Covered Securities

A “covered security” is an investment where your broker is legally required to track your cost basis—what you originally paid for it—and report that information to both you and the IRS when you sell. This rule, a godsend for most investors, simplifies tax time by putting the heavy lifting of record-keeping on the financial institution. The broker reports this information on a tax form called Form 1099-B, which details the proceeds from your sales, the date you bought and sold, and, crucially, your cost basis. Before this system was fully implemented, investors were left to their own devices. They had to meticulously track every purchase, including reinvested dividends and transaction fees, sometimes for decades. Forgetting a detail or losing old paperwork could lead to a major headache and potentially overpaying on capital gains tax. The introduction of covered security reporting rules brought order to this chaos, making tax compliance much more straightforward for the average person.

Think of the time before 2011 as the wild west of tax reporting. Investors were responsible for tracking every penny. The government, realizing that this honor system was leading to a significant “tax gap” from honest mistakes and intentional underreporting, decided to step in. The Emergency Economic Stabilization Act of 2008 mandated that brokers start tracking and reporting cost basis information. However, this change wasn't like flipping a switch; it was phased in over several years to give brokers time to adapt their systems.

• Stocks: Became “covered” if acquired on or after January 1, 2011.
• Mutual Funds & ETFs: Became “covered” if acquired on or after January 1, 2012.
• Bonds, Options, & Other Securities: Became “covered” if acquired on or after January 1, 2014.

Any security you bought before these dates is considered a “noncovered security.” For these holdings, the reporting burden remains squarely on your shoulders. Your broker will report the sale proceeds, but the cost basis box on your 1099-B will likely be empty.

A true value investor knows that returns aren't just about picking great companies; they're about what you actually get to keep after taxes and fees. Understanding covered securities is fundamental to tax-efficient investing.

For covered securities, your broker will often let you choose a cost basis accounting method. The default is usually FIFO (First-In, First-Out), which assumes you sell your oldest shares first. However, you can often elect to use other methods, like Specific Lot Identification. This powerful tool allows you to hand-pick which specific shares to sell. Example: Imagine you bought 100 shares of XYZ Corp at $50 in 2015 and another 100 shares at $100 in 2022. The stock is now trading at $110. If you want to sell 100 shares:

• Using FIFO, you'd sell the 2015 shares, realizing a $60 per share gain ($110 - $50).
• Using Specific Lot ID, you could choose to sell the 2022 shares, realizing only a $10 per share gain ($110 - $100).

This flexibility allows you to strategically manage your tax liability, a key discipline for maximizing long-term, after-tax returns.

If you hold very old stocks, perhaps inherited or bought decades ago, they are almost certainly noncovered. This is where diligent record-keeping—a hallmark of any serious investor—pays off. If you sell a noncovered security and cannot prove your cost basis, the IRS may legally assume the basis is zero. This means the entire sale amount could be treated as a taxable capital gain. It’s a costly and entirely avoidable mistake.

1. Review Your 1099-B Carefully: Your broker will clearly separate transactions for covered and noncovered securities. Pay special attention to the noncovered section to ensure you have the records needed to report your cost basis accurately.
2. Digitize Old Records: If you have paper trade confirmations or statements for noncovered securities, scan and save them digitally. Don't rely on a shoebox in the attic. Account for events like a stock split or merger that would have adjusted your original cost basis.
3. When in Doubt, Consult a Pro: For complex situations involving inheritances, gifts, or very old noncovered securities, the cost of hiring a qualified tax professional is often a small price to pay to avoid a massive tax bill.