Fund Information: Tax Center
What the Changes to Cost Basis Mean to You
Beginning January 1, 2012, new Internal Revenue Service (IRS) regulations require Principal Funds and other mutual fund companies to track and report all gains and losses from the sale (redemption and exchange) of mutual fund shares in taxable accounts to shareholders and the IRS via Form 1099-B.
What is cost basis?
Which shares are included in Mandatory Cost Basis Reporting?
What cost basis methods are available?
How do you designate your cost basis method?
What happens if no method is selected?
What is a wash sale?
Does cost basis reporting apply to corporate accounts?
What is cost basis?
Generally, cost basis is the purchase price of a security or share, including commissions and expenses, if applicable. Cost basis is used to determine if you have a capital gain or capital loss at the time you sell your shares. You must report capital gains and losses to the IRS for tax purposes.
When you sell or exchange shares, the transaction price is usually different from the original purchase price. If the selling price is greater than the purchase price, your profit is called a capital gain. If the selling price is less than the purchase price, your deficit is called a capital loss. When you are preparing your federal tax return, you must report capital gains and losses to the IRS.
Which shares are included in Mandatory Cost Basis Reporting?
It’s important to remember that the mandatory tracking of cost basis only applies to shares purchased after the effective date of the new cost basis reporting provision (January 1, 2012). This includes shares acquired through dividends and transfers. For mutual funds this means:
Non-covered shares |
Investment companies are not required to track and report these shares. For non-covered shares, the reporting process remains the same as prior to the regulation change:
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Covered shares |
For covered shares, additional cost basis information is reported to the IRS and is included on Form 1099-B starting in tax year 2012. Form 1099-B includes:
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What cost basis methods are available?
Select the primary cost basis method that works best for your accounts. You may select a different method for each of your accounts or one method that covers all of your accounts.
The cost basis methods that are available are:
- Average Cost (ACST) – This is the most common method used by mutual fund shareholders. It is a method for valuing the cost of covered shares in an account by averaging the effect of all covered transactions in the account. The gain/loss is calculated by taking the cumulative dollar cost of the covered shares owned and dividing it by the number of covered shares in the account. Non-covered shares are calculated separately from covered shares and are not reported to the IRS.
- First In First Out (FIFO) – Sell the oldest shares in the account first.
- Last In First Out (LIFO) – Sell the newest shares in an account first.
- High Cost First Out (HIFO) – Sell shares purchased at the highest cost first.
- Low Cost First Out (LOFO) – Sell shares purchased at the lowest cost first.
- Loss/Gain Utilization (LGUT) – A method that evaluates losses and gains and then strategically selects shares based on that gain/loss in conjunction with a holding period to sell shares with the smallest tax consequence first.
- For shares that would result in a loss, shares considered short term are sold first, followed by long-term shares.
- For shares that would result in a gain, long-term shares are sold first, followed by short-term shares, since long-term capital gains rates are more favorable.
- Specific Lot Identification (SLID) – The shareholder needs to designate which specific shares to redeem when placing their redemption request.
- Your gain or loss will vary, depending on which shares you choose.
- For sales where you cannot specify your lots, such as systematic withdrawals, a secondary cost method is available. If you do not select a secondary method, FIFO will be used.
Special handling for non-covered shares (those shares purchased prior to January 1, 2012):
- As a service, we continue to provide Average Cost information on sales of non-covered shares on eligible accounts.2
- You are not required to use the information we provide. You or your tax advisor may use an alternative method for your personal tax filing.
- If you have non-covered shares, they will be sold first using Average Cost (if available).
- We do not report cost basis information to the IRS for non-covered shares.
Exceptions for Specific Lot Identification:
- If you selected “Specific Lot Identification,” you may select from both covered and non-covered shares for sales.
- Cost basis information we provide for non-covered shares may not reflect your actual cost. Refer to your personal records to determine the cost of lots sold.
How do you designate your cost basis method?
If you would like to choose the Average Cost method for your account, NO ACTION IS REQUIRED. The IRS does allow you the option of selecting any of the cost basis reporting methods. Your election will apply to all future transactions unless you either revoke or change the election. If you are using Average Cost as your cost basis method, you may revoke or change your election up to the date of the first redemption, exchange, or transfer of covered shares. After that date, you will only be allowed to change your election on future purchases.
After October 2011, you will have the following options to elect, change, or revoke your cost basis method:
- Changes to your cost basis method can be made through www.principalfunds.com.
- Use the form entitled Cost Basis Options that will also be available through our Forms & Literature page on www.principalfunds.com. Any changes to or from Average Cost must be made through the website or by using the Cost Basis Options form.
What happens if no method is selected?
Principal Funds has selected Average Cost as the default cost basis method. Keep in mind, this default is not a recommendation and may not be the best choice for your situation. The method you choose for your accounts is an important decision and should reflect what is best for your personal situation as determined by you and your tax advisor.
If you sell shares at a loss and purchase shares in the same fund (including reinvested dividends) within a 61-day period, beginning 30 days before the sale and ending 30 days after the sale, the IRS considers the purchase to have “washed” and all or a portion of the loss is disallowed. The IRS designed this rule to discourage shareholders from selling securities solely for the purpose of generating a tax loss.
Please refer to IRS Publication 550, Investment Income and Expenses, for more information on wash sales.
Does cost basis reporting apply to corporate accounts?
IRS regulations require investment firms to report sales and cost basis information on accounts held by “S” corporations as defined by the Internal Revenue Code section 1361(a). In August 2011 Principal Funds sent a notice to our existing corporate accounts requesting that they designate their company as either a “C” or an “S” corporation.
If no response is received, we will register the account as an “S” corporation and begin tax reporting on those accounts starting with the 2012 tax year. We will not report sales and cost basis information for “C” corporations.
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1 This also includes shares that do not have complete cost basis information, regardless of purchase date.
2 Eligible accounts are taxable mutual fund accounts. We do not provide Average Cost for retirement, education, or money market accounts. There may be additional circumstances preventing a specific account from having cost basis information.
3 Short-term holdings are shares sold within one year of purchase. Long-term holdings are shares sold more than one year after the purchase.
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A mutual fund's share price and investment return will vary with market conditions, and the principal value of an investment when you sell your shares may be more or less than the original cost.
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