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Update: Since this article was originally published, new legislation requires that mutual fund providers calculate -- and report to the IRS -- the cost basis for all mutual fund shares purchased after Jan. Investors can choose from a minimum of three cost basis accounting methods.
For mutual fund shares purchased prior to 2012, the article below still serves as a guide to selecting the appropriate, historic cost basis method.
Like the specific identification method, you should send a letter to the fund company identifying which shares you wish to sell.
If you don't alert the fund company to the specifics ahead of the sale, you must first charge the shares sold against the long-term category, the remainder against shares that fall into the short-term category. Each method could hold wildly different tax implications -- particularly if you've been invested in the fund for several years.
Investors who don't redeem shares all that often may find the average cost method the easiest.
Simply elect to calculate the cost basis of your mutual fund shares using an average price.
Unlike FIFO, you need to decide in advance of the sale if you want to use this method.
Send your mutual fund company a written request indicating the number of shares to redeem, the date they were purchased and the purchase price -- all before you sell.
That control, though, comes for a price -- your time and patience.But for many mutual fund investors, that's when the headache begins.Selling mutual fund shares requires a fair amount of organization and planning -- especially if you want to optimize the resulting tax situation.You can calculate your cost basis differently in each of your funds, but once you've used a method for a fund, you need IRS permission to change it for that fund.Most fund companies will calculate your overall basis in a fund for you, although most charge upwards of for the service.