Tax Question: Cost basis issue

[chrisjul]

I have owned Lifestrategy Growth for decades. In early Jan, this month, I purchased an additional $30k of the fund. I decided to take the 4% "profit" on a few weeks of investment, so I exchanged the funds and then realized that Vanguard "defaults" to an average price per share cost basis. This resulted in a very large "profit" from an income tax standpoint. Vanguard states that they cannot change the cost basis after the fact.

Question: What is the best way to claim this "profit" as an identified shares trade as opposed to an average cost tax basis??

Tks in advance

[kaneohe]

In the old days you had to tell them in advance of the sale the specific shares to be sold and also get a timely confirmation from them detailing the specific shares sold. Don't know if anything has changed esp. w/ non-covered shares and if VG isn't going to cooperate, it sounds not likely.

[Keep It Simple]

I have owned Lifestrategy Growth for decades. In early Jan, this month, I purchased an additional $30k of the fund. I decided to take the 4% "profit" on a few weeks of investment, so I exchanged the funds and then realized that Vanguard "defaults" to an average price per share cost basis. This resulted in a very large "profit" from an income tax standpoint. Vanguard states that they cannot change the cost basis after the fact.

Question: What is the best way to claim this "profit" as an identified shares trade as opposed to an average cost tax basis??

Tks in advance

Believe me I feel your pain. In my opinion, Vanguard should have forced each individual to choose an id method before the first purchase(at least the first purchase after 1/1/2012) or at least explain the consequences if you do not. I was always under the impression that as long as you have not sold any shares, and have not selected any id method previously, that you could simply choose a method before your first sale. There are members of this forum who do not believe this to be the case. They believe the IRS tax law will automatically force an average cost id if you do not make the specific id selection BEFORE purchase.

I am waiting to hear from someone on this forum who has found themselves in this situation who can confirm which answer is correct.

K. I. S.

[sscritic]

Here are the IRS rules (not Vanguard's rules) for the new days:

(8) Time for making identification. For purposes of this paragraph (c), an adequate identification of stock is made at the time of sale, transfer, delivery, or distribution if the identification is made no later than the earlier of the settlement date or the time for settlement required by Rule 15c6–1 under the Securities Exchange Act of 1934, 17 CFR 240.15c6–1

That's the timing question.

(2) Determination of method. (i) If a taxpayer places shares of stock described in paragraph (e)(1)(i) of this section acquired on or after January 1, 2012, in the custody of a broker (as defined by section 6045(c)(1)), including by transfer from an account with another broker, the basis of the shares is determined in accordance with the broker’s default method, unless the taxpayer notifies the broker that the taxpayer elects another permitted method. The taxpayer must report gain or loss using the method the taxpayer elects or, if the taxpayer fails to make an election, the broker’s default method.

That the default, in Vanguard's case, to average basis.

A taxpayer may change basis determination methods from the average basis method to another method prospectively at any time. A change from the average basis method applies to all identical stock the taxpayer sells or otherwise disposes of before January 1, 2012, that was held in any account.

That's the "you can't change history."

Unless paragraph (e)(9)(iii) of this section applies, the basis of each share of stock to which the change applies remains the same as the basis immediately before the change.

That's more of "you can't change history." (e)(9)(iii) is about a revocation of an election of average basis you made (not the default). These rules were taken from
http://www.gpo.gov/fdsys/pkg/FR-2010-10 ... -25504.pdf

[sscritic]

Note: there are two aspects to the correct reporting of a sale: which shares did you sell and what was the basis of the shares sold. All the methods identify the share sold. Average is first purchased, FIFO is first purchased, and Specific ID is the ones you identify (and you are allowed to identify the first purchased). The basis is determined by the rules. On form 8949 and on schedule D, it asks for "Cost or other basis." Even with specific ID, you may have to write the "other basis" there if the rules say to.

The real issue for the OP is the timing. If he had specifically identified the shares bought earlier this month at the time of the sale (also this month, one would presume), he would have sold the new shares, and the basis of the new shares would have been average basis, but (wait for it), Vanguard averages covered shares and non-covered shares separately. This is an election that the custodian (Vanguard) is allowed to make (not just for you, but as their default method of computing their default method). For the OP, that means the average basis of the newly purchased and then sold shares would have included all dividends reinvested since 1/1/12, but none of the old non-covered shares.

