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cost basis
Old 10-18-2011, 11:28 AM   #1
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cost basis

I am used to tax deferred accounts only and have recently opened a 100,000 taxable account at Vanguard. I am now down to about 96,000. My plan was to start withdrawing 5% a year to supplement pension and leave IRA's to continue to grow. I am a bit confused about cost basis. How are the losses and withdrawals meshed together? At what point would I owe taxes?
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Old 10-18-2011, 11:33 AM   #2
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If you just opend this account, then they will keep track of the cap gains and losses and report them to you and the IRS...

You will put them on your tax return when you file.
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Old 10-18-2011, 11:39 AM   #3
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I am used to tax deferred accounts only and have recently opened a 100,000 taxable account at Vanguard. I am now down to about 96,000. My plan was to start withdrawing 5% a year to supplement pension and leave IRA's to continue to grow. I am a bit confused about cost basis. How are the losses and withdrawals meshed together? At what point would I owe taxes?
The cost basis for each investment will be tracked separately. When you first sell, you will be asked to choose between average cost, first bought or specific lot. That choice will be used for that investment from then on and reported to the IRS. They will probably also give you a year end statement with the cost basis and gain/loss for reporting - but I'm not sure about this last part.
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Old 10-18-2011, 11:46 AM   #4
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The cost basis for each investment will be tracked separately. When you first sell, you will be asked to choose between average cost, first bought or specific lot. That choice will be used for that investment from then on and reported to the IRS. They will probably also give you a year end statement with the cost basis and gain/loss for reporting - but I'm not sure about this last part.
They have always given me a year end statement which shows the gains and losses of each fund. You can plug those numbers into your tax software next year. Any losses not set off against gains next year can be carried forward to future years.

I always use the average cost rather than choose which lot to sell when making sales from a fund.
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Old 10-18-2011, 01:11 PM   #5
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They have always given me a year end statement which shows the gains and losses of each fund. You can plug those numbers into your tax software next year. Any losses not set off against gains next year can be carried forward to future years.

I always use the average cost rather than choose which lot to sell when making sales from a fund.
The difference is in 2010 and before, that was a courtesy from the broker or mutual fund company. Beginning this year it is a IRS mandate and the cost data will be reported to them. Same with choosing the cost basis.
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Old 10-18-2011, 01:30 PM   #6
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Here is a pretty good and easily readable description of what you need to know:

http://www.irs.gov/pub/irs-pdf/p550.pdf
and
http://www.irs.gov/pub/irs-pdf/p551.pdf

You can also read the instructions to Form 1040 Schedule D which is really trivial to fill out.

http://www.irs.gov/pub/irs-pdf/i1040sd.pdf

Perhaps the only complication is that some folks use "average cost" for their basis (of mutual fund shares, not ETFs and not stocks) which is probably confusing. Instead one can simply use what they actually paid for their shares as the cost basis which is really easy. For ETFs and stocks, you have to use what you actually paid for your shares as the cost basis.
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Old 10-18-2011, 03:35 PM   #7
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The difference is in 2010 and before, that was a courtesy from the broker or mutual fund company. Beginning this year it is a IRS mandate and the cost data will be reported to them. Same with choosing the cost basis.
Note: As I found out recently, they will report to IRS cost basis of only stocks / etfs you bought starting in 2011. Not sure about mutual funds - might be some future year or also 2011 (but not earlier). (For the OP that might be good enough assuming 100k account was cash and not transferred securities from elsewhere.)
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Old 10-18-2011, 04:21 PM   #8
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Note: As I found out recently, they will report to IRS cost basis of only stocks / etfs you bought starting in 2011. Not sure about mutual funds - might be some future year or also 2011 (but not earlier). (For the OP that might be good enough assuming 100k account was cash and not transferred securities from elsewhere.)
Right. Equities in 2011, mutual funds in 2012.
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Old 10-18-2011, 04:28 PM   #9
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The difference is in 2010 and before, that was a courtesy from the broker or mutual fund company. Beginning this year it is a IRS mandate and the cost data will be reported to them. Same with choosing the cost basis.
I agree.

Since the OP was asking about Vanguard I was confirming his question that he will receive all the information he needs from Vanguard, as I have always received clear statements from them on cost basis, gains and losses.

Having done a bunch of tax returns for folks earlier this year I realize that all broker statements are not so clear.
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Old 10-18-2011, 04:44 PM   #10
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Perhaps the only complication is that some folks use "average cost" for their basis (of mutual fund shares, not ETFs and not stocks) which is probably confusing.
Well . . . I've always used the average cost method because I found it less confusing. Trying to track specific shares over many years, especially when I reinvested dividends and bought .339 of a share, etc, was just more than I wanted to take on. I'm sure it's more tax efficient to utilize the specific shares method of accounting (particularly for tax loss harvesting purposes) but I was always just too lazy to do it.
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Old 10-18-2011, 09:24 PM   #11
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Ah, but did you actually calculate the average cost yourself, or did you accept the number your broker gave you?
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Old 10-18-2011, 10:55 PM   #12
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Each mutual fund I own is in a spreadsheet I designed. I track all the purchases, sales, and dividend and cap gains reinvestments, among other things. It is pretty easy to build in the FIFO (First In, First Out) method for selling shares, as that maximizes the chance of having long-term cap gains tax treatment of shares I sell at a gain. I set up the spreadsheet so I can simply copy info from it onto Schedule D.
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Old 10-18-2011, 11:16 PM   #13
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Ah, but did you actually calculate the average cost yourself, or did you accept the number your broker gave you?
I used the number Vanguard gave me, which was easier than tracking purchases myself. If I'd had to do the averaging myself (like in the "old days") then it would have been more work.
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Anyone here taking 401K distributions?
Old 10-19-2011, 01:50 AM   #14
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Anyone here taking 401K distributions?

