Cost Basis
Understand the rules, tax considerations and your options.
When the end of the year approaches, investors who want to make smart moves to reduce their tax burden often take a closer look at the adjusted cost basis for mutual funds.
You don’t have to wait until it’s time to file your taxes to begin mutual funds cost basis management though; long-term planning can help investors determine the best ways to minimize the amount of capital gains that would be taxed.
Cost basis calculations also apply to investments other than mutual funds, as IRS regulations require financial service companies to track and report cost basis for taxable accounts including stock securities and certain bond and option securities purchased through a brokerage firm.
What Is Cost Basis?
Generally, cost basis is the purchase price of a security, and it can describe the purchase price of a mutual fund share, including commissions and expenses, if applicable. You use your cost basis to determine if you have a capital gain or capital loss at the time you sell your mutual fund shares. You must report capital gains and losses to the IRS for tax purposes.
When you sell or exchange mutual fund shares, the transaction price is usually different from the original purchase price. If the selling price is greater than the purchase price, your profit is called a capital gain. If the selling price is less than the purchase price, your deficit is called a capital loss. You must report capital gains and losses to the IRS.
You will owe tax on any gain, which is the difference between your mutual fund cost basis and the amount you sold your sales for. The more difficult part is figuring out your adjusted cost basis for mutual funds, as you might have invested money in a fund at different times or reinvested your dividends.
Investment Consultants at American Century Investments® are not licensed tax advisors and are unable to give tax advice. For that reason, we encourage you to speak with your tax advisor to help you make the best choice for your situation.
When You Purchased the Shares Matters
It's important to remember the mandatory tracking of cost basis only applies to shares purchased after the effective date. This includes shares acquired through dividends and transfers. For mutual funds, this means:
Non-Covered Shares | Investment companies are not required to track and report these shares. As a courtesy, American Century Investments provides Average Cost information for non-covered shares when sold (if the data is available). No other methods are available. |
Covered Shares | As required by the new regulations, we will provide cost basis information for all clients using the method elected by the client or the corporate default if no method is elected. |
How Do I Determine the Cost Basis on the Shares I Sold?
To calculate your estimated gains and losses, you’ll need to select the primary mutual fund cost basis method that works best for your accounts.
You may select a different method per account or one method that covers all your accounts. The cost basis options you have depend on the type of shares you own. Review the options and the examples below to understand your choices.
Mutual Fund Shares* | Brokerage (Stock, Bond and Option Securities) | Primary Cost Basis Calculation Methods |
|---|---|---|
◼ | Average Cost**: The shares in the account at the time of the sales are averaged to determine the cost. | |
◼ | ◼ | Specific Share ID (also called Specific Lot): The shares to be sold are specified by the client. |
◼ | ◼ | First In, First Out (FIFO): The first shares purchased are sold first. |
◼ | ◼ | High Cost: The shares with the highest cost are sold first. |
◼ | ◼ | Last In, First Out: The most recently purchased shares are sold first. |
◼ | ◼ | Loss/Gain Utilization: The shares with losses are sold before the shares with gains consistent with the objective of minimizing taxes. For lots that yield a loss, short-term lots will be sold ahead of long-term lots. For gains, long-term lots will be sold ahead of short-term lots. |
◼ | Low Cost: The shares with the lowest cost are sold first. | |
◼ | ◼ | High Cost Long Term: The shares with the highest cost held more than 12 months are sold first. |
◼ | High Cost Short Term: The shares with the highest cost held fewer than 12 months are sold first. | |
◼ | Low Cost Long Term: The shares with the lowest cost held more than 12 months are sold first. | |
◼ | Low Cost Short Term: The shares with the lowest cost held fewer than 12 months are sold first. | |
◼ | Minimum Tax: Minimize all gains in the short term by selling shares with the highest cost first and lowest cost last. |
Note to mutual fund clients: If you choose a method other than Average Cost, we will no longer provide Average Cost information for redemptions of any non-covered shares since that method is generally no longer applicable.
According to the IRS guidelines, only the single category applies after January 1, 2012. This means short- and long-term shares will no longer be tracked for the purposes of the Average Cost double category.
Hypothetical Cost Basis Calculation Examples
Below, we describe how mutual fund cost basis is determined using three primary methods with the same purchase/sell dates for comparison. They are First In, First Out (FIFO), Average Cost and Specific Share ID (Select Lot). As you calculate potential gains and losses through these cost basis method considerations, you can help determine which option is best for your investment portfolio.
Date of Transaction | Transaction | Amount | Price Per Share | # of Shares | Total Shares |
1/15/2012 | Purchase by check | $5,500.00 | $11.00 | 500 | 500 |
12/15/2012 | Reinvest dividend | $240.00 | $12.00 | 20 | 520 |
01/15/2013 | Purchase by check | $7,000.00 | $14.00 | 500 | 1020 |
Total Amount Invested | $12,740.00 | 1020 | |||
05/01/2013 | Sell | $290.00 | $14.50 | 20 | 1000 |
First In, First Out (FIFO)
Using the first in, first out method, it's assumed that the first shares purchased are the first ones sold.
