With the new IRS tax reporting regulations, average cost positions will be bifurcated.  Thanks to government regulation, covered and uncovered shares will now maintain a separate average unit cost which require manual data entry in PortfolioCenter to maintain accurate cost basis data for both unrealized and realized gains and losses.

Here’s the gist:  The new rules that go into effect January 1, 2012 split your mutual fund shares into two buckets:  those purchased before January 1, 2012 (which are “not covered” by the legislation) and those purchased after the January 1, 2012 (which are “covered” by the legislation). Each bucket must have its own average cost, and and the legislation requires you to sell shares from the uncovered bucket first until they are exhausted.

Bifurcation of cost basis only applies to positions that meet all of the following criteria:

  • trade lots sold using the average cost accounting method
  • one or more of the trade lots acquired prior to January 1, 2012 (uncovered trade lots)
  • one or more trade lots acquired after January 1, 2012 (covered trade lots)

Managing bifurcating securities will involve complicated manual data entry until all uncovered lots are sold.  Potentially this could affect 1000’s of lots over many years, requiring consistent ongoing, detailed manual entry. You may want to revisit the decision to maintain cost basis in PortfolioCenter for average cost positions.

Don’t want the hassle?  You have two options: “give up” tracking cost basis in PortfolioCenter and let your custodian deal with it; or switch to another matching method.  You can eliminate the need for bifurcation if you move out of average cost accounting by 12/31/2011.

If you decide to switch methods, you should consult your clients and implement the change at your custodian and in PortfolioCenter on the same date.  Preferably, this switch date should be January 1, 2012.

If you decide to continue with average cost accounting and deal with bifurcation, you should:

  • Verify that the cost basis accounting methods used in PortfolioCenter match your custodian for the mutual fund securities.
  • Reconcile the cost basis in PortfolioCenter with your custodian.  If there are discrepancies and PortfolioCenter is correct, contact your custodian about uploading the cost basis information from PortfolioCenter to the custodian’s platform.  If your custodian has the correct information, update the cost basis in PortfolioCenter.
  • Use Data Management tools and custom fields to identify and track the accounts that will contain bifurcated average cost.
  • Make sure that you are running PortfolioCenter 5.4 or greater.
  • At the end of the year, run the Cost Basis Reset Wizard to lock in the cost basis for the uncovered — now bifurcated — positions. The unit cost from the custodian is assigned to each lot, in effect freezing that value.
  • To ensure that future sales use the correct accounting method, change the default value for the Mutual Fund Matching Method field to FIFO so uncovered lots are sold first.
  • Create a system for tracking bifurcated lots so that you can switch the Mutual Fund Matching Method back to average cost once the uncovered lots are exhausted.

UPDATE May 2012:  PortfolioCenter 5.5 makes handling bifurcated lots easier.

For more help:
Restting the Historical Accounting Method for Mutual Funds
Best Practices for Bifurcating Average Cost Basis for Mutual Funds
Maintaining and Exhausting Bifurcated Average Cost Positions in PortfolioCenter 5.4

Wouldn’t you rather outsource this to an expert?

Photo used here under Flickr Creative Commons.