Balancing Priorities

If you cashed out on stocks in 2016, be aware of this tax trap

If you finally cashed in some long-held stocks last year, you'll need to do some detective work — or face a steep capital gains tax.

By now, you should have received most of the tax documents you need to file your return, including a Form 1099-B from your brokerage firm in the event you've sold an investment and booked a capital gain or loss.

There's a catch: Some taxpayers will need to dig up additional documentation on long-held assets they sold in 2016 — namely, the cost basis or the amount they originally invested — or else they may be on the hook for a large tax bill.

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"The IRS can ask you to prove how you calculated your capital gain and where you came up with your basis [in the investment]," said Mark Nash, tax partner in the personal financial services group at PwC.

"If you're audited, the hard-line approach is that they will assume the basis is zero and that everything is a gain," he said.

Calculating basis

Basis — also known as cost basis — is key to understanding how much you may owe on capital gains taxes once you've cashed out of a security.

It's the amount of money that you paid for an asset, and it can be adjusted to weigh dividend payments, stock splits and other developments.

The difference between your basis in an investment and the value of the asset when you sold it is how you can determine the magnitude of your gain or loss, as well as the size of your tax liability.

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How much capital gains you'll pay depends on how long you held the investment and your income tax bracket.

Taxpayers in the 25 percent to 35 percent brackets can expect to pay a 15 percent capital gains rate on assets they've held for at least a year and sold for a profit.

In the same scenario, taxpayers in the top bracket of 39.6 percent will pay a capital gains tax of 20 percent. They will also face an additional levy of 3.8 percent if their modified adjusted gross income is over $200,000 if they are single filers or $250,000 for married filing jointly.

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Though brokerage firms are required to notify the IRS when you sell, the federal tax laws that required them to do so phased in over three years, starting in 2011.

This means that if you were holding a stock or mutual fund prior to that, you might have to do a little homework to dig up your basis and report it to the IRS.

This can be even more complicated if you've switched brokerage firms over the years and you have to track down sometimes decades-old data.

"You could go back to the institution, and they may or may not give you that information, depending on how long they keep the records," said Stephen J. Bigge, CPA and partner with Keebler & Associates in Green Bay, Wisconsin.

Digging up documentation

Under normal circumstances, your brokerage will report your basis on Form 1099-B if you sold the asset in the prior year.

If your firm doesn't have that information, either because you've held the stock for many years or because you've switched custodians over time, you'll have to do some sleuthing to file your taxes.

You can look up historical prices and dividend payments on the web, but that's just the start.

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Here's what else you need:

  • Consider how you obtained the asset: How you came across a stock matters. If you inherited the stock from a deceased relative, your original basis is generally the value on the day of death. In that case, you'll find the basis on the decedent's estate tax return (Form 706).

    If someone gifted you the stock, then you need to find out the fair market value on the day of the gift and the previous owner's basis. You should also find out whether the donor paid any gift tax when giving you this stock. If so, you might find the basis on his or her gift tax return (Form 709).

    Going forward, you can go online and determine the gain or loss you've had since you've held the asset.

  • Narrow your time frame: If you can't remember exactly when you bought the stock, try to nail the year in which you bought it.

    "If we can narrow it down to the year in which the client bought the security, he or she might be happy taking an average of what the trading price was that year," said Nash.

  • Retain all of your statements: Don't rely on your brokerage firm's document retention practices. You should at least keep a secured digital copy of your statements and trade confirmations for the next time you have to chase down your basis.

    "For old and substantial holdings, print off your statements and keep them in your personal record," said Nash. "You don't know when they may drop off the radar."