Changing cost basis on Noncoverd shares

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Topic Author
bobsmith
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Changing cost basis on Noncoverd shares

Post by bobsmith »

Hi, I'd like to sell some shares of a mutual fund but it's complicated because some shares are covered while others are not and because my intention is to switch from Average-Cost-Method to SpecID and then, in the future I'll likely need to switch back to Average-Cost-Method again. I'd like to present a simplified hypothetical of my real world situation, explain what I want to do, and see if it makes sense.

This is gonna get wonky fast. Please bear with me. For simplicity, let's assume all gains reinvested into other funds.

1/1/2005 Inside a personal Vanguard taxable account, I purchased 100 shares of Vanguards Total Stock Market Index Fund (TSMI)

1/1/2006 I bought 50 more shares

1/1/2008 I sold 20 shares using average cost basis

(at this point I hold 130 shares total)

1/1/2009 I transferred all 130 shares to another taxable account I held with Vanguard. This new account was a trust account in my name so shares transferred in kind with no tax consequences. (more on this later)

1/1/2010 I buy another 50 shares of the same fund, bringing my total shares to 180.

1/1/2012 New rules take effect. No transactions, but as a result of new rules, I have a total of 180 noncovered shares

1/1/2013 I purchase 40 more shares. At this moment, I now have 180 noncovered shares and 40 covered shares.

1/1/2015 I sell 30 shares of this fund, still using average cost basis, the only basis I have ever so far ever used with this fund.

Although I'm still using average cost basis as a method, the shares are sold according to FIFO, meaning the shares came from the older non-covered portion of my fund. Therefore, at this date I now hold 150 noncovered shares (180-30) and I also still hold 40 untouched covered shares, for a total of 190 shares.

Monkey Wrench:
Okay, here's the monkey wrench. I didn't actually keep any records and I'm using Vanguard's Transaction History as if it was my own. Vanguard has made this history available to me, but they do not report this history to IRS for noncovered shares (transactions prior to 1/1/2012). So, still working within this hypothetical example, I have shown you the time line of events, but for the purposes of record keeping I only have Vanguard's records. When Vanguard transferred the funds from my personal taxable account to my taxable trust account, it did not transfer the records from the personal taxable account. So, the only records I have to show the IRS are the same as above, but they don't start on 1/1/2005. They start on 1/1/2009. In other words, looking at the transaction history for this fund (TSMI) as held in my "newer" taxable trust fund, the first and oldest entry is: 1/1/2009 "Transfer" 130 shares.

Okay, present day. Even though I don't have records prior to 1/1/2009, and even if I did, it's still fair to say that I hold 150 noncovered shares and 40 covered shares. This is what is reported when I look at this fund over at Vanguard.

Present day: Transaction #1
I decide I want to switch to SpecID and sell only the covered shares. Using SpecID, I sell only the 40 shares I purchased on 1/1/2013. Because I'm specifically indicating covered shares, Vanguard reports the dates and shares to the IRS and there is no need for me to present my own record keeping. All is good. As a result the only shares I have remaining are the noncovered shares, totaling 150. Not having records prior to 1/1/2009 (as explained in "Monkey Wrench" above) simply doesn't matter.

To recap, these remaining 150 noncovered shares represent the original 100 from 1/1/2005, plus the 50 I bought on 1/1/2006, less the 20 I sold on 1/1/2008, plus the 50 I bought on 1/1/2010, and less the 30 I sold on 1/1/2015 using ACB.

Present day: Transaction #2
Now with only noncovered shares remaining, I now decide I want to again use SpecID to sell all 50 of the non-covered shares I purchased on 1/1/2010. Using Vanguard's transaction history as my own, I still have "my" record for this. Vanguard will not report his to the IRS because the shares are noncovered, but I can use Vanguard's transaction history as my own for the purposes of reporting to the IRS. Again, not having records prior to 1/1/2009 (as explained in "Monkey Wrench" above) simply doesn't matter.

After doing so, I now have 100 non-covered shares remaining.

