Gainskeeper Bug: Doom and Gloom for Day Traders at Tax Time?

Stock lot identification for capital gains

Starting with the tax year 2011, individuals and corporations in the U.S. have more flexibility in terms of how the cost basis for securities that they buy and sell is computed. This has the potential to be a great boon for someone who is actively trading stocks, as they are no longer required to use FIFO (first-in, first-out) basis for their investments. When you are selling an investment held in a brokerage account now you can identify a specific "lot" of stock to sell instead of having to take the cost basis of the earliest lot you purchased.

Here's the Wikipedia article on Cost Basis Reporting with a brief explanation of how this has changed because of Section 403 of the Emergency Economic Stabilization Act of 2008.

One reason this is such a significant change is because of the IRS wash sale rules. For those who are unaware, a "wash sale" is one where if you take a loss on the sale of an investment, if you purchase the same investment (or one that is substantially identical) within 31 days of the original sale, you are then disallowed from taking that loss against your income until you "close out" the position you bought back into within the 31 days.

If you're having trouble wrapping your head around this, here's a "what-if" scenario: You purchase stock in XYZ corporation for $50 a share on January 1. You are firmly convinced that XYZ stock is going to go to $100 a share if you wait long enough. Unfortunately for you, the stock goes down, not up. Still having the strength of your convictions, you don't sell any shares and instead buy more shares when the stock goes down to $40 a share. Sadly, the stock keeps going down, and you buy more shares at $30 a share. There is a respite, and the stock goes back up to $35 a share. That's the good news. The bad news is, even though you believe in the long-term prospects of the stock, you are convinced that is is going to go back down to $30 a share again and you want to cash out of some of what you bought to be able to buy more at the cheaper price when it goes down.

Under FIFO, if you sold the stock at $35, your cost basis wouldn't be the $30 you paid for the last set of stock, it would be the $50 you paid for the first set of stock. You would then take a $15 a share loss on what you sold. If you then bought back into the stock within 31 days it would trigger the wash rule and you would have to add that loss back into the basis of your new purchase. It can be done, obviously, but it's additional paperwork to deal with and just in general a pain in the ***.

If you were allowed to pick and choose which lot of stock you were selling (as you are now) if you went to sell the stock at $35 a share, you could choose as the lot you were selling the shares you bought at $30 a share. Instead of booking a $15 a share loss, you would instead be booking a $5 a share profit, and more importantly, if you bought back into the stock again within 31 days, you would not be penalized for doing a wash sale.

My recent experience

As a person who trades equities and funds and whatnot from time to time (and occasionally day trades) I was really looking forward to the new rules. That was until I tried to take advantage of them, which I have only done in the last couple of weeks.

My brokerage house (which shall remain nameless for now because I have generally been pretty happy with them, and will be again if this is taken care of) uses a program called Gainskeeper to show the realized and unrealized gains and losses in your accounts. I had seen the program name before but it really didn't mean anything to me.

Here is what happened yesterday (4 May 2011) and what I discovered today as a result of it. I have been doing day trading as the job market still seems a bit poor in my neck of the woods, and I decided doing something to bring in some income (and continuing to job hunt) was better than more fruitless job hunting with no other actions being taken.

One of the funds that I own in my brokerage account is the Central Fund of Canada, ticker symbol CEF. It is a fund that holds gold and silver bullion. Unlike some funds that say they hold physical bullion but don't seem to have credible audits, I believe CEF is the real deal, that's why I have a core position in it but I still trade the shares when I'm in a market timing mood.

Yesterday, anticipating a pullback, I sold 300 shares of CEF at $22.45 a share at 10:05:11 am Eastern time. Taking advantage of the new rules on lot identification, I specified the "lowest cost" option for the shares I was selling. Those shares would have been the ones I bought the day before, the 3rd, for $6,648.99. Since I netted $6,724.88 for the sale, I should have had a gain of $75.89.

The pullback in the share price I anticipated did in fact happen, and I bought the 300 shares back later in the day for $21.80 a share for a basis on the new lot of $6,549.99. I was happy, although I wasn't too thrilled seeing silver keep getting pounded (but that's another story).

