You determine a capital gain or loss by subtracting the cost basis from the sales proceeds. Here are some facts and sample calculations for determining capital gains or losses on mutual fund transactions.
The IRS requires mutual fund companies and brokers to report to you and the IRS on Form 1099-B the cost basis of sales of mutual fund shares purchased on or after January 1, 2012 ("covered shares"). Money market funds and tax-deferred accounts, such as IRAs, 529 accounts, and other retirement plans, generally are not impacted by these changes.
You also may find additional information regarding cost basis information and cost basis reporting regulations by visiting our web page, Cost Basis Accounting and Calculation.
The IRS allows three methods for determining the cost basis—First In First Out (FIFO), Average Cost, and Specific Lot Identification. The Average Cost (or "Average Basis") method, which is commonly used, requires you to determine the average cost per share—total dollars invested divided by the total number of shares held, and shares held longest in the account are considered to be sold first. (The other methods are discussed later.)
T. Rowe Price uses the Average Cost method to calculate your cost basis. You may select a cost basis method to use for covered shares. If you take no action, the default method used for all mutual fund shares by T. Rowe Price is Average Cost. For covered shares, this information is reported to the IRS on Form 1099-B. For noncovered shares (mainly mutual fund shares acquired before 2012), we include this information, if available, on Form 1099-B (mailed in January) for your convenience. In all cases, you will need to keep copies of your year-end statements and confirmations to accurately calculate your cost basis, and you are responsible for its accuracy. Cost Basis Regulations apply to Form 1099-B for mutual funds.
- Determining Tax Due—Stock Funds
- Determining Tax Due—Bond Funds
- Using the Specific Lot Identification Method and Other Information
The Average Cost approach is detailed in Table I, which assumes an initial investment of $10,000 made at the beginning of 2011, two additional investments of $1,000, and all dividends and capital gains reinvested. Such reinvestments are included in your cost basis.
Table I presents a hypothetical series of transactions to illustrate the process. For simplification purposes, some years have been omitted.
|Table I—Tax Calculation Using Average Cost Method: Stock Fund|
|Average Cost (Tax Basis)|
|Balance of Noncovered Shares||568.9||10,581.89||18.60|
|Balance of Covered Shares||73.9||$1,523.38||$20.61|
|Exchange Out (redeemed from noncovered shares first, unless otherwise specified)|
|Current Balance of Noncovered Shares||465.4||$8,656.73||$18.60|
On June 2, 2011, the investor redeemed $2,500 (125.6 shares). The tax cost and capital gain or loss on this transaction are figured in the following steps:
- Separate out the covered shares from the noncovered shares and determine the average cost for each group by dividing the cumulative cost of those shares in each group (the sum of all investments in each group made prior to the sale) by the total number of shares in the respective groups to find their average costs per share:
$11,723.06 cumulative tax cost ÷ 627.7 shares = $18.68 average cost per share
- Multiply the number of shares redeemed by the average cost to determine the tax cost of the shares sold:
$18.68 average cost x 125.6 shares = $2,346.21 tax cost on shares sold
- Subtract the tax cost from the sale proceeds to determine the capital gain or loss on the shares sold:
$2,500.00 sale proceeds – $2,346.21 tax cost = $153.79 capital gain
Since the shares sold using the Average Cost method are considered to be those acquired first, and all the shares in this example were acquired within a one-year period, the $153.79 would be a short-term capital gain under current rules. The investor's new cumulative tax cost after the sale is $9,376.85 ($11,723.06 - $2,346.21); the average cost per share remains $18.68.
On November 20, 2015, the investor exchanged $2,000 (103.5 shares). Exchanges from one fund to another are treated the same as any purchase or sale for tax purposes. The investor held both noncovered shares (shares acquired prior to January 1, 2012) and covered shares (shares acquired on or after January 1, 2012) in the account. Unless the investor specified otherwise, the exchange using Average Cost would be deemed to have redeemed the noncovered shares first. For the noncovered shares, the cumulative tax cost prior to this second transaction is $10,581.59 and an average cost per share of $18.60.
Multiplying $18.60 by the 103.5 shares exchanged produces a tax cost of $1,925.16. Since these shares were held more than one year, the $74.84 capital gain ($2,000 - $1,925.16) would be a long-term gain.
The cost basis of these noncovered shares will not be reported to the IRS. Had the investor closed the account on November 20, 2015, or redeemed a portion of the covered shares, then a portion of the shares sold would have been considered covered shares, and the cost basis of those covered shares sold would be reported to the IRS on Tax Form 1099-B.
The procedure for calculating your tax basis is no different for a fixed income, non-money market fund. (Money market funds are managed to maintain a constant share price, so transactions generate neither gains nor losses.)
Table II presents a hypothetical series of transactions to illustrate the process. For simplification purposes, some years have been omitted.
|Table II—Tax Calculation Using Average Cost Method: Bond Fund|
|Date||Transaction||Amount||Price||Shares||Cumulative Tax Cost||Average Cost (Tax Basis)|
|Balance of Noncovered Shares||547.6||$5,000.00||$9.13|
|Balance of Covered Shares||160.6||$1,387.71||$8.64|
|Sale of Shares (redeemed from noncovered shares first, unless specified otherwise)|
|Current Balance of Noncovered Shares||369.7||$3,375.64||$9.13|
An initial $5,000 was invested at the end of 2011, plus another $1,000 six months later. All monthly dividends were reinvested, further increasing the total cost basis. On December 11, 2015, the investor redeemed (sold) $1,500, perhaps by writing a check against the fund account.
