Tax-savvy investors know to watch out for the “wash sale” rule. But now there’s an extra wrinkle.
Alert: New cost basis reporting rules apply to mutual fund shares acquired after 2011. Mutual fund companies are required to report gains and losses from the shares on Form 1099 based on a default method if you don’t select another permissible method.
The new cost basis rules extend to automatic reinvestment plans. So don’t be surprised next year when you receive a boatload of 1099s showing wash sales in your mutual fund accounts.
Here’s the whole story: The wash sale rule says you can’t deduct the loss from a sale of securities if you acquire “substantially identical” securities within 30 days of the sale. Instead, the loss is added to your basis in the replacement shares.
You can avoid the wash sale rule by waiting at least 31 days before you buy back the same securities. Alternatively, you might use the “double up” strategy: First, buy more shares of the same security. Next, wait at least 31 days to sell the original block of shares. With this technique, you can acquire the new shares at a low price and preserve a tax loss for the old shares.
New cost basis rules
Under a three-year phase-in, financial institutions must report the cost basis and other information relating to securities transactions. This applies to stocks and comparable investments acquired after 2010; mutual fund and dividend reinvestment plan (DRP) shares acquired after 2011; and most other complex securities, such as options, fixed income instruments and debt instruments, acquired after 2012.
The new cost basis rules should make it easier to figure out the tax consequences of mutual fund transactions. But now you’re required to choose a cost basis method at the time of the transaction. Otherwise, an “average cost basis” method will generally be used as the default for mutual fund shares.
Caution: If you sell mutual fund shares at a loss and dividends from those fund shares are automatically reinvested within the 30-day period, you will trigger the wash sale—whether you intend it or not. To avoid this, you must provide express instructions to the contrary.
Tip: Stay on top of the situation by closely monitoring your accounts.
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