Course 507: Calculating Your Cost Basis
What's the Difference?
In this course
1 Introduction
2 First In, First Out (FIFO)
3 Specific Share Identification
4 Single-Category Averaging
5 Double-Category Averaging
6 What's the Difference?

Which method works best varies from situation to situation.

Let's take an example. Robert bought 25 shares of the no-load Raging Bull Fund at $9 apiece in 1998. He purchased another 50 shares at $10 apiece in 2000, and 25 shares at $11 each in 2002. In early 2003, he decided to sell 30 of his 100 shares at $12 apiece, for a total sale of $360. Assuming all his gains are long term, which method for calculating cost basis should he use, and what will his taxable gains be?

If Robert uses FIFO, he'd sell his oldest shares first. The calculation:

(25 x $9) + (5 x $10) = $275 cost basis

His taxable gains would be his total sale minus his cost basis, or:

$360 - $275 = $85

If Robert chooses the specific-share identification method, he'd sell his most expensive shares first.

(25 x $11) + (5 x $10) = $325 cost basis

His taxable gains would be:

$360 - $325 = $35

If Robert goes the single-category averaging route, he'd divide the total cost of shares by the total number of shares owned to get his average share price. He'd then multiple by number of shares sold for total cost basis.

(25 x $9) + (50 x $10) + (25 x $11)

x 30 = $300


His taxable gains would be:

$360 - $300 = $60

Robert can't use the double-category averaging method, because all his gains are long term.

Robert minimizes his taxable gains by using the specific-shares method: His taxable gains are just $35 versus $85 under FIFO and $60 using the single-category averaging method. With a little effort and a calculator, you can reduce Uncle Sam's take, too.

Next: The Quiz >>

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