IRS Cost Basis Reporting Frequently Asked Questions
What is cost basis reporting?
Under the Internal Revenue Service (IRS) regulations financial institutions are required to report the adjusted cost basis of covered securities to the IRS on
Cost basis refers to the price, including fees, at which you purchased a security, adjusted for corporate changes. Stock splits would be one example.
What is a covered security?
The IRS defines a covered security as any security purchased or acquired for cash on or after specific effective dates. A security is also considered covered if it is transferred to a subsequent account from another account in which it was a covered security. The effective dates are as follows:
- Equity securities purchased or acquired on or after January 1, 2011
- Mutual funds and dividend reinvestment plan shares (DRIPs) purchased or acquired on or after January 1, 2012
- Simple debt securities, options, rights and warrants purchased or acquired on or after January 1, 2014
- Certain complex debt securities purchased or acquired on or after January 1, 2016
What is a simple debt security?
Simple debt securities include:
- fixed-rate bonds
- original issue discount (OID) bonds
- zero coupon bonds
What is a complex debt security?
Complex debt securities include:
- Instruments that do not have a fixed yield and fixed maturity date
- Instruments that provide for more than one rate of stated interest (e.g., stepped interest rates)
- Zero coupon bonds which convert to interest paying bonds
- Convertible debt
- Stripped bonds or coupons
- Instruments that require payment of principal or interest in a non-U.S. currency
- Certain tax credit bonds
- Instruments with a payment-in-kind feature (where the instrument may be redeemed for additional debt of the issuer)
- Instruments of a non-U.S. issuer
- Instruments issued as part of an "investment unit" (i.e. investments with more than one component such as a forward contract combined with a bond)
- Contingent payment debt instruments
- Variable rate debt instruments
- Inflation-indexed debt instruments
Debt Security Elections
What are the default elections for debt securities?
For simple debt securities purchased on or after January 1, 2014, it will be assumed the client has made the following elections:
- Current amortization of taxable bond premium
- Deferred inclusion of market discount as income to the date of sale or redemption
- Computation of market discount accruals under the straight line method for bonds acquired between 1/1/2014 and 12/31/2014 and the constant yield method for bonds acquired on or after 1/1/2015
May I choose to use election methods different from the IRS default election methods?
Yes. You may choose to use different election methods related to the calculation of amortization and/or accretion of debt securities held in your account. According to IRS regulations, this will require written notification by you to your financial professional. Once your financial professional receives this notification, the election methods can be changed. It is recommended that you speak with your personal tax advisor as Wells Fargo Clearing Services, LLC cannot provide tax advice to clients. Note: Changing this election with Wells Fargo Clearing Services, LLC does not constitute changing the election with the IRS.
What if I choose to not make any different cost basis elections for debt securities?
If no different election methods are chosen and presented to your financial professional in writing, the calculations of cost basis for covered debt securities will be made in accordance with the IRS default election methods.
Do the cost basis calculations on debt securities that I held prior to January 1, 2014 now change to the new default elections?
No. Election and/or default methods for debt securities purchased prior to December 31, 2013 will not change. However, if you do want to change the election methods already in place, it will require written notification by you to your financial professional. Once your financial professional receives this notification, the election methods can be changed. Note: Changing this election with Wells Fargo Clearing Services, LLC does not constitute changing the election with the IRS.
Where can I find more information on elections related to amortization of bond premium and accretion of discount?
You can find more information in IRS Publication 550 entitled Investment Income and Expenses (Including Capital Gains and Losses). This publication discusses requirements and available elections for amortization of premiums and accretion of discounts on debt securities and is available at irs.gov/publications/p550. You can also contact your financial professional for more information. It is very important to review your elections with your tax advisor, or consult this IRS publication, to help ensure your elections are consistent with the regulatory requirements.
Tax Lot Relief Methods
What is a tax lot relief method?
A tax lot relief method determines which lot of stock or securities - and its associated cost basis - is used in computing the gain or loss on a sale and whether that gain or loss is long- or short-term.
How many tax lot relief methods are available from which clients can choose?
There are eight available tax lot relief methods from which clients can choose as their standing tax lot relief method. These methods are as follows: FIFO (First In First Out), LIFO (Last In First Out), HIFO (Highest In First Out), LOFO (Lowest Cost First Out), HCST (Highest Cost Short Term), HCLT (Highest Cost Long Term), LCLT (Lowest Cost Long Term), and LCST (Lowest Cost Short Term).
What does designating a specific tax lot relief do?
The designation of a specific tax lot relief method on an account acts as a standing order, of sorts, that automatically determines the order in which specific positions are sold. For example, if an account has a FIFO (First In First Out) designation, the positions that were purchased first will be sold first. If an account has a LIFO (Last In First Out) designation, the positions that were acquired most recently would be the first to be sold.
What if I don't designate a tax lot relief method when opening a new account?If you don't designate a specific tax lot relief method, the account will be set up using the firm default of FIFO (First In First Out) consistent with federal regulations.
Will I be able to designate a specific tax lot relief method for existing accounts?
All accounts opened prior to January 1, 2011 were opened using the firm's FIFO (First In First Out) default method unless the client specifically requested a different method. If you wish to designate a different tax lot relief method for any of your accounts, please contact your financial professional.
If I want to designate a specific tax lot after a trade is executed, is there a deadline to correct the trade/reporting information?
If the incorrect lot of a security is sold, you have until settlement date (T+1) to notify your financial professional to correct the trade. After settlement date, the trade will stand as is.
What happens if I don't realize that the incorrect tax lot of a covered security has been sold until after settlement date?
IRS regulations clearly state that specific share designation must be made by settlement date of the closing transaction. After that time, the trade must stand as is.
More questions? Please contact your financial professional.
Wells Fargo Clearing Services, LLC and its Affiliates do not provide tax or legal advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed.