I first asked about this in 2011, when the "covered" vs "non-covered" reporting legislation came into effect. It seemed clear that I needed to divide my transactions into two bins, one for "non-covered" and one for "covered" going forward. But, I never did so since I hardly sold anything in a taxable account. Now for 2020 tax season this is biting me big time:
Remember, even if you use the average cost method, the mutual fund companies all seem to calculate two different bases - one for "non-covered" (pre-2012) shares and one for "covered" (2012 and later.) For example:
2010: Buy 100 sh XYZZX at $10 (non-covered)
2015: Buy 100 sh XYZZX at $30 (covered)
2020: Sell 100 sh XYZZX at $50 (will be non-covered shares, the non-covered bin is emptied first)
2021: Sell 100 sh XYZZX at $50 (will be covered shares)
They are going to report your sale from the uncovered bin first - so the basis for your 2020 sale will be $1000, for a $4000 gain. For 2021, the shares are covered; they will report a basis of $3000 to the IRS and a $2000 gain.
If you mistakenly combined both purchases into the same bin and calculated the average basis, you might be tempted to report each of the sales with a $2000 ($20 per share) basis. Since the 2020 sale is not covered, you might report a $2000 basis for it, for a $3000 gain, which the IRS won't know about. But for 2021, you will also need to report a $2000 basis, for a $3000 gain, which is different from what you will get on your 1099-B. This could get you a letter from the IRS.
For some reason how this two-bin basis calculation works is not documented or explained anywhere online, or by any of the fund companies' tax guides. Best bet: just assume that all the numbers on your 1099-B are right, even for non-covered shares you have had a long time. You might want to break out non-covered vs covered bases now, before you exhaust your un-covered shares. Those can probably be fudged a little, as log as all the bases you have used for all the sales in each bin add up to the amount that you paid in to the fund.
Another way is to use FIFO or some other method. In retrospect, that might have been easier than average cost.