Average Cost Basis on common stock for Net Unrealized Appreciation vs. LIFO or Specific Identification Method for calculation of cost basis
I am considering a Net Unrealized Appreciation election on my company common stock that I have currently in a 401K. The investment company of my 401k has provided me with an AVERAGE COST BASIS for my shares of common stock which have accumulated over 40 years. Am I required to use the Average Cost Basis for the shares of stock calculated by the plan administrator or is it allowable for me to go through my statements (40 years worth) to cherry-pick only the lowest cost shares of stock for the NUA and rollover the high cost basis shares into an IRA? If it is permissible for me to pick the lowest cost shares for the NUA, how do I handle the shares of stock which I sold during these years? Can I use LIFO method, matching the shares of stock sold with the most recent previously purchased shares? Using LIFO method for calculating the cost basis would eliminate the higher cost shares. Or is there another option available for calculating the cost basis of the shares for NUA other than using Average Cost basis like Specific Identification Method? During these last 40 years, I only sold shares a handful of times and only a small portion of shares were sold so my lower cost shares were never eliminated.
After electing the NUA, my investment company will issue a 1099R to me which will include their Average Cost Basis used for the NUA. The investment firm is not willing to change the cost basis to another method. This is the only method they use and track. How is the discrepancy handled between the cost basis reported on the 1099R to the IRS vs.the cost basis I will report by specifically identifying only the lowest cost shares for NUA (if LIFO or Specific Identification method is permissible)?
Thanks in advance for any assistance.
Permalink Submitted by Alan - IRA critic on Tue, 2025-02-25 11:49
You are taking a large risk if you deviate from the employer’s cost basis method, of which average cost is the usual election. The 1099R which includes the total NUA and cost basis divided by the number of shares distributed is what you should report on Form 8949 when you sell the shares. If box 2a is reduced due to the plan applying any after tax contributions you made, your tax will be lower, but your basis in the taxable account is determined as if the share distributions were all taxable.
Most brokers will treat these shares as uncovered when you sell, meaning that you must report the proper cost basis yourself on Form 8949. It will not be shown on your 1099B. While the IRS may not be inclined to request documentation for your cost basis, they do receive the 1099B and are able to determine what the average cost basis is if they care to.
Conversely, if the plan itself provides a report of various cost basis lots to you, you would be on more solid ground when selling the shares. Some plans may also allow you to sell the higher cost basis shares in the plan before the distribution, leaving the lower basis shares for distribution, and this would be reflected by a lower taxable cost on the 1099R.
If you want to roll the dice and use your own records based on the price when purchased, you will have to adjust for any stock splits over the 40 year period, and if you had dividends reinvested over this period, you would also have to account for up to 160 such reinvestments purchasing more employer shares.
Also, note that the lower your cost basis is, the better NUA treatment will be. But that said, for example if your cost basis is only 10% of the value at distribution (90% NUA), you may be less likely to sell the shares and incur the cap gain tax and thereby not being properly diversified for years.
Diversification should always trump tax benefits, as several very large firms have imploded in a short period of time (eg Enron, Lehman Bros, Worldcom, Kodak, etc).
Note: There are some IRS Regs on valuing NUA shares. They are contained in Reg 1.402(a)-1(b).
Permalink Submitted by Rose Trettenero on Tue, 2025-02-25 21:24
Thank you, Alan. I appreciate your comments.