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When It Pays To ID Security Sales

Suppose you acquired shares of a single stock or mutual fund at various times during the past few years. Now the price has risen, and you may want to sell some of your holding and pocket a profit. Or maybe the price is down, and you want to sell shares to "harvest" a loss that could offset gains in other positions.

Either way, there's an important question: Which shares are you selling? Unless you say otherwise, the IRS assumes that the first shares you sell are the first ones you acquired. This "first-in, first-out" (FIFO) method acts as a default. However, you are allowed to specify other shares for the sale, and in some cases this may give you a better result in terms of taxes.

When you sell securities, such as stocks or mutual funds, you generally must recognize a gain or loss for tax purposes, based on the difference between the selling price and your "basis" (generally, your investment cost plus certain adjustments).

  • If you have a gain and you've held the securities for more than one year, the maximum tax rate on the long-term gain is only 15% (or 20% if you're in the top tax bracket for ordinary income). Other gains are considered short-term and are taxed at ordinary income tax rates topping out at 39.6%. Some high-earning investors also may owe a 3.8 % surtax on net investment income.
  • If you have a loss, it can offset capital gains plus up to $3,000 of ordinary income. Any excess loss can be carried over to next year.

Calculating your basis in a stock or fund can be confusing, especially if multiple lots of shares are involved. In the past, brokerage firms weren't required to supply information about your basis when you made a sale, although many did so when the figures were available. But now firms are required legally to report the information to investors, as well as to the IRS, for stocks acquired after 2010 and mutual fund shares acquired after 2011.

In addition, you're stuck with the FIFO default unless you opt out of it. Here's a hypothetical example of how you may do better by identifying your shares. (For simplicity, we'll avoid any transaction costs.)

Suppose you bought 1,000 shares of XYZ stock at $10 a share (Block 1) early this year and then 1,000 shares later at $15 a share (Block 2). XYZ now sells for $12 a share. If you sell 1,000 shares, the IRS will assume you're selling Block 1, so you'll be hit with ordinary income tax on a gain of $5 a share, or $5,000. However, if you specifically identify Block 2 as the shares you're selling, you'll have a tax loss of $3 per share ($3,000) rather than that $5 gain. Your proceeds from the sale, of course, are the same in either case. 

How can you ID your shares? At the time of the sale, you must notify your broker which shares you are selling. Make sure you obtain a written or electronic confirmation of the transaction for your records. Then take advantage of your tax loss or gain on this year's return.

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