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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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