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When you dispose of an investment, the Internal Revenue
Service (
It is important to note, that once you pick an
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For all investments which are Not Mutual Funds
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For all assets which are not mutual funds, such as stock or
bonds, the
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For All Mutual Fund Investments
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For all mutual fund investments, the
- First in - First out (FIFO)
- Specific ID
- Average (Single Category)
- Average (Double Category)
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FIFO
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As the name implies, for determining your cost basis you must assume that the first shares acquired are the first shares disposed or sold. Although easy to determine, as your trade slip or mutual fund account statement probably shows you your cost basis in the shares disposed, the oldest shares probably are those with the smallest cost and thus any dispose or sale will probably yield the largest capital gain.
As an example, suppose you own 300 shares of General
Electric (GE) and sell 100 shares on
--Acquire Transactions---- ----------------Resulting Dispose Transactions--------
Cost Net
Date Quantity Basis Date Qty Proceeds Taxable Gain
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Specific ID
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With this method, you must specifically identify the shares that you want sold. That is, you must define to the institution, which actually performs the dispose, the date specific shares were acquired and the quantity of each acquire transaction you want sold. This method is usually better than FIFO as you can decide to sell the most expensive shares first and thus minimize your capital gains and Federal and state income taxes. This method does require you to specifically identify all shares you want to sell to the institution doing the selling. This notification must be in writing and the institution should acknowledge your 'SPECIFIC ID' method.
Suppose instead of using the FIFO method as defined above,
we apply the specific ID method to the example sell of 100 shares of GE on
---Acquire Transactions--- -------Resulting Dispose Transaction--------
Cost Net
Date Quantity Basis Date Quantity Proceeds Taxable Gain
Note that by selling the most expensive share first (those
acquire on
Although not obvious by the example provided, it is possible
that the most expensive shares of an investment are all 'short' shares and
could in fact result in a loss on the sale.
For example, instead of the
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Average (Single Category)
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Because over time, you can have many acquire transactions
for a mutual fund (monthly dividend reinvestment for example), the
Again using the GE, 100 shares sale example used above, to
determine capital gains on the sale using the single category average method,
we must first determine the average cost basis for each share of GE owned. In this example, you own 300 shares with a
total cost basis of $7050,
which means that each share has an average cost basis of $7050/300 or $23.50. Now as required by the
---Acquire Transactions--- ----------------Resulting Dispose Transactions-------------
Cost Net
Date Quantity Basis Date Qty Proceeds Taxable Gain
Total Cost Basis = $7050
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Average (Double Category)
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Again, only for mutual funds, this method recognizes that probably some of your mutual fund holding is in long term shares and some in short term shares and thus allows you to split out long and short before calculating an average per share cost basis. That is, the average cost per share of all long-term shares is calculated first and then the average of all short-term shares. Then, this method assumes that you dispose of the first shares acquired or FIFO but you use the applicable category (long or short) average cost basis per share to determine the cost basis of the FIFO shares disposed.
Again using the 100 GE shares sell example, we first determine the average cost basis for all 'long' shares or shares with a holding period longer than 1 year (actually 1 year + 1 day) and all 'short shares'. When we do this, it turns out that since all shares owned are 'long', there is only on average share cost to use and that is the same as derived using the single category average method and thus the capital gain results are the same or $650, all taxed using the Federal long term capital gain rate.
----Acquire Transactions--- -------------------Resulting Dispose Transactions----------
Cost Net
Date Quantity Basis Date Qty Proceeds Taxable Gain
Total Cost Basis = $7050
But to illustrate how double category average actually
works, suppose we change the acquire date of some of the GE shares owned such
that they have a 'short' holding period based upon a sale date of
Now because this method requires that shares be sold using the applicable average cost basis per share in a FIFO order, the resulting capital gain is $1249.95 of 'long' capital gain and $77.75 of 'short' capital gain.
--Acquire Transactions-- -------------Resulting Dispose Transactions-----------------
Cost Net
Date Quantity Basis Date Qty Proceeds Taxable Gain
Total 'Long' Cost Basis = $1000
Total 'Short' Cost Basis = $6050
Why would anyone what to use the double category average method? Because 'short' share turn into 'long' shares as you hold them.
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Don't Let the Examples
Fool You
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If you have actually gone through the
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Strange Results
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Although an example will not be provided here, if you were
to sell all 300 shares of your GE holdings at the same time (ignoring the last
example where the holding period was changed to point out double category
average specifically), it does not matter which
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Determining the Best
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In the examples provided above, the data used really is not typical. If you examine the acquire transactions defined, the per share cost basis is higher in each younger acquire transaction. In reality, because the stock market goes up and down all the time, a typical mutual fund investor probably has shares acquired at many different prices and not necessarily in increasing cost order.
So how do you determine which method is best to use when you get ready to sell a mutual fund or equity in which you have many acquire transactions? You could look up the cost basis and acquire date for each acquire and go through the manual process of determining which method results in the lowest total income tax liability or you can use this report function to do it for you.
