Selling of Funds and Cost Basis

[RASAP]

I pretty sure I need some help...

In early 2006 I sold some shares of one of my Vanguard funds to purchase other Vanguard funds. Now that it is tax time, I THINK I want to specify specific lots to maximize my losses so as to offset other capital gains. The bookkeeping issue is not a problem since I have all the details thanks to Quicken. So here are my points of confusion...

Assuming this is the right thing to do, was I supposed to specify the lots at the time of sale? I asked a Vanguard rep this question and he said no, that I simply need to send them a letter stating which lots I intended to sell an that would become a part of my account's record. The answer came after being put on hold for a long time, so I don't have a high level of confidence in this answer.

Is specifying specific lots the right thing to do? Yeah, I'm sure it depends on my situation but I need help understanding when this is a good idea vs. a bad idea. As it stands now, the losses are significant enough to rack up carryover for the next couple of years. I intend to RE in early 2008 so there will be no significant earned income for the year (not even sure this matters).

Help!

 

[Texas Proud]

Have you ever sold from this account before?

If so, you are out of luck... once you 'elect' to sale by averge costs, you must keep that election for the rest of your life... (it might have changed since I did taxes, but I doubt it)....

I don't remember if you sell by specific lot if you can change to average later... maybe a current tax person can tell you...

BUT, you don't have to specify the lot when selling as they don't keep the records... you must keep them and be able to show what you did if audited..

Remember... if you do specific, then Vanguard will NEVER have the correct gain every again as they would have used average on this year and your true cost basis and what Vanguard has will never be the same.... LOTS of record keeping for you..

 

[RASAP]

This is the first time I have sold this particular fund. I really don't see the record keeping as a big deal - I am just trying use the most tax efficient method.

Does anyone know of some articles addressing the subject of when it is best to use average cost vs. selling specific lots?

 

[LOL!]

Everyone's situation is different. I don't think there is a best way. We have never used average cost basis. We have used first in, first out (FIFO) with mutual funds mostly so all gains were long term and none were short term. And also because we've been doing this before Quicken was invented. With stocks we have used individual lots.

Did you read the IRS publication on mutual fund distributions? http://www.irs.gov/publications/p564/index.html

 

[kaneohe]

There is some past discussion on this subject here: (sorry, couldn't link the url for some reason but you can do a search here for "mutual fund cost basis and specific shares" ).

I would second the motion to read the IRS Publication cited above. It used to require that you get written confirmation from the broker that they had received the specific shares instructions from you before the sale. If that requirement is still present, then you would have to decide whether or not to attempt to go ahead with using this technique. Then it would come down to whether or not you were audited on this point and how nasty the auditor wanted to be. I have been doing it for many years and have never been questioned but YMMV.

I personally like the specific shares method because you can control the gains or even take losses as you would like to do. The tradeoff seems to be a little more recordkeeping which doesn't seem to be a problem for you.

 

[SecondCor521]

I pretty sure I need some help...

In early 2006 I sold some shares of one of my Vanguard funds to purchase other Vanguard funds. Now that it is tax time, I THINK I want to specify specific lots to maximize my losses so as to offset other capital gains. The bookkeeping issue is not a problem since I have all the details thanks to Quicken. So here are my points of confusion...

Assuming this is the right thing to do, was I supposed to specify the lots at the time of sale? I asked a Vanguard rep this question and he said no, that I simply need to send them a letter stating which lots I intended to sell an that would become a part of my account's record. The answer came after being put on hold for a long time, so I don't have a high level of confidence in this answer.

Is specifying specific lots the right thing to do? Yeah, I'm sure it depends on my situation but I need help understanding when this is a good idea vs. a bad idea. As it stands now, the losses are significant enough to rack up carryover for the next couple of years. I intend to RE in early 2008 so there will be no significant earned income for the year (not even sure this matters).

Help!

The law used to require that you specify your lots in written instruction to your broker prior to the sale; if you did not do so you would be assumed to, i.e., required to, use FIFO.

Specifying lots can save you a lot on taxes if you plan it right and keep the right records, as others have said.

