GainsKeeper Blog

IRS Final Cost Basis Regulations – Significant Rules for Lot Selection and Averaging of Basis for Mutual Fund and Dividend Reinvestment Plan Shares

WALTHAM, Mass. – Oct. 26, 2010 – On October 12, 2010, the IRS issued the final cost basis reporting regulations (TD 9504) and related Notice 2010-67 (the Final Regs and the Notice—both documents are available at http://www.costbasisreporting.com). The Final Regs do not delay any of the effective dates relating to cost basis reporting and almost all of the key aspects of the proposed rules that create compliance complexities for brokers and cost basis systems were retained. However, some transferors of stock may delay transfer reporting due to IRS penalty relief set forth in Notice 2010-67 (the scope of the penalty relief is discussed in a separate article dated October 15, 2010 available at http://www.costbasisreporting.com).

The cost basis law and the Final Regs include a number of different sets of rules, including rules under Internal Revenue Code Sec. 1012 for determining lot selection or “lot relief” (which in turn determines the basis of the shares deemed sold) and basis averaging for mutual fund and dividend reinvestment plan (DRP) shares.

Brokers, transfer agents and other securities industry participants raised a number of comments and requested changes to various aspects of the proposed rules relating to lot selection and averaging. Many of the requests were rejected in the Final Regs.

Set forth below is our top 10 list of lot selection and basis averaging related changes and retained rules in the Final Regs:

1. Settlement date selection cutoff retained
2. Taxpayer can select an agent to pick lots & method
3. Written confirmation could be a monthly statement
4. 10 percent minimum dividend reinvestment for DRP retained
5. Lot selection is not a method of accounting and changing is not a change of method
6. DRP stock remains identical to same CUSIP stock except while averaging
7. Intra-day averaging if single confirm unless investor elects out
8. Investors failure to notify broker of a lot method is not an election of a method
9. If averaging is broker default method, taxpayer’s method change is prospective
10. Averaging election could cover multiple securities in multiple accounts

Additional changes relating to lot selection and averaging that were included in the Final Regs: brokers must generally deplete shares with unknown acquisition or purchase date first; DRP reinvestment includes distributions that are not dividends; transition rule effective date from double category extended to April 1, 2011; investor’s election can be electronic; separate acct. rule for DRP & RIC stock acquired before Jan. 1, 2012 eliminated; single account election only applies to accounts with same ownership (e.g., sole versus joint); and revocation of averaging voids the single account election—pre-election basis info must be retained for as long as taxpayer can revoke—noncovered stock that became covered due to single account election returns to noncovered after election is voided but remains covered after election is prospectively changed.

There are a number of other important rules in the Final Regs that address issues such as the determination of whether securities are covered securities, required basis and holding period adjustments that brokers must take into account in reporting basis on Form 1099-B (including wash sale and corporate action adjustments), rules for short sales, transfer reporting, and issuer corporate action reporting. Issues relating to these rules under the Final Regs will be discussed separately.

We will provide additional commentary relating to the Final Regs and other aspects of the cost basis reporting law at later dates.

Stevie

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