This week we've got a couple of questions on determining cost basis, a mortgage interest deduction quandary and a bond (eck!) question. We'll also clear up some confusion over options reporting. Please send any other questions to firstname.lastname@example.org . Please include your full name.
All About Cost Basis
What cost basis or stepped-up basis would exist if some stock is in the name of a spouse who dies? Does the other spouse get stepped-up basis? What if the stock is in a joint account with a spouse who dies? If a spouse dies and the other gets the stock at stepped-up basis and then adds an adult child as joint owner, what basis would the child use when the parent dies? Finally, if stock is owned by spouse 1 and spouse 2 dies, does the basis remain the original cost for spouse 1? -- Ron Dunn Ron, If the stock is in your wife's name and she dies, assuming the shares are left to you, you'll get the step-up in basis. That means when you sell the shares, your basis will be the fair market value on the day you inherited them, not your wife's original cost. If you jointly own stock that was contributed to the account after 1977, when one of you dies, only half the account gets the step-up in basis, regardless of how much you each contributed, says Martin Nissenbaum, national director of personal income-tax planning at Ernst & Young. For amounts contributed before 1977, you can get the step-up in basis on the entire amount your wife contributed (providing you can document her contributions). If you live in one of nine "community property" states (Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas or Washington), the rules are a bit different. If you have a joint account here, you'd get a step-up in basis for the entire amount, regardless of who contributed what. Be sure to check with a local expert, though. Adding a child to the account after one spouse dies does not change the basis, says Rande Spiegelman, personal financial services manager at KPMG in San Francisco. (Just be aware you might have gift-tax issues when your child takes a withdrawal.) The child will get a step-up in basis on the entire account when the spouse dies. And lastly, if you own the shares in your name and your spouse dies, your basis remains unchanged.
What is the tax basis of a bond? Is it the purchase price or the purchase price and accrued interest? -- Earle McCants Earle, If you buy a bond, your basis is your purchase price. Accrued interest is not included. Here's why: Most bonds pay interest every six months. If you buy a bond in the middle of that six-month period, it will have started to accrue interest. So you will owe its face value plus interest to the bond owner. Even so, that interest is not part of your purchase price. For tax purposes, it's "negative interest." Let's say you bought a bond that had two months worth of accrued interest. You'd pay the owner for those two months and show it as negative interest on your Schedule B -- Interest & Dividend Income. Four months later, you'd get a check for the full six months of interest, which you'd show as a positive number on Schedule B. Your net accrued interest will equal the four months you've owned the bond. Check out the Internal Revenue Service's Publication 550 -- Investment Income and Expenses for more details.
Can My Kid Deduct Mortgage Interest?
If my son pays the mortgage on a home I own and he is living in it, can he deduct the mortgage interest on his taxes even though he is not a borrower on the mortgage? -- Ed Hunssinger Ed, He can't "unless you put him on the deed of the house," Spiegelman says. But it doesn't matter what percentage of the house is in his name. Even the smallest amount will let him get a full deduction for the mortgage interest he paid.
Using a 401(k) as Collateral
I know I can borrow from my 401(k) plan. Can I borrow against my 401(k) plan, pledging assets in the plan as collateral for the loan? If not, is this specifically disallowed, or just a technique that hasn't been developed? -- David Yeidel David, You can't use your 401(k) assets as collateral for anything, says Dee Lee, a certified financial planner and co-author of The Complete Idiot's Guide to 401(k) Plans. Federal law prohibits what is called "alienation of benefits," which means creditors can't tap into your 401(k). "Nobody will take them as collateral because you can't get at 'em," Lee says. Sorry. Nice try, though.
Lump Sum or Individual Trades?
In your Oct. 9 Tax Forum , you initially explain how to report specific option trades. Later, you state that every transaction is not needed since "you'll just confuse the Internal Revenue Service." I'm confused. Do I list all option trades or just a lump sum? -- Joseph Cassaro Joseph, You have to report each and every trade. But you can choose to do it on your own spreadsheet or to write them all out on Schedule D --Capital Gains and Losses. Either way you have to include the detail; it's just a matter of geography. If you are confident that your personal spreadsheet includes all the necessary information (i.e., it mirrors Schedule D), just drop the grand totals on the Schedule D and write "see attached schedule" in the description column (a). Then if the IRS is not satisfied with your lump-sum numbers, it'll have a road map to find the details, says Joe Parker, tax research analyst at H&R Block in Kansas City, Mo. Make sure your write your name and Social Security number on your spreadsheet, because the IRS agents take your return apart when they process it.