Mutual Fund Conversion Taxable and Nontaxable

GW

I have read some if not all the discussions related to this action. As I understand the transaction when I convert class of an open end mutual fund it is a kike kind tax free exchange where I retain the cost basis.

We have the option of either using average cost or actual cost with the IRS allowing only the transition of actual cost to average cost but never back. Also tax deferred accounts where cost basis is not relevant we don't need to concern our self with the cost basis other than performance tracking.

So, entry of these we accomplish as follows:

Tax deferred accounts and securities where average cost accounting has been selected:
> Transfer shares out
> Transfer shares in
> Adjust the average cost basis

When actual cost basis is used:
> Transfer shares out by lot
> Transfer shares in by lot
> Adjust the cost basis by lot

Did I understand the discussions correctly?

Sherlock

The IRS does allow us to switch cost basis methods but we must do so in writing.

Cost-basis is used to determine capital gain.  For taxed deferred accounts that are either tax-free at withdrawal or require the amount withdrawn to be treated as income, we do not need to determine capital gain - we don't need to track cost basis other than to track performance.  

Quicken does not have a Transfer action transaction.  

When performing a mutual fund conversion, there is only one Removed action transaction necessary in an account to remove all of the shares of the original security.  

The conversion is completed using the Added action transaction.  Normally, there should be an Added action transaction for each lot to track cost basis.  If you're not interested in tracking the cost basis of the security, you may use one Added action transaction.   You do not need to specify cost or a date of purchase (press Ctrl + Alt + N and select Adjust share balance...).

If you're always going to be using average cost basis to track the cost basis of a security, you may not need an Added action transaction for every lot.  For example, all the long-term holdings of a security may be grouped in a single Added action transaction.  Note: The lots that are not long-term should still be entered individually unless you're certain they will not be sold until they qualify as long-term holdings.  

Note: I never use average cost basis in Quicken.

GW

Thank you! One of the primary reasons I am a quicken user started in the early 90s, was to account for actual cost basis but I got confused in the answers.

q_lurker

I am not aware of any comprehensive discussions about the pairing of real world mutual fund conversions with average cost basis considerations that encompass Quicken's treatment of both.  Fundamentally, you seem to have a basic understanding, but I'll try to get my thoughts expressed as well.  

FWIW, I am not a user of Average Cost basis designations within Quicken.  My view is that Quicken is adept at managing investments by lot and that offers me the greatest flexibility, so that is what I do.  I have, however, tried to understand the ins-and-outs for those users who do want to use Average Cost as their basis.  

I'll also point out that in past years, the IRS has allowed two different approaches on cost basis where Quicken only managed one of those two, the simpler approach.  I recent years, the IRS has allowed for the user to change the approach; within Quicken, it is still an all-or-none decision.  It is ultimately the investor's responsibility to make sure that what is reported on tax returns is correct and consistent with information reported to the IRS by the financial institutions.

The selection of average cost basis is done in Quicken at a security level (Edit security details).  Once so selected, that choice applies across ALL Quicken account - taxable and tax-deferred.  There are workarounds to that aspect, but they may carry unintended consequences. 

One other aspect to be aware of is that the selection to Use Average Cost is a toggle within Quicken.  The user can have it set to Use and then switch it off at will.  Quicken pops up a warning that making such a change may be inappropriate, but the change will proceed (with the users agreement).  Doing so essentially changes the cost basis used for any prior sales, that the cautionary note.  

The Mutual Fund Conversion macro-transaction can be used to mimic real world conversions typically from one class of fund to another.  That conversion process applies within one account at a time.  It can be used on either taxable or tax-deferred accounts.  It works the same within either account.  (You may have read of bugs in that procedure; I believe those bugs have been taken care of in the recent subscription program releases, circa 2020).  The basics of that MF Conversion is that it creates one Remove Share transaction and then a series of Add Shares transactions - one for each of the previously held lots.  Those basics apply whether the security is identified to use Average Cost or not. 

So if the users elects to use that MF Conversion process, Average Cost is not a factor in how Quicken works.  If the user elects to manually make the conversion, the user obviously has great flexibility.  One of the options is certainly to do one Remove Shares and one Add Shares, and that might be especially appropriate in a tax-deferred account.  In that case, it is not so much that the user is "adjusting" the cost basis.  Rather the user is entering the cost basis that he deems proper. 

That one Remove, one Add option might also be appropriate in a taxable account where average cost basis is being used for that security.  (Note Sherlock's comment about short term and long term holding periods.)