Hopefully, up to this point, I've correctly described the situation and the transactions I've described are possible and work out the way I describe. That just leaves me with 100 non-covered shares. Because the only records I have to provide to the IRS are Vanguard's records, the only records I have date back only as far as 1/1/2009. At this point, without a record, I really can't decide to use SpecID to sell certain shares prior to 1/1/2009. For all intents and purposes, when it comes to reporting to the IRS, I only have 100 noncovered shares left and the only date I have to represent that ownership is the 1/1/2009 "transfer". All post 2009 purchases of stock were effectively erased from the record when I cherry picked them out using SpecID and all the average-cost-basis sales I made (in total) were less than even the original purchase on 1/1/2005. Knowing all new gains are reinvested into other funds, and knowing I never intend to make any more purchases of this fund, at this point, after transactions 1 & 2 are completed, I might as well change the cost basis back to Average-Cost-Basis. Afterall I have no record to use for the SpecID except to refer the IRS to the "Transfer" on 1/1/2009. Therefore, average-cost-basis and SpecID would essentially be the same in terms of tax consequences. Right?

If you made it this far, congratulations and thank you. :D

Is all this correct? If not, where did I go wrong?

edit: edited for typos
Last edited by bobsmith on Mon Dec 11, 2017 12:55 pm, edited 1 time in total.
cas
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Re: Changing cost basis on Noncoverd shares

Post by cas »

You may want to read this: "Changing Cost Basis Methods" http://fairmark.com/investment-taxation ... /changing/ (Or, to get it from the horse's mouth, IRS Publication 550, starting about p. 46 https://www.irs.gov/pub/irs-pdf/p550.pdf . )

From the Fairmark article:
For noncovered shares (generally shares acquired before 2012) you’re on a one-way street. You’re considered to be using the separate lot method until such time as you switch to averaging. (The default method used by your broker or mutual fund company does not apply to these shares.) You can use the average basis method beginning with any year you choose, even if you used the separate lot method for sales from this account in earlier years. Once you do this, there’s no going back: the average basis method will continue to apply to all future sales of noncovered shares of this mutual fund from this account.
Topic Author
bobsmith
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Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

cas wrote: Mon Dec 11, 2017 12:44 pm You may want to read this: "Changing Cost Basis Methods" http://fairmark.com/investment-taxation ... /changing/ (Or, to get it from the horse's mouth, IRS Publication 550, starting about p. 46 https://www.irs.gov/pub/irs-pdf/p550.pdf . )

From the Fairmark article:
For noncovered shares (generally shares acquired before 2012) you’re on a one-way street. You’re considered to be using the separate lot method until such time as you switch to averaging. (The default method used by your broker or mutual fund company does not apply to these shares.) You can use the average basis method beginning with any year you choose, even if you used the separate lot method for sales from this account in earlier years. Once you do this, there’s no going back: the average basis method will continue to apply to all future sales of noncovered shares of this mutual fund from this account.
I was barely understanding this as it was and now I'm a bit lost. Still using my hypothetical, since the rules change on 1/1/2012, the first sale was on 1/1/2015 still using the average-cost-basis method. Again, being ACB was used, that means the shares were sold out according to FIFO, meaning noncovered shares were sold. I have a hard time understanding the IRS literature partly because up until now all my transactions have been totally straight forward and a lot of these concepts and terms are completely new to me. On the one hand, it sounds like were I to revoke the cost-basis I would have had to do it within a year after using the cost-basis method for the first time after 2012, so by 1/1/2016 at the latest. I didn't do that.

However, as the fairmark article points out:
Limitations. You aren’t allowed to change your method retroactively after you’ve sold any shares while the average basis method was in effect. In this situation you can change to the separate lot method prospectively, but it won’t be possible to restore the original cost basis of lots you held while using the average basis method.

In addition, you can’t make this retroactive change after the time limit set by your broker or mutual fund company expires. They’re required to allow at least a year, but permitted to allow a longer period, and many mutual fund companies have indicated they’ll be lenient, perhaps even permitting these changes for an indefinite period.
Vanguard does seem willing to allow me to change the method if I choose, an option I recently discussed with them over the phone and which is available online. When I change it to SpecID, I thought I'd be able to do as I described above. But even if they allowed that, am I to understand that SpecID could only apply to post 1/1/2015 purchases? And this is so because the 1/1/2015 sale using ACB created a situation where all shares purchased before 1/1/2015 must forever use ACB method? Or are all post 1/1/2015 sales forced to use ACB as well? (I realize there are no such sales in my hypothetical). I'm also confused how this rule seems to apply to noncovered shares but not covered shares or perhaps I've misunderstood that as well. Or perhaps by making that sale of noncovered shares in 2015, I doomed even the covered shares to forever be bound to ACB? I'm really confused.

