Tuesday, July 14, 2009


Monthly or annual service fees on an investment or brokerage account, and “investment advisory fees” that are determined based on a percentage of the value of your portfolio, and hourly professional fees paid to “fee only” investment advisers are deductible as an “investment expense” on Schedule A under the category of “Miscellaneous Expenses”, and are subject to the 2% of AGI exclusion.

However the specific service and other fees charged by a broker on the purchase or sale of an investment (stock, bond, mutual fund share, etc) – and reported on the individual “trade confirmation” slip for the transaction - are added to the purchase price or subtracted from the gross proceeds when reporting the sale on Schedule D.

As we “speak” I am looking at a trade confirmation form for the sale of a stock. The confirm reports that 200 shares were sold at a price of $18.76 – for a total of $3,752.00. A “Processing Fee” of $5.35, “Transaction Fee” of $.12 and “Charge” of $89.42 were all subtracted from the $3,752.00 gross sale price – resulting in “gross proceeds” of $3,657.11. In other words the brokerage account of the seller was credited with cash of $3,657.11 from the sale of the stock.

It is the gross proceeds of $3,657.11 that is reported on the Form 1099-B for the year, and it is this amount that is entered as the Sales price in column (d) on Schedule D.

The cost basis of the stock is taken from the confirm issued at the time of purchase – which would be the 200 shares x the share price plus any processing and/or transaction fee(s) and any other charges paid to the broker.

Often when, in the course of attempting to determine the cost basis of an investment sold for proper reporting on Schedule D, I ask a client or a client’s broker for the information I am told – “We bought it for 17 1/4 per share, or 10 5/8 per share, in June of 2003”. That does not cut it! I need to know the $17.25 or $10.625 per share cost plus the various brokerage fees and charges. If I only reported the $17.25 or $10.625 per share as the cost basis I would be overstating the gain, or understating the loss, and causing the client to pay additional unnecessary federal and state income tax.

Basically you take what you got from the sale of the investment and subtract what you paid for the investment.

When purchasing and selling a bond there may be an addition to the cost or subtraction from the gross proceeds for “accrued interest”. Accrued interest does not affect the gain or loss on the sale of the bond, and should not be included in the numbers reported on Schedule D.

Investopedia describes Accrued Interest as – “The interest that has accumulated on a bond since the last interest payment up to, but not including, the settlement date”.

Bonds usually pay interest on a regular periodical basis – quarterly, semi-annually or annually. A $10,000 bond paying 5% may pay $250 to each bond holder of record at December 31st on January 1st and each bondholder of record at June 30th on July 1st. If you purchase the bond on April 1st you will still receive a payment of $250 on July 1st, even though you are only entitled to $125 in interest for the period of time that you owned the bond. The previous bondholder is also entitled to $125, but will not receive a payment from the bond trustee.

To correct this when you purchased the bond on April 1st your cost was increased by $125 in accrued interest. If you bought the bond for $10,100 (including purchase fees) you actually paid $10,225 in cash for the bond. The seller’s gross proceeds will be increased by $125 in accrued interest.

A Form 1099-INT will be issued to the seller for the $250 interest payment made on January 1st. The seller will also need to report as interest on Schedule B the $125 accrued interest received when the bond was sold. So the net taxable interest reported on Schedule B is $375. This $125 is not included in the gross proceeds from the sale of the stock reported on Schedule D. Generally, the $125 in accrued interest will also not be included in the gross proceeds amount reported on Form 1099-B.

The purchaser will receive a Form 1099-INT for the $250 interest payment made on July 1st. This $250 is reported as interest income on Schedule B. From this $250 the purchaser subtracts, also on Schedule B, the $125 in accrued interest “paid” at the purchase of the bond. So the net taxable interest reported on Schedule B is $125. This $125 is not added to the cost basis of the bond when it is sold, called-in or matures.

When selling an investment be sure to include the cost of any dividends reinvested over the years. If you purchase 100 shares of a stock for $10,000, but accumulate an additional 5 shares over the years because you have used your dividends, which total $600, to purchase additional shares of the stock – when you sell the 105 shares of stock your cost basis is $10,600.

If you receive any “non-taxable return of capital” from the investment you must reduce your cost basis by this amount. Often companies, generally utility companies, want to maintain a regular periodic dividend payment, but do not have enough accumulated profits to issue the desired dividend. Dividends are only paid out of accumulated profits.

The company may want to pay $2.50 per share per quarter in dividends, but can only pay an actual dividend of $1.00 per share in the last quarter of the year. They still send each shareholder a check for $2.50 per share. $1.50 per share is treated as a non-taxable return of capital. In other words the company is giving you back a portion of your purchase price. This amount is reported in Box 3 of the Form 1099-DIV as “nondividend distributions”.

If you purchased a stock for $10,000, and over the years have received $500 in “nondividend distributions”, your cost basis for the stock is $9,500.

When you purchase an investment your cost basis is what you paid for the investment, adjusted as discussed above. You purchase a stock for $10,000 and sell it for $11,000 you have a taxable capital gain of $1,000.

The cost basis of an investment you receive as a gift is generally what the person making the gift paid for it, again adjusted as discussed above. Your cost basis is the cost basis of the person who gave you the investment. If they paid $10,000 for the stock, give it to you, and you sell it for $11,000 you have a taxable capital gain of $1,000. There are exceptions if the stock is sold at a loss, or if gift tax was paid by the “giver” at the time of the gift. The “holding period” (short-term or long-term) of the person making the gift will also generally “carry-over” to the recipient of the gift.

The cost basis of an investment you inherit is the value reported (or that would be reported) for the investment on the decedent’s federal estate or state inheritance tax return – which is the “fair market value” of the investment on the decedent’s date of death (or 6 months after the date of death if this is the value used on the decedent’s federal estate tax return). This is the “mean average” price of the investment on that date. The “holding period” of inherited property is always “long-term”. You would write “inherited” as “date acquired” in column (b).

It is very important to note that the burden of proof for the cost basis of an investment sale you have reported on Schedule D is with the taxpayer. As per T.C. Memo 2003-259, if a taxpayer cannot provide proof of the cost basis of a stock or other investment sold it will be considered to have a "0" cost basis. As a result, the entire gross proceeds will be fully taxable! So it is extremely important to keep good records of the cost basis of all your investments.


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