Understanding cost basis to optimize taxes
Understanding cost basis to optimize taxes
Hi,
Up till now, I have been using average cost basis for my taxes. However I think this is hurting me. If I had employed other cost basis methods, I may have been able to take more capital loss on my taxes.
I want to correct the situation going forward. So I just want to verify my understanding before employing it. Please chime in.
1. I have to choose the method of cost basis while selling the shares, not while filing the taxes.
2. The best method to maximize the capital loss is to use specific identification of shares. However to use this method, I would need to have the statements showing all the past purchases for that stock or mutual fund.
3. To use average cost method, I can rely on broker's 1099-B, and do not really need the past statements.
4. Once I’ve sold shares using the average cost method, I can change my method only for the later-acquired shares. The basis of existing shares has already been locked in. e.g. Let's say I have 100 shares of XYZ. If I sold on 50 shares on Jan 1, 2021 using average cost method, the remaining 50 shares will have to be sold using average cost method. If I buy 25 shares on Jan 2, 2021; these 25 can be sold using the specific identification method.
5. As long as the above rules are followed, I can use mix & match of average cost & specific identification on the same tax returns. In other words, all the stock market transactions on a given return do not need to follow the same cost basis method.
Up till now, I have been using average cost basis for my taxes. However I think this is hurting me. If I had employed other cost basis methods, I may have been able to take more capital loss on my taxes.
I want to correct the situation going forward. So I just want to verify my understanding before employing it. Please chime in.
1. I have to choose the method of cost basis while selling the shares, not while filing the taxes.
2. The best method to maximize the capital loss is to use specific identification of shares. However to use this method, I would need to have the statements showing all the past purchases for that stock or mutual fund.
3. To use average cost method, I can rely on broker's 1099-B, and do not really need the past statements.
4. Once I’ve sold shares using the average cost method, I can change my method only for the later-acquired shares. The basis of existing shares has already been locked in. e.g. Let's say I have 100 shares of XYZ. If I sold on 50 shares on Jan 1, 2021 using average cost method, the remaining 50 shares will have to be sold using average cost method. If I buy 25 shares on Jan 2, 2021; these 25 can be sold using the specific identification method.
5. As long as the above rules are followed, I can use mix & match of average cost & specific identification on the same tax returns. In other words, all the stock market transactions on a given return do not need to follow the same cost basis method.
Re: Understanding cost basis to optimize taxes
1. Yes.
2a. Yes.
2b. Not necessarily: are these covered or noncovered shares? See Changing Cost Basis Methods for more.
3. Trust but verify. You are ultimately responsible for the accuracy.
4. Yes.
5. Yes.
2a. Yes.
2b. Not necessarily: are these covered or noncovered shares? See Changing Cost Basis Methods for more.
3. Trust but verify. You are ultimately responsible for the accuracy.
4. Yes.
5. Yes.
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Re: Understanding cost basis to optimize taxes
Your 1099-B will show all gains/losses regardless of which cost basis method you choose.
If you want to cross-check it against your records, that's fine, but that has nothing to do with the cost basis method.
If you want to cross-check it against your records, that's fine, but that has nothing to do with the cost basis method.
Re: Understanding cost basis to optimize taxes
I do not necessarily want to cross-check 1099-B. But I come across Internet articles asking me to keep records of buys/sells. Unfortunately I do not have all the statements going back 20 years, and VG/Fidelity don't have it on their website either.
So going forward, I can certainly opt for specific identification of shares, and rely on the broker's 1099-B. But in case there is an audit; I do not really have anything to prove my point to IRS. Is that a blocker?
OTOH I have tax returns going sufficiently back for me to know which mutual funds have been sold with avg cost basis method. So at least I won't be making a blunder of selling the same funds with any other cost basis method.
So going forward, I can certainly opt for specific identification of shares, and rely on the broker's 1099-B. But in case there is an audit; I do not really have anything to prove my point to IRS. Is that a blocker?
OTOH I have tax returns going sufficiently back for me to know which mutual funds have been sold with avg cost basis method. So at least I won't be making a blunder of selling the same funds with any other cost basis method.
Re: Understanding cost basis to optimize taxes
Average cost basis cannot be used with stocks and ETFs. It is for mutual funds.
