question on mutual fund basis

[joesxm3]

I had some mutual funds that I had been DCA'ing into for years before my FIRE. They have appreciated quite a bit. I recently sold a portion of them and the year-to-date tax page is showing huge capital gains.

The amount of realized gains from these sales does not make sense to me when compared to the unrealized-gains shown for the remainder of these funds. I am going to call the company, but want to make sure I am thinking straight before I do.

The tax choice for the funds was "average share cost", which is the default choice. As I understand this, you add up the cost of all the shares and divide by the number of shares to get the average cost.

The description of the process says something about using the first in first out shares, but as part of the "average share cost" method.

Unfortunately, I did not save the unrealized cost basis page before I did the transaction.

For one of the funds, it currently shows the basis of the unrealized gain shares as $63.02 and shows "average share cost" as the basis choice.

However, I sold 30.60 shares for $196.08 per or $6000 and it is showing the basis for that transaction as $804.97 or $5195 gain on $6000.

Using the $63.02 basis per share, that should be $1928.41 not $804.97.

So . . .

My real question here is:

If I had a given number of shares with an average share cost of X before I made the sale transaction, should not the average share cost remain the same after I sell a portion of the shares?

That is, since I did not add any shares, the $63.02 average cost per share I see now should be the same as the cost per share before the sale, should it not?

 

[RunningBum]

Did you have some shares that were bought before 2011 (or maybe the year is 2012)? Before that date, holding companies were not required to track the basis of your funds, though most did. After that date, they are required to track the basis, and report it to the IRS as part of the 1099-B.

This means there is an average cost for your old shares, and an average cost of your newer shares. It sounds like you sold old shares, and still have the new shares.

 

[joesxm3]

I think you are on the right track.

I just looked at the unrealized gains and when I drill down it splits them into covered and non-covered with drastically different gain percentages. The non-covered which seem to have been sold has 645.37% gain and the covered has 171.45% gain.

I suppose it is too late to recharacterize the choice of shares to sell since it was third week of July when I sold them.

Not a huge concern, except that I estimated my ACA income as $40,000 and the gains from these sales don't leave me a lot of wiggle room for the end of year distributions.

Thanks for the help.

 

[MRG]

I think you are on the right track.

I just looked at the unrealized gains and when I drill down it splits them into covered and non-covered with drastically different gain percentages. The non-covered which seem to have been sold has 645.37% gain and the covered has 171.45% gain.

I suppose it is too late to recharacterize the choice of shares to sell since it was third week of July when I sold them.

Not a huge concern, except that I estimated my ACA income as $40,000 and the gains from these sales don't leave me a lot of wiggle room for the end of year distributions.

Thanks for the help.

Good year for ACA not to have a cliff.

 

[Graybeard]

I just happened to read many different links on Vanguard's site about cost basis a few days ago, I never knew it was so complex. I hope this isn't so obvious that my post looks dumb but using average share cost will sell FIFO IIRC and typically those have the lowest cost from years ago and that resets your cost basis as the remaining shares cost more. I don't know if you are a Vanguard client, but they have an lot of articles with links about cost basis.

Start here and just read all the links on various tabs, you don't have to be logged into their site if you don't have an account there https://investor.vanguard.com/taxes/cost-basis/

This is good to review also from the Bogleheads Wiki https://www.bogleheads.org/wiki/Cost_basis_methods

 

[Montecfo]

Two comments.

1. you want to always use specific ID in a taxable account.
2. It is NOT too late to recharacterize. Talk to your broker. I assume your choice was to sell the high basis shares first, was it not? then just tell them that.

They have time to get the reporting right.

 

[RunningBum]

I just happened to read many different links on Vanguard's site about cost basis a few days ago, I never knew it was so complex. I hope this isn't so obvious that my post looks dumb but using average share cost will sell FIFO IIRC and typically those have the lowest cost from years ago and that resets your cost basis as the remaining shares cost more. I don't know if you are a Vanguard client, but they have an lot of articles with links about cost basis.

That's an incomplete explanation at best.

The complexity is caused when you hold non-covered (bought before 2012) and covered (bought 2012 or later). These are held as two different groups, so if you choose average cost basis, you have an average cost on the non-covered shares, and an average cost on the covered shares.

When you sell, by default Vanguard (and maybe others) will sell the non-covered shares first. But within each group, the average cost of the unsold shares remains the same as the sold shares. There is no recalculation within that group, unless you buy new shares (which would be part of the covered shares group).

Once you've sold shares in a group by average cost, you can't change the method. Perhaps if this is the OP's first sale from a group, they can retroactively get the basis of that sale changed, or sell from the covered shares instead of non-covered. I don't know. I vaguely recall that VG once failed to sell the SpecID shares I selected, and I did get them to change it. It's definitely worth asking.

As montefco said, specific ID is the best way to set your basis, to give you the best flexibility for tax purposes. However, for the non-covered shares, you'd have to keep track of the basis from each pre-2012 purchase to use SpecID, at least at Vanguard. Before then they didn't have to track any basis, but as a courtesy they tracked average basis for you. So, if you're like me, you may have average basis for non-covered shares, and SpecID for covered shares.

 

[Graybeard]

That's an incomplete explanation at best.

The complexity is caused when you hold non-covered (bought before 2012) and covered (bought 2012 or later). These are held as two different groups, so if you choose average cost basis, you have an average cost on the non-covered shares, and an average cost on the covered shares.

When you sell, by default Vanguard (and maybe others) will sell the non-covered shares first. But within each group, the average cost of the unsold shares remains the same as the sold shares. There is no recalculation within that group, unless you buy new shares (which would be part of the covered shares group).

