Help! Can't solve EA problem!

[les grans]

I was using past years' exam question to study for the EA exam, and I ran across this question. It's a real stumper and I can't figure out the correct answer. Can one of you experts help me with this?

In 2002 Mary purchased 10 shares of Acorn Corporation common stock for $100 per share. In 2003 Mary purchased an additional 10 shares of Acorn Corporation common stock for $200 per share. At the end of 2004, Acorn Corporation declared a 2 for 1 common stock split. What is Mary’s total basis in her Acorn Corporation common stock?

A. $300
B. $400
C. $500
D. $600

[BOB W]

The question is worded wrong, but the answer to the exact question is $3,000. None of the answers relate to the question. Her per share basis is $75. (40 shares)

[les grans]

I sorta thought that $3,000 should be the right answer. But aren't there still two blocks of stock, now, with different tax basis per share in the two blocks?

[New York Enrolled Agent]

Yes. you are correct. You can't use the average of $75

You have 20 shares with a basis of $50 and 20 shares with a basis of $100 for a total basis of $3,000

[Nashville]

Why not a Moving Average

NYEA can we not use a "moving average" of $75 instead of two separate blocks of stock?

As we all should know, the only time this makes a difference is when stock is sold, and basis is calculated to apply against the proceeds.

I was taught (with or without cites) that a taxpayer may use any "reasonable" method for valuing his portfolio, so long as he treated all stocks consistently. And that if there were no method prescribed by the taxpayer, the IRS would assume FIFO.

Has this changed (or was it ever right to begin with)?

[snowbird]

I thought I saw that question before ... question number 54 on my 2005 exam. The official answer was "*" .... * Indicates everyone gets credit.

That year ... there were 23 question out of 320 that had either multiple answers or everyone got credit. I wonder how many bogus questions there are in the new exam. If the IRS could not write questions with correct answers, how can an outside testing firm? I don't remember how many anwers were change after the tentative answers were published and challenged. However, we will not know with the current system .... questions and answers are not published until the questions are not re-used in the future.

[erchess]

I would also like to hear from NYEA or Bees

NYEA can we not use a "moving average" of $75 instead of two separate blocks of stock?

As we all should know, the only time this makes a difference is when stock is sold, and basis is calculated to apply against the proceeds.

I was taught (with or without cites) that a taxpayer may use any "reasonable" method for valuing his portfolio, so long as he treated all stocks consistently. And that if there were no method prescribed by the taxpayer, the IRS would assume FIFO.

Has this changed (or was it ever right to begin with)?

But here is what I think.

The question at hand comes up only when the taxpayer buys a certain investment in more than one purchase and then sells some but not all of his accumulated shares. Since this is a relatively common investor behavior all tax professionals should know the rudiments of how to handle it and should have access to more information such as is provided by TTB and this board.

Average cost basis is available only for Mutual Funds

For individual securities that leaves three choices: Specific Identification, LIFO, and FIFO. I have yet to have a client who can get from the broker the necessary info for Specific Identification but it's easy enough if you do know which shares were sold. When I personally tried to instruct a broker in which shares to sell my instructions were not followed. I always continue a given stock the same way I or the previous preparer started it but I am not aware of any cite that would say I have to as long as the total basis claimed on all sales of the stock does not exceed actual basis. I am quite sure that what option you choose with one stock does not affect your options with the rest of your portfolio.

A moving average gives greater weight to more recent data points than to earlier ones and is used to identify trends in investment prices but has no use I am aware of in preparing tax returns. In particular you could never use a moving average to calculate basis of anything.

[New York Enrolled Agent]

NYEA can we not use a "moving average" of $75 instead of two separate blocks of stock?

Has this changed (or was it ever right to begin with)?

Nashville

I believe IRC §307 requires an allocation when a stock split occurs. Thus you have two different lots of stock, each with a different cost basis.

I believe regulation §1.1012-1 where basis of property is discussed allows for more than one method of identifying stock when sold. HOWEVER, as far as I know, the election (Reg §1.1012-1(e) ) to use average cost basis is only for shares in a regulated investment company (i.e. a mutual fund). Others may agree or disagree.

