The cost basis for mutual funds (or stocks) participating in dividend reinvestment plans presents an accounting challenge (some would say nightmare.)
If you have held the mutual fund for twenty years, you most likely have at least eighty-one (81) different tax lots!
On top of that, the rules are changing on 1/1/2012 for mutual fund cost basis accounting.
If you kept all of your statements, you can easily determine your cost basis by adding up the original purchase cost and all the dividends that were reinvested.
If some statements are missing, you will need to estimate the missing tax lots based on the declared dividend amount per share, the number of shares owned on the dividend record date, and the market price per share on the dividend payment date. Excel worksheets are ideal for this application. The history of declared dividend amounts can usually be obtained from the mutual fund website or from customer service.
If the shares were held directly by the mutual fund, they can usually provide missing statements for a fee. If the shares were held in a brokerage account, the monthly account statements would show the dividend reinvestment amounts.
If you inherited the mutual fund shares, see the discussion under the "Stocks" menu for inherited stock which will apply to mutual fund shares, too. Other means of acquisition discussed under the "Stocks" menu apply in the same way to mutual funds, too. If you received it as an IRA distribution or as a gift, follow the same rules as for stocks.
Once you have the detail of all the tax lots that comprise your cost basis, you have a choice of allocation methods to report cost basis when partial sales occur. Previously this decision was considered an accounting method and could not be changed without requesting permission from the IRS. However, the Treasury has relented and issued regulations in 2010 allowing the allocation method to be changed by the taxpayer without requesting permission. Before 2011, only four methods were recognized as valid by the Internal Revenue Service:
Just click on the link to be taken to the page that fully describes each method.
However, after 2010 many more methods will now be generally available; the only practical limit will be how many your brokerage firm can program into their trading system. Previously, you could always achieve the same result using the specific identification method, but now you can specify by short-cut names the matching pattern that you want your brokerage firm to use. You can choose a method or accept the default method selected by your brokerage firm or mutual fund company. Your choice of method must be made in writing or electronically, not verbally. Cost basis allocation formulas now available include:
1. Specific Identification 2. Average Cost Single Category 3. FIFO: First In First Out 4. LIFO: Last In First Out 5. HIFO: Highest Cost In First Out 6. HCLT: Highest Cost Long Term 7. HCST: Highest Cost Short Term 8. LCFO: Lowest Cost First Out 9. LCLT: Lowest Cost Long Term 10. LCST: Lowest Cost Short Term 11. MLMG: Maximum Loss Minimum Gain 12. Tax Optimization Method 13. Anything else they can dream up!
You can find more information about this on the Form 1099 page and also under "other methods."
