It’s a Cost Basis Retirement

05 December 2011

Just when you thought retirement was the time to relax and let the mind unwind a little, the tax code kicks in. Last week, I gave a tax planning seminar last week to our clients. The most-discussed slide was dealing with the new cost basis reporting that started this year with stocks, and continues next year with mutual funds and exchange-traded funds (ETF). I was surprised that this slide got the most attention, but happy as well since the ramifications could be big, particularly for those in retirement.

The new law is pretty simple. It requires custodians (brokerage firms) to start tracking the cost basis (what you paid for the investment) for all new stock purchases as of January 1, 2011, and all new mutual fund, dividend reinvestment plan (DRIP) and ETF purchases starting January 1, 2012. This is important on many levels:

1. Until this law, you were required to report your cost basis and purchase date to the IRS upon the sale of an investment; in the future, the custodian will submit that information for you on form 1099-B at year-end. This will save everyone a lot of time digging up records.
2. As mentioned above, the law starts with new purchases. Anything purchased before these dates (even if you inherited or are gifted something) will not be tracked by most custodians.  Some custodians, like Schwab, are allowing old data to be put into their system, but it might still be up to you to track down what grandma paid for the 10 shares she just gave you. Ask your advisor if they will help track these uncovered securities.
3. Custodian data now reigns supreme. The IRS is going to rely on what a custodian reports; if you want something different than that, you have a limited time to change it. Limited is the key word―you have until the settlement date (trade date plus three days for individual stocks; trade date plus one day for mutual funds) from when you sell/gift a security to decide which lot you want to work with,  and once you make that decision, you must request that the custodian code that specific sale or gift appropriately. (Some custodians will likely allow you to do this online, while others might need you to call in since this is a fairly new law.) If you rely on the custodian’s default, the "average cost basis" method will likely be used, and it might not be as tax advantageous. This is a big issue for two reasons:
   1. If you are trying to sell specific lots to reduce your tax bill, you will need to make that distinction with the custodian on each sale. If you go past the settlement date, there will be no turning back.
   2. If you are trying to gift specific lots, whether to heirs or to charity, to affect certain tax issues (usually people want to gift the shares with the most unrealized capital gain so they do not have to pay the tax down the road) you will also need to make this decision by the settlement date. Again, there is no turning back after that.

This will be a big change for many who previously just relied on their accountant to tell them what to do. By the time most people see their accountant for tax planning, it will be too late. For retirees who do a lot of gifting, do not wait until December 31^st to get it done. Instead, aim for December 15^th so you have time to think through the logistics. Bring your advisor into the discussion early so they have time to figure out the best tax method. More than ever, a good outcome for most retirees will be in the planning.

About Jon T. Meyer, CFP®