A caution with respect to such circumstances where prior sales of the security may be in the records -- which I will attempt via example.
In Quicken, you have a security (mutual fund) set to use average cost.
First, suppose you bought 50 shares for $50/share ($2500) and 50 shares for $150/share ($7500).  You have 2 lots and 100 shares at an average cost of $100/share.
Second, you sell 25 shares.  Quicken is going to so the basis of those shares sold at $100/share.  It is also going to show that the shares cam from that first lot.  Those are essentially independent programming decisions on their part.  You now have 75 shares with a total basis of $7500.  You also have 25 shares acquired in the first lot and 50 shares acquired in the second lot. 
Third, you convert those shares via a Mutual Fund Conversion (assuming a 1:1 conversion ratio for simplicity).  Quicken will Remove 75 shares from the account, then Add 25 shares with the original lot date and a basis of $50/share for a basis of that lot of  $1250.  Then Add 50 shares (second lot) using $150/share for a total of $7500.  You have ended up now with 75 shares (correct) and a total basis of $8750 (INCORRECT).
In such a case with prior sales of the security using average cost basis and trying to use Mutual Fond Conversion, IMO, the user should actively correct the Add Shares transaction to better reflect the total cost basis.  (Note that the same behavior applies if using Shares Transferred between accounts.) 

So in summary, I do not disagree with your understanding, but there can be much more to be aware of and cautious about.

HTH     

Jim_Harman

Please note that if you have more than one tax lot of a security that is set to Use Average Cost and you use the Mutual Fund Conversion macro transaction, Quicken mis-calculates the total cost basis of the new security.

If there are N tax lots, it sets the new cost basis to N times the original cost basis. This is clearly a bug.

q_lurker

Jim_Harman said:

Please note that if you have more than one tax lot of a security that is set to Use Average Cost and you use the Mutual Fund Conversion macro transaction, Quicken mis-calculates the total cost basis of the new security.

If there are N tax lots, it sets the new cost basis to N times the original cost basis. This is clearly a bug.

(D___.  I thought that had gotten fixed.  ARRRGH.)

Jim_Harman

No, I just re-tested on R28.24 and it is still broken.

It might be possible to work around this by un-checking Use Average Cost before doing the conversion then checking it for the new security, but I don't know what the side effects might be. For example it might re-compute the gains on previous partial sales.

IMO this is all the more reason to not use average cost in the first place.

skypilot744

Thank you for all your comments regarding the mutual fund conversion tool and associated cost basis errors. I'm clearly not as accomplished as you are with Quicken and really needed your help as my financial institution's wealth managers recently did some mutual fund conversions from some Class A shares to Class L shares and I had to deselect the "use average cost" option to make it work per your comments. The problem I have now is that Quicken still refuses to recognize Class L transactions. Specifically, when I purchase or sell Class L shares, Quicken records it as a Class A share transaction even though both my financial institution and Quicken holdings indicate that I have Class L but no Class A share holdings. So, I have to allow Quicken to download the erroneous transaction and then edit it in the ledger which is not a big problem but annoying. Also, whenever I download activity involving any of the accounts that I have these shares in, I receive a Securities Comparison Mismatch message that my financial institution is reporting Class A shares and that there are none in Quicken which is opposite of the actual activity history on my financial institution's website. I have double checked the symbols in Quicken and even talked to my financial reps to make sure there isn't something unusual about these mutual funds but they have no idea. Any suggestions? Thank you for your time.

Sherlock

skypilot744 said:

Thank you for all your comments regarding the mutual fund conversion tool and associated cost basis errors. I'm clearly not as accomplished as you are with Quicken and really needed your help as my financial institution's wealth managers recently did some mutual fund conversions from some Class A shares to Class L shares and I had to deselect the "use average cost" option to make it work per your comments. The problem I have now is that Quicken still refuses to recognize Class L transactions. Specifically, when I purchase or sell Class L shares, Quicken records it as a Class A share transaction even though both my financial institution and Quicken holdings indicate that I have Class L but no Class A share holdings. So, I have to allow Quicken to download the erroneous transaction and then edit it in the ledger which is not a big problem but annoying. Also, whenever I download activity involving any of the accounts that I have these shares in, I receive a Securities Comparison Mismatch message that my financial institution is reporting Class A shares and that there are none in Quicken which is opposite of the actual activity history on my financial institution's website. I have double checked the symbols in Quicken and even talked to my financial reps to make sure there isn't something unusual about these mutual funds but they have no idea. Any suggestions? Thank you for your time.

Quicken matches data for a security received from a financial institution to a security in the data file using a field provided by the financial institution which should be the CUSIP number or an alternate identifier used in the account by the financial institution when the security is not publicly traded. 

The first time we import data for a security, we are prompted to match the imported security to an existing security that is not matched to an online security or to create a new security.  We may clear this linkage by unchecking Matched with online security on the Edit Security Details window.

Based on your description, I suspect the securities have been mismatched.  I suggest you clear the linkage of the mismatched securities.  The next time Quicken processes the online security, you should be prompted to match the online security again.

q_lurker

@skypilot744 Further to Sherlock's comments, I suggest:

• Edit the security details for both classes of mutual fund.
• Make sure the security names are unique.  If the names are particularly long, make sure the uniqueness is easily distinguished in the first 10-15 characters
• Make sure the ticker for each fund is correct and unique.
• Uncheck the box "Matched with online security" for each security. 

Now with you next download, you should be given the opportunity to match the new Class L holding to the correct Quicken security.  

skypilot744

Thank you both. After un-matching with online security, I'm not getting the Security Mismatch Error anymore. Regards.