Anyone remember 1997? That year, depending upon when a fund sold underlying securities, the cap gains dividends you got would be taxed at 20% or 28%. It mattered not only when the underlying securities were sold, but whether they were held for 12 months or 18 months. Very confusing, but at least it was the funds that had to deal with all of this - they just handed you percentages that you multiplied by the cap gains dividends you got, and that was the end of it.
Fast forward to 2012. Now, when you sell shares, you get to pick the shares you sell, and the cost of those shares (average cost or actual cost). But between the financial institutions and the IRS, they seem to be working to make something relatively straightforward as difficult as possible.
Want to change between average cost and actual cost? You have to do in in writing (which may be online); that's what
TRPrice says the IRS requirements are. (I've only found something on the IRS site that says a switch in one of the directions, don't remember which, has to be in writing, but I've little doubt that TRP is correct here.) Want to do a switch at Fidelity? - they say call, but when I asked about that, what I was told is that you call and over the phone they instruct you how to put it in writing!
Some sites, like Vanguard and Fidelity, allow you to specify the shares online, so there's no ambiguity about what you're selling. Unfortunately, both Vanguard and Fidelity take a day to convert their system from average cost to actual cost (specific shares), so it's difficult if not impossible to sell specific shares if you haven't prepped the system in advance. (This would seem to violate the spirit of the IRS/Congress regs/statutes, which is for increased flexibility.) Vanguard says explicitly that you could experience delays in trading.
Other sites, like TRP (see link above) and Schwab, say explicitly that you need to call the institution to tell them the shares to sell. (TRP's instructions are the clearest - set up some default method other than average cost, and then call them when you want to do a trade.) Schwab
also says "when you want to use [specific lot] for a trade, simply contact a Schwab service representative." (See Cost Basis Methods question on link.) It is unclear how much this will add to the cost of trading an NTF fund. Perhaps what one is supposed to do is make the trade first (at no fee) and then call them prior to settlement to "fix" the shares sold.
As you can see, the institutions are incredibly bad at communicating how their systems work. It's not as though they had years to prepare for this. Oh wait! Yes they did.
And it gets worse. I helped a relative a couple of days ago sell some Fidelity shares at Fidelity on an account that had been set up (in advance) for specific share ID. The rule for uncovered shares (shares prior to 2012 for funds) is that if you don't specify which shares are sold, then the oldest ones are sold first (FIFO). The only difference between average cost and actual cost (specific share ID) if you don't pick the shares yourself is what the cost of those shares are. Yet the confirm from Fidelity said that the shares were "depleted using average cost method per customer instructions". As I just wrote, the cost method has got nothing to do with the order of depletion (sale) - something Fidelity acknowledged over the phone when I called them on this. And where they got their customer instructions from is anyone's guess, since the account was configured for specific lot ID (which we can prove because we sold a few shares by specific lot just three days prior on the same account).
Every institution seems to be fouled up - all that differs is the severity of the foul up, and how badly one may get burned. It's a shame, because this was not that hard to get right, and was a potential benefit to the investor. It seems that this is truly a case of buyer, or more accurately seller, beware.
Comments
Thank you for your time and effort with this situation.
Regards,
Catch
On the plus side nearly all of my mutual fund holdings are in Roth IRA's where it doesn't matter what I do or when.
Be careful with IRAs and wash sales. If you sell a security in a taxable account at a loss, and buy it back within 30 days (before or after the sale) in the IRA, you still have a wash sale, and you lose the deduction. Since the purchase was in the IRA, you've permanently lost the deduction. So just because most of your fund holdings are in IRAs doesn't mean you can be completely oblivious to the tax implications of trading within the IRAs. (This is also a fairly new ruling, though not as new as the ability to switch out of average cost.)
I believe you can work around this by opening up a separate brokerage account for each fund, but doesn't that defeat much of the purpose of consolidating in one place - a single 1099, no need to transfer assets between accounts to exchange from one fund to another, etc.