Years and years ago, a beloved grandmother gave you a stock certificate for shares she’d cherished for decades, and now you’re selling them for your child’s fall semester. It happens all the time.
But next April you’ll have to figure the profit and pay long-term capital gains tax. To do that, you need to know the “cost basis,” or what the shares had cost, and if grandma didn’t tell you, that could take some sleuthing.
“Cost basis is essentially what you paid to purchase an investment,” says Valerie Gospodarek, owner of VG Financial Consulting in Lafayette, California. “The difference between it and what you ultimately sell the investment for is considered your capital gain, or loss, and what you must pay taxes on.”
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And finding what Grandma had paid is not enough. Over the years, the stock may have split over and over, dividends may have been reinvested, or the original company may have merged or been split apart. Each event can affect the cost basis.
“For an investment that you purchase one time, it’s easy to calculate — it’s simply the price you pay for the investment the day you purchased it, plus any transaction costs,” Gospodarek says. “It becomes more complicated if you then reinvest the dividends and/or capital gains from the investment and/or the investment goes through some sort of change such as a stock split or a merger with another company or mutual fund.”
In a two-for-one split, for example, each share becomes two, and the cost basis is cut in half. Reinvested dividends, on the other hand, are added to the cost basis. So you can’t just go into a newspaper archive to see what the stock traded at in 1930.
Gospodarek describes clients who spent $1,750 on 200 shares of stock in 1987, and could sell now for $40,000. They assumed they’d owe tax on $38,250 in gains if they did sell, but their reinvested dividends had actually raised the cost basis to $19,000. That reduced their long-term capital gains tax by $2,578.50.
Brokers and mutual fund companies are now required to keep records of cost basis, so securities acquired in the recent past are not a problem. But that won’t help if your shares were originally on paper certificates, or were moved from one brokerage to another.
Get the calculation wrong and the IRS could accuse you of underpaying your tax. Or you might pay too much, which won’t bother the IRS but won’t do your finances any good, either.
The problem involves assets received as a gift, but not ones passed on at the original owner’s death. Inherited assets enjoy a “step-up” in cost basis to the value at the time they were passed. It’s still important to know the value at the time of the previous owner’s death, but not necessary to dig back through the decades. (You can’t claim losses built up under the original owner.)
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For gifted assets, one option is to simply assume that the original cost was zero, and pay tax on 100 percent of the proceeds after a sale. A stock purchased 60 or 70 years ago may in fact have gone up so much that most of today’s sale proceeds are profit anyway. And the long-term capital gains rate is just 15 percent, which means most of the proceeds stay in your pocket even if you pay more tax than actually required.
But calculating the cost basis of an ancient holding may not be as dreadful as you think. Rather than dig through boxes of financial records, if you have them, you might get a good picture by contacting the company’s investor relations department. Many have cost data from way back, and may even provide it on their website along with a record of key events like stock splits, mergers and spinoffs.
Of course, the stock issuer will not know how Grandma handled taxes in the past. If she paid tax on dividends that were invested in more shares, then the dividends should be added to the price originally paid for the shares. Raising that cost reduces the profit after a sale, cutting the capital gains tax after you unload the shares.
Chances are the IRS is not going to ask you to document your grandmother’s tax history, so it’s probably safe to assume she paid what she owed.
Another option: Put your broker or financial advisor on the case. They probably have access to services like the BasisPro feature of the GainsKeeper program, which you can find online. Or you can get your own subscription for $549 a year, permitting 50 searches.
Of course, services like these cannot tell when the shares were purchased — you have to provide that. So you may just have to grit your teeth and pay tax on everything you get in the sale. After all, this is found money.
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And if some benefactor hands you a dusty stock certificate, be sure to ask about purchase dates and costs, and then append that information if you give assets away.
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How to Determine Your Stocks’ Cost Basis originally appeared on usnews.com
