Cost basis reporting and computation methods change, starting this year (tax year 2011) for a few ETFs, and next year for mutual funds (open and closed end) and most ETFs. Unfortunately, because of ambiguities on which ETFs are covered which year, it appears it may depend on what your particular brokerage thinks.
http://314advisor.com/keep track of your cost basis.htmlThere is also a question of how brokerages will deal with securities acquired prior to the "new era" - they are called "uncovered" securities, and brokerages have the option of reporting them or not. (I expect nearly all brokerages to elect not to report uncovered securities' cost basis - it would be more work for them.) Remember, for the most part, all these changes are merely reporting requirement changes on the brokerages - you always were, and continue to be, responsible for tracking your costs, and reporting them accurately. In some cases, the correct cost - the one you report - is guaranteed to be different from what the brokerage is legally required to report.
But wait, it gets worse. Think about average cost basis. (One thing that gets simpler here is that there's no more double category method - if you have to ask what this is, just be happy it's gone.) Generally, the brokerage will separate the shares acquired post 2011 from the shares acquired pre-2012, and average each separately. But the brokerage can elect to report the pre-2012 shares and _also_ to include them together with the post 2011 shares in a single calculation of average cost. See question 52 in the IRS FAQ.
http://www.irs.gov/taxpros/article/0,,id=237099,00.html (FAQ)
Currently, if you use average cost basis for one account where you hold a fund, then you must use it for all accounts where you own that fund. But starting 2012, you may elect to average the cost in one account but not in another (see FAQ #51).
It also seems that if you _elect_ average cost (post 2011), then you're stuck with it in that particular account, until the later of 1 year or the first sale using average cost. (This suggests that one is better off not electing average cost, but if you want to use it for a sale you're about to place, then elect it, so that you can turn it off again immediately after that sale.) Not sure about this. It seems that if you don't notify your brokerage, but if your brokerage uses average cost as its default, then you're not stuck with this one year or first sale rule - then you would be _changing_, rather than _revoking_ your _election_. See FAQ #49, and the IRS regulations, section 2(d)(i) - Requirement for Affirmative Election. Link below.
http://www.irs.gov/irb/2010-47_IRB/ar08.html#d0e335Aside from average cost, all the choices offered by brokerages amount to nothing but rules of thumb for identifying which shares are sold (and the cost basis of those shares is the actual cost, plus any transaction fees, loads, etc.) Most people are familiar with FIFO - the shares sold are automatically _identified_ as oldest first. There are lots of other choices brokerages may give now, e.g. HIFO (identifying the highest cost shares), etc. These heuristics are nice, just as having a brokerage automatically rebalance your account is nice, but I prefer to control things myself. And for selling shares, that just means telling the brokerage _explicitly_ which shares you're selling. Do this and you're in full control and can optimize taxes.
Regardless of what you choose to do, make sure you understand what your brokerage is doing - how it is treating pre-2012 shares, what choices it offers for selling rules (FIFO, LIFO, etc.). And make sure it is doing what you want. Here are a few pages from some brokerages on this subject:
WellsTrade:
https://www.wellsfargoadvisors.com/market-economy/tax-center/irs-cost-basis-reporting.htmhttps://www.wellsfargoadvisors.com/pdf/irs-cost-basis.pdfSchwab:
http://www.mutualfundstore.com/Clients/Schwab-cost-basis-FAQs.pdf (not from Schwab site)
Fidelity:
http://personal.fidelity.com/accounts/myprofile/content/costbasis2.shtml.cvsr(I like this because it reiterates what I wrote above, that methods like FIFO are nothing but rules of thumb for how to identify specific shares.)
Comments
for small investors - The IRS are out to get you, the brokerage firms are out to get you, and the CFAs from edward jones/fidelity/schwabs are also out to get you.
you are loosing lots of money on your held dollars due to inflations, so in a sense the FEDS are also out to get you!
Some funds charge a tremendous fees to own 'em so the MFs managers are out to get you...
Do you folks have any solutions for this massive problems?
Maybe buy physical gold and gold bars?
Maybe buy individual corporate bonds [just fees of transactions and hold them until maturity]
Maybe buy annuities?
Finally this year IRS got their acts together and require brokerages to report cost basis on holdings. Unless one liquidates the entire position, one should pay attention which lots to sell in order to maintain overall control as msf pointed out. Key here is be to consistent with what the laws require. I have been using a tax accountant to help with managing my parent's accounts, and this is part of the tax planning throughout the year.
The real joke here is the suggestion by the IRS that until now it was giving a way for dishonest people to cheat on their taxes. Hah!
