New tax rules will require brokers to begin reporting basis and holding period in addition to sales proceeds when you sell stocks and other securities. Regulations implementing this requirement make some changes in the underlying rules for capital gains and losses, and these changes take effect as of January 2011, even though you won’t see basis information on the Forms 1099 you receive in this coming tax season. Here’s a look at how the rules for identifying shares of stock or other securities are about to change.
Background
Identification becomes an issue in situations where you own multiple lots of shares bought at different times and different prices, and you want to sell some of those shares but not all of them. Generally you’re treated as selling your oldest shares first — a system known as first-in first-out, or FIFO — unless you identify the shares you’re selling. Instead of selling the oldest shares, you might want to sell the shares with the highest cost basis, so that you report a smaller gain or larger loss. Or, if you’re reporting a loss, you might want to sell newer shares so you report a short-term loss rather than a long-term loss.
For many years we’ve had rules that permit investors to choose the shares they’re selling in a two-step process. First, you have to tell the broker, at the time of the sale, which shares you’re selling. And second, you have to receive written confirmation of your identification from the broker. This basic arrangement remains in place, but new regulations tweak the rules in some helpful ways.
Timing of lot selection
Your choice of which shares to sell has to be made at the time of sale: you aren’t allowed to wait until the end of the year and match up sales with purchases in the way that produces the best tax result. This basic rule remains unchanged, but the new regulations clarify that you don’t have to identify shares on the trade date. You have until the date of delivery (or, if earlier, the date set by the SEC for delivery). This means that in a normal stock transaction, you’ll have until the settlement date to identify the shares you’ve sold.
Standing orders
We’ve always believed a standing order providing the investor’s preferred method of determining which shares are sold should be acceptable as a method of identification, and the regulations confirm that this is the case. The explanation accompanying the regulations says the broker doesn’t have to accept standing orders, however. We expect most brokers will accept relatively simple standing orders (such as an instruction to always sell the shares with the highest basis), but if you want to use a more complicated rule you may have to apply it yourself with a separate identification for each sale.
Method of communication
The new regulations retain the two-step approach, where identification isn’t complete until you’ve told the broker which shares you’re selling and the broker has confirmed this instruction in writing. As under the old rules, investors may use any reasonable method, including oral communication, to tell a broker which shares they’re selling. The regs provide helpful guidance on the broker’s confirmation, however. They clarify that the confirmation may be delivered electronically, and also provide that a monthly account statement or other periodic document can serve this purpose.
Comment: Share identification requires cooperation from your broker, because you haven’t completed the identification until your broker confirms it. Some brokers have failed to create systems for confirming share identification, effectively precluding their customers from using this tax planning technique. The basis reporting regulations don’t force brokers to adopt procedures for confirming share identification, but they make it easier for them to do so. As a result, we expect the ability to identify shares will become more widespread.
Tags: share identification