I sold shares using average basis in 2012. All the shares sold were non-covered. The average basis reported to me on my 11099-B used the average of all my non-covered shares, all the shares sold being non-covered. None of my covered shares were used in the computation of the basis of those non-covered shares. It works the other way around. If I had changed my basis to specific id before the sale and identified some covered shares, the basis of those shares would have been from an average (the basis of those shares immediately before the change), but only the covered shares would have been used in that average. This would have been the OP's situation if he had identified properly at the time of sale.

[Keep It Simple]

Note: there are two aspects to the correct reporting of a sale: which shares did you sell and what was the basis of the shares sold. All the methods identify the share sold. Average is first purchased, FIFO is first purchased, and Specific ID is the ones you identify (and you are allowed to identify the first purchased). The basis is determined by the rules. On form 8949 and on schedule D, it asks for "Cost or other basis." Even with specific ID, you may have to write the "other basis" there if the rules say to.

The real issue for the OP is the timing. If he had specifically identified the shares bought earlier this month at the time of the sale (also this month, one would presume), he would have sold the new shares, and the basis of the new shares would have been average basis, but (wait for it), Vanguard averages covered shares and non-covered shares separately. This is an election that the custodian (Vanguard) is allowed to make (not just for you, but as their default method of computing their default method). For the OP, that means the average basis of the newly purchased and then sold shares would have included all dividends reinvested since 1/1/12, but none of the old non-covered shares.

I sold shares using average basis in 2012. All the shares sold were non-covered. The average basis reported to me on my 11099-B used the average of all my non-covered shares, all the shares sold being non-covered. None of my covered shares were used in the computation of the basis of those non-covered shares. It works the other way around. If I had changed my basis to specific id before the sale and identified some covered shares, the basis of those shares would have been from an average (the basis of those shares immediately before the change), but only the covered shares would have been used in that average. This would have been the OP's situation if he had identified properly at the time of sale.

sscritic,

Let's say I have not ever sold any of my covered or non-covered shares and I have not made my election, If I chose right now to make my specific id election on Vanguard's website(I wouldn't be selling anything at this time), would that mean I can then use the exact cost basis for each lot I purchase in the future(when I decide to sell those lots)?

Thanks,

K. I. S.

[sscritic]

Let's say I have not ever sold any of my covered or non-covered shares and I have not made my election, If I chose right now to make my specific id election on Vanguard's website(I wouldn't be selling anything at this time), would that mean I can then use the exact cost basis for each lot I purchase in the future(when I decide to sell those lots)?

That's my understanding. The basis used for the shares you already own would be the average over the appropriate group (non-covered or covered) and you could identify which you wanted to sell using that basis. Shares purchased after your change to specific ID would not be part of any average and their basis would be their cost (ignoring adjustments for wash sales and the like). That's how I read this:

A taxpayer may change basis determination methods from the average basis method to another method prospectively at any time. A change from the average basis method applies to all identical stock the taxpayer sells or otherwise disposes of before January 1, 2012, that was held in any account.
A change from the average basis method applies on an account by account basis (within the meaning of paragraph (e)(10) of this section) to all identical stock the taxpayer sells or otherwise disposes of on or after January 1, 2012.

I previously quoted only the first two sentences. The only difference between the second and the third is that all old shares were grouped together, and now each account is averaged separately, all of which is irrelevant to your question. The key is prospectively. Prospectively is for sales, as it is only when you sell that you need to identify the shares sold and compute the basis. Since the rules say the basis of the shares you owned before the change will stay as the basis they had immediately before the change (the average), but say nothing about the basis after the change, the only reading I can give this is that the basis of the shares bought after the change is the basis derived from the new method you have chosen. This is a very long way of saying that after your change to specific ID, the basis will be cost for the shares purchased after the change.

While not specifically addressing the change, there is an example in the regs of a revocation. The taxpayer chooses average basis, the taxpayer buys shares, the taxpayer revokes the election of average basis, the taxpayer sells the shares. The example says that the shares sold use cost as the basis as (after the revocation) they are not part of any average. Note that this example even goes back in history. With a change, rather than a revocation, you can't go back, the change is prospective, but it would have no meaning if the change didn't change anything. I think I just said the same thing for the third time, which is yes to your question.

