New Cost Basis Rule

Summary Points

• A new rule that takes effect in 2011 will make it easier for investors to track their cost basis, which usually starts with how much they paid for a security or a fund.
• Effective over a three-year period, the cost basis of a traded investment will be included on Form 1099-B and will also be reported to the Internal Revenue Service (IRS).
• Tracking cost basis is important because it is used to determine whether an investor incurs a capital gain or a capital loss.

There's an old saying in investing that it's not how much you earn but how much you get to keep that really matters. To know how much you get to keep, it's important to understand cost basis, which usually begins with how much you paid for an investment. Other factors, such as stock splits, can also affect cost basis.

Tracking cost basis, and determining whether proceeds from a trade are taxable, may be confusing for many people. But a new federal law that takes effect on January 1, 2011, is designed to help streamline cost basis reporting for investors. You can go to the TD Ameritrade Web site for more details about the new law and how it may affect you.

Currently, when an investor sells a position in a security or a fund, firms such as TD Ameritrade report only the sale proceeds to the investor and to the IRS. It is up to the investor to track the cost basis, calculate the capital gain or loss, and determine the tax implications.

What Will Change

• Effective January 1, 2011, TD Ameritrade and other financial institutions will report the cost basis of equities purchased on or after January 1, 2011, on Form 1099-B, which typically is made available to investors in January of the following year. In addition, the expanded Form 1099-B will specify whether a gain or loss was short term or long term, which influences tax treatment. Note that the new reporting requirement will apply solely to investments purchased after 2010. Also, for 2011, the reporting requirement will not pertain to stocks acquired through a dividend reinvestment program (DRIP) or to regulated investment company (RIC) stocks. The cost basis also will be reported to the IRS.
• Effective January 1, 2012, the cost basis reporting will be expanded to cover mutual funds, RIC stocks and stocks acquired through DRIP programs that are acquired on or after January 1, 2012.
• Effective January 1, 2013, the cost basis of bonds, options, warrants, rights, derivatives and commodities purchased on or after January 1, 2013, will be covered under the new rule.

What You Can Expect

In order for TD Ameritrade to report the cost basis information required by the new law, it needs to be gathered. On the TD Ameritrade Web site, when you enter an order that is covered by the new law, a tax lot identification method will be specified for the trade. The tax lot identification method is used to determine which specific securities are deemed to be sold when there are multiple purchases of the same security on different dates at different prices, and the entire position is not sold at one time.

TD Ameritrade will use first-in, first-out (FIFO) as the default tax lot identification method for equities and average cost for mutual funds and DRIP-eligible securities. If the default method is your choice, you do not have to do anything. If you prefer a method other than the default, you can select a different identification method from the drop-down menu when you place your order.

Additionally, you will have the ability to pick a specific lot for your trade from the Gain/Loss section of the Web site (under Accounts) from the day following execution up to the settlement date. Note that this is a change from the current process, under which you can do this up until year-end.

Benefits to You

• You'll gain a more complete picture of your cost basis, which may simplify your year-end tax preparation.
• You'll gain greater flexibility in specifying the lots you're trading.
• You'll be able to select the cost basis reporting method you prefer.
• You'll be able to continue to track cost basis when you make an account transfer.

Points to Remember

• The new reporting requirements phase in over a three-year period and will not cover all trades for 2011, only equity purchases.
• Although the new information on Form 1099-B will present a gain or a loss, it is up to you or your tax preparer to calculate your tax liability. Tax rates affecting capital gains and losses are scheduled to increase in 2011, unless Congress acts to maintain existing rates; so it is important to monitor how tax issues could apply to you.

You can find out more about the new cost basis accounting on the TD Ameritrade Web site. You can also visit the Tax Center. Just log on to your account and click "History & Statements" (under Accounts), then the "Tax Center" tab. If you have any questions, please call Client Services, 24/7, at 800-669-3900.