Tax lots: which shares did you sell?

Three lots, one sale

A customer who buys the same security more than once owns several tax lots, each with its own cost. When they sell part of the holding, the gain depends entirely on which lot is treated as sold, and the difference is not small: shares bought at $20 and shares bought at $50 produce very different gains at the same sale price.

The rule gives the customer a choice and attaches a deadline to it. Identify the shares to the broker at the time of the sale or transfer — in writing if possible — and the basis is the cost of those particular shares. That is specific identification, and it is the method that lets a customer manage the size of a realized gain.

Say nothing, and the choice is made for you. Where the shares sold cannot be adequately identified, the basis is figured first-in, first-out: the oldest lot is treated as sold first. In a long-held position that is usually the cheapest lot and therefore the largest gain, which is why the deadline matters more than it first appears.

The deadline is the part candidates lose. The identification belongs to the moment of sale, not to the moment the return is prepared. A customer who works out in April which lot they would have preferred to sell has left it too late; the identification was fixed at the sale, on whatever basis applied at the time.

The firm has a reporting role in this, and it is narrower than most people assume. A broker reports the adjusted basis of a covered security to the IRS in box 1e of Form 1099-B. A covered security is broadly one acquired in an account after the dates the rules took effect — stock bought for cash in an account after 2010, stock for which the average basis method is available after 2011, and later dates for other instruments. Where a security is not covered, the firm checks the box that says so and is not required to report the basis, and the record is the taxpayer’s to keep.

One rule can delay a loss itself. A wash sale happens when stock is sold at a loss and substantially identical stock is bought within 30 days before or after the sale. The loss cannot be deducted then. It is added to the cost of the new shares, so the deduction waits until those shares are sold, and the old holding period carries over. The rule reaches losses only, and stock of a different company is ordinarily not substantially identical.

Exam terms

Tax lot

A block of the same security acquired at one time and one price.

Specific identification

Telling the firm at the time of sale which shares are being sold.

FIFO

First in, first out: the oldest shares are treated as sold.

Covered security

One whose basis the firm must report to the IRS.

Form 1099-B

The form on which proceeds and, for covered securities, adjusted basis are reported.

Wash sale

A loss sale with substantially identical stock bought within 30 days before or after; the loss moves into the new basis.

Worked example

A customer holds 100 shares bought at $20, 100 at $35 and 100 at $50, and sells 100 shares at $60.

1. Proceeds are $6,000 in every version of this, because the sale price is the same.
2. Identify the $50 lot at the time of sale and the basis is $5,000, so the gain is $1,000.
3. Identify the $35 lot instead and the basis is $3,500, so the gain is $2,500.
4. Say nothing and FIFO applies: the $20 lot is treated as sold, the basis is $2,000, and the gain is $4,000.
5. The customer who wanted the smallest gain had to say so at the sale. In April there is nothing left to decide.

Check yourself

Try a question, then read the explanation to review the rule.

Same rule, new context

Related practice

• Cash vs margin and Regulation TPractice this
• Wash sales and the basis of replacement sharesPractice this