What Is Post-TEFRA Cost Basis and Why Does It Matter?
Unpack post-TEFRA cost basis. Learn how legislative changes transformed investment tracking and simplified capital gains calculations.
Cost basis is fundamental for investors to determine taxable gains or losses when an investment is sold. It represents the original value of an asset for tax purposes, directly impacting capital gains tax or losses claimed. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) significantly altered how this information is handled.
“Post-TEFRA cost basis” refers to the specific rules and methods that came into effect after this legislation. This shift aimed to streamline reporting and improve accuracy. Understanding these post-TEFRA rules is important for tax compliance and financial planning.
Understanding Cost Basis
Cost basis is generally the original purchase price of an asset, including any commissions or fees paid to acquire it. This initial cost is the starting point for calculating capital gains or losses when the asset is sold. A capital gain occurs when an asset is sold for more than its cost basis, while a capital loss occurs if it is sold for less.
The cost basis can be adjusted over time, leading to what is known as “adjusted basis.” Events such as stock splits, where one share is divided into multiple shares, will adjust the per-share cost basis. Reinvested dividends also increase the cost basis, as these are new investments made with the dividend income.
Conversely, certain distributions, like return of capital, can reduce the cost basis. The adjusted basis is the net cost of an asset after accounting for these additions or subtractions. This adjusted figure is then used to determine the taxable gain or loss upon sale.
The Impact of TEFRA on Cost Basis
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) introduced significant changes to how cost basis is tracked and reported. Before TEFRA, individual investors were solely responsible for maintaining records and calculating their own cost basis. This often led to challenges in accurate reporting due to incomplete records or complexities in calculations.
TEFRA, through Internal Revenue Code, shifted this responsibility. It mandated that brokers and financial institutions report the cost basis of certain assets, known as “covered securities,” to both the Internal Revenue Service (IRS) and the taxpayer. This reporting is primarily done on Form 1099-B.
These rules were phased in over several years, applying to assets acquired after specific dates. For instance, stocks and American Depositary Receipts (ADRs) acquired on or after January 1, 2011, became covered securities. Mutual fund shares acquired on or after January 1, 2012, also fall under these reporting requirements.
Bonds, derivatives, and options acquired on or after January 1, 2014, and more complex types acquired on or after January 1, 2016, are also classified as covered securities. This phased approach ensured that financial institutions had time to adapt their systems. Post-TEFRA cost basis means investors can generally rely on their brokers for more accurate and readily available cost basis information, improving tax compliance.
Determining Post TEFRA Cost Basis
For most covered securities, investors can primarily find their post-TEFRA cost basis information on Form 1099-B, which they receive from their broker or financial institution by mid-February each year. This form details the proceeds from sales of stocks, bonds, and other securities. Box 1e on Form 1099-B is designated for reporting the cost or other basis of covered securities.
However, there are scenarios where the reported basis might be missing or inaccurate. This can occur if securities were transferred between brokers, especially if the original acquisition predates the covered security rules, or due to certain corporate actions like mergers or reorganizations. While brokers generally report basis for covered securities, they are not required to do so for “non-covered” securities, typically those acquired before the TEFRA effective dates.
If Form 1099-B indicates a missing or unreported cost basis, investors must determine it themselves. This requires consulting personal records such as original purchase confirmations, historical account statements, or transfer statements. Contacting the previous broker or transfer agent can also help in reconstructing missing information. Even with broker reporting, maintaining personal records is important, especially for non-covered securities or for verifying the data provided by financial institutions.