Early each year, investors receive a 'Proceeds from Broker Transactions' report, IRS Form 1099-B, from each of their brokerages. This form lists the gross proceeds from stock sales for the prior year.
The bad news: the Form 1099, with just the sales listed, provides only a part of the data needed to determine the capital gains for Schedule D. For each sale, the amount of capital gain, or loss, is the difference between the gross proceeds and the 'cost or other basis'.
Cost basis depends on which stock was sold
From IRS Pub 550, the cost basis for a stock position is the purchase price plus any purchasing costs such as commissions. To know the purchase price, one needs to identify which stock was sold. When an investor has made purchases at various times, this can become difficult.
Identify stock sold with tax lots, not stock trade history
Every opening trade to purchase stock creates a new tax lot. The cost basis of the lot is the purchase price plus any purchasing costs.
Later, a sale of stock will reduce the number of shares in the lot being sold. When all of the shares are sold, the lot is closed. If only a portion of a lot is sold, the lot will have its shares reduced by the number of shares sold. The cost basis is the fractional part of the shares sold to the total cost basis of the lot.
A sale of stock may also involve multiple lots. Each lot will have a distinct cost basis and holding period. Such a sale will result in a separate capital gain or loss for each affected lot.
Cost basis record keeping is a burden
The taxpayer bears the responsibility for tracking the cost basis to substantiate their capital gains. Along with a list of current stock positions, brokerage reports include the history of trades. Except for the simplest cases, neither coincides with the tax lots.
Investors have few tools to help track cost basis over time. Many use tax preparation software to calculate capital gains at year-end. While this may appear to be a reasonable approach, this may not result in the lowest tax.
Some do maintain a record of each tax lot in their portfolios. Nevertheless, taking on this task with a spreadsheet would be time-consuming and error-prone.
A cost basis app for individual investors
A great cost basis app would make tax lots easy. Investors who know their tax lot situation can make better trades year-round. This helps them get better after-tax returns, since they trade stock with an eye on lowering their capital gains tax. With the tax lots already set up, calculating the capital gains and Schedule D becomes automatic.
Providing investors with a simple tool to maintain their tax lots is another reason why we developed the Realized app for managing stock portfolios.