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The provision of cost basis is part of the Clean Renewable Energy and Conservation Tax Act of 2007. The cost basis provision will apply to stocks purchased after January 1, 2009 and all other instruments after January 1, 2011.
Cost basis of municipal bonds is important because you can calculate your profit or loss when you sell the bond. This can be done by subtracting your cost basis from the current selling price of the bond, and the difference between the two is what the government taxes.
Cost basis is quite simple if you happen to buy securities at just one point of time. However, if you have been buying bonds and other securities all along, the calculation can get a little bit tricky. There are ways and means of calculating cost basis which can help you pay less taxes to the government.
Method I: First In First Out (FIFO)
This method assumes that you sell bonds and securities in the order of purchase. While the method is quite simple, it can lead to a lot of taxable gain because the longer you hold the securities in a rising market, the more they are worth.
Method II: Single Category Averaging
This method lets you take the total cost you paid for all the shares and bonds and then divide that figure by the total number of shares and bonds you own. This gives the average cost basis for each share or bond. This method too sells the oldest shares and bonds first. However, once you start using this method to calculate your cost basis, you cannot switch to another method without approval from IRS.
There are other methods that allow you calculate cost basis and you should choose a method that best suits your needs and situation. In most cases, municipal bonds are not taxed by the IRS unless you come under Alternative Minimum Tax (AMT).
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