record keeping and cost basis tracking

In short

A friend of mine once spent a whole weekend digging through a shoebox of old brokerage letters, just to learn what he had paid for some shares. If you hold investments in a regular taxable account, you have probably wondered where those old numbers live. Cost basis is what a person paid for something, plus certain costs of buying it. When the owner sells, the gain or loss is the sale price minus that basis. Keep the trade confirmations and year end statements from every purchase, and keep them until well after the sale is reported. Your broker tracks much of this for you, but the records are still your own. Check the broker's numbers against yours once a year. Ten minutes now can save a weekend later.

The whole of it

What it is

I once watched a neighbor sell a few shares and guess at what he had paid. He guessed high, and he was wrong. If you are holding anything that has changed in value, you are in his shoes whether you know it or not. Cost basis is the starting price for tax purposes. It is usually what was paid for an asset, including fees at purchase. Record keeping is simply holding on to the proof of that number.

Basis matters because the tax bill is built on the gain, not on the sale price. If a person sells shares for $5,000, the tax does not apply to the full $5,000. It applies to the sale price minus the basis. A higher, correct basis means a smaller gain on paper. A missing basis can leave a taxpayer in an awkward spot, because the IRS may treat the whole sale as profit.

Basis also shifts along the way. Reinvested dividends add to it, because that money was already taxed as income. Stock splits change the per share figure but not the total. Gifted and inherited property follow their own rules. For inherited property, the basis is generally the value on the date of death, though the details depend on the estate. IRS Publication 551, called Basis of Assets, lays these rules out.

How it works

A friend of mine, a retired bus driver, likes to say that paper does not forget but people do. Your broker works the same way, and it matters. Since 2011, brokers have been required to report cost basis to the IRS for most stock bought in a taxable account. Other products, such as mutual funds, were phased in on later start dates. The IRS covers those dates in the Form 1099-B instructions. This is called covered security reporting. The broker reports it on Form 1099-B.

Shares bought before those start dates are called noncovered. For those, the broker may not report basis to the IRS at all. The owner has to supply the number. That is where old paper earns its keep.

If you have bought the same stock at different times, a method must be chosen for which shares count as sold. The default at many brokers is first in, first out. That means the oldest shares go first. Many brokers also let the owner choose specific lot identification instead, which names the exact shares. The choice has to be made before the sale settles, and the broker must confirm it in writing. Pick a method, then stay consistent.

Retirement accounts work differently. Inside a traditional IRA or a 401(k), gains are not taxed year by year, so basis is not tracked for each trade. There is one exception. If a person puts after tax money into a traditional IRA, that money creates basis. The IRS asks the owner to track it on Form 8606. Skip that form, and the same dollars can be taxed twice.

The numbers, and where to find yours

You may be wondering where to look first. Your broker's website usually has a cost basis or gain and loss page. Form 1099-B arrives each year for accounts with sales. The sales go on Form 8949, and the totals flow to Schedule D. The instructions for both are free on IRS.gov.

Two numbers shape how a gain is taxed. The first is the holding period. A gain on something held one year or less is short term and taxed as ordinary income. Held longer than one year, it is long term and gets lower rates. The second is the rate bracket itself. The long term capital gains rates and the income thresholds for them change by year, so the current figures are the current figure, which the official source publishes each year. The wash sale rule matters too. It applies when a person sells at a loss and buys the same or a substantially identical security within the current figure, which the official source publishes each year days before or after the sale. In that case the loss is not allowed right away. It is added to the basis of the new shares instead. IRS Publication 550 explains the rule.

For the retention question, the IRS says to keep records until the statute of limitations runs out for the return. IRS Publication 583 covers this. For property, that means keeping the purchase records for as long as the owner holds it, then for the period after the sale return is filed. The standard period for amending or auditing a return is the current figure, which the official source publishes each year.

A worked example

Let me tell you about a woman named Marisol. She is a nurse who started investing in a taxable account at age 34. Over the years she bought shares of one fund in three batches.

In March of year one, she bought 100 shares at $20 a share. That is $2,000. In March of year three, she bought 100 shares at $25. That is $2,500. In March of year five, she bought 100 shares at $30. That is $3,000. Along the way, she let her dividends reinvest. Those reinvested dividends added another $450 to her basis.

Her total basis is $2,000 plus $2,500 plus $3,000 plus $450, which is $7,950. She holds 300 shares, plus a few extra bought with the dividends. To keep the story simple, picture her selling 100 shares in year seven at $40 a share. That is $4,000 in proceeds.

Under first in, first out, the shares sold are the oldest ones, from year one. Her basis on those 100 shares is $2,000. Her gain is $4,000 minus $2,000, which is $2,000. She held them well over a year, so it is a long term gain.

Now suppose Marisol had named the year five shares instead, using specific lot identification. Her basis on those is $3,000. Her gain is $4,000 minus $3,000, which is $1,000. Same sale. Different tax picture. The only thing that changed was the paper trail and the choice she made before settlement.

But what if she had lost her records? For shares bought before the broker's reporting rules began, the broker might show no basis. Then the form could list the sale at $4,000 with a basis of $0. A gain of $4,000 is double the real one. Her old statements would fix that. Without them, she would be arguing from memory.

Where it goes wrong

I have seen smart people trip on small things. The first is trusting the broker blindly. Brokers make errors, and transfers between firms can drop basis information. A person who moves an account should check that the basis came along. Check it, don't assume.

The second is forgetting reinvested dividends. If basis leaves them out, the owner pays tax on the same money twice. Once as dividend income, and again as gain. It is a quiet leak, and it adds up over many years.

The third is the wash sale rule, which catches people who sell for a loss and buy back soon after. The rule is not limited to one account. A buyback in a spouse's account can count, and IRS Publication 550 also addresses purchases made inside an IRA. The loss can be disallowed on this year's return. The broker may not catch trades made in different accounts, so the owner has to watch for it. Because the IRA mechanics are tricky, read the publication or ask a tax professional before relying on any shortcut.

The fourth is gifts and inheritances. A person who receives shares as a gift may take over the giver's basis. A person who inherits may get a new basis. Mixing those up changes the bill. Keep the letter, the estate paperwork, or the gift records.

The fifth is tossing records too soon. Throwing out a confirmation the day after the trade feels tidy, but it is a mistake. A good habit is a folder, paper or digital, for each holding, with every confirmation and a yearly statement inside.

Questions to answer before you leave this page

Do you know what you paid for each investment in your taxable accounts, including the reinvested dividends? Where do the confirmations and year end statements live right now, and could a family member find them if you could not? Have you looked at your broker's basis page this year, and does it match what you remember? Did any of your shares come before the broker started reporting basis, so that the number is yours to supply? Have you chosen a method for which shares count as sold, and have you confirmed it with your broker? Did you ever sell at a loss and buy the same thing back within the current figure, which the official source publishes each year days, in any account? If you moved an account from one firm to another, did the basis come over with it? Are any shares you hold a gift or an inheritance, and do you have the papers that show the starting value? And have you put a reminder on your calendar to check all of this once a year?