Honestly, I'm just a simple index investor who's trying to make the most of the room I have left in the 15% income bracket by realizing some gains on an old investment while giving myself some needed cash. Getting this right means realizing gain that will be accessed at 0% tax. Getting it wrong will mean paying 15% on at least part of the gain and getting it very wrong might well eat into my child tax credit.
Finridge
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Re: Changing cost basis on Noncoverd shares

Post by Finridge »

bobsmith wrote: Mon Dec 11, 2017 11:42 am Monkey Wrench:
Okay, here's the monkey wrench. I didn't actually keep any records and I'm using Vanguard's Transaction History as if it was my own. Vanguard has made this history available to me, but they do not report this history to IRS for noncovered shares (transactions prior to 1/1/2012). So, still working within this hypothetical example, I have shown you the time line of events, but for the purposes of record keeping I only have Vanguard's records. When Vanguard transferred the funds from my personal taxable account to my taxable trust account, it did not transfer the records from the personal taxable account. So, the only records I have to show the IRS are the same as above, but they don't start on 1/1/2005. They start on 1/1/2009. In other words, looking at the transaction history for this fund (TSMI) as held in my "newer" taxable trust fund, the first and oldest entry is: 1/1/2009 "Transfer" 130 shares.
Some of my funds were originally "Investor Shares". A few years ago, Vanguard lowered the dollar amounts needed to qualify for "Admiral Shares" and then automatically converted a number of my fund investments from "Investor Shares" to "Admiral Shares." In a very unfortunate oversight, wherever they did this conversion, all transaction history was wiped out. I spoke to my Vanguard rep and he said that they were not able to restore this.
cas
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Re: Changing cost basis on Noncoverd shares

Post by cas »

I think - but do not know for sure - that if you switch to Specific ID for the fund, you will regain the option to specify whether to sell the covered shares or the non-covered shares.

So, you would be able to do your Transaction 1. (Selling all the covered shares you have.)

And I think that Vanguard keeps separate tracking of the cost basis of the covered and non-covered shares. So, since you had only 1 lot of covered shares to start with, and have never sold any of the covered shares, I think your cost basis of the covered shares will be the price you originally paid for them. (In other words - the cost basis of the covered shares will not have been averaged with the cost basis of the non-covered shares.)

Vanguard has a "Cost Basis" page that shows what it thinks cost basis is for your funds. (Third menu item down under the "My Accounts" tab) It always divides out covered and non-covered shares for me, regardless of cost basis method. Before you go to sell - and probably both before and after you switch the cost basis method - you should check that page to make sure the cost basis listed for the covered shares is what you think it is.

If you go to sell just the covered shares, and it never gives you an option to choose just the covered shares, then back out and don't hit submit. It will almost certainly use FIFO in that case.

If it does give you an option to choose just the covered shares, make sure you take screen shots of the screen where you select just the covered shares (showing that you selected them) and, if the confirmation screen also shows proof of selection of just the covered shares, take a screen shot of that too. I have seen people report on this forum that sometimes Vanguard messes up specific ID lot selection (reverts to FIFO even though the person definitely selected specific lots), then has to be contacted to fix it. The easiest way to get it fixed is to have the screen shots proving that you definitely made specific ID selections.

What I don't think you will be able to do is your Transaction 2 (selling just the 2010 non-covered shares). Even if you switch the cost basis method to specific ID, I'm pretty sure all the non-covered shares will be presented as one big lump, with all shares having the same average cost.

