As April 15 approaches, investors recognize that they must report gains or losses on sales of securities in 2014

As April 15 approaches, investors recognize that they must report gains or losses on sales of securities in 2014. If you sold stocks, bonds, mutual funds, exchange traded funds (ETFs) or other securities last year, you have received a tax form from your bank, broker, or custodian. Data covers the sale of covered securities and non-covered securities. What does that mean?

Whenever you sell a security, you have to report gain or loss to the IRS. Brokers and fund companies report the gross sales price to the IRS and you are supposed to report your gain or loss based on the net sales price minus your cost basis for the shares sold.

Prior to 2011, you were on the honor system and the government had no way of auditing the cost basis you reported. With legislation passed in 2008 as part of federal bailout packages, new reporting requirements were phased in. Banks and brokers were mandated to begin tracking and reporting the cost basis of stocks in taxable accounts bought in 2011 or later. Mutual funds ,dividend-reinvestment plans, and certain exchange-traded funds (ETFs) had to start tracking and reporting cost basis starting in 2012.

Not all funds or brokers tracked cost basis prior to 2011 or 2012. Securities that were purchased prior to 2011 or 2012 may be reported as part of a sale as “uncovered securities,” meaning the custodian or broker did not track the cost basis. It is up to the taxpayer to come up with the data. Securities sold that were purchased in 2011 or 2012 or after are referred to as “covered securities.”

With individual stocks, you can sell specific tax lots, shares bought at specific time frames at specific prices. Tax-lot-reporting can govern the amount of gain or loss.

However, with mutual funds, where dividends were reinvested over time at different prices per share, trying to deal with tax-lots is a nightmare. So mutual funds generally use the average cost of shares held.

That’s where the fun begins. Many people who started investing in mutual funds years ago may not have kept track of cost basis. Often they do not realize that their cost basis is what they invested in the fund plus all reinvested dividends and capital gain distributions. If the fund company did not keep track of it, they have to go back and analyze all annual statements back to the beginning. If they don’t have statements, the mutual fund company may be able to provide them.

The woman purchased Mutual Fund X with a $20,000 deposit in 1993. She sent money in every month for several years, eventually investing a total of $36,105. She never sold any shares. However, the fund declared dividend and capital gains distributions every year, which through December 31, 2014, totaled $127,301. She paid taxes every year on the distributions, which were reinvested in the fund at net asset value (NAV). These distributions need to be added to her original investments to determine her tax basis, in this case, $163,406.

At the end of December, 2014, she owned 5,210 shares of Fund X. Her cost basis per share was ($163,406/5210=) $31.36 per share. Suppose she wished to sell some shares and tells her advisor to sell 1000 shares on 3/16/15. At the close of business that day, the NAV for Fund X was $53.54 per share. Her gain per share sold was ($53.54 less the tax basis per share of $31.36 per share=) $22.18 per share. If she sold shares purchased more than one year before the sell date, she has a long term gain of $22,180 on a sale of $53,540.

Fortunately for the woman in question her advisor had records going back to the original investment and was able to help her figure out her tax basis and show her how to keep track of it from now on.

Suppose she had never sold shares and died on 3/16/15, leaving shares to her spouse or children? Under current tax law, securities get stepped-up basis as of date of death. In this case, the inherited shares now have a basis of $53.54. The heirs would use that as a starting point to add any further distributions if they kept the shares or to calculate gain or loss on a subsequent sale.

Note that there are other rules under estate valuation rules so it is always best to consult a tax advisor when it comes to tax or estate matters. Isn’t tax compliance fun?

On 3/16/15, the lady had a liquid asset worth $278,943 from an investment of $36,105. She rode through the bear markets of 2001-2002 and the crash of 2008, never panicking, proving once again that when it comes to stock investing, time is more important than “timing.”

Lewis Walker is President of Walker Capital Management, LLC. Certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with Walker Capital Management, LLC. lewisw@theinvestmentcoach.com