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Author: JeanDavid Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121219  
Subject: Re: Capital Gains: Stocks vs. Mutual Funds Date: 5/2/1997 11:53 PM
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On Fri, 02 May 97 13:26:54 -0600, tmftaxes wrote:
<<On Fri, 02 May 97 09:44:00 -0600, JeanDavid wrote:
<<
I bought a closed-end mutual fund in about 1967 that
traded as a stock on the NYSE. I re-invested capital gains.
Now capital gains on stocks can be evaluated
FIFO or identified lots method. I took delivery of all the
stock certificates. Sometime in the 1970's or 1980's the
fund changed to an open-end fund for which the average-cost
method is used for computing capital gains.

Last year I sold some of the shares represented by the
certificates by sending them to the fund requesting that
they be sold. Considering them as a stock, I used the
FIFO method of computing capital gains. Since that time, I
have sold all the shares I bought as stock in closed-end
mutual fund. I hope this was legal. Does the IRS consider
those shares as stock (since I bought and sold them that
way), or a mutual fund, since that is what the new
corporation is?

I now have only the shares represented by
the reinvested dividends and capital gains. When I sell
these, I assume I will use the average cost method to
compute the capital gains. I guess I compute the average
cost by dividing the number of shares I have by the cost
basis as given by, e.g., Quicken, since I have a record
of all my transactions in there. Right?
>>

<<Problem is: A closed end mutual fund is still a mutual fund (or more properly, a 'Regulated Investment Company' (or RIC) as defined by the Internal Revenue Code. And so the laws, rules and regulations applicable to RICs also apply to closed end mutual funds.

The good news is that you took the shares in your posession. One of the methods of selling a mutual fund is the 'specific shares method'. But you blew it when you elected the FIFO method (which is also a valid method to sell mutual fund shares).
>>

In fact, how does the IRS know which of the two methods I
selected? I sent in the certificates and asked them to sell
those selected shares. It just so happens that they were
the first I bought (since they had the highest price,
and I needed a loss last year). Nowhere did I say to sell
the oldest ones; it is just a coincidence that the
specific shares were the first ones in.

<<Now that the FIFO method has been elected, you MUST stick with the FIFO method for all shares remaining in the fund. Rats.

Your problem is that you sold all of the 'shares' using the FIFO method, but ignored the reinvested dividends. Owch.
>>

At the time, they would allow reinvestment only of capital
gains; they sent me a check for the dividends, which I
just spent (after paying taxes on them, of course, just
as I did on the capital gains). So I did not ignore
the reinvested dividends, since there were none reinvested.
They only allowed reinvesting of the dividends when they
became an open ended mutual fund. I reinvested only the
capital gains (though I do not see what difference that
made; I could have just thrown in more money from another
source). I received certificates for each and every
investment. They did not do journal entry stuff then.

<< Can't do it. FIFO means FIFO. First in-First out. Regardless of HOW they were purchased (via reinvested dividends or direct cash purchase). So, when the original sales were made, it appears that your share identification for FIFO purposes was invalid. Interspersed with your 'original' purchased shares should have also been those shares that you purchased via 'reinvested dividends'.
>>

I do not believe so. I got certificates for every share
I ever bought, using whatever money, while it was a
closed-end mutual fund. So the shares I sold were the
shares I think I sold, and there were no others.

<<So you've got TWO strikes against you:

1. You are now stuck with the FIFO method.
>>

I do not see why, since I never said so anywhere.
On my Schedule D, I just listed the purchase date and
price and the sale date and price for each certificate.
Looks like the 'specific shares method' to me.

<<2. Your gain or loss computation on your original 'shares' was probably incorrectly computed.
>>

How so? I know what I paid for every share, when I paid
it, what I sold it for, and when I sold it.

<<What to do now?? Well, the right thing to do would be to recompute your gain/loss on the sales transaction, and file an amended 1996 individual income tax return (via Form 1040X). Since you have made a FIFO election on a timely filed return, you can't go back and select another method. So you're still stuck with FIFO. BUT, you'll recompute your gain/loss using the FIFO on the various 'reinvested' shares interspersed with your other shares. Then you would continue with the FIFO method with your remaining shares.

But the curious thing is that, you may have thought that you used the FIFO method, but you may have REALLY used the specific identification method.
>>
I believe that is the case. It is a coincidence that I
sold the first-in stocks first. The IRS might infer I was
using FIFO, but since I specifically identified the shares
to be sold, I conclude I was using the 'specific shares
method'. There is no box to check on the Schedule D to
tell them what method I was using, and I sure did not tell
the mutual fund company to use FIFO; I told them to sell
the specific shares.

<< If you specifically identified the shares sold, that may be your 'out' card. If this is the case, you would be able to 'identify' your remaining shares. Obviously, I don't know what you actually did without seeing more of the transaction history of the actual shares.
>>

I doubt it would be useful to send you a copy of my
Quicken and Turbotax records. Do you think it would be
useful? Mighty tedious...

<<You might also decide to ignore what happened last year, under the theory of 'what is done is done' (not recommended). But should you chose to do so, whatever method you used to dispose of your initial shares MUST be continued to be used to dispose of your remaining shares.

You've got kind of an 'odd' issue on your hands. I hope that this is of some help to you. If you need any clarification, please feel free to e-mail me directly or leave another post right here.

Thanks for the question...

TMF Taxes
Roy Lewis>>
>>
Thanks for your thoughtful comments.

I guess I am not for a flat tax, but I am for a tax code
that can be printed in a 16-page booklet in readable size
type in English that can be understood by a high-school
graduate. I have several inches thick pile of IRS
publications such as 505,525,550,551,590...
As a CPA, you must have them all. Congress should be
ashamed of itself for passing such a complex tax code.
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