Financial Advice for Retirement, Social Security, IRAs and Estate Planning

The Smart Way to Sell Stock & Fund Shares in Retirement

Published on: Mar 16 2018
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Far too many investors give the IRS far too much of their money.

Why? Because they don’t know a few simple rules.

Chances are, you already know the basics of computing capital gains taxes when you sell shares, stocks and mutual funds.

You have a gain or loss that is determined by subtracting your tax basis (usually the purchase price of the shares plus any costs associated with the purchase) from the amount realized on the sale.

The amount realized is the sale price minus any costs of the sale, such as commissions.

When you sell less than your entire position in a stock or mutual fund, however, there are a few more details you should know. These details can make a significant difference to your tax bill.

The big trick is determining the basis of your shares of a stock or mutual fund when you acquired the shares over time at different prices and are selling only part of your position.

Suppose you purchased shares of a mutual fund over the years. The net asset value of your purchases ranged from $10 to $50 with an average of $35.

You’re retired now and will probably sell some shares each year through retirement. How do you determine the basis of the shares sold?

Suppose you sold shares this year for $50 each. If you sold the first shares you bought, the gain would be $40 per share ($50 minus $10).

If the most recent shares purchased were sold, you’d have no reportable gain or loss because you bought the shares for $50 and sold them for $50.

But if you used the average cost as your basis, the gain is $15 per share ($50 minus $35).

What basis should you use on your tax return?

Since 2012, brokers and mutual funds have been required to report to you and the IRS the basis of shares sold.

Under the regulations, the reporting firm determines the default method for computing the basis.

Most firms that I’ve seen use the average cost method. In this example, that would be $35 per share.

Others assume you sold the first shares purchased, an accounting method known as FIFO, or first-in, first-out. Some others do the opposite, LIFO, or last-in, first-out.

The IRS regulations allow you to use any of these methods and one other.

You also can identify specific shares to be sold (specific share or specific identification method), customizing the basis of shares sold for the year.

To choose your method, you have to opt out of the firm’s default method.

Many investors don’t know their firm’s default method of reporting the share basis.

More importantly, they don’t know, or don’t find out until it’s too late, that they can opt out of the firm’s default method.

To opt out, you have to notify the firm in writing before you sell the shares.

If you were investing with the firm when the regulations took effect in 2012, you probably received a letter explaining the firm’s default method and how to opt out.

But you can opt out any time before you sell shares. Most firms now allow you to switch the method through their websites, or they’ll provide forms you can mail or fax to them.

Once you choose a new method, that is your default method until you choose to change. The key is you have to make a designation before shares are sold.

You can’t wait until you are preparing your tax return and then decide the best method for you.

There’s an example from a recent case. An investor directed his broker to sell a portion of a stock he’d purchased at different times over the years.

His broker’s default rule was FIFO. Since the stock appreciated over time, this maximized his taxable gain.

He completed his income tax return using the specific identification method and minimized his gain.

The broker reported the FIFO method to the IRS, and the IRS accordingly adjusted the tax due. He appealed all the way to the U.S. Tax Court but lost, because he didn’t identify his basis method before selling shares. (Turan, T.C. Memo 2017-141).

A very good detailed explanation of the different ways of computing the basis of shares sold, including examples for each, is on T. Rowe Price’s website in the Tax Planning section titled “Cost Basis Regulations.”

Before you sell partial positions of an investment from a taxable account, discover your broker’s or fund firm’s default method for calculating the basis.

Then, determine the optimum choice for you and notify the firm of your choice in writing before selling any shares.

It’s more work, but it can trim your tax bill and extend the life of your nest egg.

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