How to Report Sale of Stock You Didn’t Buy

QUESTION: How do I report to the Internal Revenue Service the sale of stock I did not buy? Several years ago, I sold some stock that I had in a company. Later, the company filed for bankruptcy reorganization. As the result of a subsequent class-action suit, stockholders were awarded a number of new shares in the surviving corporation. I’m now thinking of selling the shares I received as a part of that settlement. But how do I report my proceeds to the IRS? What is the date of “purchase”? What is the price of this “purchase”? L. P.

ANSWER: Although you probably feel as though you’re out there in the Twilight Zone, your situation is not as bizarre as you might think. We’re going to assume that you wrote off your entire loss in the company when you sold your original shares prior to the bankruptcy and that you are starting with a clean slate.

To be technically perfect, according to Margaret Bumcrot, a certified public accountant with Muller, King & Mathys in Downey, you should have reported the value of the shares from the lawsuit settlement to the IRS in the tax year you received them. You should have listed the shares and their value in the income portion of your return as a “recovery of a prior loss,” and this value would have become your cost basis for the shares. Then, when you sell the shares, the taxable gain you would report to the IRS would be your net proceeds from the sale minus your cost basis.

However, our guess is that you probably neglected to report the receipt of the shares when they were originally awarded to you. In this case, when you sell them, your taxable gain would be your entire net proceeds from the sale--that is, your total revenue minus any selling costs. Since the shares didn’t cost you anything--and you have already written off any loss in the company--you have nothing else to deduct from the proceeds.

Again, to be technically perfect, you should probably note the value of the shares on the date you received them and report that income as a “recovery.” Anything above that amount should be reported as a gain. However, since capital gains taxes have been abolished, the distinction doesn’t make any practical difference: The proceeds are still treated as ordinary income and taxed accordingly.

Q: I want to sell a rental residence that I own, but I’m confused about the tax implications of the sale. I originally purchased this rental as my primary residence and rolled over the gain from my first house into it. I lived there two years before converting it to a rental. Since it has been a rental, I have taken depreciation on it for several years. How do I calculate my capital gain on this sale? Can I continue to defer taxes on the gain rolled into the property at the time of the purchase? D. J. P.

A: No, you may not continue to defer taxes on the gain rolled into the property at the time of the purchase. Once the property has been converted to a rental, it must be treated as a business or investment property for tax purposes. The only exception is if you temporarily rented the house while you were trying to sell it.

According to our tax consultants, this is how you would calculate your taxable gain: First you must establish your tax basis in the property. This would be the purchase price plus any improvements, minus the depreciation you have already taken and minus the unrecognized gain from the sale of your first house. To arrive at the gain, subtract the basis from the net sales proceeds. The net proceeds are simply the total sales price minus any selling expenses, such as the sale commission for your real estate agent.

Q: Last year I gave my grandniece 100 shares of stock. She was 15 years old and the stock certificate was issued to me as trustee under the California Uniform Gift to Minors Act. I was told I have to pay the tax on the dividends. Is this true? Is there any way I can be relieved of paying the tax on this irrevocably held stock? A. S.

A: Sure there is. Under the Uniform Gift to Minors Act, income generated by irrevocably held trust assets are the responsibility of the recipient, not the donor. Your grandniece--not you--should declare the dividends on her tax return. If the 15-year-old is typical, she should be in a lower tax bracket than you are. By the way, your grandniece’s Social Security number should be used in all transactions involving these shares.

Q: I am over age 55. When I sold my home last year, I invoked the one-time exclusion of $125,000 in profits available to senior citizens selling their homes. But now I’m not so sure I did the right thing, since I did not take full advantage of the entire $125,000 deduction. May I rescind this exclusion, pay any capital gains I owe from the sale and invoke the exclusion at a later time?--N. N. R.

A: Yes. The Internal Revenue Service allows you to amend your tax return within three years of filing it. And IRS rules allow you to revoke your use of this special exclusion within those three years. However, be advised that if you were married at the time you used the exclusion, your spouse must concur in the revocation, whether or not you are still married.

Your question points up an important feature of the exclusion, and one that anyone over age 55 should consider before using it. The $125,000 profit exclusion is available to an individual over age 55 only once in a lifetime, and it is considered used whether or not the full $125,000 is sheltered from tax. So if you do not have $125,000 to shelter, and you think you might from the sale of another residence in the future, think twice before you invoke the exclusion. Unless you rescind its use within three years of filing your tax return, the exclusion is gone for good.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.