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Selling Mutual Funds? Don’t Forget This Tip

  • 26 August 2015
  • Author: Cari Holbrook
  • Number of views: 3129
  • 0 Comments
Selling Mutual Funds?  Don’t Forget This Tip

If you buy stocks or have a mutual fund set up to automatically buy or reinvest shares regularly, it’s important to keep track of your cost basis. By doing this, you may be able to greatly reduce your capital gains tax if you ever need to sell some of the shares before retirement.

No matter how simple-to-follow your mutual fund or investment program may be, it’s up to you to decide the best way to report and allocate cost basis in a partial sale.  First-in/first-out (FIFO) is one method that often results in more than expected capital gains. This method is quite simple: The first shares purchased are the first to be sold, producing the biggest potential tax bill (assuming the shares have grown over time). Specific share identification is often a better method because it allows the investor to specify the youngest (or otherwise most expensive) shares as the ones being sold. 

To illustrate this point, let’s say you’ve been purchasing AT&T stock on a regular basis since 1987 and find yourself needing to sell $10,000 worth of shares this year. As long as you’ve been investing consistently, and you’ve never sold any of your AT&T stock before, you can choose to designate only the latest stocks you’ve purchased (specific share identification) instead of the original stock that’s been gaining capital for more than 25 years (FIFO). That, in turn, can reduce your capital gains from the sales transaction.

The IRS certainly won’t do you any favors when it comes to helping you remember to do this. FIFO is the default when no other method is specified. And, once you sell stock from a specific fund under one method, the IRS will likely not allow you to change your method of reporting for that fund (see IRS Form 550). In fact, former IRS commissioner Fred Goldberg suggests that failing to choose specific share identification is among the top tax-saving opportunities that investors miss.

An added opportunity exists with reinvested mutual fund dividends. As the Washington Post reports, each time dividends are reinvested, your tax basis in the fund is increased. That, in turn, reduces the taxable capital gain. However, investors often forget to include the reinvested dividends in the basis, which can result in double taxation of the dividends (once when the dividends are received and later when they're included in the proceeds of the sale).

To master specific share identification, meticulous records should be kept. It’s best to decide ahead of time what method you’ll likely want to use for IRS reporting and be sure to keep track of the cost basis of purchases and sales proactively. Mutual fund companies and brokers are now required to report adjusted cost basis to their investors. But it’s up to the investor to elect the cost-basis method that’s right for them when it’s time to report a sale to the IRS. For questions, feel free to contact us.

Image Copyright: szefei / 123RF Stock Photo


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