What Are Noncovered Securities?
A noncovered security is designated by the U.S. Securities and Exchange Commission (SEC) to signify that brokers are not obligated to report the cost basis of these securities to the IRS. The adjusted cost basis for noncovered securities is only reported to taxpayers, not the IRS. Typically, these securities are smaller and more limited in scope.
However, any income derived from the sale of a noncovered security is still taxable. Taxpayers must report this on their tax return.
Key Takeaways
- Noncovered securities are not required to have their cost basis reported to the IRS.
- An investment bought in 2011 and transferred to a Dividend Reinvestment Plan (DRIP) using the average cost method in the same year is considered noncovered.
- Stocks sold by foreign intermediaries and nonresidents are also classified as noncovered.
- Form 8949 is used to categorize investment sales into covered and noncovered securities.
Understanding Covered Securities
In 2008, Congress mandated that brokers report the adjusted cost basis of securities and mutual funds to both investors and the IRS starting from the 2011 tax year. Since then, the cost basis for certain securities has been reported on Form 1099-B, which indicates whether the capital loss or gain from the sale is short or long term. Any post-2011 transaction is a covered security, reported on Form 1099-B, and includes:
- Stocks, including American Depositary Receipts (ADRs), acquired on or after Jan. 1, 2011,
- Mutual funds acquired on or after Jan. 1, 2012,
- Stocks or ADRs acquired through a DRIP on or after Jan. 1, 2012,
- Less complex bonds, derivatives, and options acquired on or after Jan. 1, 2014,
- More complex bonds, derivatives, and options acquired on or after Jan. 1, 2016.
Comprehending Noncovered Securities
Noncovered securities are basically any investments acquired before the regulatory dates outlined above. While brokers are not required to report their detailed cost basis to the IRS, they do need to report the gross proceeds or redemption value from sales. Nevertheless, taxpayers must report their adjusted cost basis on Form 1040, Schedule D, regardless of broker reports.
Securities are noncovered if acquired through a corporate action with the cost basis derived from other noncovered securities.
Types of Noncovered Securities
Corporate actions such as stock splits, stock dividends, and redemptions typically result in more shares for investors. These shares become noncovered if received through other noncovered shares. For example, if someone bought 100 shares in 2010 that split three-for-one in 2013, resulting in 200 additional shares—those shares remain noncovered.
A security transferred to a DRIP using the average cost method in the same purchase year (2010, as an example) will be noncovered. However, any transfer occurring post-2011 will retain its covered status.
Reporting on Form 8949
Investment sales are divided into covered and noncovered securities, as reported on Form 8949:
- Code C (checked box C) is for short-term holdings.
- Code F (checked box F) is for long-term holdings.
Understanding Cost Basis
Cost basis is essentially the original purchase price of an asset. For investments, it adjusts to account for stock splits, dividends, and other corporate actions, ultimately determining the profit or loss from selling the asset.
Reporting Noncovered Securities
For noncovered securities, while brokers may not report their cost basis to the IRS, taxpayers still must report it on their tax returns to calculate gains or losses. Omitting this information can result in penalties.
Lost Cost Basis Information
If you lack known cost basis data, reach out to your brokerage; they should have recordkeeping measures to provide the needed information.
Conclusion
Noncovered securities relieve brokers from reporting specific cost basis data to the IRS; however, the obligation falls on taxpayers to maintain compliance. Investors must closely monitor and report all relevant gains and losses from such securities to avoid potential tax issues.
Related Terms: covered security, cost basis, DRIP, stock splits, corporate actions.
References
- U.S. Congress. “H.R.1424 — 110th Congress (2007-2008), Public Law 110–343”, Pages 91-92.
- Internal Revenue Service. “Instructions for Form 1099-B, Proceeds From Broker and Barter Exchange Transactions”, Pages 8-9.
- Internal Revenue Service. “Instructions for Form 1099-B, Proceeds From Broker and Barter Exchange Transactions”, Page 9.
- Internal Revenue Service. “Instructions for Schedule D, Capital Gains and Losses”, Pages 1-2.
- Internal Revenue Service. “Instructions for Form 8949, Sales and Other Dispositions of Capital Assets”, Pages 6-7.
- Internal Revenue Service. “Instructions for Form 8949, Sales and Other Dispositions of Capital Assets”, Page 3.
- Internal Revenue Service. “Publication 550, Investment Income and Expenses (Including Capital Gains and Losses)”, Pages 39-40.