It is kind of like you have made soup out of all the lots of non-covered shares and have eaten some bowls of the soup. (Already sold some of the non-covered shares using average cost and reported it that way to the IRS in previous years.) You can't now go back and tell Vanguard you've decided you'd rather have a salad for dinner tonight and you want the carrots from the soup (the 2010 lot of shares) back in their original uncooked condition (original cost basis intact). Some of the carrots (cost basis of the 2010 lot) are already gone because of the bowls of soup you already ate (sales using average cost basis). And even the carrots that remain are impossible to retrieve in a fresh state (cost basis intact): during the cooking process (switching to average cost method) some of the carrot juice and little bits of carrots infused into the rest of the broth. And some of the broth has infused into the remaining chunks of carrot. It is just impossible to get the original fresh carrots (originalseparate cost basis of those 2010 shares) back.
UpperNwGuy
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Re: Changing cost basis on Noncoverd shares

Post by UpperNwGuy »

Finridge wrote: Mon Dec 11, 2017 11:43 pm Some of my funds were originally "Investor Shares". A few years ago, Vanguard lowered the dollar amounts needed to qualify for "Admiral Shares" and then automatically converted a number of my fund investments from "Investor Shares" to "Admiral Shares." In a very unfortunate oversight, wherever they did this conversion, all transaction history was wiped out. I spoke to my Vanguard rep and he said that they were not able to restore this.
Yikes! Is wiping out the transaction history when converting from Investor Shares to Admiral Shares a common practice at Vanguard?
cas
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Re: Changing cost basis on Noncoverd shares

Post by cas »

cas wrote: Tue Dec 12, 2017 5:43 am
If it [the page where you enter the requested sale of covered shares] does give you an option to choose just the covered shares, make sure you take screen shots of the screen where you select just the covered shares (showing that you selected them) and, if the confirmation screen also shows proof of selection of just the covered shares, take a screen shot of that too. I have seen people report on this forum that sometimes Vanguard messes up specific ID lot selection (reverts to FIFO even though the person definitely selected specific lots), then has to be contacted to fix it. The easiest way to get it fixed is to have the screen shots proving that you definitely made specific ID selections.
For example, as I read further in the forum today...

"Ever have Vanguard change the basis of a sale?"
viewtopic.php?f=1&t=234334

This kind of thing makes me nervous, given your situation where you say getting your child tax credit is dependent on you being able to successfully choose specific lots to sell.
rkhusky
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Re: Changing cost basis on Noncoverd shares

Post by rkhusky »

UpperNwGuy wrote: Tue Dec 12, 2017 5:44 am
Finridge wrote: Mon Dec 11, 2017 11:43 pm Some of my funds were originally "Investor Shares". A few years ago, Vanguard lowered the dollar amounts needed to qualify for "Admiral Shares" and then automatically converted a number of my fund investments from "Investor Shares" to "Admiral Shares." In a very unfortunate oversight, wherever they did this conversion, all transaction history was wiped out. I spoke to my Vanguard rep and he said that they were not able to restore this.
Yikes! Is wiping out the transaction history when converting from Investor Shares to Admiral Shares a common practice at Vanguard?
Which is why I keep track of my transactions myself in a spreadsheet. If there is disagreement between my records and Vanguard's, I can dig deeper to see who made the error. If they agree, I can be confident that it is right.
Topic Author
bobsmith
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Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

cas wrote: Tue Dec 12, 2017 5:43 am I think - but do not know for sure - that if you switch to Specific ID for the fund, you will regain the option to specify whether to sell the covered shares or the non-covered shares.

So, you would be able to do your Transaction 1. (Selling all the covered shares you have.)
Well that alone would be great. As mentioned, I've been using ACB the whole time. Yesterday I changed the cost basis method to SpecID without actually doing any transactions. Vanguard's website told me it needed 1 -2 business days to switch the basis, likely just so they could update the transactions.

Is it fair to say that if Vanguard's website let's me do it, then it's okay to do? As I mentioned in my previous post, it was unclear if the IRS was putting limits on the ability to change back the basis from ACB, or if that was up to the institution, and it seems to contradict the "one way street" suggestion from the fairmark link. Also, I was told by Vanguard over the phone that I could do Transaction 1. My concern is that the IRS has a different view.
And I think that Vanguard keeps separate tracking of the cost basis of the covered and non-covered shares. So, since you had only 1 lot of covered shares to start with, and have never sold any of the covered shares, I think your cost basis of the covered shares will be the price you originally paid for them. (In other words - the cost basis of the covered shares will not have been averaged with the cost basis of the non-covered shares.)

Vanguard has a "Cost Basis" page that shows what it thinks cost basis is for your funds. (Third menu item down under the "My Accounts" tab) It always divides out covered and non-covered shares for me, regardless of cost basis method. Before you go to sell - and probably both before and after you switch the cost basis method - you should check that page to make sure the cost basis listed for the covered shares is what you think it is.

