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Author: Lokicious 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 35367  
Subject: Re: reinvest bond fund dividends or not?? Date: 4/27/2005 3:27 PM
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"I am unfamiliar with your terminology. Are you referring to calculating the 'average cost basis'?"

Mia culpa,

Been a long time since I looked at this topic, and the memory is getting sour.

Probably as good a time as any for a crash review course on the different methods of accounting for the sale of mutual fund shares to the IRS. Straight from the horse's mouth:

http://www.irs.gov/publications/p564/ar02.html#d0e1332

Identifying the Shares Sold

To figure your gain or loss when you dispose of mutual fund shares, you need to determine which shares were sold and the basis of those shares. If your shares in a mutual fund were acquired all on the same day and for the same price, figuring their basis is not difficult. However, shares are generally acquired at various times, in various quantities, and at various prices. Therefore, figuring your basis can be more difficult. You can choose to use either a cost basis or an average basis to figure your gain or loss.

Cost Basis

You can figure your gain or loss using a cost basis only if you did not previously use an average basis for a sale, exchange, or redemption of other shares in the same mutual fund.

To figure cost basis, you can choose one of the following methods.

Specific share identification.

First-in first-out (FIFO).

Specific share identification. If you adequately identify the shares you sold, you can use the adjusted basis of those particular shares to figure your gain or loss. You will adequately identify your mutual fund shares, even if you bought the shares in different lots at various prices and times, if you:
Specify to your broker or other agent the particular shares to be sold or transferred at the time of the sale or transfer, and
Receive confirmation in writing from your broker or other agent within a reasonable time of your specification of the particular shares sold or transferred.
You continue to have the burden of proving your basis in the specified shares at the time of sale or transfer.

First-in first-out (FIFO). If your shares were acquired at different times or at different prices and you cannot identify which shares you sold, use the basis of the shares you acquired first as the basis of the shares sold. In other words, the oldest shares you own are considered sold first. You should keep a separate record of each purchase and any dispositions of the shares until all shares purchased at the same time have been disposed of completely.

....

Average Basis

You can figure your gain or loss using an average basis only if you acquired the shares at various times and prices, and you left the shares on deposit in an account handled by a custodian or agent who acquires or redeems those shares.

To figure average basis, you can use one of the following methods.

Single-category method.
Double-category method.

Once you elect to use an average basis, you must continue to use it for all accounts in the same fund. (You must also continue to use the same method.) However, you may use the cost basis (or a different method of figuring the average basis) for shares in other funds, even those within the same family of funds.

[continued with examples]: since most mutual funds do supply average basis when you sell, knowing how to calculate is unnecessary—the double category method has to do with distinguishing short term and long term capital gains.
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