By Kaye A. Thomas
Current as of January 3, 2015
This is the default, and sometimes required, method of disposition.
When you hold multiple lots of shares, the tax consequences of selling a portion of your holdings may differ depending on which lots are treated as having been sold. Shares in one lot may have a higher basis than shares in another, and the holding period (short-term or long-term) may differ as well.
- Rules discussed here apply to other types of dispositions such as gifts and donations as well as sales. Although you don’t report gain or loss for these events, you need to know which lots remain in your account after the disposition.
General rule: FIFO
As a general rule you’re treated as selling your oldest shares first. This method is known as first-in, first-out, or FIFO.
The FIFO method is required when you sell shares to which the average basis method applies. (The average basis method is permitted for mutual fund shares and for stocks held in dividend reinvestment plans.) When the average basis method doesn’t apply, you’re allowed to sell shares in a different order by identifying the shares sold at the time of the sale. The FIFO method applies whenever you sell shares without identifying them.
Example: You hold 100 shares bought two years ago and another 100 shares bought three months ago. If you sell 100 shares, you’ll be treated as having sold the shares bought two years ago unless you identify the newer shares as the ones being sold. You can do this only if you aren’t using the average basis method for these shares.
See How to Identify Shares for more on that topic.
Use the adjusted acquisition date
In various situations the tax law treats you as having acquired shares on a date that differs from your actual acquisition date.
Example: You bought 100 shares of XYZ two years ago and another 100 three months ago. If the stock splits 2 for 1, you’ll receive another 200 shares, which will be treated as held for the same periods as the original shares.
How does FIFO apply if you then sell 200 shares? If we rely on the actual acquisition dates, you would be selling the two original lots (100 long-term shares and 100 short-term shares) and you would continue to own the 200 shares received in the stock split (half of which are long-term shares). Relying instead on the adjusted acquisition date, you would be selling the 200 long-term shares and retaining 200 short-term shares.
Unfortunately the tax regulations don’t clearly state which approach is correct.* Yet nearly everyone agrees we should use the adjusted acquisition date in this case. It just doesn’t make sense to say that a sale of half your holdings before the split would come only from long-term shares, but a sale of half your holdings after the split would dispose of some of your short-term shares while you retain some of your long-term shares. Partly for this reason, and partly based on other admittedly weak but supportive authorities, the proper approach is to apply FIFO based on the adjusted acquisition date whenever it differs from the actual acquisition date.
* This is a sore point with me. When the Treasury was revising the cost basis regulations I submitted a comment pointing out the need for clarification. The drafters misunderstood my comment and failed to remove the ambiguity.
The regulations don’t tell us how to break ties in situations where it isn’t possible to determine the order in which two lots were acquired. For example, an order to buy 300 shares might be filled by a purchase of 200 shares at one price and another 100 at a different price, with both occurring simultaneously. In the absence of any authority on this issue it would appear that the IRS has little ground to object regardless of the approach you use. A principled approach to the issue might rely on the following guidelines:
- Ties will be broken according to a rule consistently applied rather than on an ad hoc basis.
- When shares are bought at the same time at different prices, the lower-priced shares will be considered purchased first, because the broker’s obligation is to acquire the lowest price available when filling your order.
- A tie that results from an adjustment in the holding period of shares (for example, when the wash sale rule applies) will be broken by looking to the actual acquisition date.
There is no authority requiring you to follow these guidelines but you may use them if you’re uncomfortable making a choice that can’t be defended on a principled basis.