If you go to sell just the covered shares, and it never gives you an option to choose just the covered shares, then back out and don't hit submit. It will almost certainly use FIFO in that case.

If it does give you an option to choose just the covered shares, make sure you take screen shots of the screen where you select just the covered shares (showing that you selected them) and, if the confirmation screen also shows proof of selection of just the covered shares, take a screen shot of that too. I have seen people report on this forum that sometimes Vanguard messes up specific ID lot selection (reverts to FIFO even though the person definitely selected specific lots), then has to be contacted to fix it. The easiest way to get it fixed is to have the screen shots proving that you definitely made specific ID selections.
ok, will do. That's good insurance, but I'm less concerned about Vanguard's competence that I am about simply not understanding the IRS rules and doing something foolish.
What I don't think you will be able to do is your Transaction 2 (selling just the 2010 non-covered shares). Even if you switch the cost basis method to specific ID, I'm pretty sure all the non-covered shares will be presented as one big lump, with all shares having the same average cost.

It is kind of like you have made soup out of all the lots of non-covered shares and have eaten some bowls of the soup. (Already sold some of the non-covered shares using average cost and reported it that way to the IRS in previous years.) You can't now go back and tell Vanguard you've decided you'd rather have a salad for dinner tonight and you want the carrots from the soup (the 2010 lot of shares) back in their original uncooked condition (original cost basis intact). Some of the carrots (cost basis of the 2010 lot) are already gone because of the bowls of soup you already ate (sales using average cost basis). And even the carrots that remain are impossible to retrieve in a fresh state (cost basis intact): during the cooking process (switching to average cost method) some of the carrot juice and little bits of carrots infused into the rest of the broth. And some of the broth has infused into the remaining chunks of carrot. It is just impossible to get the original fresh carrots (originalseparate cost basis of those 2010 shares) back.
That makes sense, but it's my very layman understanding that when you sell shares using the ACB method, the actual shares that get sold are the First in, or oldest shares. Noncovered shares go first because they tend to be the oldest. I thought if I ever did this and got audited, I would simply keep track of how many shares out of the oldest lot were sold just as I showed in my example.

Again, when you say "I don't think you will be able to do ... Transaction 2" is this because Vanguard won't allow it or because the IRS won't allow it? Keeping my own records for SpecID sale of the noncovered shares, it would really be on me, not Vanguard to make it work and they don't report noncovered share transactions to the IRS, at least not for SpecID.
talzara
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Re: Changing cost basis on Noncoverd shares

Post by talzara »

bobsmith wrote: Tue Dec 12, 2017 10:54 am That makes sense, but it's my very layman understanding that when you sell shares using the ACB method, the actual shares that get sold are the First in, or oldest shares. Noncovered shares go first because they tend to be the oldest. I thought if I ever did this and got audited, I would simply keep track of how many shares out of the oldest lot were sold just as I showed in my example.
No, the shares are not sold FIFO. As soon as you sell one share (or even 0.001 shares), the tax lots are conmingled together into one lot.

You didn't sell shares from the oldest lot. When you use Average Cost Basis, you sold shares from all lots.

Noncovered shares are a separate issue. You now have two pools of shares: covered and noncovered. You can sell the covered shares separately from the noncovered shares. But it's too late to go back to FIFO for the noncovered shares.
FactualFran
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Re: Changing cost basis on Noncoverd shares

Post by FactualFran »

Upon rereading the opening post, some details in my original version of this post were incorrect. I have deleted the first two paragraphs of what I posted and left the final paragraph.

You cannot change to SpecID for non-covered shares of a mutual fund if you have sold non-covered shares of the fund and used Average Basis. It does not matter if the shares of the same fund were held in different accounts (trust and personal in the scenario). With covered shares it is possible to change from Average Basis to SpecID and the change is specific to the account to which the change is made.
Topic Author
bobsmith
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Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

FactualFran wrote: Tue Dec 12, 2017 3:25 pm Upon rereading the opening post, some details in my original version of this post were incorrect. I have deleted the first two paragraphs of what I posted and left the final paragraph.

