Non-Covered Security: Definition, Overview & Example
In most cases, there are three primary types of securities. The first is debt, which are certain loans that need to be repaid at a specific time. The second is equity, which relates to different ownership rights. And the third is a hybrid, which combines both debt and equity.
But within these three types of securities, there are even more terms to know and understand. Non-covered security is one of these terms and can play a big role when it comes to tax reporting. Continue reading to learn everything you need to know about non-covered security.
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KEY TAKEAWAYS
- A non-covered security outlines that if a security is small enough with a small enough scope, it doesn’t need to get reported to the IRS.
- Stocks are often considered to be non-covered securities if they’re sold by foreigners or foreign intermediaries or issued through a corporate action, such as stock dividends or stock splits.
- Investment sales are separated using Form 8949 to help account for both non-covered and covered securities.
- Cost basis needs to be adjusted annually for depreciation (for fixed assets), capital expenditures, and market value appreciation.
What Is a Non-Covered Security?
Non-covered security is a term and legal definition outlined by the Securities and Exchange Commission (SEC). It explains that if the cost basis of your securities is small enough, they don’t need to get reported to the Internal Revenue Service (IRS). The cost basis is only reported to the taxpayer, who is responsible for reporting the sale of non-covered securities. The sale is reported to the IRS on Form 1099-B. For IRS purposes, a non-covered security is any security that is not covered.
The SEC, which is an independent federal agency, is the competent authority in the United States that dictates certain tax designations for reporting purposes. So, if a security is small enough or it has a limited scope, there is no need to report it to the IRS.
What Is a Covered Security?
New legislation was passed through the United States Congress in 2008 that outlined new details for mutual funds and reporting the adjusted cost basis for securities. The new legislation applied to both the Internal Revenue Service (IRS) and investors. These new changes became effective in the 2011 tax year.
Since these changes, the cost basis of specific securities is reported by submitting Form 1099-B. This form outlines if there is a capital loss or gains from selling the security. Plus, it will show whether or not it will be a short or long-term security.
Essentially, any transactions since these changes in 2011 are considered to be a covered security. And these transactions get reported on Form 1099-B. According to the IRS, a covered security is:
- Stock acquired for cash in an account after 2010, except stock for which the average basis method is available.
- Stock for which the average basis method is available and that is acquired for cash in an account after 2011.
- A specified security transferred to an account if the broker or other custodian of the account receives a transfer statement (explained earlier) reporting the security as a covered security.
- Certain debt instruments or options that are specified securities acquired for cash in an account after 2013.
- Certain debt instruments or options that are specified securities acquired for cash in an account after 2015. This includes variable-rate debt instruments; inflation-indexed debt instruments; contingent payment debt instruments; convertible debt instruments; options on debt instruments with payments denominated in, or determined by reference to, a currency other than the U.S. dollar; and options issued as part of investment units.
- A securities futures contract entered into in an account after 2013.
- A security acquired due to a stock dividend, stock split, reorganization, redemption, stock conversion, recapitalization, corporate division, or other similar action, if the basis of the acquired security is determined from the basis of a covered security.
Cost Basis for Non-Covered Securities
The new legislation passed by Congress in 2008 also requires that brokers use the adjusted cost basis, instead of using the original purchase price of a security for tax reporting purposes.
Basically, this means that an asset’s original cost will need to get reviewed and adjusted on an annual basis. The cost is decreased for depreciation of fixed assets and increased for market value appreciation and capital expenditures.
The cost basis for non-covered securities may be included when calculating the taxpayer’s income on realized capital gains subject to tax.
Examples of Non-Covered Securities
One of the easiest examples of a non-covered security are reinvested dividends. Let’s say that the investor has opened a dividend reinvestment plan (DRIP) to help generate additional shares.
Previously, an investment security purchased in the year 2011 could be transferred to a DRIP as long as it was done in the same year. The security also uses the average cost method of calculating the cost basis for an asset, meaning it’s a non-covered security.
However, if you transferred that investment security after 2011, it remains a covered security.
Summary
A non-covered security is any type of investment that was purchased before the new changes from Congress came into effect. The cost basis of a non-covered security isn’t required to be reported to the IRS. That said, the redemption value or gross proceeds from a specific sale may still be taxable and needs to be reported.
To help keep things simple, the legislation passed in 2008 made some significant changes. The adjusted cost basis of any type of security purchased in or after the tax year of 2011 must be reported to the IRS.
FAQs About Non-Covered Security
For any non-covered securities that you own, you’re going to be responsible for reporting the accurate cost basis information to the IRS. If you don’t report your cost basis, the IRS may assess a 100% capital gain on the sale of your securities, resulting in higher taxes.
It is your responsibility to report any relevant cost basis information to the IRS on Form 1040, Schedule D. You must do this for every share sold, regardless of whether the securities are covered or non-covered.
To report the cost basis for any non-covered securities you have, you will need to submit Form 1040, Schedule D to the IRS every year for any shares sold.
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