An investor has purchased 200 shares of a stock at four different times:
- 18 months ago at $16 per share
- 14 months ago at $23
- 10 months ago at $24
- 6 months ago at $17
Today the latest quote for the stock is $20. His brokerage account shows the 800 share position as having a market value of $16,000.
Selling stock using FIFO
Because the stock has not performed as well as he hoped, he has decided to sell half of the position for $20 per share.
He will use FIFO, or first-in, first-out, as the cost basis for the sale. This results in two distinct capital gains. For the shares purchased 18 months ago, he has an $800 long-term gain (200 shares times $4 per share). In addition, he will have a $600 long-term loss (200 shares times $3 per share) for the shares purchased 14 months ago.
For the sale, he will have a net long-term gain of $200. This will incur a capital gains tax of $30, ($200 times 15%).
Selling the stock lots with the highest cost basis
Instead of using FIFO, he could have sold the stock having the highest basis. Rather than two gains, this would result in two capital losses. For the stock with the highest basis, purchased 10 months ago, he would have an $800 short-term loss (200 shares times -$4 per share). Selling the next highest basis stock, purchased at $23, would result in a $600 long-term loss (200 shares times -$3 per share).
Altogether, he would realize a $1,400 capital loss by using HIFO, or highest-in, first-out cost basis. Since he falls into the highest marginal tax bracket of 35%, this loss would reduce his tax by $490 ($1,400 times 35%).
In either case, he still holds 400 shares of stock. Selling the highest basis stock has lowered his tax by a net $520 ($490 plus $30). As mentioned in a previous post, to use HIFO an investor must make an adequate identification of the stock being sold.
Review each tax lot before selling
Each closing trade may produce various taxable outcomes. As we saw above, this is notably true for stock positions composed of multiple purchases, or tax lots.
A typical brokerage account will display each position's current market value and the share quantity. This is not enough. Without knowing the cost basis of each lot being sold, an investor has no idea what the prospective capital gain might be. By relying on FIFO as his cost basis, he risks incurring capital gains tax that might have been avoidable.
Instead, imagine him already having an estimate of the expected capital gain, prior to placing a trade order. With that information in hand, he could place a trade with a specific capital gain outcome already in mind.
Providing investors with that insight (and more) is one reason why we developed the Realized app for managing stock portfolios.