On October 18, 2010, the IRS finalized regulations that require brokers and mutual funds to report cost basis to their customers and to the IRS. For the sale of stock that is acquired on or after January 1, 2011, brokers must report adjusted cost basis (and whether the gain or loss on the sale is long-term or short-term). Effective for shares acquired on or after January 1, 2012, mutual funds must provide the same reports on sales. Historically, brokers and mutual funds have only reported gross proceeds on the sale of securities (on Form 1099-B).

To determine the adjusted basis of securities that are sold, the proper lot (or lots) of the securities must be determined. Customers may use a variety of conventions to determine the lot of securities that are sold, including first-in, first out, average cost, or specific identification. The final regulations specify how and when the customer and broker will establish the conventions to be used to determine basis. The final regulations afford customers many choices and, in many instances, permit customers to change their choice without the consent of the IRS.

The regulations generally require customers and brokers to use the same conventions to determine gains and losses. However, in some circumstances, customers and brokers may report different amounts of gains and losses. For example, customers, but not brokers, are required to apply the straddle tax rules to determine gains and losses. In addition, customers must consider all of their holdings to apply the wash sale tax rules, while brokers need only consider the securities within an account in which the stock was sold.

The IRS is revising Form 1099-B to allow for the reporting of the new basis information and is revising the schedule D of the Form 1040 to require taxpayers to reconcile differences in the gains and losses that they report on their income tax returns and the gains and losses that have been reported on the brokers’ information returns.

As noted above, mutual funds have an extra year to implement cost basis reporting. However, mutual funds also face special challenges. For example, many funds currently report gains and losses using average cost basis. These funds may elect to consolidate their existing reporting with their new reporting of sales of mutual fund shares, but the funds must notify their customers of the single-account election, and their customers must agree to use the average cost basis method for the mutual fund shares subject to the election.