Tax planning and compliance for investors
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This page takes you step by step through the purchase and sale of shares of stock We'll walk through opening an account, buying some shares and selling those shares.
Remember the first time you opened a checking account? You may have been uncomfortable because it was unfamiliar territory, but now it seems like a very simple financial tool. The procedures for buying and selling stocks are a little more involved, but not much. We can't tell you what to buy and sell, and when, but how you do it is fairly straightforward.
Brokers usually make it easy for you to open an account because that is something they dearly love for you to do. You can visit their office, or open an account by telephone or mail. Increasingly, people open accounts via the Internet. Generally two things are involved: filling out forms and writing a check. You'll need to give the broker your social security number and, if you're married, decide whether this account will be in your name alone or a joint account with your spouse. This is a regular, taxable account — not an IRA — so you can put in as much as you like.
Once you have an account open and money on deposit you're ready to buy some stock. Suppose you enter an order to buy 25 shares of XYZ at the market price. You may enter the order at your broker's office, or by telephone — or via the Internet if your broker provides this service.
If all goes well, your broker will confirm your purchase shortly after it's made. If you're trading via computer while the market is open, this may happen literally within seconds. Your broker will send you something called a trade confirmation in the mail, setting forth the essential facts of the transaction.
Normally you'll never see certificates for these shares of stock. Unless you make a special request to have the certificates sent to you (which usually incurs an added fee), a custodian selected by the broker will hold the shares for you. But you're considered the owner, so you'll get any dividends and have the right to exercise whatever voting rights the shares provide.
Many investors think they're done with the purchase when they receive confirmation of the transaction from the broker. It's true that you don't have anything yet to report to the IRS. But you do have an obligation — to yourself as well as to the IRS — to keep a record of this transaction. Don't wait until you sell. Create a permanent record at the time of the purchase, with the following information:
The date your broker filled the order is called the trade date. This is the date that establishes your holding period for the stock. That's true even though the stock and the money won't change hands until the settlement date, which is usually a few days after the trade date. The trade date of your purchase is one of the essential pieces of information you must record for tax purposes.
Suppose your broker confirms that you've bought 25 shares of XYZ at $64, paying $1,600 plus a commission of $40. The commission isn't considered an expense that you can claim as a separate deduction. Instead, it's considered part of the cost of the stock. You add the purchase price and the commission to determine that your basis in the stock is $1,640.
Time passes. You're ready to sell. Unless it's an emergency you should stop and think about the tax consequences. How much gain or loss will the sale produce? Long-term or short-term? Should you sell something else first? Should you identify the shares you are selling?
When you're satisfied you know what you want to do, you enter an order with your broker to sell 25 shares of XYZ. Once again you can enter the order at the broker's office, by telephone or via the Internet. Let's assume your broker confirms that you have sold at $72, incurring another $40 commission.
Normally the sale proceeds will go into your account at the brokerage firm. The broker won't send the money to you unless you specifically request a check. But you report the gain or loss in the year the transaction occurs. You're not allowed to wait until you take the money out of the brokerage account.
Time to update your records. The sale record will be very similar to the purchase record, with two added items:
The trade date of the sale is used for two purposes. First, it determines what year you report the gain or loss. For example, if your trade date is December 31, 2004 you'll report your gain or loss on your 2004 income tax return, even though the settlement date doesn't occur until 2005. As explained below, the trade date of the sale is also used to determine your holding period.
Your sale proceeds are equal to the $1,800 sales price minus the $40 commission, or $1,760. You determine the gain or loss by subtracting your basis from the sale proceeds. In this case you have a gain: $1,760 minus $1,640 leaves you $120 ahead of the game.
Notice that if you hadn't paid $80 in commissions your gain would have been $200. Here's another way to look at it: if you sold the stock at $64, the same as the purchase price, you would report a capital loss of $80 because of the commissions.
Besides the amount of gain or loss, you need to know the category of the gain or loss. This is determined by the holding period of the stock. You find this by comparing the trade date of the purchase with the trade date of the sale. For more information on holding periods, see Capital Gain and Loss Categories.
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