This morning I logged into my brokerage account and on a whim I looked at the realized gains on my CEF positions. I noticed they didn't seem to tie out with what I had in my records. Then I figured it out. Boy, I was not happy to say the least.

Gainskeeper showed the sale amount correctly on my trade that was executed yesterday. However, instead of using the cost basis from the buy on the 3rd (which was the lowest cost as of the time the trade was executed), the system calculated my cost basis was $6,549.99 and showed the lot that was sold was bought the same day, on May 4th.

The software was trying to say that I sold the stock BEFORE I BOUGHT IT!

I got on the phone with my brokerage house. The representative ended up talking with his supervisor, then asked me to send them a written message using the message feature built into the brokerage account. I obliged and sent them a detailed write-up of what I had done, the amounts, dates, times, prices, etc., and what the system had done with that.

I was talking to one of my relatives about this a bit later (who uses a different broker than I do, also one of the top brokerage houses in the country) and he checked his system and told me his broker is also using Gainskeeper.

Wolters Kluwer Gainskeeper

I did a bit more research on Gainskeeper after that. It is not owned by my brokerage house, it is a product from a Dutch company Wolters Kluwer (here's a link to their corporate website, here's a link to the Wikipedia article on them. And here, for the sake of completeness, is the link on the Wolters Kluwer website to the Gainskeeper product page.

Wolters Kluwer brags a bit on their site that Gainskeeper is "Installed at more than 30% of the top ten brokerage firms and processing 14 million accounts". To which my response is, WTF? They claim to be industry leading software and they can't even handle simple day trades correctly?

The Ramifications

Some of you out there are probably saying, who cares? So your capital gains is a few bucks off, it's all going to end up the same anyway, right?

Wrong. Two things make this a big deal, and I am a bit stunned that it is already May and this bug is still there. I can't believe I was the first person to notice this and pass it along to my brokerage house, these rules have been in effect since the beginning of the year. Item one, if the difference between the cost basis of the two trades changes a gain to a loss, then the wash sale rules apply. If people are using the realized gains/losses from Gainskeeper to figure out if they have a wash sale or not, they may have wash sales they are blissfully unaware of and this could lead to serious consequences come tax time.

Item two, at the end of the year your broker is going to report the 1099 information to the IRS. Up to now, the IRS had to rely on you to be honest about your cost basis. You could have made all kinds of crazy stuff up and if it didn't trigger an audit, the IRS would not be any wiser. At the end of this year, when the brokerages report the 1099 information to the IRS they are going to also report the cost basis according to their records. This is a first, this has never been done in the US before. If the brokerage houses have flawed cost records, they're going to report incorrect information to the IRS. I can also tell you this, I have tried to get my broker to fix incorrect 1099 information before, and all I can tell you about that is I have had NO LUCK getting them to change anything.

If this is any indication of what's going on, this could mean that anyone who is doing day trading may well have massively incorrect 1099s filed with the IRS next year. Anyone have any idea how many people in this country are doing day trading? I don't know, but the House of Representatives and Senate alone gives you at least 535 . . .

What my brokerage has to say about Gainskeeper

The information below is from my broker's website, with the name of the broker redacted (again, I have no beef with the broker over this, but to me this is a stunning lapse on the part of Gainskeeper):

"How does the (Brokerage Firm) gain/loss tracking work?"

"Powered by GainsKeeper®, one of the leading tax lot accounting (TLA) providers, this gain/loss service automatically adjusts your cost bases for corporate action events, such as mergers, spin-offs and stock splits, and wash sales.

* Trades appear in this tool the day after transaction date.
* Corporate actions are applied on effective date.
* Wash sales are identified, cost basis adjustments calculated, deferred and reversed.
* Capital gains are calculated and characterized."

"Learn more about cost basis reporting"

"GainsKeeper is a registered service mark of GainsKeeper, Inc. (Brokerage Firm) and GainsKeeper are separate, unaffiliated companies and are not responsible for one another's products or services. However, (Brokerage Firm) is required to provide accurate tax lot basis information in connection with 1099-B reporting for "covered" securities and uses the services of the GainsKeeper system in so doing. (Brokerage Firm) is solely responsible for the accuracy of tax lot basis information it makes available to its clients for "covered" securities whether through the Gainskeeper system or otherwise."

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© 2011 by Christopher & Michelle Mills