Learn something new every day
More Info... by email
The cost basis for mutual funds represents the premium that the investor paid to buy the shares of a particular fund. Investors can calculate the cost basis of a mutual fund sale redemption by using an accounting method called the first in first out (FIFO) method. Alternatively, investors can use the specific identification method or the average cost method although rules on calculating the cost basis for tax reporting purposes vary from nation to nation.
Many mutual fund companies require investors to pay commissions known as loads whenever shares are bought or sold. Fees paid at the time of purchase are referred to as front-end loads and in most countries investors can add these loads to the cost basis for mutual funds. When an investor sells a share, the investor deducts the cost of the share and the load from the redemption value and reports the difference as the taxable gain from the transaction. The prices of mutual fund shares are determined after the stock market closes for the day and the share price depends on the closing values of the securities that are held inside the fund. Consequently, if an investor buys a number of shares in a particular fund on a single day then all of those shares will have the same price and the same cost basis.
When an investor buys a number of shares in a particular fund at different periods of time, then each of those shares has a different cost basis. If the investor then sells those shares at regular intervals, the investor normally has to calculate the cost basis of the shares by using the FIFO method. Under FIFO, it is assumed that the first shares that an investor buys are the first shares that the investor sells.
The specific identification method enables investors to specify the shares that are being redeemed at a particular point in time. This means that an investor can choose to sell the shares that were bought at the highest price so as to minimize the capital gains and the taxes that result from the share redemption. The average cost method involves adding up the total cost of the share purchases and the load fees and dividing that total between the number of shares that the investor holds. Every share then has the same cost basis although the capital gains on the share redemption’s may vary if the investor sells the shares at different points in time.
Some mutual fund companies sell so-called no-load funds and investors do not have to pay loads to buy these shares. In many instances, however, shareholders with no-load shares do have to pay transaction fees for buying shares but these are processing fees as opposed to sales commissions and are not regarded as part of the cost basis for mutual funds. Therefore, transaction fees are not added to the purchase price when calculating the cost basis for mutual funds unless the investor can write these fees off as tax deductions.
One of our editors will review your suggestion and make changes if warranted. Note that depending on the number of suggestions we receive, this can take anywhere from a few hours to a few days. Thank you for helping to improve wiseGEEK!