What are the “average cost” methods?
As the name suggests, these methods take the total you paid for your shares and divide by the number of shares you own to arrive at an average cost per share. The “single-category” method considers all of your shares as one group, whether you have owned them for more than one year or less. For the investor in our example, using the single-category average cost basis approach would have resulted in a reportable gain of $3,750 ($10,000 sales price, less $6,250 cost basis). To report the sale on his tax return, the investor has to determine whether his holding period is long-term or short-term. The IRS requires that this be decided on a first-in, first-out (FIFO) basis, so he would consider this a sale of the first 500 shares he bought January 1, 2004, for a long-term holding period and capital gain.
