Based on a new tax law that takes effect in 2011, nowis the time to become familiar with cost basis. Although inaccurate reporting can lead to dire consequences, the new law has as much to do with improving the conversation with your financial advisor as it does with getting the numbers right.

What is cost basis and why does it matter?
Cost basis is the price paid for a stock, along with commissions and other fees. Before 2011, it was up to an investor or his/her accountant to keep track of that amount. This can be somewhat confusing, especially when a stock is old or there are multiple purchases, splits or dividend reinvestments. The bottom line: If you estimate high on the return, capital gains will be lower.

Stockbrokers and mutual-fund companies will have to provide investors with the cost basis for stocks that they cash in – a calculation used to determine capital gains. Under a 2008 law, brokers must report the cost basis of securities to investors and the IRS on Form 1099-B.

Although this is good for investors because they no longer have to figure out the amount for themselves, the requirement leaves no room for estimation because the totals are reported by brokers on the IRS form. Before now, the only way the IRS had to determine if taxpayers figured gains and losses correctly was through an audit.

What are the deadlines?
Based on the type of investment, the new law takes effect on different dates.

• As of Jan. 1, 2011, brokers must track acquisitions on subsequent sales of stocks, real estate investment trusts and foreign stocks.
• Mutual fund sponsors and dividend-reinvestment plans have until Jan. 1, 2012, to comply. If a customer holds both stocks and mutual funds with 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; many get pushed to 2012, while foreign investments classified as stocks must be reported in 2011.
• The new law becomes effective Jan. 1, 2013, for individual bonds and options. Although most partnerships and derivatives other than options aren’t covered by the rules, the IRS can extend the law to these after Jan. 1, 2013.

Improving the investment conversation
Of course, accountants do not intentionally make mistakes in calculating cost basis for returns; that would not be beneficial for the client and certainly not for the accountant. Nevertheless, based on the law, accountants are now likely to scrutinize cost basis more closely because of the 1099-B reporting.

With this scrutiny comes a positive outcome – the new requirements have the potential to improve the investment conversation. Investors might ask for more advice about the tax consequences related to investments that are bought or sold. Even though this potentially puts more responsibility on the tax advisor, investors should never hesitate to ask for their help in understanding everything possible about an investment.

Investors must decide whether to put in a standing order on which shares to sell first, or to specify their order on a case-by-case basis. If you do not instruct your broker on which situation you prefer, the law specifies that any transactions must be handled on a first-in, first-out basis.

Now is the right time to acquaint yourself with the new rules, communicate effectively with all your advisors, and keep up with the changes in order to minimize any surprises.