The IRS implemented new rules to help the taxpayers report capital gains and losses from securities sales more accurately. They did it by requiring the brokers and mutual fund companies to report the cost basis for securities bought after a certain date and subsequently sold. For stocks and ETFs, that date is January 1, 2011. For mutual funds, it’s January 1, 2012. The new rules of course only affect taxable accounts.
Brokers and mutual fund companies will report the cost basis for shares bought and sold after the cutoff date. Brokers will not report the cost basis for shares bought before the cutoff date no matter when you sell them; those shares are so-called "noncovered" shares.
You can still use all methods allowed by the IRS to track your cost basis. These include first-in first-out (FIFO), specific identification, and average cost (only for mutual fund shares). If a taxpayer wants to minimize the tax on a sale, specific identification is the best method to use. Because brokers and mutual fund companies aren’t required to do anything extra for the noncovered shares, the support you get on your noncovered shares vary from place to place.
I sold some mutual fund shares at Vanguard a month ago. They were noncovered shares. I wanted to use the specific identification method because it minimizes my taxes on the sale. I’m documenting the process here for my own future reference and for those who also want to use specific identification for noncovered shares at Vanguard.
I first bought shares in this Vanguard mutual fund in January 2011. I bought more shares in August 2011. That was it. I did not reinvest any dividends or year-end distributions. Up to the time I wanted to sell, I had not sold any shares in that fund. Therefore I had two lots:
- Lot 1 = X shares bought in January 2011
- Lot 2 = Y shares bought in August 2011
I bought the shares directly at Vanguard. Vanguard shows my purchase history. I wanted to sell shares from Lot 2 bought in August 2011. It should’ve been really simple.
I placed the sell order online at vanguard.com. Vanguard’s online interface showed all my shares in one lot. There wasn’t any way to specify which lot the shares to be sold should come from. It displayed this note in a popup:
"If applicable, all shares acquired prior to January 1, 2012, will be displayed as one lot, and will be reported to you as average cost since Vanguard only has average cost records for these shares. You’ll need to use your own records to report these "noncovered" shares to the IRS using specific identification."
The highlighted part (by me) isn’t entirely true. Vanguard has my cost records (two purchases, no sale). It just chooses not to use them.
I remembered reading from the Bogleheads Wiki that you will have to send the request for specific identification to Vanguard by secure email. So I sent this to Vanguard according to the wiki.
"I placed an order to sell XXXXXX shares of XXXXX Fund in my account xxxx-xxxxxxxxxxx. You are instructed to sell XXXXXX shares purchased on mm/dd/yyyy. Please confirm by return email. Thank you."
I received an auto-response saying
"Please note that it may take up to 1 hour for the recipient to receive this message, and that most messages are answered within two business days. We will notify you by e-mail when our secure response is available in your personal Vanguard mailbox."
Not Detailed Enough
Vanguard kept its SLA. I sent my message on a Sunday afternoon. I received a reply two business days later on the following Wednesday.
Please make sure you’ve provided all the information listed below in another secure e-mail or by letter.
* Your name.
* Your address.
* The last four digits of your Social Security number.
* The Vanguard(R) fund and account number from which you’re redeeming or exchanging shares.
* The share amount to be redeemed or exchanged.
* Whether the shares were redeemed or exchanged.
* The specific date(s) on which the shares were originally purchased.
* The number of shares purchased on each date.
* The net asset value (NAV) on the date the shares were purchased.
You can mail your request to the following address:
P.O. Box 1120
Valley Forge PA 19482-1120
Once we receive all the information above we’ll prepare you a letter confirming your sale of noncovered shares using the specific identification method. You should retain this letter for your records. Please allow two to four weeks for delivery.
I sent the required information in a second secure email the next day.
The Confirmation Letter
Vanguard again stuck to its promise. Almost exactly four weeks after I sent the second secure email, I received the confirmation letter.
Dear Vanguard Clients:
We received your request to use the specific identification method to determine your cost basis for the XXXXX shares sold from your XXXXX fund, account xxxxxxx, on [date].
Below, we’ve confirmed the purchase information for these noncovered shares, in accordance with the Internal Revenue Code:
Date purchased Number of shares Share purchase price xx/xx/xxxx xxxxxx $xx.xx
Done, finally. It seemed a lot of trouble and very slow turnaround. Four weeks to confirm the tax lot for a simple sale. Vanguard’s procedure and requirements aren’t documented anywhere. If you give all the required information in the format Vanguard wants (see above), you will save a little bit of time and one round of correspondence, provided that Vanguard doesn’t change the requirements.
Other companies I use, for instance Fidelity and Wells Fargo, have built-in support in the online interface for specific identification of tax lots. That support extends to both covered and noncovered shares. At Vanguard (the mutual funds side), the online interface only supports specific identification for shares bought after January 1, 2012.