Avoiding Unpleasant Surprises

One of my first tasks when I joined a small financial planning firm in the late 90s was creating painstaking history in spreadsheets of client positions for years and years of transactions. Ughhh! I remember those hours that first year well, but not necessarily fondly. I toiled calculating subsequent purchases, partial sales, dividend reinvests...sometimes wondering what I had gotten myself into. But, you see, only when armed with this data could investors accurately file their tax returns. 

Grab the remote and fast forward thirteen years to the present. The spreadsheets and pencil scratches of times past have been replaced by comprehensive legislation requiring brokerage reporting in cost basis.  The Emergency Economic Stabilization Act of 2008 requires broker-dealers and financial intermediaries to track and report cost basis directly to the IRS and becomes enforceable gradually in 2011, 2012, and 2013. 

So, what once was a courtesy provided by many firms (and a rather dark memory for me), is now becoming a requirement by the IRS.  Here's a brief summary of the cost basis legislation:

  • All individual stocks purchased after January 1, 2011, will have cost information reported to the IRS.
  • Pooled investments and dividend reinvestment plans will report if bought after January 1st, 2012.
  • For bonds, options, and other securities the date is January 1, 2013.

What does this mean for you?  While implications can be very specific to your circumstances and potentially far-reaching, there are some general things to keep in mind:

  • Financial intermediaries are choosing a default cost basis method for their client investments.  For many firms such as our broker dealer, Raymond James, the default is First In, First Out (FIFO).  To alter the reporting method for a transaction, you will need to plan in advance or simultaneous to the transaction.  Because the firms must report cost basis based upon information from the trade settlement, you will lose the opportunity to make these decisions at a later date.  That means you need to get familiar with the default cost basis method for your brokerage so you are prepared to adjust if needed.

  • Pooled investments are often reported via Average Cost method.  This is considered a straightforward and popular method but there is a wrinkle:  it cannot be revoked for positions which have already reported.  For this reason, firms may require you to complete additional paperwork to make average cost elections.  Consider whether this is appropriate for you.

  • Assets owned prior to the legislation are grandfathered.  This may result in two tracking methods used for your holdings in a single investment:  before and after the legislation.  Be prepared for some extra tracking if you hold grandfathered assets.

  • You may have relied on an outside reporting source to track your cost basis information in the past such as Quicken, MSN Money, or portfolio reporting software such as Advent/Axys. If these sources are not reconciling cost basis data with your brokerage, they may be less reliable than they have been in the past.  Best Practice:  A periodic intra-year review of brokerage cost basis information may alert you to unpleasant capital gain surprises.

Beware: if you're not careful, you could get locked into a costs basis method you did not intend!  Now is the time to review your options and elections for cost basis.  And by all means, think before you trade!


Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters.  You should discuss tax or legal matters with the appropriate professional.