cost basis method - please help

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

cost basis method - please help

Post by exigent »

I've been catching up on some record keeping and spent part of last night creating a cost basis spreadsheet for our taxable Vanguard mutual fund holdings.

We've built a fairly substantial position in Total Stock Market (now converted to Admiral shares) and I wanted to get a better handle on things so we could harvest losses going forward. We missed our opportunity to TLH during big decline of the past few years, but that's water under the bridge.

Anyway, in collecting the data, I realized that we had two smallish sales back in 2004 and 2005 (one each year) and we failed to identify the shares that we sold. I was thinking this wasn't a big deal, as I thought they used FIFO by default. However...

When I went back to our tax returns, I saw that the numbers didn't appear to match up with FIFO, so I dug deeper. It seems that VBS uses FIFO by default, but that for mutual funds, they use average cost basis. Honestly, I can't even remember where I got the capital gains number - is this likely something that Vanguard would have provided?

Regardless of where I got the gain info, assuming that it's based on average cost basis, I'm now locked into using that approach going forward - correct? That's what it sounds like from the Wiki page, but I would hate for that to be the case, esp. since these were fairly small sales that occurred 5-6 yrs ago when I wasn't really paying attention. I also wasn't as well informed then as I am now, though I realize that's not a particularly good excuse.

I guess this really boils down to two things: (1) am I technically locked in, (2) assuming that I am locked in, what can I do to change that, and (3) in practice, what problems might arise if I just arbitrarily started doing specific ID from here on out?

Thanks in advance...
livesoft
Posts: 85971
Joined: Thu Mar 01, 2007 7:00 pm

Post by livesoft »

Did you declare on your 2004 tax return that you used average cost basis? The declaration is described in the Form 1040, Schedule D instructions.
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

Post by exigent »

Hi livesoft,

I just looked at my 2005 Schedule D (this is for the second sale, still digging for my 2004 paperwork) and I don't see anything on either page where I say anything about how the cost basis was figured. It just reports proceeds, cost basis, and then the difference (which is a small lt capital gain).

This is all based on a pdf of the return, so I will have to dig some more to see if there was additional paperwork that went with it. However, one troubling thing is that I indicated "various" for the acquisition date. As it turns out, if I used FIFO, then these shares would have all been sold from one particular acquisition (our initial buy, which exceeded the total number of shares sold in 2004 & 2005).

Thanks, exigent
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

Post by exigent »

From the 2009 instructions:

"If you are reporting an average basis, include "AVGB" in column (a) of Schedule D."

I did not do this in 2005, though I think that I actually did use the average basis -- presumably I just went with whatever was reported on my 1099-B.

Still digging for the 2004 paperwork...
livesoft
Posts: 85971
Joined: Thu Mar 01, 2007 7:00 pm

Post by livesoft »

exigent wrote:From the 2009 instructions:

"If you are reporting an average basis, include "AVGB" in column (a) of Schedule D."

I did not do this in 2005, though I think that I actually did use the average basis -- presumably I just went with whatever was reported on my 1099-B.

Still digging for the 2004 paperwork...
In 2010 and earlier, cost basis is/was not reported on your 1099-B
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

Post by exigent »

Ahh, yes. I see that now. (re: the lack of cost basis reporting on 1099-B)

Let me pose the question another way... If I didn't specifically declare that I was using average basis, and I didn't take steps to specifically identify the lot to be (partially) sold, then would this default to FIFO?

I ask because:

The price that I used doesn't match the price if I was doing FIFO - as I noted above, I think that what I used was the average price at the time, even though I didn't declare it as such.

Also, as I said above, I used the "various" designation for dates even though FIFO would have been a single date.

What I'm hoping is that I could argue this was FIFO (even if I technically got the price wrong) b/c that would allow me to do specific ID in the future.
dbr
Posts: 46137
Joined: Sun Mar 04, 2007 8:50 am

Post by dbr »

This is an interesting question that I think came up once before.

