cost basis of a gift


H

Huayong Yang

Consider this hypothetical scenerio:

I received 200 shares of a mutual fund as a gift, of which
100 shares was purchased at $10 and the other 100 shares at
$20. Since the fund NAV on the gift date is $5, which is
less than the donor's cost basis, the cost basis of a
subsequent sale of the gift shares depends on whether the
sale is a gain or loss. (I learned most of this from the
informative article
http://invest-faq.com/articles/tax-cap-gains-basis.html)

My question is as follows: If I sell 100 shares of the gift,
do I have a choice either to use average cost basis (ACB),
which is $15, or to specify which 100 shares I am selling
and use their actual purchase price (APP)?

I perceive there is an advantage of using ACB over APP if I
sell the 200 gift shares in two installments (100 shares
each) and the sale prices stay between $10 and $15: using
ACB, I have no gain or loss; using APP, I have a gain when
selling the 100 shares purchased at $10. (Actually, the
advantage exists in the price range from $10 to $20, as one
can prove that if 15<x<20, (x-15)*200<(x-10)*100, with the
left hand side being the capital gain using ACB and the
right hand side, the gain using APP. Outside this range,
there is no difference whether to use ACB or APP.)
 
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A

Arthur Kamlet

Huayong Yang said:
Consider this hypothetical scenerio:

I received 200 shares of a mutual fund as a gift, of which
100 shares was purchased at $10 and the other 100 shares at
$20. Since the fund NAV on the gift date is $5, which is
less than the donor's cost basis, the cost basis of a
subsequent sale of the gift shares depends on whether the
sale is a gain or loss. (I learned most of this from the
informative article
http://invest-faq.com/articles/tax-cap-gains-basis.html)
And an excellent article it is, if I say so myself :^)
My question is as follows: If I sell 100 shares of the gift,
do I have a choice either to use average cost basis (ACB),
which is $15, or to specify which 100 shares I am selling
and use their actual purchase price (APP)?

I perceive there is an advantage of using ACB over APP if I
sell the 200 gift shares in two installments (100 shares
each) and the sale prices stay between $10 and $15: using
ACB, I have no gain or loss; using APP, I have a gain when
selling the 100 shares purchased at $10. (Actually, the
advantage exists in the price range from $10 to $20, as one
can prove that if 15<x<20, (x-15)*200<(x-10)*100, with the
left hand side being the capital gain using ACB and the
right hand side, the gain using APP. Outside this range,
there is no difference whether to use ACB or APP.)
The rules for dual basis when receiving shares as a gift at
below cost basis, are clearly intended to discourage any
mechanism which allows using the loss to reduce gain.

I know of no rulings on the subject, but I personally would
see using Average Cost Basis to achieve a reduced gain and
thus using some of that loss as going against the intent of
the law.

That being the case, and the fact that I tend to be fairly
conservative, I would not agree with your position, but
would like to see a ruling on the subject. However I am
sure you can find someone who might take an aggressive
stance on the issue and reduce the gain for you. And argue
that point before the IRS.

__
Art Kamlet ArtKamlet @ AOL.com Columbus OH K2PZH
 
H

Huayong Yang

And an excellent article it is, if I say so myself :^)
The rules for dual basis when receiving shares as a gift at
below cost basis, are clearly intended to discourage any
mechanism which allows using the loss to reduce gain.

I know of no rulings on the subject, but I personally would
see using Average Cost Basis to achieve a reduced gain and
thus using some of that loss as going against the intent of
the law.
However, if the donor sold 1 share before giving me the rest
199 shares and he used average cost basis for his
transaction, I would have no choice but to use average cost
basis for _my_ transactions in the gift account, as the
shares have been "polluted". Right?

Here is another question: If I got the 200 shares when the
NAV was $16, is the cost basis of the gift

(1) $3000 (the donor's original cost basis, which is
< $16*200) or

(2) $1000 for the 100 shares purchased at $10 and some
unknown amount for the 100 shares purchased at $20 to
be determined at the time of sale?

I don't see anything wrong with choosing #1, but that would
imply using average cost basis.

From my point of view, the actual benefit of using average
cost basis lies in bookkeeping rather than taxes. (If I were
the donor giving away shares when they are significantly
below their cost basis, I'd sell them, pocket the loss and
give away the proceeds instead.) For a mutual fund account
with dividends and capital gains reinvested, it is quite
common to have shares purchased at various prices. When the
ownership of the account is transferred to me, chances are
that its NAV per share is lower than the purchase prices of
some shares and higher than those of others. In this case,
it is a real hassle having to separate the "cheap" shares
from the "expensive" shares to determine the cost basis of
the gift.
 
