A Lesson in Record-Keeping

[lastlib]

My mother got a tax bill for $3,700 from the IRS a couple weeks ago. Seems she failed to report the sales of some mutual-fund shares in 2018, and her tax preparer didn't catch it on the 1099 form she got. She and my father apparently bought shares in 1995, and have been re-investing monthly dividends since then. Since she didn't report the sale, the IRS is taxing her on the full proceeds of the sale, approx. $18,000, plus interest.

To challenge this, I have to a) find all of the statements since 1995, then b) figure out what shares she sold, based on the purchase prices of the re-investments; and c) compile it all for the IRS to prove the cost basis of the sales. Problem I am running into is that she has lost many of the statements that I need that will prove the cost basis. And that may cost her a WHOLE BUNCH of $$ in the end.

So the lesson from this that I want to pass on is this: If you purchase an investment, be it a mutual fund, stock, real estate (eg, your home) you NEED to KEEP RECORDS of what you pay for it, for AS LONG AS YOU OWN IT, plus at least seven years after you dispose of it! Store them in a secure place where you can locate them if the IRS ever challenges you on them. This includes statements showing original purchases and any dividends or distributions re-invested. And if possible, record these in spreadsheets or databases that can be readily sorted and analyzed however you need them. It's a bit of trouble, but could save you beaucoup bucks in the long run.

Peace and prosperity to you all!

[question everything]

1. I think that you can averaging the cost

https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/mutual-funds-costs-distributions-etc/mutual-funds-costs-distributions-etc-1

To figure your gain or loss using an average basis, you must have acquired the shares at various times and prices.

To calculate average basis:

Add up the cost of all the shares you own in the mutual fund.
Divide that result by the total number of shares you own. This gives you your average per share.
Multiply the average per share by the number of shares sold.

You may no longer use the double-category method for figuring your average basis. If you were using that method for shares acquired before April 1, 2011 and you sell, exchange, or otherwise dispose of those shares on or after April 1, 2011, you must figure the average basis of those shares by averaging together all identical shares in the account on April 1, 2011, without regard for the holding period.

If you wish to use the average basis to figure the gain on the sale of mutual fund shares, you must elect to do so. To choose the election, there are two separate processes for making the election for average basis method for covered and noncovered securities. See Publication 550, Investment Income and Expenses (Including Capital Gains and Losses) for information on how to make these elections.


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You may want to use a CPA to help you.

[progree]

2. You still need the records to come up with average cost -- mutual fund companies didn't

Last edited Fri Oct 23, 2020, 02:37 PM - Edit history (1)

keep track of cost basis until 2012 or thereabouts when required by law. (Speaking of personal experience with Vanguard, Fidelity, and Schwab mutual funds). So for shares bought in or after 2012 (depends on asset class, different dates for stocks, for bonds, for mutual funds, different for ETFs blah blah), they (the brokerage or wherever one's account is) will be tracking that. For shares purchased prior to 2012 or whatever the year was, nobody is tracking what their cost basis is.

Fortunately I've been keeping track, got it all in a spreadsheet including the pre-2012 shares.

And yes, when I do partial (or total) sales of mutual funds, it's using average cost basis (the default).

[progree]

4. As for the pre-2012 shares, of mutual funds I still own, I entered what I figured into

Last edited Fri Oct 23, 2020, 02:41 PM - Edit history (1)

the cost basis information for my holdings at Schwab, Vanguard, and Fidelity, where I declare what shares I had before they started keeping track and their cost basis. They keep track after that, and if I trust what they are doing, I don't need to do any more tracking or record keeping. (Actually I don't trust what they do, and for good reason, GRR SCHWAB, but that's another story),

On my 1099 for any sales, the cost basis has a little footnote saying that some cost basis information was supplied by the client or words to that effect. So in case of audit, I would still have to prove the cost basis of the pre-2012 shares.

Edited to add: this is why I extensively go over my tax information (prepare spreadsheets and all that) before seeing my tax preparer. And why I don't do H&R Block or any other Speedy-Big-Refunds-Are-Us tax preparers whose business model is to get you in and out as fast as possible (some think that is great, for me, the alarm bells go clang clang clang). And why I go over EVERYTHING on my prepared tax return before signing. And why I extensively read tax minutiae (AAII Journal and Bob Carlson's Retirement Watch for example).