You cannot change to SpecID for non-covered shares of a mutual fund if you have sold non-covered shares of the fund and used Average Basis. It does not matter if the shares of the same fund were held in different accounts (trust and personal in the scenario). With covered shares it is possible to change from Average Basis to SpecID and the change is specific to the account to which the change is made.
So I can change to SpecID and sell all the covered shares, then switch back to ACB to sell all the Noncovered shares treating them forever more as one lot? (This would mean I change BACK to ACB after selling off all the covered shares using SpecID) Is that correct?
Finridge
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Re: Changing cost basis on Noncoverd shares

Post by Finridge »

Stupid question: How does use adjusted cost basis (ACB) help? Don't you still need all your transaction data to calculate what the adjusted cost basis is?
TravelGeek
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Re: Changing cost basis on Noncoverd shares

Post by TravelGeek »

Finridge wrote: Tue Dec 12, 2017 11:39 pm Stupid question: How does use adjusted cost basis (ACB) help? Don't you still need all your transaction data to calculate what the adjusted cost basis is?
Average, not adjusted, I think.

And Vanguard tracks that, separately for the covered and non-covered shares, as far as I recall.
Topic Author
bobsmith
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Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

TravelGeek wrote: Tue Dec 12, 2017 11:57 pm Average, not adjusted, I think.
Yes, I was referring to Average Cost Basis.
FactualFran
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Re: Changing cost basis on Noncoverd shares

Post by FactualFran »

bobsmith wrote: Tue Dec 12, 2017 8:38 pm So I can change to SpecID and sell all the covered shares, then switch back to ACB to sell all the Noncovered shares treating them forever more as one lot? (This would mean I change BACK to ACB after selling off all the covered shares using SpecID) Is that correct?
If you sell all remaining shares, whether covered or not, the cost and Average Basis methods will calculate the same gain or loss for the sale. If the sale involves short-term shares (shares held for a year or less), the different methods may calculate different short-term and long-terms gains, but the sum of the short-term and long-term gains will be the same regardless of the cost or other basis method used.

The cost or other basis method you use for covered shares is independent of the method for non-covered shares. If you sell all covered share, the cost or other basis method elected for covered shares in no longer meaningful.

In the scenario that you gave, on 1/1/2008 you sold shares using Average Basis, due to changes in IRS regulations that happened later, those shares are non-covered shares. Once you use Average Basis on non-covered shares, you must continue to use it for the non-covered shares in all accounts in the same fund. You may not change from having used Average Basis to using SpecID for non-covered shares and later "switch back to ACB" for non-covered shares.

Because all remaining non-covered shares are now over a year old, they may be considered as being one lot. Any sale of those shares will be a sale of long-term shares. The date on which each long-term share was bought is no longer relevant because non-covered shares were previously sold using Average Basis. The cost at which each share was bought is no longer relevant because it has been incorporated into the Average Basis.
senex
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Re: Changing cost basis on Noncoverd shares

Post by senex »

You've gotten meaty replies on the tax law. In addition, I like to think outside the box when things get so complicated. Some ideas:

1) If you make regular donations to charity, you can donate the noncovered shares, and use the cash you would have donated for other purposes. This is a great technique in general, and I've used it to dispose of shares in similar situations (lost or complicated cost basis). Make sure to only donate securities you've held for over one year -- the rules are less favorable for <1yr holdings.

2) If you can control the timing of your income, arrange a year in which your AGI is low enough to put you into the 0% capital gains bracket. Then sell as much as you can (while staying in the 0% zone) -- your cost basis won't matter.

3) If you don't need the money from this particular account, punt on this question. Hold it until you can do #1 or #2 or until you die. Under current rules your heirs will get a step-up basis (i.e. their cost basis will reset to the price on the day they inherited), so no one will ever need to disentangle the mess. Money is money, so if you can get the cash you need from another source, you can punt on this problem indefinitely.
Topic Author
bobsmith
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Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

FactualFran wrote: Wed Dec 13, 2017 2:20 pm
bobsmith wrote: Tue Dec 12, 2017 8:38 pm So I can change to SpecID and sell all the covered shares, then switch back to ACB to sell all the Noncovered shares treating them forever more as one lot? (This would mean I change BACK to ACB after selling off all the covered shares using SpecID) Is that correct?
If you sell all remaining shares, whether covered or not, the cost and Average Basis methods will calculate the same gain or loss for the sale. If the sale involves short-term shares (shares held for a year or less), the different methods may calculate different short-term and long-terms gains, but the sum of the short-term and long-term gains will be the same regardless of the cost or other basis method used.

