How the IRS Can Check Up on You

Q: How does the Internal Revenue Service check up on the buy and sell dates of stocks? Can it really know every transaction in the portfolio of every taxpayer? M.S.C .

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A: No, the IRS can’t “know” everything, but if they want the information badly enough, IRS auditors can turn your stock dealings upside-down to get the information they want.

Typically, brokerage houses are required to report all stock sales to the agency on what is known as a Form 1099. You receive copies of these reports and are required to attach them to your income tax return every time you sell shares. The IRS also receives this information, and, thanks to the power of computers, routinely cross-checks the data against your tax return to ensure you have reported exactly what the brokerage house reported. (Similar forms covering interest and dividend payments are completed and filed by brokerages, corporations and financial institutions.)

However, merely reporting the sale of securities on the Form 1099 isn’t where your obligation as a taxpayer ends. You must also tell the IRS how much money you made--or lost--in the deal. This computation requires you to state what you paid for the shares and calculate your so-called taxable basis in the securities. The difference between the basis and the sales price--if the sales price is greater--is the amount on which you are obligated to pay taxes. If the sales price is lower than the taxable basis, you are allowed to deduct the difference between the two amounts as a loss. These computations must be completed on Schedule D of the tax form and filed with your Form 1040.

The IRS says it is the obligation of all owners of securities to keep records of their holdings, their original costs and any transactions affecting their taxable bases in these securities. In most cases, this is where it ends. However, if you are one of those lucky individuals selected for an IRS audit, you may be required to prove how you arrived at your taxable basis in your just-sold securities. If your records can’t satisfy the IRS, you could be liable for taxes on the full amount of the proceeds from the sale.

Postponing Exemption on Home Sale Profits

Q: We bought our house for $90,000 and expect to clear $170,000 after sales expenses--when we sell it. We expect to buy a new house for $150,000. Although we are over age 55, we do not want to take advantage of the onetime exclusion of $125,000 of profit because we hope to accumulate even more tax-exempt profit on the sale of our new house. Can we simply pay taxes on the $20,000 difference between the sales price of the old house and the cost of the new one and postpone taking advantage of the onetime exclusion? -- C.V.B .

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A: Yes. The strategy you have laid out is perfectly proper and sound. If you were to invoke the $125,000 exemption with this sale, you would not be able to take full advantage of it because the gain on the sale of your old house is just $80,000. The law does not permit you to use just a portion of the exemption and save the remainder for a later sale. So whatever portion of the exemption you don’t use--in your case it would be $45,000--is forever lost. The tax advisers we consulted said it was probably better to pay taxes on the $20,000 gain that was not reinvested in a new house than to permanently forgo use of $45,000 worth of the home sellers’ exemption.

For a more complete explanation of how to handle your gain, consult Internal Revenue Service Form 2119.

You Can’t Hide From Home Sale Taxes

Q: I have a substantial capital gain position in a home in California in which I have resided for about 20 years. I plan to move to Nevada, establish legal residence there and then return to California and sell my home. Do I have to pay taxes on that gain to the state of California? -- F.D.Y .

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A: The law requires that when you sell property in California--no matter where you live at the time of the sale--any taxable gain is subject to California state income tax as well as federal taxation.

California has been taxing real estate sales by out-of-state residents for decades, but it is fair to say that some have slipped through unnoticed and untaxed because the state Franchise Tax Board has not had a particularly good method of policing such sales. However, assessor’s offices in most counties in the state have begun sharing computerized records of property sales and reassessments to help the tax board collect what the state is owed.

What the ‘Ex’ in ‘Ex-Dividend’ Means

Q: I understand that dividends are the amounts some companies pay their shareholders every quarter. But what does it mean when a company goes “ex-dividend”? *

P.G .

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A: “Ex-dividend” defines a period of time during which a dividend is not payable to those who buy the stock; it occurs immediately prior to the payment of a regular corporate dividend. Here’s how it works.

Let’s say that Company XYZ pays dividends for the quarter ending March 31 to shareholders of record on March 10. This means that between March 10 and March 31 the company’s shares are ex-dividend, and investors purchasing stock in the company during that time are not entitled to dividends on those shares. On the other hand, investors selling shares during the ex-dividend interval are still entitled to the dividend because they were the owners of record on the date of reckoning. Generally, shares actually turn ex-dividend a few days before the official shareholder-of-record date to allow trades to clear by the official date.