| Mutual Funds & Stock Dividend Reinvestment Plans |
The cost basis for mutual funds (or stocks)
participating in dividend reinvestment plans
presents an accounting challenge (some
would say nightmare.)
If you have held the mutual fund for twenty
years, you most likely have at least eighty-one
(81) different tax lots!
On top of that, the rules are changing on
1/1/2012 for mutual fund cost basis
accounting.
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If you kept all of your statements, you can easily determine your cost basis by
adding up the original purchase cost and all the dividends that were reinvested.
If some statements are missing, you will need to estimate the missing tax lots based
on the declared dividend amount per share, the number of shares owned on the
dividend record date, and the market price per share on the dividend payment
date. Excel worksheets are ideal for this application. The history of declared
dividend amounts can usually be obtained from the mutual fund website or from
customer service.
If the shares were held directly by the mutual fund, they can usually provide missing
statements for a fee. If the shares were held in a brokerage account, the monthly
account statements would show the dividend reinvestment amounts.
If you inherited the mutual fund shares, see the discussion under the "Stocks" menu
for inherited stock which will apply to mutual fund shares, too. Other means of
acquisition discussed under the "Stocks" menu apply in the same way to mutual
funds, too. If you received it as an IRA distribution or as a gift, follow the same
rules as for stocks.
Once you have the detail of all the tax lots that comprise your cost basis, you have
a choice of allocation methods to report cost basis when partial sales occur.
Previously this decision was considered an accounting method and could not be
changed without requesting permission from the IRS. However, the Treasury has
relented and issued regulations in 2010 allowing the allocation method to be changed
by the taxpayer without requesting permission. Before 2011, only four methods were
recognized as valid by the Internal Revenue Service:
1. Average Cost Single Category (available for mutual funds & dividend
reinvestment plans only)
2. Average Cost Double Category (available for mutual funds until 4/1/2011)
3. FIFO: First In First Out
4. Specific Identification
Just click on the link to be taken to the page that fully describes each method.
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However, after 2010 many more methods will now be generally available; the only practical
limit will be how many your brokerage firm can program into their trading system.
Previously, you could always achieve the same result using the specific identification
method, but now you can specify by short-cut names the matching pattern that you want
your brokerage firm to use. You can choose a method or accept the default method selected
by your brokerage firm or mutual fund company. Your choice of method must be made in
writing or electronically, not verbally. Cost basis allocation formulas now available include:
1. Specific Identification
2. Average Cost Single Category
3. FIFO: First In First Out
4. LIFO: Last In First Out
5. HIFO: Highest Cost In First Out
6. HCLT: Highest Cost Long Term
7. HCST: Highest Cost Short Term
8. LCFO: Lowest Cost First Out
9. LCLT: Lowest Cost Long Term
10. LCST: Lowest Cost Short Term
11. MLMG: Maximum Loss Minimum Gain
12. Tax Optimization Method
13. Anything else they can dream up!
You can find more information about this on the Form 1099 page and also under "other methods."
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