[FEDUKE404]

Two groups is correct

From a technical standpoint, NYEA is 100% correct regarding the cost of Group A and the cost of Group B. After the stock split, the underlying shares (two groups) still maintain their separate cost bases.

You cannot do a moving average on shares of stock, or use anything resembling an average cost basis, so far as I know. It is always FIFO, and as mentioned no one ever "instructs" their stockbroker at the time of sale (as required!) to sell a specific lot.

The simplest scenario is to dispose of ALL of the pre- & post-split shares simultaneously, then the point becomes moot. Even gifting some of the shares can create a similar problem.

This entire issue is more of a tax rule issue, as in the real world it frequently is a moral victory just getting the client to come up with anything regarding an accurate cost basis. I'm still enduring Ma Bell and her progeny problems!!

FE

[JSLATER]

>When I personally tried to instruct a broker in which shares to sell my instructions were not followed.<

My wife is not a day trader, but makes 350 to 400 trades a year. She is constantly "picking" what lot of stock to sell. After a few phone calls, when her instructions were not followed, the broker is finally getting it done right. In each case, the brokerage went back and corrected the sale as per instructions. The normal investor probably is not even aware this can be done, but believes and I have the clients to prove it, they can average down any investment that will give them smaller cap gains. When you tell them, they come up with "the guy at work said..............."

[JohnH]

Tell them they need to stop listening to "the guy at work".

Other than tax pros, only hairstylists and mechanics are qualified to dispense tax advice.

[JSLATER]

I don't know about that, I have met some pretty sharp bartenders.

[OtisMozzetti]

Two or more Different Brokerage Accounts

What if a taxpayer owns the same stock issue, XYZ Corp., via two or more different brokerage accounts (or other ways of acquiring the stock)?

I have heard some rumbles about ALLOWING the FIFO lot inventory rule to apply separately to each separate brokerage account? Is that true, and if so, would it become a REQUIREMENT to track each account separately? And, if so, what about TRANSFERS of stock between the different brokerage accounts?

As far as I know, FIFO is FIFO is FIFO, but I just thought I'd ask.

EA in Calif.

[JohnH]

Bartenders aren't allowed to dispense tax advice directly to the public - their role in the process consists entirely in providing Continuing Ed to hairstylists and mechanics.

[JSLATER]

Below is a quote about selling different lots of the same security or equity. The "proper term" is VSP or versus purchase.

'If you've been buying shares in a high cost fund all along, sell the shares for which you paid the highest price but keep those you bought way back when.' My question is: how exactly do you do this? In the olden days, when dealing with a flesh-and-blood broker, you would send him a note saying something like 'Please sell the 100 shares of XYZ purchased on 4/1/66 and not the ones I bought last week.' Of course the shares are all the same to your broker and you, but this polite fiction was sufficient to hold the IRS at bay. Nowadays though, with online brokerage accounts, how do we effect this little charade?"

Send the note anyway and keep a copy with your tax records. (Actually, since these are no longer the olden days, fax it and you won't even have to make a copy.) You're not likely to be audited, but if you are, and you have good records -- along with clear instructions to your broker directing him to sell "the 300 shares versus purchase date 7/13/93" -- it seems to me you've done your bit. (Don't blame me if the IRS disagrees. I limit my liability in this to price you paid for this column.)

But you raise a good point. An enhancement on-line brokers could easily add is an optional field in which to enter the VSP date (VSP = versus purchase)."

The investor, when selling, though most are not even aware, has three choices: FIFO, LIFO or specific lot identification. Hence, the note or documented phone call to the broker and your own records. In audits I have been involved in, no mention was ever made about FIFO or the others. As long as the basis could be proven, confirmations or statements, there was no problem.

Again, referring to my wife as an almost day trader, at one time she had accounts at three different brokerages. I tracked each account for our personal use, but when she sold a stock, the basis of that stock or the one she designated was used. Where it was located, did not enter into the sale. Basis is basis. The character of the equity does not change when to tranfer it to another account. But, the investor should be aware of wash sale rules and other little investing inuendos. You sell ABC in one account and buy it in another, no matter where the equity is located, wash rules will apply for 31 days as you are the registered owner.