If 20 shares are sold, they would be the first 20 shares purchased on January 15, 2012. To determine the mutual fund cost basis:
Multiply the purchase price of the shares x the number of the shares sold
$11.00 x 20 = $220 (Cost Basis)
Average Cost
Using the average cost method, the shares in the account at the time of the sale are averaged to determine the cost.
The cost of the 20 shares sold is an average of all the purchase prices. To determine the cost basis using the average cost method, there are three steps:
Step 1. Find the total amount invested.
Cost of all purchases including reinvested dividends = Total amount invested
$5,500 + $240 + $7,000 = $ 12,740
Step 2. Find the average cost of the shares.
Total amount invested / share balance = Average cost per share
$12,740 / 1,020 = $12.49 per share
Step 3. Determine the cost basis for the 20 shares sold.
Average cost of shares x the number of shares sold
$12.49 x 20 = $249.80 (Cost Basis)
How Do I Select the Cost Basis for My Account?
If you have a mutual fund in a taxable, non money market account at American Century®, then you can log in to your account and select the Choose your cost basis method link from the My Profile page. Or print and return the Cost Basis Election Form.
Additional Questions
What happens if I don’t select a cost basis method?
We will select a corporate default method if we do not receive an election from you. Keep in mind, our default is not a recommendation and may not be the best choice for your situation. Cost basis method considerations are important decisions and should reflect what is best for your personal situation as determined by you and your tax advisor.
American Century Investments - Cost Basis Default:
Brokerage - First In, First Out (FIFO)
Mutual Fund - Average Cost
Why don’t I see the mutual fund cost basis on my account?
If you sold non-covered shares (purchased prior to 1/1/12) and we have not provided Average Cost information on your tax form, it may be because we were unable to calculate it. This may be because the records are not available or the shares were transferred. To find the details to calculate your cost basis, log in to your My Account page and review your Transaction History.
What about Giftrust® accounts, corporations or transfers?
Giftrust Clients
The maturity status of your Giftrust determines your cost basis options.
Matured Giftrust accounts
You have the same choices for electing a cost basis method as other mutual fund account holders.
Non-matured Giftrust accounts
You do not need to make an election. American Century Investments will continue to complete the tax reporting on your behalf as outlined in the trust agreement. The trustee has selected the First In, First Out (FIFO) method for the shares purchased under the trust.
Corporate Clients
The regulations require investment firms to report sales and cost basis information on accounts held by S corporations as defined by the Internal Revenue Code section 1361(a).
If no response was received, we registered the account as an S corporation. We do not report sales and cost basis information on C corporations.
Transfer of Shares
In the event account shares are transferred to another company (including American Century® Brokerage) and you have not indicated the cost basis method to be used, the receiving company's default will apply regardless of the underlying fund company's default.
What if I have an individual bond at American Century Brokerage?
We are required to report cost basis to the IRS for certain bonds purchased after January 1, 2014. A bond is covered by the reporting requirement if it has a fixed rate, fixed maturity, and fixed payment schedule, even if it is callable by the issuer. At this time, we will not report cost basis to the IRS for more complex bonds or debt instruments issued with less than one year to maturity.
What do I need to know about individual bond cost basis reporting?
Bond Accounting Is Unique
Bond amortization methods are used to account for the difference between a bond's purchase price and its stated redemption value, or par value.¹ Bonds purchased above par value carry a premium. Conversely, bonds purchased below par value carry a market discount.²
Amortization Methods for Covered Instruments
For bonds purchased at a premium, American Century Brokerage will amortize the premium using the constant yield method. The amount of amortization will reduce your current-year income and cost basis.
For bonds purchased at a market discount, we will accrue the market discount using the constant yield method.³ We will not report your accrual as current-year income or adjust your cost basis upward. You will incur a tax liability for the entire accrual when the bond matures or you otherwise dispose of it.
If you would like to keep the default methods listed above, you do not need to take action.
Alternative Methods Available to You
You may elect one or more of the alternatives below:
For taxable bonds purchased at a premium, you may elect that we do not amortize the premium. Your income will not be reduced by the amount of amortization nor will your cost basis be adjusted.
For bonds purchased at a market discount, you may advise us to calculate your accrual using the ratable method instead of the constant yield method. Additionally, you may opt that the accrual be included as current-year income. This method is known as inclusion. We will adjust your cost basis upward by the amount of the accrual if you chose the inclusion method.
If you would like to choose an option other than the default methods, please mail a request signed by all authorized owners/signers to:
American Century Brokerage
PO Box 419146
Kansas City, MO 64146
A request to change the default amortization method will apply to all of your covered bond holdings, and it must be received in the year in which the election is to apply.
See IRS Publication 550 for additional information.
For OID instruments, the discount is the difference between the adjusted issue price and the purchase price.
Once the constant yield method has been used to report accruals for bonds purchased at a market discount, it cannot be revoked.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Giftrust® is an irrevocable trust designed to be given as a long-term gift to someone other than yourself or your spouse and is not available for an IRA. The Giftrust investment is invested in the Growth fund.