Q: My wife held 600 shares of a utility company. Under the dividend reinvestment program, her holding increased to 1,100 shares, and she deferred tax on $1,500 per year of the income. In November, she sold 500 of the 1,100 shares to switch to a higher-yielding investment. Would you please explain how to determine the cost of the 500 shares for tax purposes?
A: Under the circumstances you describe, the practical effect of the rules governing tax deferral for reinvested utility company dividends is to allocate the first sale to the shares acquired under the plan.
If the $1,500 annual exclusion included the total amount of the reinvested dividend each year, then the cost basis of the 500 accumulated shares is zero, and the entire proceeds of the sale represent income.
She would report the income from those shares received more than one year before the sale date as a long-term capital gain on Schedule D. The proceeds from sale of shares a year or less after the dividend date should be reported as ordinary income, on line 22 of Form 1040.
If the total dividend for any year exceeded the $1,500 ceiling, then her cost basis for the shares received that year would be zero for those that fell under the $1,500 ceiling, plus the amount in excess of the $1,500 that was reported as dividend income for that year. The split between long-term capital gain and ordinary income would be required in this situation, as well.
To be quite honest, this explanation represents a personal interpretation based on my reading of the available literature. The IRS hasn't published any detailed rules governing the various conditions and questions that may arise.
For example, should the shares that were reported and taxed (because they were above the annual ceiling) be subject only to the normal six-month waiting period for long-term gain treatment? Because the shares were included in the same reinvestment account, I think they should be governed by the same one-year rule -- but the question is certainly open to argument.
In the absence of definitive rules from the IRS, and considering the high probability that such rules may never be published because of the tremendous rule-writing backlog facing that agency and the termination of the tax deferral program entirely at the end of 1985, I suggest you accept my interpretation -- or that of your tax adviser, if he or she reads the situation differently.
Q: I sold my house in 1984 under the same circumstances as you described in your Jan. 13 column, and took the over-55 exclusion on the gain. I checked with not one, but two, IRS specialists on the phone and they both told me that because I was single at the time of the sale, my wife did not have to join me in the election, and that after my death she could elect to exclude gain if she sold a house, providing she met the other requirements. Would you please recheck your source of information and let me know who is correct?
A: Unfortunately, the specialists you talked to were wrong; my answer in the earlier column was correct. I checked several sources and came up with the same answer.
Although IRS Publication 523 ("Tax Information on Selling Your Home") doesn't deal directly with this specific circumstance, the following quotation demonstrates how all-inclusive the once-in-a-lifetime rule is: "If after choosing to exclude gain, you and your spouse divorce, neither of you may exclude gain again. If you remarry, you and your new spouse may not exclude gain on sales or exchanges after your marriage."
In other words, the new spouse -- who may not have even known the original couple at the time of the sale -- loses his or her right to claim the exclusion simply by marrying a person who had claimed the exclusion in a previous marriage.
The Commerce Clearing House Federal Tax Guide is more specific on the question you raise. Paragraph 13,536 says: "This once-in-a-lifetime privilege applies to both the taxpayer and his spouse. . . . The election is also prohibited where the taxpayer's spouse formerly made an election as to the sale of a residence, even though the spouse was not married to the taxpayer at the time of the sale."