If you own stocks or are thinking of owning stocks in 2011, you have new tax accounting methods available to you courtesy of the IRS. The good news is that the discount brokers will be responsible for keeping track of all your stock purchases and sales starting this year.
Brokerage firms already report the sales proceeds from stocks to the IRS. Now the brokerages will be required to report the purchase price, known as the cost basis, of all stock purchases. This also means you’ll need to know how to calculating cost basis for stock at the time of sale.
Your Tax Lot ID And You
Each time you purchase a stock, that position is given a tax lot id, even if you already own shares of the same stock. A tax lot simply is a record of a securities transaction and its tax implications, including the purchase date and number of shares.
If you purchased any new stocks this year, those purchases were given tax lot ids, allowing the IRS to track your exact profit or loss from that lot of stocks when you decide to sell them. Prior to this change brokerages only recorded the sales of stocks, the only way the IRS would know exactly how much you profited or lost from a stock sale was through an audit. You won’t be able to intentionally forget the purchase price of a stock at tax time to lower your taxes.
Tax Lot ID Methods
Things get a little tricky if you buy multiple tax lots of the same stock. For instance, if you buy 100 shares of stock XYZ at $10 and another 100 shares of stock XYZ at $13. After a few months, stock XYZ is at $15 and you decide to sell 100 shares to lock in some profits. You now have a decision to make, you could pay taxes on the profits from the $10 shares ($500 profit) or on the $13 shares ($200 profit). I’d rather pay taxes on the $13 shares, but it will depend on the tax lot ID method you have in place at the time of sale.
There are several tax lot id methods and depending on which one you use at the time of sale, you could pay significantly more or less taxes at the end of the year.
- First-in, First-out (FIFO) – sells the the tax lot you bought first.
- Last-in, First-out (LIFO) – selects the most recently bought tax lot for sales.
- Highest Cost – selects the highest price tax lot for sales.
- Lowest Cost – selects the lowest price tax lot for sales.
- Specific Lot – you choose the specific lot at the time of the sale or, at the latest, by the settlement date of the trade.
If you don’t specify which tax lot id method your using when you sell a stock, FIFO will be used by default, even if it’s not the best method. You may want to change the default tax lot ID method or choose which method to use at the time of each stock sale.
When the end of 2011 rolls around, you won’t be able to sit down, do your taxes and looking back on the year, decide which tax lots you would have used for each sale. That will have to be done at the time of sale for each stock.
Other Changes Coming In 2012 And Beyond
Feeling a bit left out because you don’t own stocks, the IRS has thought of you as well. Starting in 2012, brokerages will be required to report the cost basis for mutual funds and most ETFs. The same rules take effect for options and fixed income securities that are purchased after January 1, 2013.