Figuring your basis for ETFs

Exchange-traded funds (ETFs) share features of both individual stocks and mutual funds. To determine your gain or loss when you sell shares in ETFs, you need to know your basis. This is a tax term that has special meaning.

General rule

Like stock, an investor’s basis in ETF shares usually is based on cost—what you paid for the shares, plus any sales commissions. However, if you did not buy the shares yourself, there are other ways to determine basis:

• If you acquire shares by inheritance, your basis is the shares’ value for estate tax purposes (usually fixed on the date of the decedent’s death).
• If you received shares as a gift, your basis usually is the same as the basis of the person who made the gift; ask that person for basis information.

Adjustments to basis

ETFs that invest in commodities and currencies can be set up differently requiring basis adjustments. It's best to check with your tax professional if you hold these types of ETFs.

Tracking basis

It is important for you to keep track of basis so you can make smart decisions about selling for tax advantage. For example, if you acquire shares in the same ETF at different prices, your basis in all the shares is the sum of everything you paid. However, if you decide to sell less than your entire holdings in the ETF, you’ll need a basis breakdown if you want to sell and minimize your tax results.

If you do nothing—simply ask to sell a certain number of shares in the ETF—you are presumed to have sold the first shares acquired. This is referred to a FIFO, or first in, first out. However, if you identify which shares you want to sell, you can choose those that produce the lowest gain or the greatest loss, depending on the situation.

For example, say you bought 100 shares of the XYZ ETF at $67 in March 2018. You also bought 100 shares in January 2019 at $110. In July 2020, you sell 50 shares at $155. If you do nothing, you are presumed to have sold 50 of the shares for which you paid $67, which would give you an $88 profit per share (ignoring transaction costs for the purpose of the example). However, if you identify the shares that you wish to sell and name those purchased in 2019, your gain is only $45 per share.

You may also be able to use the average cost basis method for your ETF holdings; check with the firm that sold you the ETF to see if your shares are eligible for averaging.

Final Word

It may be helpful to retain confirmation statements whenever you purchase ETF shares. Work with your tax advisor to make sure your actions with respect to ETF holdings optimize tax results.