Once you've sold shares in a group by average cost, you can't change the method. Perhaps if this is the OP's first sale from a group, they can retroactively get the basis of that sale changed, or sell from the covered shares instead of non-covered. I don't know. I vaguely recall that VG once failed to sell the SpecID shares I selected, and I did get them to change it. It's definitely worth asking.

As montefco said, specific ID is the best way to set your basis, to give you the best flexibility for tax purposes. However, for the non-covered shares, you'd have to keep track of the basis from each pre-2012 purchase to use SpecID, at least at Vanguard. Before then they didn't have to track any basis, but as a courtesy they tracked average basis for you. So, if you're like me, you may have average basis for non-covered shares, and SpecID for covered shares.

Yeah it is complex. I don't remember if the OP had non covered shares, I don't so I don't even think about the difference between covered and non covered, I just think about covered.

So selling older shares that were bought at a lower price leaving newer shares bought at a higher price does not change your cost basis due to the less expensive shares you sold (for covered shares)?

You keep the same average cost forever, you don't calculate a new average using the shares unsold (for covered shares)?

What about newly purchased shares with proceeds from cap gains and dividends, aren't those newly purchased shares resetting the average cost?

Clearly I'm not understanding this. I am asking specific to my case holding only covered shares in a taxable account.

 

[RunningBum]

Yeah it is complex. I don't remember if the OP had non covered shares, I don't so I don't even think about the difference between covered and non covered, I just think about covered.

So selling older shares that were bought at a lower price leaving newer shares bought at a higher price does not change your cost basis due to the less expensive shares you sold (for covered shares)?

You keep the same average cost forever, you don't calculate a new average using the shares unsold (for covered shares)?

What about newly purchased shares with proceeds from cap gains and dividends, aren't those newly purchased shares resetting the average cost?

Clearly I'm not understanding this. I am asking specific to my case holding only covered shares in a taxable account.

No, average cost means you take the average of all shares, so selling some at that average price doesn't affect the average price of the remaining shares.

Suppose I bought 1000 shares at $5, and later 1000 shares at $15. The average price is $10. 2000 shares bought for a total of $20,000.

If I sell 500 shares using average cost basis of $10/share, my sales basis for the 500 shares is $5,000. I have 1500 shares remaining with a total basis of $15,000, or $10/share.

My way of making sense of this is that when selling with average cost basis, I'm not selling the earliest purchased shares, I'm selling a portion of each share I own. This is why they don't let you sell some at average cost, and then switch to FIFO or SpecID.

If you buy new shares, then yes, you recalculate the basis, as I said earlier. So extending the example above, if you buy another 500 shares at $20/share ($10K total purchase) you now have 2000 shares with total basis of $25,000, or $12.50 average cost/share.

Perhaps there is some difference if you have long term shares and short term shares. I don't know if you'd be hit with some LT gains and ST gains as well, or if they would only take the average of the LT shares.

I can't see a good reason for using average cost basis on covered shares. Nor FIFO. Spec ID is the way to go.

 

[Graybeard]

No, average cost means you take the average of all shares, so selling some at that average price doesn't affect the average price of the remaining shares.

Suppose I bought 1000 shares at $5, and later 1000 shares at $15. The average price is $10. 2000 shares bought for a total of $20,000.

If I sell 500 shares using average cost basis of $10/share, my sales basis for the 500 shares is $5,000. I have 1500 shares remaining with a total basis of $15,000, or $10/share.

My way of making sense of this is that when selling with average cost basis, I'm not selling the earliest purchased shares, I'm selling a portion of each share I own. This is why they don't let you sell some at average cost, and then switch to FIFO or SpecID.

If you buy new shares, then yes, you recalculate the basis, as I said earlier. So extending the example above, if you buy another 500 shares at $20/share ($10K total purchase) you now have 2000 shares with total basis of $25,000, or $12.50 average cost/share.

Perhaps there is some difference if you have long term shares and short term shares. I don't know if you'd be hit with some LT gains and ST gains as well, or if they would only take the average of the LT shares.

I can't see a good reason for using average cost basis on covered shares. Nor FIFO. Spec ID is the way to go.

Thank you, I appreciate that. I know from following this site for a few years you know this stuff.

I see now that average price means there is no older or newer share price as all the shares are averaged, as you said it is like selling a small part of each share at the average price.

Also the average cost will change if/when I reinvest cap gains and dividends. What confused me was once you select average cost you must continue to use that for all the shares until they are all sold, you don't have the ability to use average cost one time and spec id another. This makes choosing a method important as you are now locked into it. Does that apply to multiple mutual funds held in a taxable account ie whatever method you use to sell Fund A you have to use that same method for Funds B, C, D etc?

 

[RunningBum]

Thank you, I appreciate that. I know from following this site for a few years you know this stuff.

I see now that average price means there is no older or newer share price as all the shares are averaged, as you said it is like selling a small part of each share at the average price.

Also the average cost will change if/when I reinvest cap gains and dividends. What confused me was once you select average cost you must continue to use that for all the shares until they are all sold, you don't have the ability to use average cost one time and spec id another. This makes choosing a method important as you are now locked into it. Does that apply to multiple mutual funds held in a taxable account ie whatever method you use to sell Fund A you have to use that same method for Funds B, C, D etc?

No, you can have different cost basis methods for different funds, and you can change out of average cost if you have not yet sold any shares.

It's really a disservice that average cost is the default method, at least at Vanguard.