Huge Opportunity For Your Clients' Portfolios!
After that, a taxpayer may change from the average cost method at any time, but only for shares acquired after the date of the change. (The basis of stock prior to revocation remains averaged.)
A key planning point: Under prior law, once the average cost method was applied to a particular fund for a particular taxpayer, the taxpayer was required to use average cost for all shares of that fund forever! Under these new rules, taxpayers can now choose a more favorable cost basis method.
As of January 1, 2012, mutual fund positions will be bifurcated into two separate pools: “uncovered” shares and “covered” shares. Shares owned prior to 2012 will be part of the uncovered pool and cost basis for that pool will be unchanged. Thus, if average cost previously applied, it will continue to apply to that pool separately from the covered pool. Absent an affirmative election by the taxpayer, the average cost method will be applied to the new covered pool. Custodians will be required to track the two pools separately and will generally sell from the uncovered pool first.
Tax law identifies cost basis methods as average cost; first-in, first-out (FIFO); or “specific identification.” When selecting a method with a custodian, the specific identification method encompasses other conventions such as last-in, first-out (LIFO); high cost; low cost; and “tax optimized.” Although, in the past, high cost has been the simplest way to minimize tax consequences from sales, the new “tax optimized” (or “best tax”, etc.) applies more sophisticated tax minimization strategies automatically. Thus, to minimize taxable gains, the “tax optimized” method should generally be elected. (Note that even for clients currently using “high cost”, the “best tax” or “tax optimized” method will be better.)
Depending on the custodian, it may be necessary to make an affirmative election to use a different cost method even if the taxpayer wishes to retain a pre-2012 method (that was other than average cost). Taxpayers (and advisors) should check with their custodians to avoid any unintended changes.
From an administrative standpoint, I recommend the following:
1. Affirmatively choose “best tax” or “tax optimized” for all clients (especially for those currently using average cost).
2. Double-check with your custodians to be sure that an affirmative election is not required for clients already using “best tax” or “tax optimized.”