Prior to this, brokers would only report your sales transaction. IRS did not have a good way of tracking cost basis and a lot of people apparently lied or mis-calculated the cost basis in their tax return. Now, that loophole is closing. You better match the cost basis report of your brokerage or will have some explaining to do to the IRS.
However, the method used (and shares sold) by the taxpayer _must_ be declared by the taxpayer by the time the trade settles; the taxpayer declares this to the brokerage, and the taxpayer cannot dispute what the brokerage reports. As far as the method and particular shares is concerned, what the taxpayer says is totally irrelevant. (Brokerages provide default rules - this constitutes your declaration if you don't override it on a sale-by-sale basis. This is why it is important for people to pay attention to this, especially since some funds/brokerages are changing their defaults.)
Even now, there's data reported by brokerages that a taxpayer, for all intents and purposes, cannot rebut - the date of the transaction, the net proceeds. This is just an extension of that idea - now the taxpayer will not be able to select the shares sold after the fact, or defer until filing whether to use average cost.
There is no reason to believe Schwab, Fidelity and Co. will do account three different ways just to help me out. There is no reason for me to. And if you are saying IRS will have ME do explaining if I don't report tax basis in the way the brokerage has reported it, then that would be nothing more than a witch-hunt and going after the wrong person. If that happens, Obama is not getting elected in 2012.
Good stuff and thanks MSF. Last year scottrade made me go thru and record the cost basis for all of our taxable securities. This has been coming. The IRS wants to better track the gains on asset sales to maximize tax receipts. It's their job.
We were lucky to get the 1099 reporting requirement repealed
http://www.bloomberg.com/news/2011-04-14/obama-signs-law-repealing-business-tax-reporting-mandate-1-.html
Hey, I dislike the increasing invasion of my privacy as much as the next person, but you either have to get the law changed (as above with the 1099) or you have to move or otherwise attempt to insulate yourself.
peace,
rono
Then again, I have long suspected the alignment of the planets must have been messed up when I was born. If not, then there are some really sadistic people at Fidelity.
Regardless, WTF do I have to tell broker anything? Report what you want to the IRS, I will use FIFO accounting. And if I get audited, I have all documents to prove I've done nothing wrong. Now if the law requires brokers to report FIFO from next year onward, at least I have nothing to worry about, other than broker making mistake doing math and me having to correct him. THAT would really suck. Because ordinarily I would save myself the time and use brokerage's FIFO statement, except the last 10 years of experience have turned me into a not so old cynical bastard.
http://www.irs.gov/instructions/i1040sd/ch02.html#d0e998
The requirement to notify the IRS remains intact, it's just the reporting mechanism that changes.
Going forward, you will report the method not by a notation on Schedule D, but by informing your broker, who in turn will pass that information onto the IRS. If you choose not to tell your broker anything, the broker will select a method for you. (Most brokers and fund families will select average cost as that method if you say nothing.)
No big deal. What is the big deal is that the IRS is going to start checking your calculation to make sure that you actually used the method you selected. So, if you tell the broker nothing, and if the broker selects average cost for you, and if you calculate your cost based on FIFO instead, you lose.
Or, if you tell the broker average cost, and then you use FIFO in calculating your taxes, you lose. Or, if you tell your broker FIFO and then you use average cost in calculating your taxes, you lose.
Notice I said nothing about your numbers matching the ones calculated by the brokerage. They don't have to match, so long as you can show that you used the method you selected (or let the brokerage select) at the time of the sale, and that your arithmetic is correct.
So you'd better have all the documents to prove you've done nothing wrong, including the documents that show what method you told the brokerage you were using to calculate cost.
I mean this sucks. No broker has contacted me as yet. No email telling me to go fill a form. Nothing. Unless something changes soon, we will have he said she said problems.
Can you please clarify what "documents" you are talking about that "show the method" I told my brokerage (again how???)
There are two interrelated factors in computing cost basis.
1) Method - there are really only two - average cost and specific share.
2) Which shares - here there are many choices - FIFO (even for average cost, the oldest shares are the ones sold first), highest cost first, lowest cost first, etc.
Right now, the Fidelity page cited (see above) says that one must call them to set up a "standing order" (default share selection rule - for item #2 above). If using that, I would press them on providing written acknowledgment. But the safest (IMHO) thing to do is, when placing an order there, check the little box on the order form that says: "Tax Lots, Choose Specific Shares".
If you haven't told Fidelity that you want to switch from average cost basis, their system will ask you whether you want to. If you answer yes, it will be able to tell you all the shares you own, when they were purchased, and at what price. It can prefill your order (FIFO, highest first, etc.). If you answer no, then you can just manually fill in when you purchased the shares, and at what price (the same info you're using right now for the IRS). The system may say that this doesn't match its records, but it will still process the order. Both the confirmation page and the paper confirmation will show exactly which shares you sold. There's your document.
