Dear Tax Talk,
I would like your opinion on the various options available due to the new IRS cost basis reporting rules, which are now in full effect across all investment options.
Just a brief background as to my personal investments and strategies: I would describe myself as a buy-and-hold investor. All the stocks that I currently hold have been in my portfolio for several years. In addition, the majority of my holdings are within the three major transfer agents. Where allowed, all of these equities participate in dividend reinvestment plans, or DRIPs.
I do have one brokerage account, and the holdings within that account also participate the same way. At this time, the brokerage company automatically defaulted the account to first in/first out, or FIFO!
I recently reviewed all the options available. For the brokerage account, I am considering changing my cost basis from first in/first out to minimum loss/minimum gain, or MLMG.
I would appreciate your insight on this matter and further input.
Beginning Jan. 1, 2011, the IRS required brokers to file informational returns which report gross proceeds from the sale of stocks, bonds and other investments along with the taxpayer’s “adjusted basis.” There are different ways in which your adjusted basis can be reported that will affect the gains and losses that end up on your return.
The three overall methods of determining your cost basis are: First in/first out, average cost and specific cost.
Determining cost basis
FIFO means that the oldest shares purchased are sold first. This method may result in larger gains since the longer you own stock, the higher your gain may be.
Average cost is generally for mutual funds and DRIP shares that are acquired through dividend reinvestment plans. The average cost per share is calculated by dividing the total dollars invested by the total number of shares held.
Specific identification lets you identify specific shares that will give you the best tax results in your particular situation. Some of the specific identification methods are:
- Low cost: The low-cost shares are sold first.
- Low cost, long term: The low-cost shares that produce a long-term gain are sold first.
- Low cost, short term: The low-cost shares that produce a short-term gain are sold first.
- Last in/first out: The most recent shares purchased are sold first.
- Minimize short-term gains: Shares that produce short-term losses are taken before short-term gains.
- Other variations include high-cost, long-term gains and high-cost, short-term gains.
Unless you choose differently, the IRS default method for stocks, ETFs, bonds, options and other securities is FIFO, so your broker is just following the rules on that one. The default method for mutual funds is average cost.
There is no one best method, as every investor has a different situation. At this point, you need to sit down with your broker and take a look at your specific portfolio and come up with a plan that works for you.
You should be determining what gains and losses are in your portfolio, what your investment strategy is regarding rebalancing your portfolio, what your income needs are, what, if any, capital loss carryovers you have, along with other items your broker may have to discuss.
Thanks for the great question and all the best to you.
Ask the adviser
To ask a question on Tax Talk, go to the “Ask the Experts” page and select “Taxes” as the topic. Read more Tax Talk columns.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.