The new investment cost basis rules should simplify tax accounting, although they may also leave investors facing some difficult decisions. But at least you’ve had fair warning from financial institutions and the media.
Still, the impact on “wash sales” might catch you by surprise. The wash sale rule prevents you from deducting a tax loss on the sale of securities if you acquire substantially identical holdings within 30 days of the sale, and it applies to purchases both before and after a sale. But the amount of any disallowed loss is added to the basis of the new securities you’ve acquired. That silver lining reduces your taxable gain or increases your deductible loss on a future sale.
For purposes of this rule, the stock of different companies isn’t considered to be substantially identical except in cases of a reorganization or merger. The rules for mutual funds aren’t as clear, though replacing shares with those of another fund within the same family may result in a disallowed loss.
Under the new cost basis rules being phased in over three years, financial institutions must report the cost basis and other information relating to securities transactions on the Form 1099s they send to you—and to the IRS. These rules apply to stocks, American Depository Receipts, real estate investment trusts, and exchange-traded funds acquired after 2010; mutual fund and dividend reinvestment plan shares acquired after 2011; and other securities—including options, fixed-income instruments, and debt instruments—bought after 2013 (after being postponed for one year).
The new rules should make it easier to figure out the tax consequences of your securities transactions. However, you’re now required to choose a cost basis method at the time of the transaction rather than when you file your taxes. If you don’t indicate another choice, the “first-in, first-out” (FIFO) method generally will be used as a default, although your broker could opt for the “average cost basis” method as the default for mutual fund shares.
In addition, financial institutions now must monitor wash sales for some securities transactions. For stocks, the rule applies only when the same securities are repurchased within the same account. But you could run into complications when you sell mutual fund shares at a loss if dividends from those fund shares have been automatically reinvested within the 30-day period. You may be surprised to find 1099s rolling in next year with reports of wash sales you didn’t even know had occurred.
To avoid problems, keep a close watch on transactions to see whether a wash sale has been triggered. You can rely on us for guidance.