But that's Fidelity. Other brokerages may not currently have the ability to handle specific shares. In general, I would submit my selection in writing to the brokerage, and keep a copy for my records, if the brokerage does not provide a better mechanism. Of course, this is what I'd do, and is not advice that you should rely on.
I've always used specific share identification in my own taxable transactions and admitedly it requires good records. I am glad that brokerage will be tracking the cost basis from now on.
However, I agree that brokers did not do enough to communicate the changes coming and this transition will be confusing. At this time not all securities are subject to the cost basis reporting and different brokers are interpreting the requirements slightly differently. So, there will be some headaches the first couple of years until this is fully implemented. There is also the problem of older shares acquired many many years ago and perhaps transferred from one broker to another. So, finding cost basis for these shares could be difficult but IRS will probably not going to concentrate on these older ones but who knows...
In a couple of years, I think most everyone will be happy that broker is tracking the cost basis (and cost basis info will be transferred from broker to broker along with shares)
Now what about funds I haven't purchased at Brokerages? Say I sell shares of DEFIX I hold at Tocqueville? They also have to ask me right? I just can't believe the mutual fund industry is prepared for this. This is going to be bad. I can just feel it.
Methinks brokerages will then simply do "average cost" reporting. I think I'm concluding there's really nothing much one can do for 2011 tax year. Just wait till end of the year and follow along with how cost basis has been reported and follow it. From now on, we just have to make sure we have written documentation advising brokerage, individual fund company as to how we would like cost basis reported for anything outstanding.
One more thing for the tax payer to remember. This is just going to drive up business for HR Block. Sucks most intensely.
I've got some that were transferred but Scottrade quieried me about each this past year. Hell, the cretins even quieried me about stuff I'd bought on their watch.
I just fill in the blanks BUT once you've got them all recorded, you don't have to go thru piles of stuff at tax time.
peace,
rono
I also have Scottrade account. I own some DEFIX directly with Tocqueville. I have to mail written request to sell my shares there and have been lazy. I also own some DEFIX in my Scottrade account. And I own some TMCGX with Scottrade for years.
When I transferred funds to Fidelity, they simply asked me "what is the cost basis for these shares". So I simply typed in my cost basis. At that time, all my cost basis was not long-term. But right now I think it is. I'm thinking it doesn't matter much then whether I do "average" or "fifo" accounting if I sell today.
PS. I cannot stop laughing at the usage of "cretin". I vote Fidelity-ians be called "nincompoops" and am open to suggestions for Schwab.
1) Transferred shares - for any "covered" securities (stocks purchased 2011+, funds in 2012+, etc.), brokerages are required to transfer cost info along with the shares when you move from broker to broker. So they'll know what you paid.
2) Average cost when you have "covered" and "uncovered" securities - Brokers will generally only include "covered" securities in the average they report. When you sell "uncovered" securities (fund shares purchased pre-2012), you're on your own, just as you are now. (As a service, brokers will tell you what they think the average cost is for those uncovered securities, but that won't be reported to the IRS, and it's your responsibility, as it is now, to get the numbers right.) There's a provision in the rules for brokerages averaging everything together (covered and uncovered), but only if they have all the cost info for the uncovered securities.
3) Default rules vs. per-trade elections - You can always tell the brokerage at the time of sale, what method you're using, and which shares you're selling. This overrides any default rule with the brokerage. That's what I described regarding Fidelity and what others are describing. But you're also supposed to be able to tell the brokerage what you want as a default rule (that will kick in if you don't tell the brokerage anything special when you sell your shares). That's different, because right now, most places pick one default (usually average cost), and you're stuck with it. Starting in 2011, you're supposed to be able to tell the brokerage to change its default rule, e.g. from FIFO to LIFO. That's what seems harder to document - Fidelity says "call them".
4) Identifying shares sold under average cost - HCF, LCF don't seem to make sense with average cost; all shares have the same cost, so there is no highest or lowest. More generally, I'm pretty sure that one cannot indicate which (of the equal cost) shares one is selling (even via a rule like LIFO), it's just oldest first (FIFO). But I don't have the time right now to validate this. Will check and get back to this (could be late this week).
http://www.irs.gov/irb/2010-47_IRB/ar08.html#d0e821
To keep things simple will let it build to a certain level over 2-3 years and than stop making new investments. At a later date would begin to sell as money needed in retirement. Reinvest option could probably be dropped then for added simplicity.
QUESTION 1 Does this buy first/sell later plan simplify taxes any, or am I still looking at alota trouble down the road?