R

Rich Carreiro

However, if the donor sold 1 share before giving me the rest
199 shares and he used average cost basis for his
transaction, I would have no choice but to use average cost
basis for _my_ transactions in the gift account, as the
shares have been "polluted". Right?
You can use whatever basis method you want. So you can use
avg cost, fifo, specific ID, whatever.

HOWEVER, because the giver sold that one share via average
cost, that irrevocably made the basis of all the 199
remaining shares be equal to the average cost, and so that's
the per-share basis you take over.

To be concrete, say the owner bought 100sh for $10/sh and
another 100sh for $20/sh, then sold 1 share and subsequently
gave you the other 199 at a time when the NAV of the fund
was over $15/sh. Every share you received would have a basis
of $15/sh. You now buy another 100sh at $22/sh. Now you
plan to sell. You are free to use any cost basis method to
account for your sale. However, you only have two share
lots -- one lot of 199sh with each share having a basis of
$15 and one lot of 100sh with each share having a basis of
$22. You do *not* have three lots.
 
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A

Arthur Kamlet

However, if the donor sold 1 share before giving me the rest
199 shares and he used average cost basis for his
transaction, I would have no choice but to use average cost
basis for _my_ transactions in the gift account, as the
shares have been "polluted". Right?
I agree by the owner electing to use average cost basis, his
cost basis when he gifted the shares to you is the average
cost basis of the shares. Remark: Selling shares in no
way changes the average cost basis.

Side question:

Choosing to use average cost basis (Type I or Type II) is an
election made by the taxpayer which, once made, remains in
effect while he holds substamntially identical shares.

My understanding is the way the election is made is simply
to calculate the average cost basis in your internal records
and use that ACB when filing schedule D.

However CCS UltraTax, which contains a whole list of
"election letters" includes an election letter (like an
attachment) to elect to use average cost basis for a stock.

Is this just a conservative addition requested by UltraTax
legal types or is there a requirement of which I am unaware
that you must elect to use average cost basis by an actual
statement on or with the tax return stating "I elect to use
average cost basis Type (I/II) for the following mutual
fund?"

If there is I will take the time toi fill out the UltraTax
Average Cost Basis election, but otherwise it seems like a
pain in the neck and I'll ignore it.
Here is another question: If I got the 200 shares when the
NAV was $16, is the cost basis of the gift

(1) $3000 (the donor's original cost basis, which is
< $16*200) or

(2) $1000 for the 100 shares purchased at $10 and some
unknown amount for the 100 shares purchased at $20 to
be determined at the time of sale?

I don't see anything wrong with choosing #1, but that would
imply using average cost basis.
As discussed above, if you wish to use average cost basis,
you must, make that election at the time of filing your
1040.

If the owner did not make such an election by selling and
filing a tax return using ACB, then his cost basis when he
gifted the stock to you is his cost, not an average cost.

To calculate gain at time of sale you have to use donor's
cost basis. If donor never elected ACB I don;t see how you
can, but I am, as I said before, being very conservative on
this issue. Someone else might take a more aggressive
position which would argue you can use ACB since owner's
cost of each lot is known and owner could have made such
election so you should be able to.

But IMO the recipient is stuck with using owner's actual
cost for calculating gain.
From my point of view, the actual benefit of using average
cost basis lies in bookkeeping rather than taxes. (If I were
Sure. But ignoring ease of use, the IRS has made the use of
ACB which, once used, must continue to be used for that
stock, into a pretty strong rule.
the donor giving away shares when they are significantly
below their cost basis, I'd sell them, pocket the loss and
give away the proceeds instead.) For a mutual fund account
with dividends and capital gains reinvested, it is quite
common to have shares purchased at various prices. When the
ownership of the account is transferred to me, chances are
that its NAV per share is lower than the purchase prices of
some shares and higher than those of others. In this case,
it is a real hassle having to separate the "cheap" shares
from the "expensive" shares to determine the cost basis of
the gift.
We're talking of the case of someone with big bucks who has
a very large paper loss and a low life expectancy. Selling
will not allow the loss to be used in his lifetime. So now
there is a rule to prevent him from transferring that loss
to another. Death can be harmful to taxes, at least in this
case.

__
Art Kamlet ArtKamlet @ AOL.com Columbus OH K2PZH
 

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