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Tax Q - Remember you have two different basis-ies for the average cost method.

I first asked about this in 2011, when the "covered" vs "non-covered" reporting legislation came into effect. It seemed clear that I needed to divide my transactions into two bins, one for "non-covered" and one for "covered" going forward. But, I never did so since I hardly sold anything in a taxable account. Now for 2020 tax season this is biting me big time:

Remember, even if you use the average cost method, the mutual fund companies all seem to calculate two different bases - one for "non-covered" (pre-2012) shares and one for "covered" (2012 and later.) For example:

2010: Buy 100 sh XYZZX at $10 (non-covered)
2015: Buy 100 sh XYZZX at $30 (covered)
2020: Sell 100 sh XYZZX at $50 (will be non-covered shares, the non-covered bin is emptied first)
2021: Sell 100 sh XYZZX at $50 (will be covered shares)

They are going to report your sale from the uncovered bin first - so the basis for your 2020 sale will be $1000, for a $4000 gain. For 2021, the shares are covered; they will report a basis of $3000 to the IRS and a $2000 gain.

If you mistakenly combined both purchases into the same bin and calculated the average basis, you might be tempted to report each of the sales with a $2000 ($20 per share) basis. Since the 2020 sale is not covered, you might report a $2000 basis for it, for a $3000 gain, which the IRS won't know about. But for 2021, you will also need to report a $2000 basis, for a $3000 gain, which is different from what you will get on your 1099-B. This could get you a letter from the IRS.

For some reason how this two-bin basis calculation works is not documented or explained anywhere online, or by any of the fund companies' tax guides. Best bet: just assume that all the numbers on your 1099-B are right, even for non-covered shares you have had a long time. You might want to break out non-covered vs covered bases now, before you exhaust your un-covered shares. Those can probably be fudged a little, as log as all the bases you have used for all the sales in each bin add up to the amount that you paid in to the fund.

Another way is to use FIFO or some other method. In retrospect, that might have been easier than average cost.


  • not sure what your question is. Numbers in 1099-B form should be accurate.
  • For some reason how this two-bin basis calculation works is not documented or explained anywhere online, or by any of the fund companies' tax guides
    Mutual fund bifurcation
    For those accounts in which Average Cost is the disposal method for mutual funds, Fidelity is required to track and report holdings of noncovered and covered shares separately. That is, Fidelity will display separate average cost calculations for fund shares bought before and after January 1, 2012.

    Numbers in 1099-B form should be accurate
    You remain responsible for reporting your cost basis information to the IRS every year on Form 1040, Schedule D, for all shares sold, whether they're covered or noncovered. You should use your own records in addition to the cost basis information we provide.

    In addition ... We aren't required to make certain adjustments that are necessary for your tax return.
  • I sold BRUFX in 2020 as part of simplifying and consolidating various accounts. Previously I had sold some HCFO shares, picking the ones I wanted to sell, a method that required me to do likewise with other sales, even though I was closing the account. My final 1099 from Bruce was a challenge to figure out because of what is discussed above. Several different groups of shares, some covered, some not, some purchased outright, some acquired via distributions, some LT, some ST gave me fits at first. I finally figured it all out and assigned the correct basis to each lot, but I’d rather not do that again.
  • msf
    edited March 2021
    Calculating gain on the sale of mutual fund shares is not as hard as it may appear to be. There are just two questions to answer: "you need to determine which shares were sold and the basis of those shares."

    If one uses average basis, there is no choice in which shares were sold. They are sold oldest first.

    If one uses what the IRS calls "cost basis", i.e. actual cost of the shares, then one must say which shares one is selling and for each of those shares state its cost basis (actual cost). It doesn't matter whether those shares are covered or noncovered, their cost basis is what you paid for them. Pretty straightforward, unless you previously sold some shares using average basis.

    There are three ways to state which shares you are selling:
    • By enumeration - stating explicitly which shares you're selling,
    • Algorithmically - giving a rule to enumerate the shares, e.g. highest cost first (HCFO), or
    • Oldest first (FIFO) - this is just the default algorithm that's used if you didn't specify a different algorithm. So in a sense it isn't even a third way of saying which shares you're selling.
    Where things might get a bit tricky is where, as @BenWP did, you sell some shares using an algorithm to enumerate those shares, and then later sell more shares. You have to know which shares were sold previously to know which shares you've got left now to sell.

    At least you have a paper trail of the shares you sold previously, because you had to report that on your 1040 when you sold them. So just cross them off your list of shares and whatever is left is what you're able to sell going forward.

    To reiterate, covered vs noncovered has no effect on basis if you are consistently using cost basis (actual cost) and not average basis (average cost).
  • @msf: I knew which shares I had previously sold, and I had good records, but when BRUFX issued its 1099 this year, the fund had combined several of the sold shares into amounts that I did not recognize immediately. It didn't take forensic accounting, but it did take my clumsy work on the calculator to unravel what at first seemed to be a mess. I believe that a fund or brokerage must continue to use the average price method if the client has used that method previously. It certainly is the simplest.
  • There are so many possibilities here that I'm not going to try to guess what lots you sold under what conditions and what was aggregated on the 1099.

    It is worth commenting on the suggestion that "a fund or brokerage must continue to use the average price method if the client has used that method previously."

    For covered shares, " A taxpayer may change basis determination methods from the average basis method to another method prospectively at any time."
    26 CFR § 1.1012-1(e)(9)(iii)

    For noncovered shares, the fund company does not report costs to the IRS. So it doesn't matter what it thinks your costs are. Further, the fund company does not know what method you elected to use when reporting gains from noncovered shares on your tax return.

    What is true is that the taxpayer must continue to use average basis on the noncovered shares unless granted permission by the IRS to change methods.
  • edited March 2021
    Thanks for the discussion. I think this is the key point: "If one uses average basis, there is no choice in which shares were sold. They are sold oldest first."

    The "mutual fund bifurcation" is correct, but it doesn't explicitly say whether it's IRS rules or convention the require it. One I redo the calculations that way, it's clear that that is what all my funds are doing: oldest shares are sold out of the noncovered bin first, until they are all gone, then the covered shares are sold. I'll just assume this is required by IRS rules.

    For years I've just been keeping track of my average basis using a single bin. I've only liquidated two funds since the bifurcation rules started, and my results vs the funds have only been off by a few cents.
  • BTW Many funds provide a "tax lot basis" report that lists your covered vs uncovered shares and their basis. This helps you reconcile your records if you have been lumping all your transactions into one basis bin.
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