Cost basis regulations are rules pertaining to cost basis accounting, where the original value of assets is reported at the time of disposition and used to determine gains or losses. A classic example comes up for investors who sell stock. When they make the sale, they need to report the cost basis and provide information about whether they took a gain or loss on the sale. This determines tax liability, based on the size of the profit or loss.
A significant reform in cost basis regulations occurred in the United States in 2008, when more formal rules for this process were released by the government. This was part of the legislation designed to stabilize the economy to address a financial crisis. Under the new cost basis regulations, brokers, mutual funds, and other entities who transferred securities on behalf of clients were required to report the cost basis. This was a shift from the past, where investors were responsible for this calculation, and it was provided as an optional extra service by some firms.
These requirements mean that financial agents need to maintain highly detailed and accurate records on securities, using a consistent valuing method for investments like mutual funds where people do not hold securities directly. When securities or shares are transferred, the agent must comply with the cost basis regulations. In the reports filed with the U.S. Internal Revenue Service (IRS), they disclose the original cost of the asset and the profit or loss taken by the client. They also need to indicate whether it is a short or long-term gain or loss.
For investors, the cost basis regulations require that their tax filings disclose their profits and losses. They can use the information provided by their agents on their own tax returns. If there are inconsistencies between the agent’s report and the investor’s, this may trigger an investigation. It is important to review copies of tax declarations sent to the IRS to confirm that the information is accurate. When it is not, investors can request a correction and amended form to provide updated and complete information to the government.
Within the financial industry, the updated cost basis regulations sparked considerable discussion. Critics argued they created a regulatory burden that added to the cost of administering client accounts. Some were also concerned that it could create confusion, as there are several ways to handle cost basis accounting and disclosures. When a client wants to use a different method, it could create a mismatch between filings which might lead to an audit.