All the shares purchased in a single transaction are considered a “lot” for tax purposes. Find out the impact these lots can have on your cost basis determination.
When you buy multiple shares of a security on separate dates, you will have multiple cost bases and holding periods, all of which can impact potential gains as well as the holding period that determines your tax liability.
It is important to understand how to track your various lots so that you can make strategic decisions about which to sell and when.
For example, let’s say you purchased 100 shares of XYZ with a cost basis of $5 per share 14 months ago
(Lot A), and then purchased 100 shares three months ago with a cost basis of $7 per share (Lot B). By Now, the stock has risen to $10 per share. Lot A is over a year old, and therefore subject to long-term capital gains tax rates. Lot B on the other hand, is less than one year old and, thus, subject to higher tax rates but with a lower potential gain of just $3 per share.
When you decide to sell Lot A, you are choosing first in, first out or FIFO. When you choose Lot B, you are choosing last in, first out, or LIFO. You can also choose to take some shares from Lot A and some from Lot B. Before choosing either FIFO or LIFO, you must also consider what short- and long-term losses you might have throughout the year to potentially offset the gains from the lot you liquidate.
Lot A: $5 x 100 = $500 Lot B: $7 x 100 = $700
Total price paid = $1,200
ABC price per share today: $10
$10 x 200 shares owned = $2,000
Net unrealized gain is $800
If you sell all 100 shares from Lot A and 50 shares from Lot B (FIFO):
(100 shares X $5) + (50 shares X $7) = $500 + $350 = $850 cost basis
(150 shares X $10) = $1,500 - $850 = $650 Total Gains
Using the FIFO method, you have a realized gain of $650 (excluding commissions and fees).
$500 will be taxed at long-term rates of 0 to 15 percent and $150 will be taxed at your ordinary income tax rate.
Now let's try another method—selling 100 shares from Lot B and 50 shares from Lot A (LIFO):
(100 shares X $7) + (50 shares X $5) = $700 + $250 = $950 cost basis
(150 shares X $10) = $1,500 - $950 = $550
In this example, you have a realized gain of $550 (excluding commissions and fees). This method results in $100 less in taxable capital gains when compared to the FIFO method but you now have the bulk of your gains ($300) taxed at ordinary income tax rates and a lower amount ($250) taxed at 0-15 percent long-term rates.