If you have a “regular” taxable investment account (anything other than your tax advantaged accounts such as your 401k, 403b, IRA, Roth etc.), you should understand the different cost basis tracking methods and how they affect your taxes when you sell. Fidelity has a good article describing the background.
If you only have tax advantaged accounts at this time, this doesn’t apply to you yet. It’s still good to know for the future.
When I looked at my taxable account at Fidelity to see whether any shares I bought this year can be sold for a tax loss, I noticed that my shares in a mutual fund I purchased at different times this year all had the same cost basis per share. Fidelity apparently was displaying the average cost.
If you want to minimize taxes when you sell an investment, or if you want to do tax loss harvesting, the best method to track your cost basis is specific identification. You pick the lot that’s most advantageous to you when you sell. Unfortunately at many places including Fidelity, Vanguard, and Schwab, the default tracking method for mutual funds is average cost, which isn’t the best.
You can change it from average cost to specific identification. It’s best to do it now before you have any sales that complicate things. Here’s how to do it at Fidelity and Vanguard.
1. Under Accounts & Trade, click on Update Accounts / Features.
2. Then find and click on Cost Basis Information Tracking in the navigation pane on the left hand side.
3. Click on Convert under Mutual Funds.
4. Read the information on the next page. Follow the prompts.
Switching from Average Cost to Actual Cost means you can pick which lot(s) the shares will come from when you sell. If you don’t pick or if you forget to pick, the default disposal method kicks in. I suggest also changing it from the default First In, First Out (FIFO) to something else.
Fidelity offers many choices. Be sure to read and understand what each method means. I chose Tax Sensitive.
1. On the Balances and holdings page, click on Cost basis.
2. Click on View/Change cost basis method on the right hand side.
You don’t have as many choices as in Fidelity, just Average Cost, First In First Out, and Specific Identification.
I don’t have an account there. According to a FAQ on Schwab’s website:
The default for mutual funds is the average cost method. You can check or change the default cost basis method on file for your accounts in Account Settings.
If it’s not obvious how to see or change your cost basis tracking method, contact customer service.
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.
This is one thing that always bugged me about Vanguard — poor support for specific ID. I believe that the situation has improved (starting in 2011?), but in the past I’ve always had to keep my own records on share lots and email them with a list of lots being sold when I did a sale and they’d reply acknowledging it. Clunky.
I believe this improved in recent years (again, 2011? haven’t sold anything recently) but I think the ability to track this stuff online is limited to newer purchases (so-called “covered” shares) for which Vanguard tracks and reports cost basis info. I have a mix, so they sorta help out and they sorta don’t.
I wish there was a way way to manually enter (and the track) tax lots for older stuff. Sure, mistakes might be made, but the same is true for keeping all my older info in a spreadsheet.
Claire Halsey says
It is great to have the ability to choose your tax lot accounting method, but how do you know which one is the most advantageous? There are a total of five different options and unless you can calculate all of them, you may be making the wrong selection. There is an online app. netbasis.com, that allows you to see all of the results of the calculated tax lot accounting methods so you can select the lowest gain or highest loss and then after your selection, it will continue to move forward and calculate your adjusted cost basis based on that selection. After selecting your security, the next page is where you enter your buy and sell information. When you enter the “sale” the tax lot accounting method drop down window will become active. Choose the “all” option and it will take you to the page where you can select the best method. Cost $25.00.
Harry Sit says
Michael – You’re right. With Vanguard, you are completely on your own for the “non-covered” shares bought before the IRS cutoff date. Fidelity does a much better job.
Great idea Harry. Can you do this with Merrill Edge as well?
Harry Sit says
Here’s a reply from Merrill Edge customer service. I don’t know whether this applies equally to equity/ETF and open-end mutual funds. I didn’t pursue further because I’m not planning to buy mutual funds at Merrill Edge.
“Customers are now able to select specific tax lots for online trades in Cash Management Accounts. When selling held security shares, or buying to cover a short sale, you may select share lots to place the trade against at the time of order entry. If tax lots are not selected, all trades will default to the First in First out (FIFO) method. Please note that the ability to select tax lots is not available for retirement accounts.
At the bottom of the trade entry ticket, click the “Choose specific shares” link. A window will pop up displaying all available share lots for the selected security. Once you have selected the specific lots and share amounts, click the “Save” button at the bottom of the window and proceed with completing the trade entry.
Please note that tax lots previously selected for orders that are still open, or for trades that have not settled, will continue to be displayed until after the settlement date. If you select the same lot for multiple orders, the first trade will be executed per your instructions; however, subsequent trades will default to FIFO.
Currently, you may only select up to four share lots online. If you wish to sell or buy against more than four share lots, you may contact us via the Secure Message Center or at the number below following order execution to request an associate submit a trade correction to match the tax lots of the order. Tax lot adjustment requests for covered securities must be entered before trade settlement. Equity trades settle three business days following the trade date. Requests received after this timeframe has elapsed cannot be processed. Due to the limited timeframe in which these instructions can be entered, we do recommend contacting us by phone to provide these instructions. Requests received after the trade date but prior to settlement are typically processed within 2 – 5 business days.”
I recently moved a mutual fund position to Merrill Edge taxable account, so I can comment on this.
The stock trading page is still as Harry described; there’s a link there for specific shares. A pop up still says that you’re limited to four lots. (One thing that has changed is that stocks now trade T+2, not T+3 as in the older note from Merrill.)
It’s now 2019 and Merrill Edge still doesn’t have a “choose specific shares” link on its mutual fund trading page. One might be able to specific specific shares for funds by phone as described in the note. But remember that funds generally trade T+1.
Perhaps worse is that Merrill doesn’t seem to be clear on the concept of fractional shares – something that’s an oddity for stocks but common for funds. It usually shows just whole shares. So the number of shares it shows for each of my tax lots is off by a fraction. Merrill jiggers the numbers by adding a share (as a separate lot) here and there, with offbeat prices.
For a single reinvestment of mine (which was part of my transfer to Merrill), the brokerage shows three different purchases on that date, with three different purchase prices! Who knows what cost it would report to the IRS if I managed to ask it to sell one of those offbeat lots.
Is there a worthwhile improvement in profit from interest when changing from average cost to an actual cost basis …??
I am investing in funds in a taxable account and looking to change from the defaults but will increased taxes override any increase in returns….????
Harry Sit says
Changing the cost basis method does not affect the overall gains or losses before taxes. It only changes the gains and losses for a partial sale, and the taxes you will pay on that partial sale. When you make the gains smaller this time, you will have larger gains in the future. If you sell the entire holding in that fund in one shot, it doesn’t matter what method you choose.
what about HSA accounts
Harry Sit says
It doesn’t matter in HSA accounts unless you’re in California or New Jersey. Those two states don’t recognize HSAs for state income tax.