2012 Mutual Fund Cost Basis

[S T]

Vanguard has sent out to their clients a notice "It's Time to Choose a Cost Basis Method"

Here is an excerpt from that notice

New regulations require investment companies, including Vanguard, to report cost basis information to the IRS for mutual fund and most exchange-traded fund (ETF) shares that were acquired on or after January 1, 2012, and then sold after that date. We'll report this information to you and the IRS on your Form 1099-B.

Shares you acquired before January 1, 2012, are not affected by the new regulations. We'll continue to report cost basis information only to you—not the IRS—when you sell these shares, using the average cost method, explained below.

Time to decide
You'll need to select a preferred cost basis method before you sell shares of Vanguard mutual funds (excluding money market funds) and most Vanguard ETFs® in your taxable (nonretirement) accounts:

Average cost. Calculates the average cost per share for each share you own.

First in, first out (FIFO). The first shares you acquired will be the first ones we sell.

Specific identification. At the time of sale, you choose the shares (or lots) to sell, which will determine your capital gain or loss.

My question is which would be the best method to choose? Seems like in the past for mutual funds info has been provided on Average Cost Basis as stated?

Thanks

Sandy

[Snaggletooth]

I Favor Average Cost

...but I think the "correct" answer would be to see if your clients have a method they were already using and stick to it. Historically, IRS has applied "FIFO" in absence of any taxpayer's pattern.

The requirements have always been mandated that a stockholder choose a method and be consistent. That should not change just because brokers now have to conform to something.

It's possible many clients don't even know the difference. Most of mine pull out purchase statements for me to use when they sell. This method is called "specific identification" but has its drawbacks for serious and voluminous investors. "Average Cost" serves frequent investors better because of its simplicity.

[OtisMozzetti]

I have found that Vanguard's web site is nowadays very appealing, because at least for stocks purchased via Vanguard Brokerage Services, you can select the lot(s) (specific identification!) being sold AT THE TIME OF SALE.

It seems to me that Snaggletooth is right on track in his comments. Specific identification isn't supposed to be applied later at the time of preparing tax returns; it is applied at the time of selling securities (such as mutual fund shares, or stocks).

My own use of Vanguard has always been FIFO, except I documented that certain exchanges of shares made years ago were on the specific identification method.

If you ask me, FIFO has usually got more simplicity than does average cost basis. FIFO has the advantage that only the most recently acquired shares are still in play (unless wash sale demons are lurking) as far as the computation is concerned. A lot depends upon the transaction habits of the taxpayer(s) involved.

[Gary2]

I've always considered single-category, average cost basis to be the simplest, because once you have it, you can keep updating it with current year's records. For example, if you've calculated that value for Dec. 31, 2011, then you only need the 2012 transaction history to calculate the basis for any 2012 transaction. Of course, with the mutual fund companies doing the work, this advantage becomes moot.

In an up-market (i.e., most of the time), it also results in tax deferral with no mental effort, since the average cost is usually higher than the FIFO cost.

I see no general advantage in having only the most recent shares in play versus average cost, as far as the basis computation is concerned.

[Edward]

My client elected the FIFO method - can anybody recommend a record for use in maintaining documentation on the FIFO? Thanks.

[joanmcq]

I'm curious; if a client has already bought & sold shares and we've used the cost basis provided, are they not already locked into the average cost basis method, at least for that fund?

For example, I have a client that owns quite a bit of one fund, and has sold shares as cash was needed. Dividends and capital gains are reinvested. Since average basis was used from the beginning, FIFO can't be used for subsequent shares sold. At least this has been my understanding of selecting a method of calculating basis on funds.

[Gary2]

I'm curious; if a client has already bought & sold shares and we've used the cost basis provided, are they not already locked into the average cost basis method, at least for that fund?

I would not assume that the cost basis provided was the single-category average cost basis, but yes, once you've used either type of average cost basis for a given fund, you must continue using that method for that particular fund (but not necessarily other funds in the same fund family).

[Gary2]

My client elected the FIFO method - can anybody recommend a record for use in maintaining documentation on the FIFO? Thanks.

I'm not sure what you're asking. Obviously the regular statements from the mutual fund or brokerage supply adequate documentation. If you're asking for software, any of the usual programs for tracking investments can handle it.

Since you used the phrase "elected the FIFO method", it sounds like the mutual fund company will be handling this anyway when it reports the basis on the 1099-B.