Noncovered Security: Definition, Reporting Rules, and Comparison with Covered Securities

A comprehensive guide to understanding noncovered securities, their reporting rules, and how they differ from covered securities, including historical context and examples.

Noncovered securities are designated by the Securities and Exchange Commission (SEC) as securities for which the cost basis information is not required to be reported to the Internal Revenue Service (IRS) by brokers or financial institutions. This designation specifically applies to certain small and limited scope securities, making them distinct from covered securities whose cost basis must be reported for tax purposes.

Definition and Characteristics

A noncovered security is typically a security that was acquired before certain reporting requirements were established or is exempt from these requirements due to other criteria. The primary characteristics include:

• Lack of Mandatory Cost Basis Reporting: For noncovered securities, brokers and financial institutions are not required to report the purchase price (cost basis) of the security to the IRS.
• Historical Context: Noncovered securities might include those acquired before January 1, 2011, for stocks and before other specific dates for mutual funds and other securities.
• Limited Scope: Often includes smaller or less commonly traded securities that do not fall under the purview of the more rigorous reporting standards.

Reporting Rules

The reporting of noncovered securities follows distinct rules compared to covered securities:

• Brokers’ Obligations: While brokers must report the sale of a noncovered security, they are not obligated to report its cost basis.
• Taxpayer’s Responsibility: The responsibility of tracking and reporting the cost basis for noncovered securities falls to the taxpayer. This makes accurate record-keeping crucial for investors who hold such assets.
• Forms and Documentation: Taxpayers must report the sale and calculate capital gains or losses using Schedule D of Form 1040 and the corresponding Form 8949.

Comparison with Covered Securities

To better understand noncovered securities, it’s essential to compare them with covered securities:

• Covered Securities: These are securities acquired on or after specific dates (e.g., stocks on or after January 1, 2011, mutual funds and ETFs on or after January 1, 2012). Brokers must report both the sale and cost basis to the IRS.
• Noncovered Securities: These include securities acquired before these dates or those exempt from the reporting requirements. Cost basis reporting to the IRS is not mandatory.

Special Considerations and Examples

Investors holding noncovered securities should consider:

• Record-Keeping: Maintaining accurate records of purchase dates, prices, and any adjustments (such as stock splits or dividends) is vital for proper tax reporting.
• Historical Examples: Stocks bought before 2011, or certain unique financial products or less common investments, often fall into the noncovered category.

Historical Context

The distinction between covered and noncovered securities began with the Emergency Economic Stabilization Act of 2008, which aimed to improve the accuracy of capital gains and losses reporting and streamline the IRS’s ability to match cost basis information with tax returns.

Applicability

Noncovered securities are particularly relevant to long-term investors holding assets acquired before the reporting changes, as well as collectors of unique or limited-scope investments.

Related Terms

• Cost Basis: The original value of an asset for tax purposes, used to calculate capital gain or loss.
• Capital Gains Tax: A tax on the profit realized on the sale of a non-inventory asset.
• Form 8949: IRS form used to report sales and other dispositions of capital assets.
• Schedule D: IRS form used to report capital gains and losses.

FAQs

What should I do if I don't have cost basis information for a noncovered security?

If you don’t have the cost basis information, you should make a reasonable effort to determine the cost basis through brokerage statements, historical prices, or consulting a tax professional.

Why are noncovered securities not reported to the IRS?

Noncovered securities are not reported to the IRS due to historical constraints or because they are exempt under certain regulations. This primarily includes securities acquired before new reporting rules were instituted.

Can I convert a noncovered security to a covered security?

No, once a security is designated as noncovered, it remains as such. However, any new purchases of similar securities might be considered covered if they meet the relevant criteria.

References

• IRS Publications and Guidelines
• SEC Regulations and Reporting Requirements
• Financial Industry News and Articles

Summary

Noncovered securities represent an important classification within the investment and taxation landscape, defined by their exemption from mandatory cost basis reporting to the IRS. This distinction necessitates diligent record-keeping by investors and a thorough understanding of the relevant rules to ensure proper tax compliance. Comparing noncovered with covered securities highlights key differences in reporting obligations and regulatory context, providing clarity for effective financial management.