Cost Basis and Taxable Amount

[franksmith16]

I have a mutual fund with T. Rowe Price that I started in 1997.Since then I have re-invested all dividends and capital gains. So I assume I have both non- covered and covered shares.  

I'm thinking of selling a portion of it and will need to figure the cost basis and taxable amount.

TRP states that when I withdraw money from an account with both covered and non-covered shares, they first use non-covered shares. Furthermore, they said they do not track or provide a cost basis for non-covered shares however on my account page they provide the following:

                                     Shares            Cost Basis             Cost per Share   

Covered                                              Average Cost       $23.16  

Noncovered               4,972.270      Average Cost       $15.70

Current Share Price: $24.32

So, if I wanted to raise $50,000 gross, I would need to sell about 2,056 shares at the current price of $24.32.

If I understand correctly, then the taxable amount would be $50,000 - ($15.70)*2056) = $17,720.80.

Is that correct?

[DianeW777 · Accepted solution]

Yes, you are exactly correct if you base it on what TRP is providing. However, you are allowed to use an average price for the shares in mutual funds which includes all purchases (covered and noncovered). This applies to mutual funds only. 

Also, it's somewhat rare that an investor does select a specific batch of shares to be sold. This simply means the first in, first out (FIFO) method is almost always used. In your case the there's no reason to make any specific selection of funds because the gain or loss is the same regardless of shares sold.

• Average Cost
  Using the average cost, cost basis is calculated based on the average price paid for all shares held, regardless of holding period. Gains or losses are defined as short-term or long-term based on the assumption that the oldest shares are sold first, even though the average cost is the same for all shares. This method of calculating cost basis is permitted for mutual funds only and cannot be used to calculate cost basis for individual securities such as stocks and bonds. Fidelity uses the average cost method when calculating your cost basis for all mutual fund shares.
  • $23.16 + $15.70 = $38.86 per share is your cost.  You can use this higher number. 

Keep all of your records to show how you arrived at your cost basis and gain.

[franksmith16]

You're summing up the average cost of covered and non-covered to get to what you say I should use as the average cost -  $38.86, which is way higher than the current price of $24.32.

Wouldn't it be more like the average of the two - ($23.16 + $15.70) / 2 = $19.43 ?

[DianeW777]

No, the tax law is clear on the cost basis for mutual funds.  They allow the average cost of all mutual funds from purchase to sale date. You are not required to break them down between covered and noncovered. This law has been in effect for many years.

• IRS FAQ on Mutual Fund Cost Basis
• IRS Publication 550-Average Basis

[franksmith16]

Thanks.

A couple questions on the following scenario, if you please.

Suppose I created an account in 1995 and re-invested all gains and dividends. 

Suppose further that Quicken reports the current market vale to be $550,000 and Quicken says the (avg) cost basis is $350,000 for a gain of $200,000.

1) Am I correct that I will only owe taxes on the $200,000?

2) If so, then will that $200,000 will be taxed at 15% rate (given my income).

3) Will that $200,000 be added to my income and push me into a higher tax bracket, or will I just owe the cap gains tax plus whatever the tax is on my regular taxable income (as if I never sold any shares)?

Thanks again.

[DianeW777 · Accepted solution]

The answers to your questions are shown below. However, keep in mind that only you know the true and total investment, including reinvested dividends. The financial companies are now required to keep track, however that's only as long as the investment is in their hands.  Once moved from one financial company to another, the cost basis may not be clear to the new company. 

The answers below assume the long term holding period which is more than one year.  It starts with the first in-first out (FIFO) time frame.

1) Am I correct that I will only owe taxes on the $200,000?

• Yes, you are correct.

2) If so, then will that $200,000 will be taxed at 15% rate (given my income).

• The gain will be taxed as low as 0% up to a maximum of 20% depending on your income level per tax year.
  • IRS Tax Topic 409 - Capital gains tax rates at various income levels
  • Tax will be calculated on the Schedule D worksheet.

3) Will that $200,000 be added to my income and push me into a higher tax bracket, or will I just owe the cap gains tax plus whatever the tax is on my regular taxable income (as if I never sold any shares)?

• You will pay tax on your regular income at whatever rate, depending on filing status and income level; you will pay tax on the capital gain at the rates shown above.  Income levels will change with inflation.