Non-Covered Security

A non-covered security is an SEC designation under which the cost basis of securities that are small and of limited scope may not be reported to the IRS. The adjusted cost basis of non-covered securities is only reported to the taxpayer, and not the IRS.

In 2008, Congress passed legislation which required brokers to report the adjusted cost basis for securities and mutual funds to both the investors and the Internal Revenue Service (IRS), effective tax year 2011. Since 2011, the cost basis of certain securities has been reported through Form 1099-B which indicates whether the capital loss or gain from the sale of the security is short or long term. Any transaction that occurs on or after this effective year is a covered security, and is reported on Form 1099-B. A covered security is defined as:

1. Any stock in a corporation, including American Depositary Receipts (ADRs), acquired on or after January 1, 2011
2. Mutual funds acquired on or after January 1, 2012
3. Stocks or ADRs acquired through a dividend reinvestment plan (DRIP) on or after January 1, 2012
4. Less complex bonds, derivatives, and options purchased on or after January 1, 2014
5. More complex bonds, derivatives, and options purchased on or after January 1, 2016

Non-covered securities refer to any investments purchased before the effective dates listed above. The detailed cost basis following the sale of a non-covered security is not required to be reported to the IRS by a broker. However, the gross proceeds or redemption value from a sale may still be reported to the IRS. While a broker will still report the cost basis to the investor or taxpayer, it is up to the investor to report this information to the IRS through Schedule D on Form 1040 for shares sold, whether covered or non-covered. Even if the taxpayer does not receive a cost basis report, he must still report his adjusted cost basis to the IRS.

The IRS considers securities to be non-covered if they are acquired through a corporate action and if their cost basis is derived from other non-covered securities. Corporate actions, such as stock splits, stock dividends, and redemptions, usually result in additional shares for the investor. The additional shares will be classified as non-covered if they were received through non-covered shares. For example, an individual who bought 100 shares in a company in 2010 that split three-for-one in 2013 will receive additional 200 shares. Even though the 200 shares were acquired after 2011, they are considered non-covered because they were split from shares acquired before 2011.

A dividend reinvestment plan (DRIP) allows an investor to reinvest his dividends for additional shares in the same company. An investment security that was purchased in 2011 but transferred in the same year to a DRIP that uses the average cost method of calculating the cost basis for an asset is a non-covered security. But if the transfer occurred after 2011, it will remain a covered security.

Stocks are also considered non-covered if sold by foreign intermediaries and foreigners, that is, individuals who are not present in the country for at least 183 days of the calendar year. Regarding these entities, brokers are exempted from issuing Form 1099-B to report cost basis from stock sales.

Investment sales are divided into covered and non-covered securities using Form 8949. Transactions on non-covered securities not reported on Form 1099-B are reported on Form 8949 where Code C is used for short-term holdings, and Code F for long-term holdings.