The cost or other basis method you use for covered shares is independent of the method for non-covered shares. If you sell all covered share, the cost or other basis method elected for covered shares in no longer meaningful.

In the scenario that you gave, on 1/1/2008 you sold shares using Average Basis, due to changes in IRS regulations that happened later, those shares are non-covered shares. Once you use Average Basis on non-covered shares, you must continue to use it for the non-covered shares in all accounts in the same fund. You may not change from having used Average Basis to using SpecID for non-covered shares and later "switch back to ACB" for non-covered shares.

Because all remaining non-covered shares are now over a year old, they may be considered as being one lot. Any sale of those shares will be a sale of long-term shares. The date on which each long-term share was bought is no longer relevant because non-covered shares were previously sold using Average Basis. The cost at which each share was bought is no longer relevant because it has been incorporated into the Average Basis.
Thanks for the time to explain this and all your help during this thread. I have read and considered all your advice, even that which I haven't directly responded to. So far as I understand, Vanguard doesn't let me chose different basises for covered and noncovered shares within the fund. If they did, I would just sell the covered shares lot using average cost basis because, as you point out, it's the same as selling them at SpecID if I sell them all. By switching to SpecID I can choose just the covered shares and Vanguard can do the reporting for me. Learning from you and others, it seems I'll have no choice but to treat the remaining noncovered shares as one lot using average cost basis, but as a matter of method, I'll need to go back and change to average cost basis after selling all the covered shares. At least that's how I see it. All the unrealized gains are LT, but I never had any intention of selling all the shares.

I'm confused how my 1/1/2008 transaction created noncovered shares because I didn't think the term existed until 1/1/2012 when the rules changed. I've been using the term simply to refer to shares purchased after 1/1/2012. That said, I think I now know enough to finally move forward on this for my purposes. Thank you again for your informative advice.
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bobsmith
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Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

senex wrote: Wed Dec 13, 2017 3:51 pm You've gotten meaty replies on the tax law. In addition, I like to think outside the box when things get so complicated. Some ideas:

1) If you make regular donations to charity, you can donate the noncovered shares, and use the cash you would have donated for other purposes. This is a great technique in general, and I've used it to dispose of shares in similar situations (lost or complicated cost basis). Make sure to only donate securities you've held for over one year -- the rules are less favorable for <1yr holdings.

2) If you can control the timing of your income, arrange a year in which your AGI is low enough to put you into the 0% capital gains bracket. Then sell as much as you can (while staying in the 0% zone) -- your cost basis won't matter.

3) If you don't need the money from this particular account, punt on this question. Hold it until you can do #1 or #2 or until you die. Under current rules your heirs will get a step-up basis (i.e. their cost basis will reset to the price on the day they inherited), so no one will ever need to disentangle the mess. Money is money, so if you can get the cash you need from another source, you can punt on this problem indefinitely.
While I'm familiar with these strategies, I appreciate you taking your time to post them. Good ideas!
FactualFran
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Re: Changing cost basis on Noncoverd shares

Post by FactualFran »

bobsmith, concerning: "So far as I understand, Vanguard doesn't let me chose different basises for covered and noncovered shares within the fund." Vanguard needs to know the method a shareholder wants used for covered shares so Vanguard can report to the IRS and the shareholder the capital gain of each sale of covered shares. In general, mutual funds 1) do not know whether a shareholder has used FIFO or Average Basis when selling non-covered shares, 2) need to have been informed by a shareholder in writing what shares were sold when the shareholder sold specific shares.

I don't know what the Vanguard web site does when someone sells shares of a fund for which they have both covered and non-covered shares. Perhaps, Vanguard requires that the method for covered shares be SpecID in order for a shareholder to be able to explicitly indicate that the shares being sold are: covered, non-covered, or a combination of the two.
Topic Author
bobsmith
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Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

FactualFran wrote: Thu Dec 14, 2017 2:11 pm bobsmith, concerning: "So far as I understand, Vanguard doesn't let me chose different basises for covered and noncovered shares within the fund." Vanguard needs to know the method a shareholder wants used for covered shares so Vanguard can report to the IRS and the shareholder the capital gain of each sale of covered shares. In general, mutual funds 1) do not know whether a shareholder has used FIFO or Average Basis when selling non-covered shares, 2) need to have been informed by a shareholder in writing what shares were sold when the shareholder sold specific shares.

