Don’t panic, this may be a common brokerage error
Dear Dan,
I’m doing my taxes and I have a huge tax bill because of capital gains. Last year, I sold some holdings I inherited in 2010. I expected some gains but these were way higher. Looking at the report from my investment firm, they say all of the sale is taxable gain. Can that possibly be right?
— Sticker Shock
Dear Sticker Shock,
It could be right, but I wouldn’t panic. Chances are good that is not correct.
Brokerage firms have only been required to track the “cost basis” of investments acquired since Jan. 1, 2011. The requirement was effective in stages between 2011 and 2013. If you had not supplied the basis to them, they would not have it to calculate the gain. The term for such holdings is “uncovered” securities.
You said the entire sale is showing as a gain. That suggests the report is showing a zero cost-basis. Many brokerages report uncovered securities as having a zero basis. Many of these reports will have an asterisk or footnote that mentions that the securities are uncovered, and the firm does not have the basis.
If you know the basis, you do not need to get that information to the brokerage firm and have the report corrected. However, there is an adjustment process found in the instructions for Form 8949 That should be used. Whatever basis you have will reduce the gain.
If you have other holdings that were acquired in taxable accounts before the 2011-2013 phase in for the reporting requirements, you should acquire the basis information for those holdings. Then, contact the brokerage firm and have that information added to your records. This will prevent future reports from overstating gains again by calculating the gain off a zero basis.
Your basis is the cost you paid for the shares of the security in question. In your case, however, you said you inherited the shares. This means you may have no idea what the shares cost originally. Fortunately, that is probably not important. By inheriting the asset, you are likely entitled to receive a “step up in basis.” Instead of using the original cost to calculate the gain, you use the value at the date of death.
For instance, say your benefactor left you shares worth $20,000 that were bought for $5,000 and you sold those shares for $50,000. Due to the step up in basis at death, you calculate the gain based on the value on the date of death. So, the gain is $30,000 ($50,000-$20,000), not $45,000 ($50,000 – $5,000 original purchase cost).
Anyway, despite the time since enacting the reporting requirements, paying taxes on overstated gains because an uncovered security showed a zero cost basis on a report from a brokerage is a common error. One of the first things we do when reviewing a return is look for zero basis shares. For some securities, often as a result of a corporate action like a spinoff, a zero basis is accurate. However, most of the time a zero basis is the result of an uncovered security.
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Originally published on MarketWatch. Read the original article here.