if you were not the originally purchaser of the shares, as is the case if share were gifted or inherited, you may need to follow a different approach. For example, if you were the recipient of gifted shares, the cost basis will need to be traced back to the original donor. Generally, valuing gifted stock for tax purposes is based upon the donor’s cost basis and holding period. According to the IRS, to figure out the basis of property you receive as a gift, you must know three amounts: The adjusted cost basis to the donor just before the donor made the gift to you, the fair market value (FMV) at the time the donor made the gift and the amount of any gift tax paid on Form 709 if applicable.
If the fair market value at the time the donor made the gift is equal to or greater than the donor's adjusted basis before the gift, your cost basis is the donor's adjusted basis at the time you received the gift. For example, lets assume you received a gift of stock from a parent. If they had purchased the stock for $20 and gifted it to you when it is worth $30, your basis would be $20 per share and your holding period would be based upon when your parent originally purchased the shares. Sell the stock for $35 and you may realize a gain of $15 per share. If you later sell the gifted stock for $15, you could realize a $5 loss.
Alternatively, If the fair market value of the asset at the time of the gift is less than the donor's adjusted basis, your adjusted basis depends on whether you have a gain or loss when you dispose of the asset. For example, let’s assume that your parent bought the stock for $20 but gifted it to you when it was only worth $15 per share. Let’s assume you sell the stock after it declines further to $10 per share. In this case your loss would be $5 per share ($15 - $10) and your holding period is based upon the date the shares were gifted.
Finally, if you sell the stock at a price between the donor’s basis and the fair market value on the date of the gift when it is gifted for less than the donor’s basis. According to the IRS, if you use the donor's adjusted basis for figuring a gain and get a loss, and then use the fair market value for figuring a loss and get a gain, you have neither a gain nor loss on the sale or disposition of the property.
Despite all the changes in the new tax bill, the step-up in cost basis at death remains. When assets are inherited, the cost basis is stepped-up to the value on the date of death (or six months later if alternate valuation is used). For example, let’s assume that a parent leaves a stock to their child. The stock was originally purchased for $10 per share and is valued at $50 on the date of death. In this case, the cost basis is “stepped up” to $50, essentially extinguishing the $40 per share gain. Keep in mind, estate and inheritance taxes could still apply.
This highlights the importance of maintaining records of the value of all assets on the date of death for beneficiaries. From individual stocks to real estate, obtaining a snapshot of asset values on the date of death is critical. In the case of real estate or other non-publicly traded assets, it is often advisable to obtain an appraisal on values.
So, what should be done if you are missing records? Darcy add, “In the absence of good records, we would suggest a taxpayer attempt to recreate the basis with historical data related to stock values at the time of original purchase and adjust for any increases or decreases to basis. In an audit situation, if the IRS agent determines your calculation is reasonable they may accept it, however the IRS may also require you to treat your basis as zero in the absence of acceptable documentation.”
Obtaining historical quotes via www.bigcharts.com or finance.yahoo.com can help. Consider working with your accountant and be sure to print documentation to substantiate the methodology if you are ever audited. The information above is not intended to be substitute for specific tax advice so consider speaking to your accountant and reviewing Publication 551 - Basis of Assets to determine the most appropriate approach for you.
Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.