If you have a brokerage account, you soon will get a mailing or call about a new tax law that takes effect next year. Don't ignore this one.  The subject: what you must do now that your broker must report an investment's cost basis to the Internal Revenue Service after you sell a stock.  Cost basis is an area that is both crucial and confusing to taxpayers. It refers to the price of acquiring an investment, which then becomes the starting point for figuring tax when it is sold. Tracking basis can be complex, especially when there are multiple purchases, splits or dividend reinvestments. Shares in the same investment sold for the same price, for instance, generate different amounts of tax if they have different cost bases.  Example: Five years ago, Elizabeth bought 500 shares of Acme Co. for $17, and two years ago she bought another 500 shares for $8. The stock now is at $25, and she sells out for $25,000. The taxable gain on the $8 shares is $8,500, while the taxable gain on the $17 shares is $4,000.  Formerly the IRS had no way to know, short of an audit, whether taxpayers figured gains and losses correctly. This irked Congress, especially after studies estimated that basis errors—innocent or not—were contributing up to $25 billion a year to the "tax gap."  "It seemed that people who wanted to comply with the law were finding it too hard, while those who wanted to skirt the law were finding it too easy," says National Taxpayer Advocate Nina Olson. In 2008, Congress mandated that investment providers would have to track customers' cost bases and report them to the IRS on a 1099 form when an investment is sold, beginning in 2011.  Although the rules phase in, brokerage customers need to make decisions soon. The IRS recently published over 100 pages of rules pertaining to the new law. Here are answers to some important questions:  When does the new law take effect?  At different times for different types of assets. Brokers must begin tracking acquisitions and subsequent sales of stocks, real-estate investment trusts and foreign stocks as of Jan. 1, 2011.  Mutual-fund sponsors and dividend-reinvestment plans (DRIPs) have until Jan. 1, 2012, to comply. So if a customer holds both stocks and mutual funds within one brokerage account, the new law applies to the stocks in 2011 and the funds in 2012.  The effective date for exchange-traded funds varies. Stevie Conlon, tax counsel at Wolters Kluwer Financial Services, says many ETFs fall under the 2012 rule. But some—such as foreign ones classified as stock—are subject to the 2011 rule.  For individual bonds and options, the law kicks in on Jan. 1, 2013. Most partnerships and derivatives other than options aren't covered by the rules, but the IRS can extend the law to them after Jan. 1, 2013.  Will the IRS receive basis information for all my sales?  Not at first. Although many providers have been tracking cost basis for years, the new rules apply only to sales of investments purchased after Jan. 1, 2011, 2012 or 2013, as described above. So if you sell a stock in two years that you bought three years ago—or 30—your broker doesn't have to tell the IRS the cost basis when you sell it.  What changes in cost basis do my investment providers have to track for me?  In addition to purchases and sales, they have to track events such as splits, reinvested dividends and mergers, which can raise or lower cost basis. They also must track inherited or gifted investments.  Providers also must adjust for "wash sales." Taxpayers can't deduct a loss if similar shares are purchased 30 days before or after a sale. Ms. Conlon says wash sales are fairly common: "People change their minds, or sell shares at a loss near an automatic dividend-reinvestment date."  Providers must adjust basis if investments have matching Cusip numbers within one account. But they don't have to look across accounts at different firms or even different accounts at one firm—though the customer does.  So if Mr. and Mrs. Smith have two accounts—one joint and another in her name—at the same firm, the broker needn't combine information from the accounts, even if the couple files a joint tax return.  A footnote: Currently if a customer puts in an order to sell 1,000 shares of stock, he may get a voluminous statement showing multiple partial sales on different exchanges at prices pennies apart. Steven Rosenthal, a tax attorney with Ropes & Gray, points out that now brokers are clearly allowed to aggregate the bits of such intraday trades and show one average cost basis.  What does my broker need from me now?  You must decide whether to put in a standing order on which shares to sell first, or specify on a case-by-case basis. Examples of standing orders: FIFO (first-in, first-out), LIFO (last-in, first-out) or HIFO (highest-basis-in, first-out). You also may give the broker or another agent full or limited power to choose shares for you. You may change your mind anytime up till the settlement date, Ms. Conlon says.  If you identify shares on a case-by-case basis, you have to specify which were sold by the trade's settlement date. Many taxpayers have flouted existing rules by identifying which shares were sold much later, when they do their taxes.  If you don't tell your provider what to do, the law will choose for you—usually FIFO.  What if the amount of basis my broker reports to the IRS differs from what I report on my tax return?  If there is a discrepancy, it isn't clear how it will be resolved. There is currently no ready way to explain such a difference on Schedule D.  Do these rules affect my IRA, Roth IRA or 529 college-savings plan?  No, because investments in these tax-sheltered accounts don't have a cost basis.  Write to Laura Saunders at taxreport@wsj.com
Starting in 2011, your broker has to tell the IRS important information about your investments. Here's what you need to know.