QUESTION 2 Regarding MSFs last post (directly above): Once you make an initial withdrawal, is the "average cost basis" of the remaining shares re-calculated for just what those remaining shares cost, or does the cost of shares you have already sold remain part of that average cost? Thanks
Now (and also with the new rules), unless someone says differently, the oldest shares are sold first. That's the default.
With average cost, the cost of all the shares (including those old shares that are getting sold) are the same - the average (duh). When you use average cost, the only effect of the FIFO (sell oldest first) rule is that the gain or loss is long term (because you're keeping your youngest, short term shares, and selling your oldest, long term shares).
If you're not averaging the cost of the shares, then the cost of each share is the actual cost you paid (including load, if any, commission, etc.) I find this conceptually simpler, but can require more record keeping (since you have to keep track of how much you paid for each share).
Under the current (not new) rules, you have only the following options:
1. Use average cost to compute the (equal) cost of each share sold. No choice in which shares are sold - it's oldest first.
2. Use actual cost of each share sold
a) Don't tell your fund/broker anything - then you're automatically selling your oldest ones first (FIFO)
b) Tell your fund/broker exactly which shares you're selling (when you sell them!); then you're selling those particular shares, and their costs again are what you paid for each of those particular shares. This is called Specific Shares.
I'm giving the old rules because the calculations are the same for average cost either way (I have an example below), and I don't want to clutter this post too much with new rule complexities. Next 2 paragraphs are FYI how the new rules complicate things.
[ Under the current rules, the default is FIFO (2a). See end of note for comment on this, since you are currently able to change this to average cost when filing. That won't be true in the future. Under the new rules, your broker specifies the default (and most will use average cost (1)). And you won't be able to override this once the trade settles. But you will be able to tell the broker explicitly to use a different default method (within reason - it has to be one of the ones the broker is set up to handle).
Under the old rules, once you selected average cost (#1) you couldn't switch to actual cost (#2). Under the new rules, you can. I'm not going to try to answer question #2 if you want to switch back from average cost; I'll assume that you're sticking with average cost. ]
All said,
Answer 1: selling oldest first simplifies matters - you don't have to say anything to the IRS or your broker, this will happen automatically. If you're averaging cost, then this just helps ensure that the gains are long term gains (see above).
Answer 2 (assuming you stick with average cost) - you just need to keep a running total of the number of shares bought and the average cost. For example:
1. Buy 100 shares @ $10: average cost is $10
(total cost = $1000, divide by 100 shares)
2. Sell 20 shares: average cost of shares sold = $10 (from #1)
average cost of remaining shares = $10 (from #1)
number of remaining shares = 80
3. Buy 40 shares @ $20:
total number of shares = 80 + 40 = 120
total cost of shares = 80 * $10 + 40 * $20 = $1600
average cost of shares = $1600 / 120 = $13.33
4. Sell 100 shares: average cost of shares sold = $13.33 (total cost = $1333.33)
average cost of remaining shares = $13.33
number of remaining shares = 20
Notice that you never have to go back more than one step - you just keep track of your current average cost and the number of shares you still own.
Had you used actual cost, then the cost of the 20 shares you sold would still have been $10, but you'd have more bookkeeping for the remaining shares:
1) 100 shares bought at $10
2) Sell 20 shares
a) 20 shares sold with a cost of $10
b) 80 shares remaining with cost of $10/share
3) 40 shares bought at $20
You now have 80 shares at a cost of $10 (2b) and 40 shares at a cost of $20 (3)
4) Sell 100 shares
a) 80 shares with a cost of $10 (2b)
b) 20 shares with a cost of $20 (3)
c) 20 shares remaining with a cost of $20/share (leftover from 3)
Notice that you had to keep track of multiple lots of shares, so long as you had any shares remaining from each purchase.
In the future (2012+), the method used for computing your cost (and which shares were sold) will be determined by the time the trade settles. You will either explicitly tell the broker what method you're using, or you'll be stuck with whatever the broker has on record as the default method. That's a big change.
Currently, the default rule (despite what the industry would have you believe) is FIFO; but you're allowed to change that to average cost when you file (obviously much later than the settlement date).
From IRS publication 564: "You chose to use the average basis of mutual fund shares by clearly showing on your income tax return ... that you used an average basis in reporting gain or loss".
Even now, if you don't mark this on your tax return (and you didn't tell the broker which shares to sell), you're technically using FIFO (regardless of what the broker tells you it thinks your cost was). I will bet that nearly all filers get this wrong - they omit marking up their tax return. (I haven't figured out how to get TurboTax to put this on a tax form - I write it in by hand.)