I’ve read about the different ways to calculate basis for selling shares in mutual funds.
What about this [seemingly] simple situation:
Some years ago, you sent $3,000 to Vanguard to purchase shares in ABC mutual fund. Aside from reinvesting all dividends and distributions, you never purchased additional shares, and have never sold any shares. After the initial purchase, you’ve been passive.
Your total shares in fund ABC are now worth $10,000, and you want to liquidate–to sell all shares in the fund.
Is there a best basis method to chose in such a case?
If one had elected to receive dividends and distributions in cash, then the basis would be simple, correct?–the price of the shares when you made initial investment.
But with the reinvestment of all dividends and cap-gains distributions, would it be simplest to use average cost when you want to sell all shares?
Please re-orient my thinking if I’m misconceiving this, which is likely–
There is no best method for this situation. Since you are liquidating all the shares, all the basis calculations will come out with the same result. The different basis calculation methods matter only if you are selling less than all your shares.
Yes. If you only bought shares a single time and never reinvested distributions or added other investments, you would have only one lot of shares to sell. You would have purchased them all at the same price. Once again, it wouldn’t matter which method you used. Even if you sold only some of the shares, all of the basis calculation methods (and there are several: Cost Basis Accounting and Calculation | T. Rowe Price) would come out with the same result because you paid exactly the same amount for each share.
If you sell all the shares, it doesn’t matter which method you use. If your financial services firm can do average cost basis for you automatically, that is the easiest method.
The important thing for you to consider is what method you want to tell your financial services firm to use for all your future transactions. Generally, if your firm offers it, high-cost, long-term winds up being advantageous. You get the benefit of realizing less in taxable capital gains while giving you the best chance of ensuring that you get long-term capital gains tax treatment for the gains. However, I don’t know your tax situation. If you have lots of unrealized passive losses you need to offset, it might be to your advantage (or at least cause no tax harm) to realize lots of taxable gains. These things can be complicated. You should talk to your tax adviser.
As a mutual fund buys and sells stock shares for the fund, capital gains and loses are realized. Once a year, usually in December, the fund calculates the gain (or loss) for the year and reports this to the IRS. You have (or should have) been paying taxes on these reported gains. If a gain was reported in a given year this raises the basis of your shares by the reported amount and thus when you sell your shares you will pay less capital gains tax. It is a pain to calculate what effect capital gains distributions have on the basis of your mutual fund shares. This should have been done for you by the brokerage firm that you bought the shares through and should be reported on each monthly statement.
This is my concern. I’ve reported all the info fr/1099 forms every year on tax return–dividends, qualified dividends, capital gains distributions–boxes 1a, 1b, 2a–but do I need to get so “granular” that I do a basis calculation for every year? So might the “average cost” method be best in such a case?
There must be millions of people in similar situation–ie, you buy, passively hold, then sell/liquidate–but the reinvestment of dividends+capital gains distributions must be considered when figuring best basis to use, correct?
I’d really have no idea how to get so granular, going over years of statements, etc–advice?
PS–this was not done thru brokerage; it was a direct purchase/investment–check sent to Vanguard–
A capital gains distribution or an income distribution does not change the basis of the shares you already own (except for the extremely rare return-of-capital distribution). The NAV of your shares generally goes down by the amount of the distribution and hence you have a smaller capital gain when you sell.
If you just had the distributions mailed to you as a check and deposited them in the bank, they would have no effect on your basis whatsoever.
BUT if you reinvest the distributions, you are buying more shares. The distributions become the basis of the new shares that you bought. So, in that sense, the total basis of all the shares you own (new plus old shares) increases by the amount of the distributions. And there is nothing special about capital gains distributions. If your fund has any income distributions that are reinvested, those too are are treated the same way.
If you sell all of your shares at one time and have never sold any shares of this fund before and have reinvested all of your dividends (of any kind) do two calculations:
Add up the amount you originally paid for the shares plus the amount of any distributions (of any kind) reinvested more than one year before the sale. This is the basis of the shares you owned more than one year before the sale. List this as a long term capital gain. You do not have to list all the individual transactions. You are allowed to show the purchase date as “various.” Just list all that as one single transaction.
Next add up all of the dividends reinvested one year or less before the sale. This is your basis for the sale of the shares you owned one year or less. The sale price of these shares minus the basis of these shares is a short-term capital gain. Again, you may list the purchase date as “various.”
Before I sell all shares in this fund, don’t I need to specify what cost basis I want to use? I thought this was a recently implemented IRS rule–
And if Vanguard will include this info on the forms I’ll get in early 2017 [if I sell/liquidate this fund before end-of-2016]–then do I even need to make the calculations you specify?
If you make no choice, Vanguard will use the average cost method, so you don’t need to specify.
For mutual fund shares, Vanguard offers the average cost, FIFO, HIFO, and specific lot methods. Since you are selling all the shares you’ve ever owned all at the same time, the last 3 will give you exactly the same result. Exactly. So I’m ignoring the HIFO and specific lot methods.
The only difference between the average cost and FIFO methods will be how much of your gain is short term or long term. Short term gains (or losses) are the amount of gain (or loss) you made on shares purchased in the year before you made the sale. In other words, the dividends reinvested a year or less before before you sold the shares. The average cost method will average out your basis over all your shares instead of actually identifying the basis of your long and short term shares. The overall gain/loss will be the same, but how much of it is short and long term may change. To determine the actual effect on your taxes, you’d need to know the specific numbers and other factors such as whether you had other short term gains that you would benefit from canceling out with short term losses (if available).
But, unless the dividends reinvested in the last year before the sale were huge, it just won’t make that much of a difference. It’s not worth worrying about. Just let the default method stand.
Or consult with an accountant, keeping in mind that their fees for figuring this out might be more than the money you stand to save, unless we are talking about huge dividends here.
If Vanguard provides the data, no you don’t have to do the calculations.
“Or consult with an accountant, keeping in mind that their fees for figuring this out might be more than the money you stand to save, unless we are talking about huge dividends here.”
That’s the dilemma for small investors–whether the fees paid for a professional consultation would be worth it; in my case, no.
I’ve previously sold different mutual fund shares using the average cost basis. On the 1099 form for such redemptions, it shows a single $$ figure for the average share cost. I think I “get” that.
But: if one uses a different cost basis method, and redeems different lots, does the 1099 form show a list of the different cost bases?
So what if one has say $50,000 total dollar value in a mutual fund held for years, reinvesting dividends and cap gains, and then you liquidate the fund, selling all shares using say FIFO basis. Would the 1099 form show a huge list of the different cost bases for different purchases thru the years?