(In the last 2 years, I've been doing TurboTax instead, as my tax preparer of 35 years was getting more and more erratic).

[progree]

5. Another thought: lastlib's parents probably have no choice but to use average cost

unless PRIOR TO THE SALE, and IN WRITING, they elected a different method.

Also, if in prior years they had sold some of it, then they have to use the method that was used in prior years (one can't elect a different method).

Above from recollecting from my memory of things I've read.... There have been times where I'd like to use, for partial sales, to declare which shares I'm selling (the ones with the highest cost basis meaning the lowest cap gains). Or to use a method like LIFO (Last in first out) or more expensive shares first -- I forget what my options were when I looked into it, and what kind of hoops I'd have to jump through. Decided it wasn't worth the hassle, so far.

[progree]

3. My tax prep person has done this a lot -- figure out the cost basis

For shares purchased through automatic distribution reinvestment, that can be figured out by looking at available (e.g. Yahoo Finance Historical) and seeing what the distribution was ... so if you are missing some records for shares acquired through distribution reinvestment, there is that. I don't know if my ex-tax prep guy uses Yahoo Finance or something else. (He's done that for other clients, he hasn't done that for me because I have the needed information).

Works like for someone who bought 1000 shares of XYZ and just let it sit and accumulate more shares through distribution reinvestment (I use the term "distribution" because for mutual funds, some distributions are capital gains distributions and some are dividends).

Of course it won't tell you what other shares your parents may have been purchased or sold along the way...

Don't know what to tell you, sorry.

You are absolutely right one needs to keep records at least up to 2012 - for mutual funds, I think 2012 is the year when mutual fund companies and brokerages were required to keep track of cost basis.

Yeah it sucks having to keep all the damn statements.

For taxable accounts, I turn off all distribution reinvestments to keep things simple. I take the distributions in cash, and then decide what to do when the cash builds up to a high enough number that it bugs me enough having it earning near-zero return, and then I invest the cash on whatever I want to invest it in (helps with asset allocation rebalancing)

(BTW another advantage of IRAs and 401k's -- none of this applies)

The other thing that some don't realize is FOR EXAMPLE in the simple case of having bought 1,000 shares at $10/share for $10,000, and then doing nothing except let them accumulate shares through distribution reinvestments, until say one has say accumulated an additional 900 shares for a total of 1,900 shares, and let's say the price still happens to be $10/share, so now you have 1,900 shares worth $19,000.

On selling it, one might erroneously and self-harmfully report a capital gain of $9,000: $19,000 (sale proceeds) less $10,000 (the initial purchase price); and pay capital gains tax on a supposed $9,000 of capital gains.

Actually though, there was no capital gain in my example -- all the gain in the number of shares was from the dividends and capital gain distributions being reinvested, for which one paid already paid taxes on every year (dividends and capital gains distributions being reported annually on 1099's). So one should pay $0 capital gains tax. Otherwise are paying double taxes.

(Actually not quite that simple: the share price at which distributions were reinvested has to be considered too in calculating cost basis, so my example and conclusion above is accurate only if the share price had been $10 throughout, so that every share had a cost basis of $10).

All of above is of course just message board rando advice, I claim no expertise, though have talked about this subject a lot with my CPA / tax-preparer and read a lot.

[tibbir]

6. You can look up historical records of stocks and funds

In my CPA practice, I've had to compute the tax basis of stock or fund shares when my taxpayers' brokers can't provide them and there aren't complete statement records. You will need to know the date and amount of your mother's original purchase. If she made subsequent purchases, you'll need to know the dates and amounts for those as well.

Once you have this, you can google the ticker symbol for the fund to get it's daily share value and transaction history records. Sometimes a fund's website will have the history of the daily values and cash or stock dividends. The combination of the values from the statements your mother has on hand plus the computed values from the historical value and transactions records that you look up will be adequate to support your computation of the fund's tax basis for the IRS.

Also, if your mother gave her tax preparer the fund's 1099 in the year the shares were sold and the sale wasn't reported in her return, you definitely have preparer error. That kind of thing rarely happens but my rule is that if I make an error resulting in taxes owed, plus penalty and interest, I cover any penalty charged - plus I'd comp a portion of my tax prep fee. Just a thought.