In this function, you define a pending sale or a sale which
has already occurred and the system will use stored acquire transaction data
and your defined sell information and present a report detailing the capital
gains or losses and type ('long' or 'short') of each applicable
Additionally, this report will show a date, that it you delay your sale to, will result in no 'short' capital gains.
Applicable to this function:
- This report is only applicable to currently owned investments in taxable
accounts. For example, since withdrawals from IRA, SEP and Pension fund investments will all be taxed as ordinary income, these investments should all be disposed of as first-in first-out or FIFO.
- If you are completely selling out a investment or have already sold an
investment and established an
- Gifts. If the report defined 'INVESTMENT', has gift transactions,
gift sales will be applied to determine both pre and post-tax gains or loss and holding period for post-tax reports.
- You will only have access to post-tax reports if the system 'TAX RATES
TABLE' is in use.
- If you are selling all shares of a mutual fund or equity, it really does not matter
which
method you use to determine your cost basis for shares sold as all
- This function does not actually dispose and record a dispose transaction. It is
simply for
your use to determine if one allowed
- This function can be slow in initially loading after selection from the main
menu, as the drop down list presented when you click on the down arrow of the 'INVESTMENT NAME' field, only shows investments which can be disposed and the system determines this list before the screen form displays.
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How to: Define a
Best Method Report
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To define a best
- Define the 'INVESTMENT' you are disposing. You do this by defining:
'INVESTOR';
'ACCOUNT TYPE'; 'TRUST NAME', if applicable and finally 'INVESTMENT NAME'. Please note, that in
this function, only those investments currently owned by the defined
'INVESTOR', in the defined 'ACCOUNT TYPE', which can be disposed, will appear
in the 'INVESTMENT NAME' drop down list.
As '
- Defined 'REPORT TYPE. You can either received a '
TAX' report. Difference? '
- Define dispose details. Once you have defined an 'INVESTMENT NAME', the
Fields: 'DATE'; 'QUANTITY'; 'SHARE PRICE' and
‘TOTAL’ will all be enabled. Using these
fields, you define a dispose transaction.
Note that you only have to enter either 'SHARE PRICE' or '
- Define the 'REPORT DESTINATION'. The default here is 'SCREEN' but you
can click
on this field and have a created report sent either to an attached printer or
to an 'ASCII
- Click the 'CREATE REPORT' command button. If there is a report definition
error when you click this command button, you will receive an error message and you will have to correct the error and click this command button again to have the defined report created.
If the 'REPORT DESTINATION' is 'SCREEN', when the report has been created, a report window will open at the bottom of the report definition window. You can review the created report by either using the scroll bars along the bottom and side of the report window or you can expand the report window to full screen by clicking on the 'box' icon in the upper right hand corner of the report window. One you have finished viewing the created report, you can close the report window by clicking on the 'X' in the upper right hand corner of the report window or if the report window is not in a full screen display mode, click on any report definition field or the 'X' in the upper right hand corner of the report definition window to return to the system main menu.
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Interpreting the Results
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In most cases, you will want to use the
All methods show the same results? If the defined investment has been held for
many years, all gains are long and thus all
No loss shown although sale proceeds are less than total
cost basis? Remember that on top of cost
basis methods, the
'TOTAL TAX" shown on screen or printed reports is the sum of Federal, state and any local income tax based upon the tax rates in the system 'TAX RATES TABLE' for the defined 'INVESTOR' and 'ACCOUNT TYPE' for the defined 'DISPOSE DATE’ year.
Think carefully about which
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Notes:
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Although you may think you know the cost basis of any sales you want to sell, you may or may not. For example, you buy 100 shares of equity for $1000. In this case, you cost basis per share is $10 but suppose while you own the equity shares, the equity spins off a new company for which you receive some shares. In this case, the cost basis of the original 100 shares is reduced by some amount or percentage which is assigned to the new spin-off company and thus when you sell shares of the original equity, your cost basis is no longer $10 but some amount less due to the spin-off. In this case and all other cases where cost basis must be adjusted do to some transaction such as a spin-off, if you use the system to record any and all such events, the system will automatically adjust cost basis for you such that when you do sell an investment, the correct cost basis will be used to determine capital gain or loss.
The "Specific ID" method is determined by disposing of the most expensive "long" shares first and then the most expensive 'short' shares.
ASCII text file. In all system reports and functions which allow you to create an ASCII text file, recognize that once you create an ASCII text file from a specific report definition, you must "process" this ASCII text file via a word processor or spreadsheet before defining a new report ASCII text file or the existing file will be over written by the new report definition results. Actually, if you attempt to create a new ASCII text file and one already exists for the report you are using, you will receive an 'ALERT' message and be asked if you wish to over write the existing ASCII text file. You do not need to worry that if you create an ASCII test file in "CURRENT HOLDINGS" that it will over write an ASCII text file created in some other report. ASCII text file names are unique per report.