GainsKeeper Blog

IRS Final Cost Basis Regulations – Required Basis Adjustments

WALTHAM, Mass. – Oct. 27, 2010 – On Oct. 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 Oct. 15, 2010 available at http://www.costbasisreporting.com).

The cost basis law and the Final Regs include a number of different sets of rules. The core set of rules—the required basis adjustments—relate to the required adjustments to basis and holding period that brokers, transfer agents and others must make in calculating the basis and holding period information (or determining whether gain or loss reported is long-term or short-term) for covered securities. As discussed elsewhere, brokers on Form 1099-B (and transferors subject to transfer reporting) may, but are not required to compute or report basis for noncovered securities.

Brokers (and applicable persons subject to transfer reporting) must make two key sets of basis adjustments under the cost basis reporting law and the Final Regs—basis and holding period adjustments in connection with corporate actions affecting securities and adjustments and loss deferrals relating to wash sales. Basis and holding period adjustments relating to corporate actions and wash sales can be complex and require tracking issuer corporate actions returns and data, and buy and sell activity. A key new aspect of the Final Regs is that a broker or transferor must make corporate action adjustments only for the period they hold a covered security.

Set forth below is our top 10 list of required basis adjustments, related changes and retained rules in the Final Regs:

1. Regs clarify that holding period, not holding date is required for transfer reporting and determining whether gain or loss is long-term or short-term.
2. Wash sale basis adjustments and loss deferrals are not required if an investor has properly notified the broker that he or she has made the active trader Internal Revenue Code Sec. 475 mark-to-market election, but only if the investor’s entire account solely contains assets subject to the mark-to-market election.
3. Brokers must adjust basis of mutual fund (and other regulated investment company, RIC) “load” and sales charges (if load paid on shares sold within 90 days of purchase provides credit or offset for load on other shares purchased during a window and other requirements are met) under Sec. 852(f).
4. Mutual funds (and other RICs) and real estate investment trusts (REITS) can retain undistributed capital gains and require holders to be taxed on the undistributed amounts as set forth in IRS Forms 2438 and 2439. Investors should adjust the basis in their shares for these undistributed capital gains as set forth in Sec. 852(b)(3)(D) or 857(b)(3)(D) and brokers are required to make these capital gain basis adjustments.
5. Brokers are not required to adjust the holding period of covered securities for straddles, the short sale rule of Sec. 1233(b)(2) or hedging transactions under Reg. 1.1221-2(b) when determining whether gain or loss is long-term or short-term. The negative inference of this limited exclusion is that brokers must take into account the short sale rules of Sec. 1233(b)(1) & 1233(d) in determining whether gain or loss is long-term or short-term.
6. Brokers are permitted (but are not required) to optionally adjust for wash sales across multiple investor accounts, take into account substantially identical securities for purposes of computing wash sales, and may also adjust basis and holding period for rules like straddle, constructive sales and passive foreign investment company (PFIC) mark-to-market under Sec. 1296.
7. A broker is not required to reclassify RIC & REIT gains and losses to take into account special rules under Sec. 852(b)(4) or 857(b)(8) that apply based on long-term capital gain distributions and exempt interest dividend distributions received.
8. In determining basis and holding period adjustments as a result of corporate actions, brokers can assume investors are minority shareholders unless broker knows of majority shareholder status.
9. Form 1099s only need to be corrected for 3 years based on revised information.
10. Adjustments for transfer taxes in definition of gross proceeds permitted.

Other basis adjustment related items included in the Final Regs: the proposed rule that currency translation spot rate for transactions converted to US dollars is determined on payment receipt date was retained; the determination of whether the payment receipt date is the date the broker receives payment from customer or the settlement date—the settlement date is treated as the customer payment date if the security is traded on established market; the Final Regs do not include any wash sale de minimis rule; brokers are not required to compute wash sales across stock and dividend reinvestment plan (DRP) identical stock that is subject to an averaging election or across covered and noncovered identical stock; and a broker is not required to compute wash sales or related basis adjustments for previously transferred securities if identical securities are subsequently sold at a loss within the 61 day wash sale period.

There are a number of other important rules in the Final Regs that address issues such as the rules for lot selection and averaging of basis for mutual fund and dividend reinvestment plan shares, the definition of covered securities, 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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