Figuring taxes on your mutual fund sales

Figuring your tax bill on mutual fund sales is not an easy undertaking. That's because you probably have purchased shares at different times for different amounts.

Selling all your shares of a particular fund at the same time eases the process: All you do is add up all the payments you made and compare

that to the selling price to determine whether you have a loss or gain.

However, if you don't sell all your shares at once, calculating the tax

basis or cost of the shares you sell gets complicated.

In order to do it right, you must keep track of your tax "basis" in

the mutual fund shares you own. The original basis of mutual fund shares

you buy is usually their purchase price, including any commissions or load

charges paid. For example, if you bought 100 shares of Fund A for $10 a

share and paid a $50 commission to the broker for the purchase, your cost

basis for each share is $10.50 ($1,050 divided by 100). The original basis

of mutual fund shares you acquire by reinvesting your distributions (dividends

and/or capital gains) is the amount of the distributions used to purchase

additional shares.

Things get tricky when you receive capital distributions from your mutual

fund because that reduces your tax basis. And if there are undistributed

capital gains at the time you sell your shares, this will increase your

tax basis.

There are four Internal Revenue Service-approved methods for calculating

your gain or loss on the sale of mutual fund shares. Figuring out which

method to use is complicated enough without having to worry about calculating

your tax basis. The four IRS-approved methods are:

1. First in, first out (FIFO). This method assumes the shares sold were

the ones you purchased first. For example, say you bought your first 100

shares in the XYZ fund for $20 per share and later bought 100 more at $25.

Now you sell 50 shares. Under FIFO, you are assumed to have sold 50 of the

100 shares you bought at $20 per share. If you sell the 50 shares for $30,

your gain is $10 per share. To use FIFO, you must keep records of all share

purchases. In a rising market, FIFO produces the biggest tax bill because

the shares you've held the longest cost less. However, FIFO increases the

likelihood that your gains will be long term and qualify for the 20 percent

maximum rate. If you don't specify what method you are using for calculating

your tax liability on mutual fund sales, the IRS assumes you are using FIFO.

2. Specific identification. If you can definitely identify the shares

you sold, you can use the adjusted basis of those particular shares to figure

your gain or loss. To identify the shares, you must specify to your broker

or other agent the particular shares to be sold or transferred at the time

of the sale or transfer, and you must receive written confirmation of your

specification from your broker. Confirmation by the mutual fund must indicate

that you instructed your broker to sell particular shares. You continue

to have the burden of proving your basis in the specified shares at the

time of sale or transfer.

3. Single-category or "regular" average basis.

4. Double-category average basis.

Methods 3 and 4 rely on an "average basis." You can figure your gain

or loss using an average basis only if you acquired the shares at various

times and prices and you left the shares on deposit in an account handled

by a custodian or agent who acquires or redeems those shares. To figure

average basis, you can use the single-category method and the double-category


Once you elect to use an average basis, you must continue to use it

for all accounts in the same fund. (You must also continue to use the same

method.) However, you may use the cost basis (or a different method of figuring

the average basis) for shares in other funds, even those within the same

family of funds.

In the single-category method, you find the average cost of all shares

owned at the time of each disposition, regardless of how long you owned

them. Include shares acquired with reinvested dividends or capital gain


In the double-category method, all shares in an account at the time

of each disposition are divided into two categories: short-term and long-term.

Shares held one year or less are short-term. Shares held longer than one

year are long-term. The basis of each share in a category is the average

basis for that category.

— Zall is a freelance writer based in Silver Spring, Md., who specializes

in taxes, investing and business issues. He is a certified internal auditor

and a registered investment adviser. He can be reached via e-mail at [email protected]

To read more from Milt Zall (Bureaucratus), type "Zall" in the search

box at


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