You receive this message from your broker with a list of accounts, dates and dividends: “Cost Basis Adjusted. No Action Required. The following accounts’ cost basis was adjusted due to an action such as return of capital.”
The notice may say “no action required?” but the cost basis in PortfolioCenter no longer reconciles with the broker. You’ll need to do something.
Most likely the fund reclassified some or all of its dividends as return of capital.
Due to complicated IRS rules and regulations, fund companies may need to adjust dividends already paid when they close their books at the end of the fiscal year. Since they can’t ask for their money back, they reclassify part or all of dividend as a return of capital, keeping the number of shares the same and reducing the cost basis of each trade lot by the amount of reclassification.
For example Vanguard REIT ETF (VNQ) adjusted its prior year dividends with this explanation:
The Vanguard REIT Index Fund pays quarterly distributions consisting of dividend income, return of capital, and capital gains. However, the tax characteristics of these distributions cannot be determined until after the end of the year since the REITs in which the fund invests do not designate the composition (i.e., dividend income, return of capital, and capital gains) of their payments until the new calendar year.
How do you reconcile PortfolioCenter cost basis to the broker after an income reclassification? Here are 4 options — none of them perfect.
- Give up, designate your broker as the system of record and stop tracking cost basis in PorfolioCenter. While not a serious option for most managers, this option has merit in some cases.
- Use the Income Reclassification Wizard. Good luck with that. The first page of the Schwab PortfolioCenter documentation reads: “If you do find that a mutual fund company has changed income, you should request a list of all changed assets from the company. This list should tell you the security, the pay date of the income, and the original distribution type, as well as the percent of the income that should be reallocated to different distribution types.”
In my experience, the process breaks down at this step. Getting this information can be challenging. First, try calling the cost basis team at your broker. If they don’t have it, try a searching the company website or calling their investor relations phone number.
- Use the Trade Lot Reconciliation Tool to identify the new cost basis for each lot and enter an Amortization transaction to adjust PortfolioCenter accordingly. Since this must be done on an account by account basis, it is slow and time-consuming. But you can find all the information necessary, it works and avoids rounding errors.
- Use the Cost Basis Reset wizard to debit the current trade lots and replace them with the adjusted lots. This option is the quickest and easiest of the methods. However, it will produce credits/debits in the accounts. Before using the Reset Wizard, make sure you understand the implications for holdings and tax reports.