Specific identification can be used with stocks, ETFs, and mutual funds.
So if you have not been using mutual funds, then you have been using specific identification. If you do not at the time of sale specifically identify the shares sold, then the rule is that the FIrst shares in are the ones you sold. That is, FIFO (First-in, first out). That is, the brokerage specifically identifies the earliest purchased shares for you. Many brokerages have alternate default methods for specifically identify shares (LIFO, HIFO, ...), but those are all subsets of implementing specifically identifying shares.
I wonder if you have read IRS Publication 550?
Specific identification can be used with stocks, ETFs, and mutual funds.
So if you have not been using mutual funds, then you have been using specific identification. If you do not at the time of sale specifically identify the shares sold, then the rule is that the FIrst shares in are the ones you sold. That is, FIFO (First-in, first out). That is, the brokerage specifically identifies the earliest purchased shares for you. Many brokerages have alternate default methods for specifically identify shares (LIFO, HIFO, ...), but those are all subsets of implementing specifically identifying shares.
I wonder if you have read IRS Publication 550?
Re: Understanding cost basis to optimize taxes
I own only mutual funds. So I was asking wrt mutual funds only.
Re: Understanding cost basis to optimize taxes
2. The best method to maximize the capital loss is to use specific identification of shares. However to use this method, I would need to have the statements showing all the past purchases for that stock or mutual fund.
Thanks, I went through the provided link. I've covered as well as noncovered shares.FiveK wrote: ↑Fri May 07, 2021 11:16 pm 2a. Yes.
2b. Not necessarily: are these covered or noncovered shares? See Changing Cost Basis Methods for more.
But I'm not sure what do you mean by "Not necessarily". Do I not need to have all the statements in some cases? or do you mean to imply something else?
Re: Understanding cost basis to optimize taxes
For all covered shares, the brokerage would have the basis for each lot so you wouldn't need to have statements (unless you disagree with the brokerage numbers). Sometimes brokerages have the basis for noncovered shares also, even if they don't report that to the IRS.gurusw wrote: ↑Sat May 08, 2021 10:46 pm2. The best method to maximize the capital loss is to use specific identification of shares. However to use this method, I would need to have the statements showing all the past purchases for that stock or mutual fund.Thanks, I went through the provided link. I've covered as well as noncovered shares.FiveK wrote: ↑Fri May 07, 2021 11:16 pm 2a. Yes.
2b. Not necessarily: are these covered or noncovered shares? See Changing Cost Basis Methods for more.
But I'm not sure what do you mean by "Not necessarily". Do I not need to have all the statements in some cases? or do you mean to imply something else?
Re: Understanding cost basis to optimize taxes
Just make the switch.
Your broker will have all the cost basis info for covered shares. For non-covered shares, they'll be grouped into a single lot with one cost.
The only records you'll need is to confirm for yourself if the broker's info is accurate, if you want to.
Your broker will have all the cost basis info for covered shares. For non-covered shares, they'll be grouped into a single lot with one cost.
The only records you'll need is to confirm for yourself if the broker's info is accurate, if you want to.
Last edited by JustinR on Sun May 09, 2021 12:47 am, edited 2 times in total.
Re: Understanding cost basis to optimize taxes
The broker may or may not have the basis of the noncovered shares.
Specific ID is still a good idea going forward.
Last edited by FiveK on Sun May 09, 2021 12:07 am, edited 1 time in total.
Re: Understanding cost basis to optimize taxes
Either the brokerage needs to provide you with the basis information or you should have your own records to show your basis. This is true whether you use the specific shares or the average cost basis method.
If the brokerage has the cost basis information for specific shares even though the shares are non covered, then you would not need all the statements. I have my records going back over 20 years. However, I have never needed them as my cost basis information has always been accurately kept by whatever brokerage I am using. This has been true for non covered shares and has followed accurately during in kind transfers as well.
If the brokerage is not able to provide you with basis information then you need your own records.
A brokerage is not required to keep track of cost basis for non covered shares even if you use an average cost basis. It sounds like you have been fortunate that you have been provided with basis information even though it was not required. There is nothing special about trusting the average cost basis on the 1099-B vs the cost basis using one of the other methods. For covered shares, the cost basis on the 1099-B must be provided and is reported to the IRS, no matter what method you selected.