Cost Basis Elections and Reporting Requirements by Karla Hopkins

In October 2010, the IRS issued new mandatory regulations regarding the cost basis of stocks. Mutual funds are now required to report cost basis information to the IRS.

Effective January 1, 2012 mutual fund companies will begin their reporting, and to prepare for this they are currently sending investors election forms to dictate how the investor wants the mutual fund company to calculate the cost basis in their shares.

Due to the new regulations, shares in mutual funds will now be broken down into two categories. Shares purchased prior to January 1, 2012 are defined as non-covered shares. Mutual funds are not required to report cost basis to the IRS for shares purchased prior to January 1, 2012. These shares will be costed using the Average Cost Method unless you inform the mutual fund company to use a different method.

Shares acquired after January 1, 2012 are defined as covered shares. Mutual fund companies will now report the cost basis for all covered shares to both you and the IRS. When filing your tax return, YOU ARE REQUIRED TO USE THE
COST BASIS REPORTED ON YOUR 1099-B FOR YOUR COVERED SHARES.

The mutual fund company must select a default method for cost basis reporting and notify you of its selection. These notifications are currently being made by most mutual fund companies. You have the option to choose the same method as the fund's default or you may choose an alternate method. The election is for all future transactions for the mutual fund unless you revoke it.

The different cost methods are: FIFO, a standing order to sell the oldest shares in the account first; LIFO, a standing order to sell the newest shares in the account first; HIFO, a standing order to sell shares purchased at the highest cost first; LOFO, a standing order to sell shares purchased at the lowest cost first; LGUT, a method that evaluates losses and gains then strategically selects lots based on that gain/loss in conjunction with the holding period; SLID, the shareholder designates which specific shares to redeem when placing their redemption request; ACST, a method for valuing cost of covered shares in an account by averaging the effect of all covered transactions in the account.

For many investors, relying on the mutual fund company to provide some sort of cost basis, generally the average cost basis, has been the tax plan. While simplest, this is not always the most strategic, especially when selling high value mutual fund holdings. To keep the calculation in your own hands, the SLID (or specific identification), is the best election to make. Then, when you sell shares, you will notify the mutual fund company of the gain/loss that you expect.

What this change means to most investors is that they should now pay closer attention to their mutual fund purchases, which happen regularly if they reinvest dividends, so that they can identify their potential gains/loss upon future sales. You may also wish to review your cost basis election immediately prior to the sale of investments to determine that it is indeed to be accounted for on the basis that represents optimal tax impact.