Cost Basis Definition in the Sale of Mutual Funds
According to the Internal Revenue Service, cost basis is a way to measure your investment for tax purposes. By comparing the cost basis to the money you receive when you sell a mutual fund, you will know if you have a gain or loss on the sale. If you make a partial sale, selling only part of your investment in a fund, you have options on how to define the cost basis.
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Total Sale
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If all things were very simple, your cost basis of selling your shares in a mutual fund would simply be the price that you paid for it. However, there are other factors to consider that might increase your cost basis. For instance, if you paid fees over the cost of ownership, those fees are part of your cost basis. If you received dividends or other taxable disbursements from the mutual fund and reinvested those monies into the fund, that money can also be included in the cost basis. Check your records to confirm that you have included all expenses in the cost basis.
Partial Sale -- FIFO Method
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If you do not specify otherwise, the IRS assumes you sold the oldest shares first. The costs of these older shares represent your tax basis.
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Partial Sale -- Specific Identification
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Before you sell, you instruct the mutual fund company, in writing, specifically which shares to sell. The cost of only those specific shares make up your cost basis.
Partial Sale -- Average Cost Single Category
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Before you make your first sale, you add up all of the money used to buy shares, whether it was your initial investment, additional investments over time or reinvestment of dividends into partial shares. Add into this total the cost of any fees. Divide that sum by the total number of shares owned. When you sell shares in the mutual fund, multiply the number of shares being sold by this average to determine your cost basis.
Partial Sale -- Average Cost Double Category
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This is similar to Average Cost Single Category except you create two sets of numbers, one for short-term investments within the mutual fund and the other for long-term investments. The total of the two is the total cost basis.
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