Here are some things that I think have to be true/can be verified:

1. You used whatever cost basis amount you actually entered on the Schedule D. Whatever is on the records at some broker is completely irrelevant. The broker does not actually sell any shares in particular as particular shares do not exist in a street name account. Particular shares do exist if you had actual certificates and you would have had to mail those exact certificates to your broker to match.

2. You did not elect average cost basis because you did not write AVERAGE on your schedule D.

3. You did not elect specific share identification because to do that you would have had to get a confirmation from the broker as to what shares you sold at the time of sale.

4. Ergo, you elected the only other possibility, which is FIFO.

5. For the basis value in 1. you entered the value for average cost basis rather than the value for FIFO. Therefore your Schedule D is in error. The question is, can you file an amended return and enter the correct basis data? It would seem to me that this would be perfectly ok granting that if additional tax were owed there could be penalties and interest while if a refund were due and the return is more than three years old you would forfeit the refund.

Any takers on this analysis?
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

Post by exigent »

Ugh. This is so frustrating b/c the difference is so small. For example, in 2005 I sold $6000 worth of shares and reported the basis at $5315.22 when in reality the basis should have been $5293.65 -- just $21.57 lower. While I don't want to screw up my ability to do specific ID in the future, I'd also hate to refile those returns for a $3 difference in taxes owed...
dbr
Posts: 46137
Joined: Sun Mar 04, 2007 8:50 am

Post by dbr »

exigent wrote:Ugh. This is so frustrating b/c the difference is so small. For example, in 2005 I sold $6000 worth of shares and reported the basis at $5315.22 when in reality the basis should have been $5293.65 -- just $21.57 lower. While I don't want to screw up my ability to do specific ID in the future, I'd also hate to refile those returns for a $3 difference in taxes owed...
If my theory is correct, you haven't done average basis. You have submitted a FIFO method with slightly incorrect data. You could ask a tax accountant or a tax attorney for an opinion. Heck, you could even ask the IRS.
User avatar
CaliJim
Posts: 3050
Joined: Sun Feb 28, 2010 7:47 pm
Location: California, near the beach

Post by CaliJim »

..
Last edited by CaliJim on Thu May 26, 2011 12:29 am, edited 1 time in total.
-calijim- | | For more info, click this Wiki
minesweep
Posts: 1667
Joined: Fri Mar 02, 2007 8:17 pm
Location: 27,000 light years from the Galactic Center of the Milky Way Galaxy (the suburbs)

Post by minesweep »

[quote="exigent""]Ugh. This is so frustrating b/c the difference is so small. For example, in 2005 I sold $6000 worth of shares and reported the basis at $5315.22 when in reality the basis should have been $5293.65 -- just $21.57 lower. While I don't want to screw up my ability to do specific ID in the future, I'd also hate to refile those returns for a $3 difference in taxes owed...[/quote]
The IRS is looking for bigger fish to fry (Wesley Snipes comes to mind.) For that small an amount you could claim it as a rounding error. :)

Mike
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

Post by exigent »

dbr wrote:If my theory is correct, you haven't done average basis. You have submitted a FIFO method with slightly incorrect data. You could ask a tax accountant or a tax attorney for an opinion. Heck, you could even ask the IRS.
Yes, I think your description of what happened is correct.
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

Post by exigent »

CaliJim wrote:IF you get audited, deal with the mistake then. If you are racked with guilt - make a $3 error in their favor on your next return.
Nope, no guilt here. I just want to be sure I don't do a bunch of TLH and then, for example, get audited and told that I have to do avg basis due to an old mistake and inadvertently get whacked with a gain.
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Post by sscritic »

One of the sources of confusion is a misuse of terms. In social security, "entitled" has a specific meaning. In capital gains and taxes, terms like basis have specific meaning.

[RANT ON]
For example, have you ever wondered why your write AVGB on your tax return and not AVGCB? That's because there is something called "average basis" in IRS publications, but nothing called "average cost basis." "Average cost basis" doesn't exist. Go ahead, try it; open publication 564 and search for the string "average cost basis." My browser says "Not found."
http://www.irs.gov/pub/irs-pdf/p564.pdf

If you read publication 564, you will find the following hierarchy of categories:

One major heading is "Keeping Track of Your Basis" in large letters and is listed that way in the table of contents. Another major heading in the table of contents is "Sales, Exchanges, and Redemptions." A second level heading below "Sales, Exchanges, and Redemptions" is "Identifying the Shares Sold." A third level heading under Identifying the Shares Sold is "Cost Basis." A fourth level heading under Cost Basis is "Specific share identification." The headings use smaller print and they descend. Note that Specific share identification is in the smallest font and does not use capital letters to start each word. It also has a period at the end, unlike the higher level headings. A parallel fourth level heading is "First-in first-out (FIFO)."with the period and without capital letters. Next comes "Average Basis" which is a third level heading, without the period and with capital letters. "Average Basis" is comparable to "Cost Basis," not to specific share identification or FIFO.
Identifying the Shares Sold
  • Cost Basis
    • Specific share identification.
      First-in first-out (FIFO).
    Average Basis
    • Single-category method.
      Double-category method.
This distinction between the levels of various terms is continued in Table 3. Example of How To Figure Basis of Shares Sold. It has two sections
COST BASIS
(FIFO)

AVERAGE BASIS
(single-category)
COST BASIS and AVERAGE BASIS are both in all caps and bold. FIFO and single-category are not bold (If they had spelled out First-in-first-out, it would not have been in all caps).

When you sell shares, you have to do two things: tell the IRS which shares you sold and the basis of those shares. Those are two separate issues.

You can use cost basis for the basis and specific share identification to tell the IRS which shares you sold using cost basis. You can also use cost basis and FIFO to tell the IRS which shares you sold using cost basis. That is why COST BASIS is in all caps and specific share identification and first-in-first-out are not. The identification is secondary to the basis method you use. Specific share identification is not a basis method, it is an method for identifying the shares you are selling using cost basis.

The other basis method you can use is AVERAGE BASIS. Note the parallelism: COST BASIS and AVERAGE BASIS. Both are basis methods, and they both use a single word to distinguish using cost from using average. One way to think about average basis is that you are not averaging costs, you are averaging bases.

Note that both Average Basis - single category and Average Basis - double category use first-in-first-out as the way to identify the shares sold (as opposed to telling the IRS the basis of those shares). The words single category and double category also help to identify the shares since in double category you separate out long term from short term both for the computation of the basis and for the identification of the shares sold.

Also, FIFO does specifically identify the shares sold. If you use FIFO, you are telling the IRS that you specifically sold the first shares you bought that you still own. FIFO is the default method of identification for Cost Basis, for Average Basis - single category, and for Average Basis - double category. The IRS doesn't tell you to use FIFO for Average Basis, but does say
To determine your holding period, the shares disposed of are considered to be those acquired first.
That sure sounds like first-in-first-out to me.

[RANT OFF]
livesoft
Posts: 85971
Joined: Thu Mar 01, 2007 7:00 pm

Post by livesoft »

^ So the thread title should be modified to be "Basis method" :)

I'm sorry I was a recidivist on this.
Topic Author
exigent
Posts: 1309
Joined: Fri May 07, 2010 8:49 am

Post by exigent »

sscritic: That was a very helpful rant. :)

So the essence of what you are saying is that I sold FIFO either way, and that the distinction is in how I figure the basis. Since I didn't specifically indicated that I was using average basis, then I'm assumed to have used cost basis - though in this case I used a slightly wrong value for that.

By extension, I'm beginning to realize that I'm probably not hosed after all.

And I'm learning a lot!
User avatar
tetractys
Posts: 6192
Joined: Sat Mar 17, 2007 3:30 pm
Location: Along the Salish Sea

Post by tetractys »

You could call the IRS and ask for permission to change to specific share accounting. I imagine there would be a letter or two involved, and that they would say yes. -- Tet
Post Reply