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I think I'm beginning to understand
what I need to do in order to determine
the taxes I would owe if I sold my funds.

I do have another related question, the answer
to which will probably help me to understand this
whole subject a little better:

Hypothetical: I own a fund for 10 years.
The only additional shares purchased are
through capital gains and dividend reinvestment.
Obviously, taxes are paid yearly. As of
12/31/1998 the fund is valued at $10,000.
I sell a full position in a mutual fund (no
previous shares had been sold) on 06/01/1999.
The value of the fund at that time is now $12,000.
Why can't $10,000 be the cost basis, $2,000
be the capital gains, and $400 be the
capital gains tax owed (based on 20%).
(Also assuming that there is no reinvestment
between 01/01/1999 - 06/01/1999)

I understand that this is not right but I hope
the answer to why it is wrong will help me
to finally understand this wonderful world
of taxes.

Thanks to all-
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ChrisPRocks writes (in part):

Hypothetical: I own a fund for 10 years. The only additional shares purchased are through capital gains and dividend reinvestment. Obviously, taxes are paid yearly. As of 12/31/1998 the fund is valued at $10,000. I sell a full position in a mutual fund (no previous shares had been sold) on 06/01/1999. The value of the fund at that time is now $12,000. Why can't $10,000 be the cost basis, $2,000 be the capital gains, and $400 be the capital gains tax owed (based on 20%). (Also assuming that there is no reinvestment between 01/01/1999 - 06/01/1999)

I understand that this is not right but I hope the answer to why it is wrong will help me to finally understand this wonderful world of taxes.


I reply:

Your basis is what it is; in the situation you describe, there's no room to manipulate your total basis, although you might (through the selection of single-category cost averaging) be able to convert long-term basis to short-term basis or vice versa. In your hypothetical, your basis probably is less than $10,000, even though that was its value on January 1, 1999, because some of the increase in value probably results from price appreciation that had not been distributed to the shareholders. Similarly, the increase in value from $10,000 to $12,000 was definitely attributable to price appreciation that had not been distributed, because you asked us to assume that no distributions had occurred in 1999. To get your basis, simply add your contributions to the total distributions that you reinvested. --Bob
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The greatest hassle with reinvesting dividends and capital gains distributions (and DRIP programs) is the large number of transactions generated. Each share you sell has an associated cost. So your calculation of cost basis can become complex. It is definitely more complicated than if you bought 100 shares of IBM twenty years ago.

A spreadsheet program is an easy way to add up all of those purchases and make sure you have them entered correctly. But you will probably spend a few hours at it if you have owned the mutual fund for years.

Selling accumulated mutual fund shares always makes tax time more complicated. Suddenly tax similification looks more and more attractive.
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