Capital losses first offset capital gains and then can offset ordinary income up to $3,000 per year and can be carried over to future years. I prefer to harvest losses in years that I harvest no gains so that they are used against ordinary income and become more valuable to me (because OI rates are higher than CG rates), but that's just my preference and works well for my situation.

2Cor521

 

[mickeyd]

Hey RASAP,

I asked a Vanguard rep this question and he said no, that I simply need to send them a letter stating which lots I intended to sell an that would become a part of my account's record.

They told me the same thing in November when I wanted to sell shares in my TSM fund @ VG. I plan on selling much of my TSM account this year and next and I just sold a few shares that were purchased with dividends over a year prior. This is really just an experiment for me to see how easy/difficult the process is to do on TurboTax, so I am about where you are on this thing.

IRS Pub 564, mentioned above, gives all of the rules about the transaction so it's just a matter of deciding which way (average or specic shares) is best for you and yours. As mentioned, once you select a way to go, there is no turning back and trying it the other way. Not sure how the IRS will track you down if you try to make a switch along the way, however it should be considered as a factor in your assessment of which way to go.

 

[SecondCor521]

Not sure how the IRS will track you down if you try to make a switch along the way, however it should be considered as a factor in your assessment of which way to go.

I've always understood that it was a combination of the honor system and the threat of an audit.

2Cor521

 

[RASAP]

The IRS Pub referenced above states...

"You will adequately identify your mutual fund shares, even if you bought the shares in different lots at various prices and times, if you:
Specify to your broker or other agent the particular shares to be sold or transferred at the time of the sale or transfer, and ..."

What I don't get is that if Vanguard does not allow you to specify which shares are being sold at the time of sale (keep in mind I did this via the Vanguard website) then how does one adhere to the above requirement? Is it OK to send a letter to them "after-the-fact" stating which shares you sold (as suggested by the Vanguard rep I talked to) or must one send this letter to them before the sale takes place?

 

[SecondCor521]

The IRS Pub referenced above states...

"You will adequately identify your mutual fund shares, even if you bought the shares in different lots at various prices and times, if you:
Specify to your broker or other agent the particular shares to be sold or transferred at the time of the sale or transfer, and ..."

What I don't get is that if Vanguard does not allow you to specify which shares are being sold at the time of sale (keep in mind I did this via the Vanguard website) then how does one adhere to the above requirement? Is it OK to send a letter to them "after-the-fact" stating which shares you sold (as suggested by the Vanguard rep I talked to) or must one send this letter to them before the sale takes place?

According to the strict letter of the law and what I understand it's intent to be, it is not OK to send the letter after; it must be sent before.

The intent of this rule, as I understand it, is to prevent you from cherry-picking after the fact and lowering your tax burden unfairly. I'm not clever enough to make up an example for you at the moment, but I think you can see that if you bought and sold a bunch of the same stock or mutual fund at different times and prices and on different dates, deciding after the fact which actual shares you bought and sold would help you reduce your taxes more so than if you have to decide before each sale.

So in practice, what I do is just make sure I identify in my own records which shares I'm selling and have adequate records to prove the basis I claim on schedule D. If I'm ever audited I know I've complied with the spirit of the law if not the actual letter, so that's good enough for me. I personally just want to avoid any negligence penalties or fines; if the IRS tells me I've made an honest mistake I'm OK with that and willing to pay the difference in tax and interest. I just want to avoid jail.

2Cor521

 

[kaneohe]

It probably depends a lot on what the broker/fund co. will accept but one thing I have done in the past is to e-mail/fax a copy of the order detailing the specific lots to be sold and ask them to time-stamp receipt and send it back to you. That's just for your record and the execution could be by phone or computer.

It might help if you sell all of a number of specific lots (rather than a round dollar amount) so that you can show that e.g. 1001.235 shares is composed of lot A of 501.230sh and lot B of 500.005sh since it is unlikely that any other combination of shares will add up to that same 3 decimal number. Of course, better check your original data and addition a few times before you do it.