Multiple Stock Purchases

Determining the basis and the holding period of shares you sold can be complicated, if you've made more than one purchase of shares of the same company's stock or the same mutual fund. This might occur because you were participating in a dividend reinvestment plan, or because you were dollar-cost averaging by making regular periodic investments over an extended period of time.

If you sold the entire investment and you stopped reinvesting dividends more than a year before the sale, it's fairly simple. The entire gain will be considered long-term, to be reported in Part II of Form 8949 and carried over to Part II of Schedule D.

If you continued to reinvest income or make purchases up to the date of sale, you can follow the same procedure described above, except that any dividends reinvested or purchases made within the last year will be reported in Part I of Form 8949 and carried over to Part I of Schedule D for short-term gains.

If you sold only part of your investment, and you purchased shares at various times during the year(s), you may have a choice as to which shares you can treat as the ones you sold. If, before the sale, you inform your broker or financial institution as to which specific shares you want to sell, you can treat those specifically identified shares as the ones that were sold. This gives you the opportunity to plan (some would say manipulate) the timing and amount of your gains.

Example If, at various times over the course of several years, you purchased 100 shares of XYZ at $35, 200 shares at $42, and 100 shares at $55, and you now want to sell 200 shares, you can tell your broker to sell the most recently purchased shares. In that case, your tax basis would be 100 x $42 plus 100 x $55 = $9,700. However, if the most recent purchase was less than one year ago, you would probably prefer to tell the broker to sell the 200 shares purchased at $42, to take advantage of the lower tax rate.

If you don't specifically identify the shares of stock that you sold, the IRS requires you to assume that the shares you sold were the first ones you purchased. Since, over time, stock prices tend to rise, this first-in, first-out (FIFO) method tends to result in higher gains reporting. It's not surprising that the IRS prefers it. On the upside, it will usually result in your reporting long-term gains if at all possible, rather than short-term gains.

If you own shares in a mutual fund and want to sell some, but not all, of them, it will be very difficult, if not impossible, to ask the fund in advance to sell specific shares. You can use FIFO to determine your basis and holding period for the shares you sell.

However, you can also use something called "average cost basis," which is an average of the prices you paid for all shares you own at the time of the sale. Many mutual fund companies will automatically calculate average cost at the time of the sale, and if they do, this is an easy way to report your sale. If it's not automatically calculated, however, it can be very difficult to compute.

Once you choose a method for selecting the shares you sold in a partial sale (e.g., FIFO, specific identification, or average cost), you must stick with it for that particular investment. For more information, see IRS Publication 564, Mutual Fund Distributions.