[Keep It Simple]

Let's say I have not ever sold any of my covered or non-covered shares and I have not made my election, If I chose right now to make my specific id election on Vanguard's website(I wouldn't be selling anything at this time), would that mean I can then use the exact cost basis for each lot I purchase in the future(when I decide to sell those lots)?

That's my understanding. The basis used for the shares you already own would be the average over the appropriate group (non-covered or covered) and you could identify which you wanted to sell using that basis. Shares purchased after your change to specific ID would not be part of any average and their basis would be their cost (ignoring adjustments for wash sales and the like). That's how I read this:

A taxpayer may change basis determination methods from the average basis method to another method prospectively at any time. A change from the average basis method applies to all identical stock the taxpayer sells or otherwise disposes of before January 1, 2012, that was held in any account.
A change from the average basis method applies on an account by account basis (within the meaning of paragraph (e)(10) of this section) to all identical stock the taxpayer sells or otherwise disposes of on or after January 1, 2012.

I previously quoted only the first two sentences. The only difference between the second and the third is that all old shares were grouped together, and now each account is averaged separately, all of which is irrelevant to your question. The key is prospectively. Prospectively is for sales, as it is only when you sell that you need to identify the shares sold and compute the basis. Since the rules say the basis of the shares you owned before the change will stay as the basis they had immediately before the change (the average), but say nothing about the basis after the change, the only reading I can give this is that the basis of the shares bought after the change is the basis derived from the new method you have chosen. This is a very long way of saying that after your change to specific ID, the basis will be cost for the shares purchased after the change.

While not specifically addressing the change, there is an example in the regs of a revocation. The taxpayer chooses average basis, the taxpayer buys shares, the taxpayer revokes the election of average basis, the taxpayer sells the shares. The example says that the shares sold use cost as the basis as (after the revocation) they are not part of any average. Note that this example even goes back in history. With a change, rather than a revocation, you can't go back, the change is prospective, but it would have no meaning if the change didn't change anything. I think I just said the same thing for the third time, which is yes to your question.

Thanks for the detailed response, sscritic - that is how I am reading this too.

K.I.S.

[JW Nearly Retired]

I have owned Lifestrategy Growth for decades. In early Jan, this month, I purchased an additional $30k of the fund. I decided to take the 4% "profit" on a few weeks of investment, so I exchanged the funds and then realized that Vanguard "defaults" to an average price per share cost basis. This resulted in a very large "profit" from an income tax standpoint. Vanguard states that they cannot change the cost basis after the fact.

Question: What is the best way to claim this "profit" as an identified shares trade as opposed to an average cost tax basis??

Tks in advance

Your technical cost basis question appears to be answered. Dare I ask what was the deal with selling the $30k purchase in less than a month to realize a 4% gain? Just a hunch?
JW

[marci2013]

It is my understanding with the new cost basis regulations that went into effect last year, you have three days from the sale. It is very important to declare a sales method because normally the one that the firm default's to is not to your advantage. When you do initiate a sale, it's wise to use a "tax optimization tool" to check which way is optimal for you on the capital gains calculations. You can find that online just by googling. Live and learn...just keep it in mind for future sales. Good luck.

[sscritic]

It is my understanding with the new cost basis regulations that went into effect last year, you have three days from the sale. \ way is optimal for you on the capital gains calculations. You can find that online just by googling. Live and learn...just keep it in mind for future sales. Good luck.

I think you have until settlement (earlier of actual and required). With a stock it's three days, but not with a mutual fund.

(8) Time for making identification. For purposes of this paragraph (c), an adequate identification of stock is made at the time of sale, transfer, delivery, or distribution if the identification is made no later than the earlier of the settlement date or the time for settlement required by Rule 15c6–1 under the Securities Exchange Act of 1934, 17 CFR 240.15c6–1 (or its successor).

[LadyGeek]

This thread is now in the Personal Finance (Not Investing) forum (tax question).

[sscritic]

I have modified my stand since January 31. The above comments are no longer complete, in particular my responses to Keep It Simple. Please see Changing Cost Basis on Covered Lots starting with kaneohe's discovery of interim guidance that supplants the published regulations. In that thread KIS and I agree that the rules aren't what I thought they were (actually, they were, but the rules were changed, just not officially).

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