Suppose “Joe Investor” bought a (new) growth fund with $10,000. He had intended to hold it a year to qualify for the long term cap gains tax. Instead, he sells off 25% of the fund earlier in order to lock-in some big gains early on.
For tax purposes, is (1) the short term capital gains tax assessed only on the 25% he sold early? Or (2) Does he get hit paying ST cap gains on the entire investment?
Logic tells me it’s the 1st scenario. But not sure.
Comments
Thanks @LLJB. That’s what I was trying to get my head around. PIEQX has done better than I would have expected since this spring. (Had held it earlier in a tax-sheltered account, but moved it to non-sheltered to put some real estate proceeds to work.) I just might lock-up some gains on a small portion (although compared to other areas of the market I still like it).
These losses rollover from on tax year to the next if they are not used to offset gains in the year the loss is realized.
More on the topic here:
Investopedia:
investopedia.com/articles/taxes/08/tax-loss-harvesting.asp
Fidelity:
https://fidelity.com/viewpoints/personal-finance/tax-loss-harvesting
Boglehead Wiki:
https://bogleheads.org/wiki/Tax_loss_harvesting
Carryover rules for tax losses:
fairmark.com/investment-taxation/capital-gain/capital-losses/capital-loss-with-little-or-no-income/
Here’s a related question. Suppose Joe investor does not sell anything. Instead, he adds $2,000 to that same fund six months after after making the original investment (He’s now invested $12,000.)
A year (or more) after making the original investment, Joe sells $2,000 of the fund.
Can I assume that “first-in / first-out” applies in this case - so that for tax purposes the shares sold would not be subject to the higher short term rate?
Seems logical - but I’m treading unfamiliar ground.
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Added: I found this link http://www.investopedia.com/articles/mutualfund/cost-basis-mutual-funds.asp
Now my question becomes How do you make this selection re method of reporting?
Did (or will) your fund company request it? Or, do you decide when doing your tax return? If the second method, would a program from HR Block or TurboTax do the calculation as to which method is best? Since you can’t change the method once selected (in future years) I guess leaving the decision to a tax program might be problematic.
If you're not identifying which shares to sell, then the oldest ones are sold first. Unless you're selling all shares, it's likely that you're not selling the newly minted shares purchased with the reinvested dividends.
If you use average cost to determine the basis of the shares, then by law you're selling the oldest shares first. So here too, it's likely that you're not selling those reinvested dividend shares.
If you gave the broker/fund company instructions on how to pick (identify) the shares sold, then this changes. For example, you might specify HIFO (highest in, first out). In that case, it's quite likely that the reinvested dividend shares were sold first - they are the newest shares and thus likely the highest cost ones.
The fund company is required to report to the IRS what (it thinks) your shares cost. So you don't have the option of "fixing this up" at tax time.
Where a lot of confusion comes in is that there are two questions to be answered:
- which shares did you sell?
- how much did those shares cost?
If you told the fund company that you want to use average cost (or you let the fund company default to this), and you don't change this with the fund company prior to selling your shares, you are stuck with oldest first (which shares were sold) and average cost (what was the cost basis of each of those shares).
If you told the fund company that you wanted to use any other method (or the fund company defaulted to something other than average cost, such as FIFO), then you have a little more flexibility.
At the time of the sale, or anytime until the transaction settles (typically one day after sale for funds sold through brokerages), you can tell the fund company/broker which shares you wanted to sell. The cost of those shares will be the "actual" cost (with possible adjustments that are beyond the scope of this post).
If you don't give any explicit instructions regarding this particular sale (and the default isn't average cost), then the fund company will use the instructions it has on file to select the shares to sell. For example, you might have told the fund company to use HIFO (see previous post above). Regardless of which shares are selected, the cost of those shares is the "actual" cost.
All of this is reported to the IRS by the fund company (for post 2011 shares). If there's something you know that the fund company doesn't, you have the opportunity to correct the report on your 1040. I've done that, but it happens rarely (e.g. wash sale spanning multiple accounts).
How do you answer the two questions above (which shares, what cost method)? Depends on tax situation, expectations for the future, etc. I almost always identify the shares myself, so that I have total control and can do what's best for the particular situation.
@hank, I believe in all of my accounts I have to choose how the cost basis of shares I sell is determined. At least in the 2 accounts I checked the cost basis election is found in my profile and account preferences. There's no choice available for my IRAs and I assume that's because there aren't any tax implications, but I think they default to FIFO in terms of what they show as purchase dates and gains or losses in my account. I've chosen specific lot identification for all of my non-IRA accounts because I like the flexibility and I don't sell often enough to mind the slight extra effort involved.
My second question was prompted because I actually opened two non-sheltered accounts (in equal amounts) on the same day last June - the international equity fund and a high yield muni. I consider the muni less risky and so was playing with the idea of moving some of the equity fund into it to shelter (partially) some of those gains.
Thanks.