Electing the Average Basis Method Beginning January 1, 2012

Electing the Average Basis Method Beginning January 1, 2012

The Energy Improvement and Extension Act of 2008 made changes to the average basis method rules. One of these changes is that the average basis method must be elected on an account-by-account basis beginning January 1, 2012. See IRC § 1012(c)(1).

A taxpayer may use the average basis method either for shares of stock in a regulated investment company ("RIC") or for shares of stock acquired (after December 31, 2010) in connection with a dividend reinvestment plan ("DRP") provided two requirements are met:

  1. the shares are left by the taxpayer in a custodial account maintained for the acquisition or redemption, sale or other disposition of the RIC or DRP shares; and
  2. identical shares of stock have been purchased or otherwise acquired in the account at different prices or bases. Treas Reg § 1.1012-1(e)(1).

The taxpayer generally makes an election to use the average basis method for RIC or DRP shares by providing notice to the custodian or agent for the account that she wishes to determine the basis of shares in the account using the average basis method. See Treas Reg § 1.1012-1(e)(9).

If the taxpayer places shares of RIC or DRP stock in the custody of a broker, including a transfer from an account with another broker, and fails to elect the average basis method (or another permitted method) in the manner prescribed by the Treasury regulations, the basis of the RIC or DRP stock in the account will be determined under the broker's default method.  The broker's default method may be the average basis method or another permitted method, such as FIFO. Treas Reg § 1.1012-1(e)(2)(i).

For covered securities, the taxpayer's notice must be in writing, but can be given to the broker "by any reasonable means," including a writing in electronic format. Treas Reg § 1.1012-1(e)(9)(ii).  A taxpayer who makes an election to use the average basis method with respect to covered securities may revoke that election with retroactive effect by notifying the custodian of the account of the revocation, by any reasonable means, by the earlier of one year from the date the taxpayer made the election or the date of the first sale, transfer or disposition of the covered securities to which the election applied. Treas Reg § 1.1012-1(e)(9)(i). After revocation, the taxpayer's basis in the shares of stock to which the revocation applies is the basis before averaging. Treas Reg § 1.1012-1(e)(10).
 
After the revocation period has expired, the taxpayer may also change prospectively from the average basis method to any other basis determination method at any time, provided that the taxpayer notifies the custodian or other agent holding the stock of the change in writing by any reasonable means. See
Treas Reg § 1.1012-1(e)(2)(ii), Ex.  In this case, the basis of each share of the stock to which the change applies remains the same as its basis under the average basis method immediately before the change. Treas Reg § 1.1012-1(e)(10)(iii).

The IRS has issued interim guidance to provide consistency between revoking a taxpayer's average basis election and changing from a broker's default average basis method. Notice 2011-56 states that "when a taxpayer changes from a broker's default averaging method for RIC or DRP stock to the cost basis method, the basis of the stock reverts to the cost basis if the taxpayer requests the change by the earlier of:

  1. one year after receiving notice of the broker's default method, or
  2. the date of the first sale, transfer, or other disposition of the stock. A broker may extend the one-year period, but not later than the date of the first sale, transfer, or disposition of the stock.”

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