Mutual Funds and Cost Basis Reporting – IRS

With each sale or exchange of mutual fund shares, you may realize a capital gain or loss that must be reported to the IRS. To calculate gains and losses, you need to determine which shares were sold and the cost basis of those shares. The sales proceeds minus the cost basis of the shares is your gain or loss.

The IRS permits four methods of accounting for mutual fund cost basis:

First-In, First-Out (FIFO) Method

  • The FIFO method is the most common way of computing a basis. If you do not specify that another method is being used, the IRS will presume you are using the FIFO method. As the name implies, the oldest shares available (first-in) are those considered sold first (first-out).

Specific Identification Method

  • The specific identification method allows you to choose which shares you are selling, thereby giving you more control over whether you will generate a gain or loss by the transaction. To use this method, you must specify to the mutual fund at the time of sale the particular shares to be sold. Your gain or loss will vary, depending on which shares you choose.

Average Cost – Single and Double Category

  • You may elect to calculate the cost basis of your mutual fund shares using an average price. There are some special requirements if you wish to do so. The IRS requires you to elect this method by stating so on your tax return and by using the method consistently for all your accounts in the same fund. The choice is effective until you get permission from the IRS to revoke it. These methods may be appealing for shareholders who redeem shares infrequently. 

    The single category method averages all shares owned at the time of sale.

    In determining the holding period, the IRS considers the shares sold to be those shares acquired first (i.e., first-in, first-out).

    The double category method requires you to divide all shares owned at the time of sale into two categories (long- and short-term) and calculate an average cost for each category. Shares held one year or less are short-term. Shares held longer than one year are long-term.

    Similar to the specific identification method, you may specify to the fund at the time of sale from which category you wish to sell shares. If no specification is made, you must first charge the shares sold against the long-term category and then any remaining shares sold against the short-term category.

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Mutual Funds and Cost Basis Reporting

With each sale or exchange of mutual fund shares, you may realize a capital gain or loss that must be reported to the IRS.  To calculate gains and losses, you need to determine which shares were sold and the cost basis of those shares.

The sales proceeds minus the cost basis of the shares is your gain or loss.

The IRS permits the following methods of accounting for mutual fund cost basis:

1. First-In, First-Out (FIFO) Method

The FIFO method is the most common way of computing a basis. If you do not specify that another method is being used, the IRS will presume you are using the FIFO method.  As the name implies, the oldest shares available (first-in) are those considered sold first (first-out).

2. Specific Identification Method

The specific identification method allows you to choose which shares you are selling, thereby giving you more control over whether you will generate a gain or loss by the transaction. To use this method, you must specify to the mutual fund at the time of sale the particular shares to be sold. Your gain or loss will vary, depending on which shares you choose.

3. Average Cost – Single and Double Category

You may elect to calculate the cost basis of your mutual fund shares using an average price. There are some special requirements if you wish to do so. The IRS requires you to elect this method by stating so on your tax return and by using the method consistently for all your accounts in the same fund. The choice is effective until you get permission from the IRS to revoke it. These methods may be appealing for shareholders who redeem shares infrequently.

The single category method averages all shares owned at the time of sale.

In determining the holding period, the IRS considers the shares sold to be those shares acquired first (i.e., first-in, first-out).

The double category method requires you to divide all shares owned at the time of sale into two categories (long- and short-term) and calculate an average cost for each category. Shares held one year or less are short-term. Shares held longer than one year are long-term.

Similar to the specific identification method, you may specify to the fund at the time of sale from which category you wish to sell shares. If no specification is made, you must first charge the shares sold against the long-term category and then any remaining shares sold against the short-term category.

Wash Sale Rule

If you sell shares at a loss and purchase shares in the same fund within 30 days before or after the sale, the IRS considers the purchase to have “washed” all or a portion of your loss. The IRS designed this rule to discourage investors from selling securities solely for the purpose of generating a tax loss. A wash sale is indicated on your statement.

In the case of a wash sale, two important adjustments must be made. All or a portion of the loss must be deferred and added back to the basis, and the holding period of the purchased shares must be changed to account for the deferral. Your statement already reflects the adjusted cost basis and allowable loss. You need not make any further adjustments.