Figuring taxes on your mutual fund sales
- By Milt x_Zall
- Mar 30, 2000
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
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
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@example.com.
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