When you sell securities such as stocks, bonds, or mutual funds held in a taxable account, you report the net proceeds you received on aSchedule D attached to your federal tax return, and then also report the date you purchased that security and the amount you paid for it. By doing so, you correctly calculate your short-term and long-term capital gains or losses. Remember, long-term transactions are those securities that are held for more than a year before being sold and qualify for a reduced federal tax rate.

Through 2010, financial institutions were only required to report the sale side of the transactions to you and to the IRS on the Form 1099-B. In other words, they only reported the date of the sale and the net proceeds received. It was up to the taxpayer (many times with the help of a paid tax preparer) to determine the “cost-basis” and holding period of the securities that were sold.

Starting in 2011, all that changes. Check out the newly revisedForm 1099-B. For securities purchased in 2011, financial institutions must now report Cost or Other Basis in Box 3 and then check off Short-term or Long-term in Box 8. Please note that this change only applies to securities purchased as of 2011, so you still need to keep records for your stock, bonds, and mutual funds purchased prior to this year.

Please be aware of a change to the rules if you sell mutual funds within a taxable account. The financial institution will report your cost-basis to you and to the IRS using the Average Cost Method unless you notify the financial institution prior to the sale that you have opted to use either Specific Share Identification or First-in First-Out (FIFO) method.

Here are the rules from IRS Publication 550:

You can figure your gain or loss using a cost basis only if you did not previously use an average basis for a sale, exchange, or redemption of other shares in the same mutual fund. To figure cost basis, you can choose one of the following methods.

  • Specific share identification.
  • First-in first-out (FIFO).

Specific share identification.

If you adequately identify the shares you sold, you can use the adjusted basis of those particular shares to figure your gain or loss. You will adequately identify your mutual fund shares, even if you bought the shares in different lots at various prices and times, if you:

1. Specify to your broker or other agent the particular shares to be sold or transferred at the time of the sale or transfer, and

2. Receive confirmation in writing from your broker or other agent within a reasonable time of your specification of the particular shares sold or transferred.

You continue to have the burden of proving your basis in the specified shares at the time of sale or transfer.

First-in first-out (FIFO). If your shares were acquired at different times or at different prices and you cannot identify which shares you sold, use the basis of the shares you acquired first as the basis of the shares sold. In other words, the oldest shares you own are considered sold first. You should keep a separate record of each purchase and any dispositions of the shares until all shares purchased at the same time have been disposed of completely.

Time Will Tell

It will be interesting to see how well these new rules will work to help people correctly and easily calculate their capital gains and losses.

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