If you take money out of a mutual fund or stock account after you’ve sold the funds or the accounts, how do you know what to pay for taxes? Usually, your statement will show what you paid for the stock, what the fees to buy and sell were, and what you sold the stock for; your profit or loss will be calculated for you based on the basis of the stock price you paid. However, if you changed accounts, your basis might be gone or wrong, and that could result in your reporting a profit that you didn’t actually earn paying taxes you don’t actually owe. What should you do?
This situation is frustrating – we have investments from the 1980’s and 1990’s and I dread having to figure out the cost basis for them myself. I’ve got records in plastic bins in the attic…but lack the initiative and time to figure it all out. I’m thinking that if possible we’ll just hold on to the stuff until we die and then the kids can use fair market value on the date of death of whoever dies last – me or my husband – and then problem solved!
What is Cost Basis?
Let me first explain cost basis and why it matters. When you buy stocks, mutual funds, real estate – really pretty much anything – you pay some amount for your purchase. You may also pay taxes, fees, and other charges that add to the cost. That total is your cost basis or just basis. So if you buy 100 shares of a stock for $25, and it costs you $10 to buy it and $10 to sell it, your cost basis is 100 share x $25 or $2,500 plus $10 and $10 for the sales fees for a total of $2,520. You don’t have to pay any income or capital gains tax on stock or mutual fund shares when you buy them or during the time you hold them, even if they go up during that period. However, when you go to sell them, you have to pay income or capital gains tax on the profit you make.
Continuing the example above, if you sell those 100 shares of stock for $50, you would make $5,000. If you subtract the original cost of $2,520 (the $2,500 to buy the stock plus the fees) that’s a profit of $2,480, which is most likely taxable profit unless these shares are in a tax-deferred retirement account like an IRA or 401(k). If you sell those 100 shares for $10, you’d have a loss of $1,520 ($1,000 sales price + the $20 - $2,500 basis) that, depending on circumstances may be able to reduce your personal taxable income by up to $3,000 that year.
Do I Only Owe Taxes When I Sell Stock?
People sometimes get confused when they own stocks or mutual funds in a brokerage account and they see the statement that says the account was worth $10,000 on the last day of 2019 and is worth $15,000 on the last day of 2020 and think that maybe they owe taxes on that $5,000 of gain. There is a special kind of accounting called mark-to-market that would have you count that gain, but for us average folks, we aren’t in that category. Even though your stocks are up $5,000 in the previous example, you haven’t sold them yet, so you haven’t realized and locked in a gain or loss. Those stocks could go up another $5,000 tomorrow or sadly drop to a total worth of $2,500. You don’t know that you’ve got a profit or loss for sure until you sell, and so you don’t owe taxes until then.
What If I Don’t Know My Basis?
If you don’t know the cost basis of something or can’t figure it out, the IRS tells you to assume a cost basis of zero. In our example here, that would mean you would have to pay tax on the whole $5,000 of gains because you have no cost basis to subtract. You want to make sure you know or can reasonably estimate what you paid for something so that you can minimize taxes. If you don’t have the basis but know when you bought the stock, you could go to Yahoo Finance or Etrade, look up the stock’s cost at that time and get an estimated basis.
Example of Basis “Detective Work”
Here’s an example. Say you own mutual fund shares that you bought from Company A 30-some years ago. Company A became Company B somewhere along the line. Company A most likely would have transferred your shares and the whole mutual fund directly to Company B rather than selling the mutual fund and buying into a new mutual fund. (If they did that, then there is no problem because they WILL know the exact cost basis and be able to tell you.) So it may be that you can call Company B and ask them what your basis is, or go online and see the basis in your account. Then when you sell $15K of the mutual fund, the basis will be reported to you on Form 1099-B, and you would report that amount on your IRS form 8949. You will be taxed on the amount you get upon selling minus the cost basis Company B tells you.
The basis may not be accurate, however, because sometimes when a company changes hands, the cost basis on the day of the transfer is recorded as the cost basis with the new company rather than recorded the actual basis from day the client purchased it. For example, when I transferred some like-kind shares from an Etrade account to a Tradestation account, the basis on the date of transfer appeared on my statements. These particular stocks were at values lower than what I paid for them – I was having a loss, but when the transfer occurred, it looked as if the loss was gone until I contacted Tradestation, gave them the correct basis, and had them adjust it in my account. If I hadn’t done that, when I went to sell them later – hopefully at a profit – I would have been taxed on much more profit than I actually would have gotten because the new transferred basis was much higher than what Tradestation had recorded at the transfer.
Let’s look at a possible scenario in the mutual fund case. Let’s say that you bought into the mutual fund in 1995 for $5,000. The fund grew to $10,000 and was worth $10K in, say 2005, when the company you initially invested with (Company A) became Company B. Between 2005 and today, your investment grew to $30,000. If you were to sell it today, it is likely that the 1099-B form that reports cost basis would say your cost basis was $10,000 rather than $5,000 because Company B probably just recorded your basis based on the amount when they transferred it. That may not be the case, but it could be. In that case, things would be better for you because instead of paying taxes on a profit of $10,000, you’d pay taxes on a profit of $5,000. Because you have no record of what you actually paid, you’d use the 1099-B you got from Company B, and I am not aware of any illegality or tax evasion because of that issue. The unfortunate case would be if say your cost basis when you bought in was $10,000, but the mutual fund had taken a downturn and when Company B took over in 2005, the market value was $5,000 and they send you a 1099-B with a basis of $5,000 so you are taxed on a profit of $30k - $5K or $25K which is much more than the true basis in this case of $30K - $10K or $20K.
My advice would be to call Company B and see if they have the records of your purchase that was transferred from the original company where you bought them. It’s unlikely that Company B will know what you paid BEFORE they took over, but they will know the market value of the mutual fund when it was transferred from the old company to Company B. That’s probably much higher than your original basis but better than no basis at all. Another possibility if you have a mutual fund with searchable fund names like VITXX or VVXXI is to search on a financial database for their value in the 1990s when you think you bought them. That may also help you estimate basis.
You can read more about determining basis at these two IRS pubs:
Kathryn Hauer, a Certified Financial Planner™, adjunct professor, and financial literacy educator has written numerous articles and several books including the “11-Step, DIY, Comprehensive Financial Plan Workbook” and “Financial Advice for Blue Collar America.” She works to help clients and readers understand and act on complex financial information to keep them and their money safe. She functions as a strong advocate and guiding light for her clients as they move through a murky and unfamiliar financial world. Learn more at her website.