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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76238  
Subject: Re: stupid question about figuring basis Date: 2/28/2009 2:00 AM
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I m not exactly numerate, so forgive any naivete in this neophyte's queries and this may not even be the right forum but you all have been very helpful as regards our IRA, so here goes:

The Tax Strategies board might be a better place to ask. But I'll answer here anyway, just for simplicity. And if you're truly innumerate, I'd strongly advise two things: keep lots of paper records, and get professional help with your taxes.

Perhaps some back story might help. We own a simple ETF from a discount brokerage, with the election to have dividends reinvested, dollar cost averaging into it all along.

Just to make sure we're clear - you're doing two things? You are reinvesting your dividends whenever those are paid. And you're buying a certain dollar amount every month. Right?

I am wondering mathematically how to figure the cost basis if we plan on selling incrementally now and again?

OOOooookkkkaaayyy. For starters, you're going to have a mess on your hands. At first blush it's pretty simple. Your cost basis is just the total of all of your purchases. But that's much easier said than done.

Please tell me that the reinvested "additionally purchased shares" via those reinv. divs don't count insofar as figuring new "trade dates" for those particular fractions.

Sorry, they do. From a tax standpoint, reinvested dividends are simply two separate transactions: The receipt of a dividend, and the purchase of additional shares. It just happens that the dollar amount of the dividend is the same as the purchase cost of the shares.

Just curious, really, how to figure the new cost basis including the reinvested dividends.

First off, don't ever try to keep track of the cost on a per-share basis. You're just going to confuse yourself (and often everyone around you). When you need a per-share number, we'll figure it at that time. All you want to keep track of is the number of shares you own and the total cost to purchase those shares.

Since this is a mutual fund, you will have three possible ways to determine the cost of any shares sold. There is FIFO (First In, First Out), specific identification, and average cost. And there are a couple of flavors of average cost - single category and double category. (BTW - average cost is NOT available for ordinary stocks, just for mutual funds.) Once you pick FIFO or average cost, you have to stick with that method for that mutual fund.

Rather than try to explain each of these, I'll let you do a google search on those terms. There are probably several good explanations out there that would be better than what I'd toss together in a short post.

And am I correct the expense ratio on ETFs just comes out of the dividends automatically so no additional math on our part is required?

That is a new subject. The expense ratio basically tells you how expensive it is to manage your mutual fund. The expenses don't really come out of the dividend so much as they come off the earnings before you can even think about a dividend. For figuring your cost basis in the shares, the expense ratio is not a concern.

But for a simple example, if at the end of a year's trading, we had a vested amount of roughly $832.00 in an ETF worth, at the time, say $40/share, with $32 of it from reinvested dividends equaling like 20.8 shares (the .8 part from the divs).

I can't figure that out at all. What you really need is just a simple list of transactions. Date, purchase cost (NOT per share, just the total dollars), number of shares purchased. That's it. From that list, a good tax preparer will be able to figure the cost for you.

And we wanted to sell about the first two shares purchased (FIFO right?),

FIFO is one option, yes.

how to figure the basis?

OK. I'll run through FIFO quickly.

Look at your first purchase. Is it more than the number of shares you sold? If so, look at that purchase and figure the per share cost. That is, divide the total purchase cost (which includes any commissions and fees) by the number of shares purchased. Then multiply that by the number of shares sold - two in this case. That is the cost of the shares sold.

If you need two (or more) different purchases to get the number of shares sold, you'll use all of the shares in the oldest purchases. So you don't need to do any per-share calculations there. You'll eventually get to a lot that you need to split to get the last of the shares you sold. Just allocate the cost as I did above. Then total up each of those to get to the total cost of the shares you sold.

I know you have to include the commissions, but how to include the dividends to raise one's cost basis.

Remember, reinvested dividends are just another purchase. It doesn't matter if the dollars for the purchase came from money you saved or dividends that the fund paid.

Perhaps someone smart could come up with a simpler, cohesive example, but I m trying.

There is very little that is simple when dealing with reinvested dividend or dollar cost averaging.

And how to know if your investment is IRS-wise considered a DRIP and are there more complications of which to be aware on those?

The IRS doesn't care about DRIPs. They only care about dividends paid and the purchase and sale of shares.

--Peter
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