Covered Shares

Over several years Anselm Kirkbride accumulated Halloway Industries shares in three lots in one taxable account: 200 at $22, 300 at $38 and 200 at $61. The stock trades at $55 today and he needs to sell 200 shares while minimizing this year taxable gain. He should:

1. A.Elect the average cost method, which is available for individual stocks and would produce the smallest gainAverage cost is available for mutual fund and DRIP shares, not for individual stock positions.
2. B.Simply place the sell order, because the broker will automatically apply the highest-cost lot to minimize his taxThe default is FIFO unless he instructs otherwise. No such automatic optimization applies.
3. C.Specifically identify the 200 shares from the $61 lot at the time of sale and obtain written confirmation, producing a $6 per share loss instead of the gain that default FIFO treatment would createCorrect. Specific identification, made and confirmed at the time of sale, is the only way to override FIFO.
4. D.Sell the $22 lot, since the oldest shares receive the most favourable long-term treatmentAll three lots are long term. The $22 lot produces the LARGEST gain, which is the opposite of his objective.

Why: The default cost basis method for stock is first in, first out, which would sell the $22 lot and realize a $33 per share gain. To do better he must use SPECIFIC IDENTIFICATION: instruct the broker at or before settlement which lot is being sold and obtain written confirmation of that identification. Selling the $61 lot produces a $6 per share loss instead of a gain. Average cost is available only for mutual fund and dividend reinvestment plan shares, not for individual equities.

Ines Delacroix bought 400 shares of Talbridge through Wexler Securities in 2014. She separately holds 300 shares of the same stock that she deposited into the account from an old paper certificate, with no purchase records. She now sells both positions. How does cost basis reporting work?

1. A.Neither sale is reported to the IRS, because basis reporting applies only to mutual fund shares.Wrong. All sales are reported on Form 1099-B, and basis reporting covers equities as well as fund shares, debt and options.
2. B.Wexler must report basis for both lots, since both are held in the same account at the same broker.Wrong. Custody does not create covered status. Shares transferred in without acquisition data remain noncovered.
3. C.Wexler reports gross proceeds only for both lots, because brokers never report cost basis to the IRS.Wrong. Brokers have been required to report adjusted basis for covered securities for years; that is the whole point of the covered/noncovered distinction.
4. D.The 2014 purchase is a covered security, so Wexler reports her adjusted basis to the IRS; the certificate shares are noncovered, so Wexler reports proceeds only and Ines must substantiate her own basis.Correct. Covered status depends on when and how the security was acquired, and the two lots fall on opposite sides of the line.

Why: Brokers must report the customer's ADJUSTED COST BASIS to the IRS, not just gross proceeds, but only for COVERED securities - broadly, equities acquired through the broker on or after January 1, 2011 (with later effective dates for fund shares and for debt and options). Ines's 2014 purchase is covered, so Wexler reports both proceeds and her basis on Form 1099-B. The certificate shares came in without acquisition information and are NONCOVERED: Wexler reports the sale proceeds but leaves the basis blank, and Ines bears the burden of substantiating what she paid.

Ottilie transfers her whole position in Merriwether Fund from Braylock Securities to Ainsley Securities. Part of the position was purchased in 2009 and part in 2019. With respect to cost basis after the transfer:

1. A.No basis information transfers between firms; each shareholder reports basis from personal recordsBasis for covered shares must be transmitted to the receiving firm, which will report it on a later Form 1099-B.
2. B.Braylock must transfer basis for the entire position, since both lots are held in the same accountThe covered and noncovered distinction turns on acquisition date, not on how the shares are held.
3. C.The IRS supplies the missing basis to the receiving firm on requestThe IRS does not maintain shareholder basis records or furnish them to brokers.
4. D.Braylock must transfer basis for the 2019 covered shares to Ainsley; basis for the 2009 noncovered shares is not required to be transferred and remains Ottilie to substantiateCorrect. Fund shares acquired on or after 1 January 2012 are covered and their basis travels with the transfer; older shares do not.

Why: Mutual fund shares acquired on or after 1 January 2012 are covered shares, and the delivering firm must transmit their cost basis to the receiving firm within the period the regulations allow, so that the receiving firm can report basis on a later Form 1099-B. The 2009 shares are noncovered: their basis is not required to be transferred or reported, and Ottilie must be able to substantiate it from her own records.

Endicott has held Verrall Equity Fund since 1998 and added to the position several times, including purchases made last year. He now redeems part of the position and is surprised that his Form 1099-B reports cost basis for only some of the shares. His representative should explain that:

1. A.basis is reported only for shares held less than one year, because long-term lots are taxed at a flat rate that makes basis irrelevant.Holding period sets the tax rate, not the reporting obligation. Long-term lots still need a basis.
2. B.basis reporting is optional for any fund that uses the average cost method, so the gaps reflect the fund election.Averaging is a basis-computation method, not an exemption from reporting.
3. C.fund shares acquired on or after January 1, 2012 are covered shares whose basis must be reported, while older lots are noncovered and require him to substantiate basis from his own records.Correct. The covered-share regime applies to mutual fund shares acquired on or after January 1, 2012.
4. D.the noncovered lots are not reported to the IRS at all, so he may leave them off his return.Gross proceeds on noncovered lots are reported. Omitting them invites a notice from the IRS.

Why: Mutual fund shares acquired on or after January 1, 2012 are covered shares: the fund or broker must report both the gross proceeds and the adjusted cost basis to the IRS. Shares acquired before that date are noncovered, and only the gross proceeds are reported, leaving Endicott to substantiate basis himself from his own records. A single long-held position therefore routinely splits into covered and noncovered lots on one form.