Cost Basis.

[aviator]

Hi Mark,
Earlier this week I receive an email from my brokerage house informing me of upcoming changes to the accounting method used to calculate and report cost basis.

According to the help text in Fund Manager, "once you choose any accounting method you must continue to use the same method for the life of the associated investment.

My accounting method will undoubtedly change later this year. Currently, they use Average Cost but going forward it will likely be Specified Lots. What changes, if any, do I need to consider within Fund Manager?

Thanks.

[Mark]

Hi aviator,

First off a disclaimer: I'm not a tax advisor, and can't give tax advice.

I believe though that according to the IRS once you select an accounting method for reporting sales within an investment, you cannot change it until you've sold all those shares. This makes sense, as switching accounting methods in the middle would lead to incorrect total cost basis and gain numbers. In Fund Manager you can choose from any of the 3 accounting methods:

FIFO
AVG
Specific Lot

You can assign these on a per-investment basis under "Investment Properties... / Other / Accounting Method". You can also specify the default for new investments under "Options / General Preferences... / Other / Default Accounting Method for New Investments:"

I don't know how this new cost basis reporting to the IRS will work, but it seems you should still be able to use any of the 3 accounting methods you want. In the end, once you've sold everything, your total cost basis ends up the same no matter which accounting method you use. If you want to switch to Specified Lots going forward, do this on only investments that you haven't already reported gains on with the AVG method. When using Specific Lots you must specify the shares as you sell them. Right mouse click on the investment, and choose "Investment Data / Specify Lots...".

[aviator]

First off a disclaimer: I'm not a tax advisor, and can't give tax advice.

Understood. I'm not seeking tax advice from you, but rather am trying to understand if there are any limitations within Fund Manager that would impede what my brokerage house is trying to do.

I believe though that according to the IRS once you select an accounting method for reporting sales within an investment, you cannot change it until you've sold all those shares.

According to the email I received, it's the IRS that's forcing this change. Here's a verbatim excerpt of the email, with personal information redacted:

Today, [my brokerage house] doesn't send cost basis information to the IRS. However, beginning with the 2012 tax year, [my brokerage house] will be required to report cost basis information to both you and the IRS on Form 1099-B. The new reporting requirement will apply to all shares of mutual funds (other than money markets) you acquire on or after January 1, 2012, and subsequently sell, in a nonretirement account.

We currently offer one cost basis accounting method for self-managed mutual fund accounts—average cost. As the name implies, this method calculates your gains or losses on shares sold based on the average purchase price of all the shares you own. So if you've ever sold shares and used the information we provided to you to complete IRS Form 1040, Schedule D, you were using this method.

Soon we'll begin offering additional cost basis methods for mutual fund accounts. Here are the methods that will be available to [my brokerage house] clients:

Average cost. Calculates the average cost per share for each share you own. This will be [my brokerage house] default method for self-managed mutual fund accounts.
First in, first out (FIFO). Shares with the oldest purchase date will be sold first.
Specific identification (SpecID). At the time of sale, you choose the shares (or lots) to sell, which will determine your capital gain or loss.
Minimum tax (MinTax). The shares (or lots) to be sold will be chosen based on the purchase date and price, with the objective of generating the lowest tax obligation. This will be the default method for any mutual fund assets that [my brokerage house] oversees.

This makes sense, as switching accounting methods in the middle would lead to incorrect total cost basis and gain numbers.

Right, but this change is being initiated by the IRS. The rest of the email goes on to say that I will be allowed to select which accounting method to use, and they (my brokerage house) will handle the conversion from one cost basis to another. I'm assuming they'll use a cutoff date, and use whatever the cost basis is as of that date as the beginning amount going forward.

You can assign these on a per-investment basis under "Investment Properties... / Other / Accounting Method". You can also specify the default for new investments under "Options / General Preferences... / Other / Default Accounting Method for New Investments:"

So it appears that the help text is referencing the (pre-2012) IRS requirement, but isn't necessarily a system requirement or limitation.

I don't know how this new cost basis reporting to the IRS will work, but it seems you should still be able to use any of the 3 accounting methods you want. In the end, once you've sold everything, your total cost basis ends up the same no matter which accounting method you use. If you want to switch to Specified Lots going forward, do this on only investments that you haven't already reported gains on with the AVG method. When using Specific Lots you must specify the shares as you sell them. Right mouse click on the investment, and choose "Investment Data / Specify Lots...".

I'm not sure how this will work either. Right now, my investments have a mixture of accounting methods.

The ones using average cost create the most headaches, particularly with reinvested dividends. An example would be a fund that pays, say, a $1500 dividend. To reinvest that amount at a market price of $100/share means I buy 15 shares. But the brokerage house is using average cost for this fund (which in this example is $60/share) and, according to their website, the cost basis for this transaction is $900 ($60 times 15 shares). The downloaded transaction shows a dividend reinvestment of $1000. I have to manually change each transaction for average cost funds.

[Mark]

Hi aviator,

It sounds like your broker is going to allow you to specify which accounting method you want them to report basis information to the IRS. You can tell them to use whatever method you've already been using up to this point, and the method you want to continue with. So, if you've been reporting sales to the IRS based off FIFO accounting method, tell your broker you want FIFO for that investment, and it seems they will report future sales based off this method, as if you had been using FIFO all along, which would be correct. I don't think you can "convert" between cost accounting methods. They may have been reporting your cost basis to you in AVG, but this was just informational cost basis, and you were free to use a different accounting method.

There is no restrictions in Fund Manager on what accounting method you choose, and you can even change it at any point. However, you wouldn't want to change it for a particular investment if you've already reported some cost basis/gain information using a particular accounting method. If you change the accounting method property for an investment in Fund Manager, it will change all basis calculations, even those that were reported in the past, which is why you don't want to change it if you've already reported off that accounting method.