I don't know what the Vanguard web site does when someone sells shares of a fund for which they have both covered and non-covered shares. Perhaps, Vanguard requires that the method for covered shares be SpecID in order for a shareholder to be able to explicitly indicate that the shares being sold are: covered, non-covered, or a combination of the two.
I just mean that Vanguard doesn't let the investor chose one method for covered and one for noncovered. You can only declare for the fund whether is 100% covered, 100% noncovered, or a combination of both. I just made the transaction yesterday and, along with the covered shares, I did have the option to sell the noncovered shares using SpecID. Of course, I only sold the covered shares. There are those who have kept their own SpecID records and so this could have been a legitimate choice. Regarding the rule about not being able to switch from Average Cost Basis after making a sale, I don't think Vanguard's software keeps track of this either. So, while I could have sold the noncovered shares, I believe it would have created a rule violation with the IRS once they figured out I shouldn't have been able to use SpecID on them. Had I never sold any shares and had I kept my records, it's my understanding I could have been able to use SpecID for the noncovered. But again, it's my job to figure that out before making the trades. Now that I've sold off all the covered shares, I'll go back and change the cost basis method to average cost basis because all that's left are noncovered shares. The fund is set NOT to reinvest into itself, so all I'll ever have is noncovered shares.
FactualFran
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Re: Changing cost basis on Noncoverd shares

Post by FactualFran »

bobsmith, concerning: " So, while I could have sold the noncovered shares, I believe it would have created a rule violation with the IRS once they figured out I shouldn't have been able to use SpecID on them."

There would not have been any rule violation as long as on your tax return you indicate that the sale used Average Basis and provide the correct basis. Because you used Average Basis on non-covered shares of a fund in the past, you need to continue to use Average Basis when selling non-covered shares of the fund.

Vanguard does not report the basis of sales of non-covered shares to the IRS. Vanguard provides the Average Basis of non-covered shares to the shareholder as a convenience. That information from Vanguard should be correct as long as Average Basis has been used for all sales of non-covered shares of the fund.

I think is was a poor decision by Vanguard to use the basis election of SpecID, which applies only to covered shares, to indicate whether a sale may include non-covered shares. I think if would have been better if Vanguard made indicating whether a sale includes non-covered share a separate choice when making a sale though their web site.
Topic Author
bobsmith
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Joined: Thu Jan 24, 2013 3:02 pm

Re: Changing cost basis on Noncoverd shares

Post by bobsmith »

FactualFran wrote: Fri Dec 15, 2017 4:26 pm bobsmith, concerning: " So, while I could have sold the noncovered shares, I believe it would have created a rule violation with the IRS once they figured out I shouldn't have been able to use SpecID on them."

There would not have been any rule violation as long as on your tax return you indicate that the sale used Average Basis and provide the correct basis. Because you used Average Basis on non-covered shares of a fund in the past, you need to continue to use Average Basis when selling non-covered shares of the fund.

Vanguard does not report the basis of sales of non-covered shares to the IRS. Vanguard provides the Average Basis of non-covered shares to the shareholder as a convenience. That information from Vanguard should be correct as long as Average Basis has been used for all sales of non-covered shares of the fund.

I think is was a poor decision by Vanguard to use the basis election of SpecID, which applies only to covered shares, to indicate whether a sale may include non-covered shares. I think if would have been better if Vanguard made indicating whether a sale includes non-covered share a separate choice when making a sale though their web site.
Yep, everything you say makes sense. I might well have gotten myself into a bad place had you and Cas not pointed out the rule about not being able to go back after selling using ACB. All my covered shares are now sold using SpecID. I'll just go back and change the cost basis back to ACB for my remaining noncovered shares. When I sell those, I'll rely on Vanguard's reporting for ACB, but I'll also be keeping my own records (which were really just Vanguard's).

Thanks again for your advice!
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