If so, do you pay a fixed rate of tax, depending on your income?
OR, do you also pay taxes on dividends/cap gains you receive on the mutual funds along with the taxes you pay for the distribution?

I always thought you paid one flat percentage depending on your tax bracket, but someone on a mutual fund board says this:

" I thought everyone understood dividends get taxed at the marginal 15% rate regardless of your adjusted gross income and interest gets taxed at your regular tax rate which for most is 35%"

Is he right?
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Old 10-19-2011, 06:29 AM   #15
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Dividends may be taxed as low as 0% (that is, they may be tax-free).

That's why I think it is helpful to understand how to do your own taxes and how to understand how you are taxed. It also helps you to understand who to vote for when you act as a citizen because you will understand the issues involved with what happens to your money.

Ordinary dividends are taxed at your marginal income tax rate.
Qualified dividends get a special tax treatment if you have held the investment that pays those dividends for the required time period. If you have not held the underlying investment for the required time period, then the qualified dividend becomes unqualified and is taxed as an ordinary dividend.

Generally bond dividends are not qualified and are taxed at your marginal income tax rate. Tax-exempt bond dividends or muni bond divideds are generally not taxed by the federal government, but may be taxed by the state government. US Treasury bond income is taxed by the federal government but is state income tax-free. Generally dividends from stocks or from stocks in mutual funds are qualified, but not always.

There are a few more nuances because the special tax treatment of qualified dividends will get them a tax rate of between 0% (i.e. tax-free) to 15% that depends on the rest of your income.

Got that?
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Old 10-19-2011, 08:10 AM   #16
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Anyone here taking 401K distributions?
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Originally Posted by heirloom View Post
If so, do you pay a fixed rate of tax, depending on your income?
OR, do you also pay taxes on dividends/cap gains you receive on the mutual funds along with the taxes you pay for the distribution?

I always thought you paid one flat percentage depending on your tax bracket, but someone on a mutual fund board says this:

" I thought everyone understood dividends get taxed at the marginal 15% rate regardless of your adjusted gross income and interest gets taxed at your regular tax rate which for most is 35%"

Is he right?
Looking at the title of your post, your questions are about the treatment of gains and dividends within your 401k, and what happens when you withdraw them.

All 401k distributions, I believe, are taxed as regular income regardless of their source.

I am still some years away from being able to take distributions so can't speak from experience but if dividends and cap gains are treated the same as after-tax accounts, that is great news.
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Old 10-19-2011, 08:39 AM   #17
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Anyone here taking 401K distributions?


Looking at the title of your post, your questions are about the treatment of gains and dividends within your 401k, and what happens when you withdraw them.

All 401k distributions, I believe, are taxed as regular income regardless of their source.

I am still some years away from being able to take distributions so can't speak from experience but if dividends and cap gains are treated the same as after-tax accounts, that is great news.
Alan is correct. 401K distributions are taxed as regular income (if the contributions were tax "deductible", that is, no taxes were paid on them).
You pay taxes at your tax bracket (s)......if you are close to the dividing line between brackets, you may pay at a couple rates if the 401K distribution makes you cross brackets. You do not pay CG rates in addition to the regular rates on CGs.

What you read on the mutual fund site refers to funds held in a taxable account. If your fund is held in a tax deferred 401K, the structure of that tax shelter changes the nature of the distribution to ordinary income and you do not get the benefit of qualified dividend and CG rates.

btw: sometimes it is dangerous to put critical info in the title but Alan has a good eye and picked it up anyway.
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Old 10-19-2011, 09:34 AM   #18
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Thanks to all for your input. Now this brings me to my next question. I am also considering tax loss harvesting. There are two similar funds which I can buy by selling the two losers. I understand I have to stay in them for 31 days before I can go back. Then my cost basis would go from 100,000 to 96,000. I guess I could write off 3000 this year and 1000 next. But I do realize then I would be paying taxes on any gains going forward from 96,000. Any ideas on this one?
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Thanks Alan and Kane
Old 10-19-2011, 01:14 PM   #19
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Thanks Alan and Kane

That sure puts my mind to rest.

I won't be collecting distributions until 9 more years, but it is nice to know what we will be paying so we can be prepare our budget accordingly.
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Old 10-19-2011, 01:55 PM   #20
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Thanks to all for your input. Now this brings me to my next question. I am also considering tax loss harvesting. There are two similar funds which I can buy by selling the two losers. I understand I have to stay in them for 31 days before I can go back. Then my cost basis would go from 100,000 to 96,000. I guess I could write off 3000 this year and 1000 next. But I do realize then I would be paying taxes on any gains going forward from 96,000. Any ideas on this one?
You need to do the math for your own situation. A simple example:
1) Stay put. The fund goes back to 100K in N yrs. You sell and have no gains and pay no tax.
2) TLH. You have 4K loss . You are in e.g. 25% bracket and gain 1K from that TLH (assuming the loss is not offset by any LTCG). N yrs later the fund goes back to 100K and you have a 4K LTCG. You pay, assuming LTCG rate of 15%, $600 on that gain. You are ahead by $400 (difference between 1K gain from TLH and $600 LTCG tax. In addition, you have the time value of the 1K earning ?? for N yrs.

Change the tax bracket now and you have a different number. Change the
LTCG rate in N yrs and you have a different number. Change the assumed rate of return of the 1K during those N yrs and you get a different number. Perhaps you never sell after N yrs and expire.....your heirs get a stepup in basis so the LTCG tax never has to be paid. Different scenarios, different results.....YMMV.....but generally it is not a bad idea to TLH.
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