Missing Basis: Reporting Stock and Property Sales on Late Returns

Here is a scenario I see often. Someone stops filing for a few years. During that time, they sell some stock, or a rental property, or an inherited house. The broker or the closing agent reports the sale to the IRS. Years later, the IRS's calculation treats the whole sale price as if it were income.

The tax on that number can be enormous. In most cases it is also wrong, because the person had basis. The job is to prove it.

The rule: gain is proceeds minus basis

IRC 1001(a) defines gain as "the excess of the amount realized therefrom over the adjusted basis." IRC 1012(a) says the basis of property is generally its cost. IRC 1016(a) requires adjustments to basis for items properly chargeable to capital account, such as improvements.

So the tax is not on what you sold something for. It is on the difference between what you received and your adjusted basis. If you sold stock for $80,000 that you bought for $70,000, the gain is $10,000, not $80,000.

The problem for non-filers is that the IRS may only have half of that equation.

What the IRS knows about your sales

Securities. Brokers file information returns on sales. IRC 6045(g) requires that for a "covered security," the broker's return include "the customer's adjusted basis in such security and whether any gain or loss with respect to such security is long-term or short-term." Covered securities are generally specified securities acquired on or after an applicable date, either in the account or transferred in from an account where they were covered. Older holdings, and securities transferred in without the required statement, may be reported with gross proceeds only.

Real estate. IRC 6045(e) requires a "real estate reporting person," generally the person responsible for closing, to file a return for a real estate transaction. That reporting typically shows the sale, not your purchase price or improvements.

Your transcript. The IRS wage and income transcript shows information returns filed with the IRS, including 1099 forms. Check it for every unfiled year with a sale. See using wage and income transcripts.

Why the SFR makes this worse

The IRS's substitute for return rules leave out most of what lowers your tax. The examination manual says deductions and credits will not be allowed on an SFR, with the standard deduction as the exception for individuals (IRM 4.12.1.25.4), and that business expenses do not have to be allowed without your documentation (IRM 4.12.1.25.2). The ASFR program computes tax from information reported by payers combined with other internally available information (IRM 5.18.1).

If the IRS's information shows gross proceeds and no basis, you are the one who has to supply the missing half. That happens on your own return.

Rebuilding basis for securities

• Brokerage statements and trade confirmations. Purchase confirmations show the date, quantity, and price.
• Account history from the broker. Many brokers can produce transaction histories for closed or old accounts. Ask how far back their records go.
• Transfer statements. If you moved an account between brokers, the transfer paperwork may show the basis carried over.
• Dividend reinvestment records. Reinvested dividends buy additional shares, and those shares have their own cost. Missing them overstates gain.
• Corporate action history. Splits, spinoffs, and mergers change per-share basis.
• Inheritance or gift documents. Inherited and gifted property have their own basis rules. Estate inventories and appraisals can be critical.

Rebuilding basis for real estate

• Purchase closing statement. It shows the price and many capitalized costs.
• Improvement records. Invoices, permits, contractor agreements, and bank payments for additions and major improvements. IRC 1016(a) adjusts basis for items properly chargeable to capital account.
• Depreciation history. For rentals, depreciation claimed or allowable reduces basis. Prior filed returns show what was taken.
• Sale closing statement. Selling costs reduce the amount realized.
• County records. Recorded deeds and sale prices can corroborate the purchase date and price when your own copy is gone.

When records are truly missing

Sometimes the purchase records cannot be found. Do not invent a number. Do the work:

1. Pin down the acquisition date from whatever evidence exists, such as a deed, an account opening document, or an old statement.
2. Find the market price on that date from reliable historical sources.
3. Corroborate the quantity or the property interest you acquired.
4. Document every step, so a reviewer can follow your reasoning.

An estimate built on evidence is very different from a guess. The first is a reconstruction. The second is a liability.

Do not forget the holding period

Basis is not the only missing fact. Whether a gain is short-term or long-term can change the tax substantially. IRC 6045(g) requires brokers to report whether gain or loss on a covered security is long-term or short-term, but for non-covered securities and real estate, you establish the holding period from your own acquisition records. The same documents that prove basis usually prove the date.

Inherited and gifted property

Property you received from someone else follows its own basis rules, and those rules often help. The Code has separate provisions for property acquired from a decedent and property acquired by gift, and the basis can be very different from what the original owner paid. If you sold inherited property during an unfiled year, the estate's records, such as an inventory, appraisal, or estate tax return, may establish your basis. Ask the executor or the estate's attorney for copies. Those documents are often easier to find than the original owner's purchase records.

Digital assets

IRC 6045(g)(3)(B) now lists digital assets among the specified securities subject to broker basis reporting. For older years and for assets held outside a broker, basis records may be scattered across exchanges and wallets. The same rule applies as with stock: gain is amount realized minus basis, and you are the one who has to prove the basis.

Rental and business property

For rental property, depreciation matters in two directions. It lowered your taxable income in the years you claimed it, and it reduces your basis when you sell. IRC 1016(a) requires adjustments to basis, and depreciation is one of them. If you did not file during some of the rental years, your preparer will need to work out what depreciation was allowable for those years too, because IRC 1016(a)(2) reduces basis by depreciation allowed, but "not less than the amount allowable." Depreciation you never claimed can still reduce your basis. Get that analysis right before you report the sale.

Losses count too

If a sale produced a loss, report it. A late return with a capital loss is not just a compliance exercise. It can reduce the tax for that year and, depending on the rules, carry forward to later years. Losses on sales of personal-use property, such as a personal residence, are generally not deductible, so the type of property matters.

Report the sale even if you think there is no gain

Some people leave a sale off a late return because they believe they broke even. That is a mistake. The IRS has the information return showing the proceeds. If the sale is missing from your return, the mismatch is what gets noticed, and the burden is on you to explain it. Report the sale, show the basis, and let the math show the result.

When to slow down

If a sale was large, if it involved property held through an entity or a nominee, or if the proceeds went somewhere you would rather not explain, get legal advice before filing. Sales are one of the first places the IRS looks for concealment, and the fraud screening for non-filers in IRM 25.1.7.2 lists significant income on information returns, including stock and bond transactions, as a potential indicator.