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Capital Gains and Cost Basis

If you sell a security, the IRS requires that you report any resulting capital gains or losses as well as the associated cost basis when you file your income tax return. Learn the basic principles behind reporting this information.

Should I sell at a loss to offset capital gains?

This is a strategy many investors choose, and it can be effective if you haven't bought new shares of the same security within the past month and do not plan to purchase any in the following month. However, if you purchase additional shares of the same or substantially identical security within 30 days before or 30 days after the sale date, you will have made a "wash sale," and you cannot claim the loss on your income tax return. Instead, you can add the disallowed loss to the basis of the security in your account.

Cost basis is the price you paid to purchase a security plus any additional costs such as broker's fees or commissions.

When you sell a security, your tax liability is determined by how much you spent to buy the security (cost basis) and your sales price. If you sell a security for more than the original purchase price, the difference is taxable as a capital gain.

Gains from the sale of securities are generally taxable in the year of the sale, unless your investment is in a tax-advantaged account, such as an IRA, 401(k), or 529 plan. Generally, for those accounts, you only incur taxes when you start taking withdrawals.

Capital gains are taxed at different rates depending on your tax bracket and how long you've held a security. If you sell a security that you've held for more than a year, any resulting capital gains are considered long-term and are taxed at lower rates than ordinary income. Conversely, short-term capital gains are taxed as ordinary income. In addition to offsetting certain capital losses against capital gains, investors can generally deduct net capital losses of up to $3,000 from their taxable income each year. If you incur more than $3,000 in losses in a given year, you can carry forward the remaining loss balance to subsequent years.

The IRS generally identifies two methods for calculating cost basis—the cost basis method and the average basis method. The average basis method is strictly for mutual funds and equities held in certain dividend reinvestment plans.

Cost basis method – There are many variations of this method but the fundamental principle is the same: investors must identify the cost of the actual shares sold. This is important because investors may have a portfolio that contains shares purchased at different times or prices. You need to know the purchase price of the shares you sell. Below are two applications of this method.

  • First-in, first-out (FIFO) – Shares are sold in the order in which they were acquired - so the oldest shares are sold first. FIFO is Fidelity's default method for calculating cost basis for all securities with the exception of mutual funds. If you do not specify the exact shares you want sold, Fidelity may apply this method, thus making your cost basis the purchase price of your oldest shares.
  • Specific share identification – With this method, prior to settlement, you must specify precisely which shares you want sold and receive a written confirmation following the sale.

View a list of other applications of the cost basis method. You can use any of these variations to establish standing disposal instructions for subsequent sales from your account.

Average basis method – The average basis method determines basis by calculating an average cost per share for all purchased shares. Because of the new IRS cost basis reporting regulations, we must separately calculate the average cost of shares you acquired before January 1, 2012 and shares you acquired after that date. The IRS regulations permit this method only when calculating the basis for mutual funds and equities held in certain dividend reinvestment plans. See IRS Publication 550, Investment Income and Expenses (PDF), and the Instructions for Form 8949 (PDF). Average basis is Fidelity's default cost basis calculation method for mutual fund sales, redemptions, and exchanges.

Taxpayers have a long-standing responsibility to report gains and losses, and related cost basis information when they file their income tax returns. Brokers, such as Fidelity, also have a requirement to report sales information to the IRS on Form 1099-B. However, new regulations have expanded these requirements to include additional reporting on various types of securities. Beginning with certain securities, acquired as early as 2011 and subsequently sold or redeemed, brokers' IRS reporting obligations expanded to include cost basis information related to your sales or redemptions of "covered" securities on Form 1099-B.

Covered securities include:

  • All stock purchased on or after January 1, 2011
  • Shares in mutual funds and dividend reinvestment plans (DRIPs) purchased on or after January 1, 2012
  • Certain fixed-income securities and options purchased on or after January 1, 2014

The IRS will require reporting for other related securities in following years. Since these regulations are new, many customers hold both covered and non-covered securities, and Fidelity tracks and reports sales and other dispositions from each category separately.

How Fidelity calculates cost basis

Fidelity uses the average basis calculation method as its default method for determining the cost basis for mutual fund sales and exchanges. For other securities, we use the FIFO method. In many cases, you can elect to change these methods by contacting a Fidelity representative at 800-544-6666.

To report capital gains on your return, you must file Schedule D with your Form 1040 or 1040A; most filers need to begin with Form 8949, which provides a format for listing each individual sales transaction that you make during the year. For more information about cost basis and completing these forms, see Form 1040 Schedule D guide for capital gains and losses.

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Applications of the Cost Basis Method

Method Used for How it works for each security Typical effects
First-in, first-out (FIFO) Any securities* Sells shares starting with the ones you have held the longest and works up to the most recently acquired May result in larger taxable gains than other disposal methods
High-cost (HICO) (also HICO Long-Term and HICO Short-Term) Any securities

Sells shares with the highest purchase price first. If more than one lot has the same price, we sell the lot with the earliest purchase date first.

Long- and short-term variations sell shares starting with the highest purchase price in the short-term or long-term holding period first. Depending on the variation, after all short-term or long-term shares are depleted, we then follow the same approach for the other category.

May help minimize taxable gains
Low-cost (LOCO) (also LOCO Long-Term and LOCO Short-Term) Any securities Sells shares with the lowest purchase price first. Long-term and short-term variations sell shares starting with the lowest purchase price in the long-term or short-term holding period first, as we explained with the high cost method. May increase taxable gains
Last-in, first-out (LIFO) Any securities Sells shares starting with the shares you purchased most recently and works backwards to the shares you held for the longest time. May help minimize taxable gains
Tax-sensitive Any securities Sells shares starting with the greatest losses, works through to the smallest losses and then from the smallest to greatest gains; includes calculation of the estimated gain using static long-term and short-term rates to determine the tax per share. May help minimize taxable gains
Specific share identification Any securities Allows you to choose which specific lots you sell at a given time. You must identify the shares by the Settlement Date. Most labor-intensive; can result in the least taxable gain, since it gives you discretion over which gains become realized and, therefore, are taxable
*Fidelity's default method for all types of securities except mutual funds.

Additional resources

Qualified Dividends
Learn the basic principles behind what dividend income is taxed at lower capital gains rates.

Help with cost basis

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