Similar to the example above, the investor held noncovered shares (shares acquired prior to January 1, 2012) and covered shares (shares acquired on or after January 1, 2012) in the account. To find out whether the redemption resulted in a capital gain or loss, the investor takes the following steps:
- Separate out the covered shares from the noncovered shares, and determine the average cost for each group by dividing the cumulative cost of those shares in each group (the sum of all investments in each group made prior to the sale) by the total number of shares in the respective groups to find their average costs per share:
$5,000 cumulative tax cost ÷ 547.6 shares = $9.13 average cost per share for the noncovered shares; and $1,387.71 cumulative tax cost ÷ 160.6 shares = $8.64 average cost per share for the covered shares.
- Because the investor selected Average Cost as the account cost basis method, all noncovered shares were redeemed first. Multiply the number of shares redeemed by the average cost of the noncovered shares to find their tax cost:
$9.13 average cost per share x 177.9 shares sold = $1,624.23 tax cost
The cost basis of these noncovered shares will not be reported to the IRS.
- Compare the tax cost with the sale proceeds:
$1,624.23 tax cost - $1,500.00 sale proceeds = $124.23 capital loss.
Since the tax cost exceeds the sale proceeds by $124.23, the investor would report a capital loss. And since these shares were owned less than one year, this would be a short-term loss under current IRS rules. In addition, the wash sale rule would apply because the redemption on December 11 occurred within 30 days of the reinvested dividend for November. This would limit the portion of the capital loss that could be deducted for 2015. Although we would not report the wash sale loss disallowed on noncovered shares to the IRS, the investor must take the wash sale loss into account in the investor's own tax return.
"Wash sale" rules apply to mutual funds. If you sell shares at a loss, your deduction for some or all of the loss may be deferred if you purchased other shares in the same fund within 30 days before or after the sale.
While Average Cost is the default method we use for covered shares for mutual funds, you may choose other methods when selling covered mutual fund shares.
To choose your cost basis method, log in to your account and use this online application. If you would like to keep Average Cost as your method, you don't need to do anything, although you may confirm your choice of Average Cost online or by mail or fax. If you do not want to use Average Cost, you may select another method online or by mail or fax at any time. In some cases, you also may select a method other than Average Cost over the phone.
If you change your cost basis method from Average Cost to another method after a sale or exchange of covered shares, the new cost basis method will apply only to shares purchased after the date that the change request was processed.
We offer the following cost basis methods for mutual funds:
|Cost Basis Methods|
(method we generally provide to you for your noncovered shares on Form 1099-B)
|The cost of shares, including reinvested dividends and capital gain distributions, divided by the number of shares held, is used to compute the average cost of each share. Shares are disposed of on a First In First Out basis (FIFO).
If you would like to use Average Cost for your covered shares, you do not need to do anything. Average Cost will be calculated separately for your covered and noncovered shares.
Please note: the IRS requires that changes into and out of Average Cost be made in writing, either online or through U.S. mail or fax. Other methods may be changed online or by mail, fax, or phone.
|First In First Out (FIFO)||Assets acquired first are sold first.
Purchase Price of Particular Shares Purchased First = FIFO Cost
|Last In First Out (LIFO)||Assets acquired last are sold first.
Purchase Price of Specific Shares Sold = Cost of Shares Sold
|Highest In First Out||Highest-cost shares are sold first.
Purchase Price of Specific Shares Sold = Cost of Shares Sold
|Low Cost First Out||Lowest-cost shares are sold first|
|Loss Gain Utilization||Evaluates losses and gains and also strategically selects lots based on the loss/gain in conjunction with the holding period.|
|Specific Lot Identification||You select the specific shares you wish to sell or exchange at the time of each sale. The shares you select determine the cost basis and holding period.
Please note: to use Specific Lot Identification when selling or exchanging shares, first choose in writing a cost basis method for your account other than Average Cost (such as, FIFO, LIFO, etc.). This can be changed online or using a form. When ready to sell or exchange shares, please call us—to identify the specific shares you wish to sell or exchange—at 1-800-225-5132.
Under the Specific Lot Identification method, you may specify which shares are considered to be sold on the trade date, and such specification will be indicated on the confirmation statement. The tax cost is the specific cost of those particular shares. Please call a representative if you wish to use this method. You will need to keep a record of all your past purchases so you can accurately identify the cost basis.
If you have never sold shares of a particular mutual fund investment, you may choose any method—FIFO, Average Cost, or Specific Lot Identification—for determining your capital gain or loss when a sale occurs. If you have sold shares using Average Cost, your ability to use another method for your existing shares may be restricted and you should consult your tax adviser.
For further information on tax matters, you may wish to call the Internal Revenue Service at 1-800-TAX-1040. To receive federal tax forms, call 1-800-TAX-FORM (829-3676) or visit the IRS Web site. Information on mutual fund tax matters is available in IRS Publication No. 550, and information on individual retirement accounts can be found at IRS Publication 590-A: Contributions to Individual Retirement Arrangements (IRAs) and IRS Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs).