Basis is the cost of something you own. You use the basis to figure the amount of gain or loss when you sell your stock.

Your stock's basis will usually be the amount you paid for the stock, including commissions. You'll figure your stock's basis differently if your stock is 1 of these:

• Inheritance - The basis is usually the fair market value on the date the person who gave you the stock died.
• Gift - Figure the basis 1 of these ways:
• The basis is generally the amount paid by the person who gave it to you.
• If the market value on the date of the gift was less than the giver's basis, use the market value to figure a loss and the other person's basis to figure a gain.
• Stock split - If stock you own splits 2 for 1, the basis of each resulting share is half of the total basis at the time of the split
• Spinoff from an existing company - Figure the basis 1 of these ways:
• If the spinoff was taxable, the basis is the fair market value on the spinoff's date.
• If the spinoff was nontaxable or partially taxable, 1 or both companies will send you information explaining how to figure the basis. This information is usually available on each company's Web site, too.
• Stock option - Figure the basis 1 of these ways:
• The basis is the exercise price of the option plus any commission you pay.
• If the option is an employer-provided stock option, also include in the basis any ordinary income you recognize as a result of 1 of these:
• Exercise of nonstatutory option
• Disposition of the shares from incentive stock option (ISO) or employee stock purchase plan (ESPP)

If you bought shares of a company on more than 1 occasion, you'll start with the basis of the shares you bought first to figure the basis of the shares sold.

You're considered to have sold specific shares if you either:

• Sell stock for which you own the certificate.
• Tell your broker the shares you want to sell and get written confirmation of this from your broker.

Beginning in 2011, brokers will report stock basis to you and the IRS, along with the sale information they already report.

See IRS Publication 550 to learn more.

If you sell a stock at a loss and purchase the same stock within 30 days of the sale, it's called a wash sale and you can't claim the loss.

If you replace some but not all of the stock, it's a partial wash sale. You can claim the loss for the stocks you didn't replace.

Ex: Amanda sold 100 shares of stock ABC Co., losing $10 per share. She then bought 50 shares in ABC Co. the next day. She can claim a loss of $500. The remaining $500 loss is a wash-sale loss, and she can't claim it.

Important information about wash sales includes:

• Wash-sale losses increase your basis in the newly purchased shares. This will reduce a future gain or increase a future loss.
• You have a wash sale if you sell stock at a loss in a regular account and replace it in an IRA.
• You have a wash sale if you sell a stock at a loss and your spouse buys the same stock within 30 days.
• The 30-day rule applies to the 30 days before and 30 days after the sale.
  Ex: Amanda buys 30 shares of ABC Co. on July 10. On July 15, she sells 10 shares of ABC Co. at a loss. The loss is a wash sale loss, even if she already owned 10 shares of ABC Co. before the July 10 purchase.
• The wash-sale rule also applies if you purchase substantially identical shares.
  Ex: On December 5, Amanda sells 100 shares of an index fund managed by Broker A at a loss. On December 10, she purchases 100 shares of an index fund, tracking the same index, but managed by Broker B. Since the two index funds are substantially identical, the December 5 sale is a wash sale.
• There's no wash-sale-gain rule. So if you sell a stock at a gain and buy replacement shares within 30 days, you still must report the gain.

The tax treatment differs for each of these 3 types of employer-provided stock options:

• Nonstatutory options - sometimes referred to as nonqualified options
• Incentive stock options (ISOs)
• Employee stock purchase plan (ESPP)

The major difference between the types of stock options is:

• You have income when you exercise nonstatutory options.
• You don't recognize ISO or ESPP income until you sell the stock.

You might have Alternative Minimum Tax (AMT) consequences by exercising ISOs. See Incentive Stock Options and Alternative Minimum Tax to learn more.

If you meet specified holding-period requirements, you should consider your profit on the sale of ISO or ESPP options a long-term capital gain. You'll be taxed on the profit at a lower rate. To meet the holding-period requirement, you usually can't sell the stock:

• Acquired through the ISO within 2 years after the option is granted.
• For 1 year after the ISO or ESPP option is exercised.

Employees commonly take advantage of a cashless exercise of stock options. In a cashless exercise:

• The broker sells the shares immediately after the employee exercises the options.
• The employee receives the sale proceeds minus the stock option exercise price.

The profit is wage income, and it's included on the employee's W-2. Employees must report the sale on Schedule D, but there's no taxable gain since the stock option price and the wage income add up to the sale proceeds.

Ex: Sean exercises 10 ISOs in a cashless exercise. The shares are worth $50 each, and Sean's option price is $10. He has $400 of wage income (10 x $40). Sean's basis in the shares is $500 ($400 wage income plus $100 paid to exercise the options). Since Sean's basis is the same as the amount realized on the sale, he doesn't have a gain on the sale.

Stock options tax rules are complex. If you have employer-provided stock options and are unsure of the tax consequences, we recommend you get help from a tax professional.

See IRS Publication 525 and IRS Form 6251 to learn more.

For 2010, a net capital gain that would have been taxed at 15% (or a lower rate) is taxed at 0% if it's ordinary income.

Ex: For 2010, the 15% tax bracket for a single taxpayer ends at $34,000. If your taxable income - not including net capital gain - is $25,000, you're taxed at the 0% rate for up to $9,000 of net capital gain.

To take advantage of the 0% capital gain rate, try to defer income to 2011 or accelerate deductions and losses to 2010.

If a security you own, like stock, became worthless (value = $0) during the year, it's treated as having been sold on December 31.

A security isn't considered to be worthless, though, if it has a value of even a penny per share. If you own a stock that's worth only a few cents a share, you can claim the loss only if you sell the security or abandon it. To abandon a security, permanently surrender all rights to the shares and get nothing in exchange.

You normally have 3 years from the due date of the original return to file an amended return to claim a loss. However, for worthless securities, you have 7 years.

The IRS has created special procedures allowing taxpayers to claim losses from investment scams, like Ponzi schemes.

The procedures include:

• The loss is treated as a theft loss, which you can claim:
• Only if you itemize deductions
• By completing Form 4684
• You deduct the loss in the year you discover it. However, you can't claim the deduction if there's a reasonable possibility you'll recover your losses.

If someone institutes legal action against the person(s) responsible for creating the scam, additional special procedures for claiming losses include:

• You don't have to initiate a lawsuit on your own.
• You can deduct at least a portion of the loss even when some prospect for recovery of your loss exists.
• See Ponzi Scheme Questions and Answers to learn more.

If you pay a premium when you buy a taxable bond, you can choose to amortize the premium over the term of the bond. The amount you amortize reduces your interest income.

If you choose not to amortize the premium and hold the bond until maturity, you'll have a capital loss equal to the amount of the premium when the bond matures.

It's generally worth your while to amortize the premium.

If it's a tax-exempt bond, you're required to amortize the premium.

The amortization deduction reduces the amount of tax-exempt interest you'd otherwise report. So, it might reduce the amount of Social Security benefits that you're required to include in your income.

See IRS Publication 550 to learn more.

You can deduct margin account interest under these investment-interest-expense rules:

• Your deduction for investment-interest expense can't be more than your net investment income for the year.
• If your interest expense exceeds your net investment income, you can carry over the nondeductible amount to next year.

You can claim the deduction for your investment-interest expense only if you itemize deductions. You can't deduct investment interest used to purchase tax-exempt securities, like municipal bonds.

You must use a reasonable method to allocate interest expense related to both taxable and tax-exempt income. Ex: If you used 50% of a borrowed amount to purchase tax-exempt securities, half of the total interest you paid isn't deductible.

Alternative Minimum Tax Income (AMT) is the difference between your shares' fair market value and the shares' option price when both of these apply:

• You exercise incentive stock options (ISOs).
• You hold those shares through the remainder of the year.

For AMT, the basis (cost) of the shares includes the amount of income you report for AMT - even if you're not subject to the AMT. When you dispose of the shares, you can reduce AMT income by the amount you included in AMT income in the year you exercised the ISOs.

If you owe AMT because of the adjustment for ISOs, you'll be able to claim an AMT credit in a later year when you're not subject to the AMT. You can claim the credit whether or not you get rid of the shares. Calculate the credit on Form 8801.

The AMT consequences of exercising ISOs and selling the shares you acquire by exercising them is complex. If you're unsure about your computations, get help from a tax professional.

For tax purposes, there are 2 types of stock sellers:

• Investors, who aim to profit from dividends and long-term appreciation in prices
• Traders, who engage in substantial activity on a continual and regular basis for the purpose of profiting from daily market movements

The IRS considers these issues to determine if you're a trader:

• Length of time you hold the securities you buy and sell
• How often you trade and the dollar amount of your trades during the year
• If you rely on your income from trading to support yourself
• Time you spend trading

Whether or not you're considered to be a trader depends on your situation. The IRS considers these issues in making this determination:

• The length of time you hold the securities you buy and sell
• How often you trade and the dollar amount of your trades during the year
• Whether you rely on your income from trading to support yourself
• The time you spend trading

Few individuals are traders. If you're unsure about your status as a trader, research court rulings about other taxpayers.

If you qualify as a trader:

• Deduct your trading expenses as a business expense on Schedule C, not as a personal expense on Schedule A.
• Report your trading gains and losses on Schedule D as capital gains and losses.

If you're a trader and elect to make the mark-to-market election, report your gains and losses as ordinary income (or loss) on Form 4797. Report your gains and losses not only on the shares you sold, but also on shares that you still own. You figure the gain or loss on these shares by using the market value on the last trading day of the year. Then, the market value of the shares becomes the new basis of those shares.

An advantage of making the mark-to-market election is that there's no limit on the amount of annual losses you can deduct. A disadvantage is that your gains are taxed at ordinary income rates rather than at lower capital-gain rates.

See IRS Topic 429 to learn more.

You can't deduct the loss of value in your retirement account since it's a tax-deferred account. You don't report the income earned in the account or deduct losses sustained by the account until you take distributions from the account.

You can deduct a loss from a retirement account only when you close the account and only under these specific circumstances:

• Employer-provided plans
1. Withdraw the entire balance.
2. The amount you receive is less than the amount of your investment in the plan. This is your after-tax contributions minus any tax-deferred contributions you recovered in prior years.
• Traditional IRA
1. Close all your traditional IRAs.
2. The amount you receive is less than your basis in your IRAs.
• Roth IRA
1. Close all your Roth IRAs.
2. The amount you receive is less than your basis in your Roth IRAs.

See the instructions to Form 8606 to learn more about computing the basis.