When you've been investing for a long time, chances are there are at least a few companies whose stock you've bought on multiple occasions and at different prices. When you sell some of your shares, picking which shares you want to sell can make a significant difference in how much you owe in taxes. And, the less you owe, the more of your profits you can reinvest or spend.
The first-in, first-out method is the default way to decide which shares to sell. Under FIFO, if you sell shares of a company that you've bought on multiple occasions, you always sell your oldest shares first. FIFO results in the lower tax burden if you bought the older shares at a higher price than the newer shares. For example, if you bough a bunch of stock before a recession, and then bought additional shares when the recession bottomed out, you would minimize your tax burden by using the FIFO method.
The last-in, first-out method works in exactly the opposite manner: you sell your newest shares first. The LIFO method typically results in the lowest tax burden when stock prices have increased, because your newer shares had a higher cost and therefore, your taxable gains are less.
For example, say you bought 150 shares of Company A stock for $40 per share six years ago and another 150 shares of Company A stock for $50 per share four years ago. If you're selling 200 shares today for $65 per share and using the FIFO method, you sell 150 shares with a cost of $40 and 50 shares with a cost of $50. That gives you a taxable profit of $4,500. If, in the same scenario, you use the LIFO method, you sell 50 shares with a cost of $40 and 150 with a cost of $50. That gives you a taxable profit of only $3,500.
If you plan to use any method besides FIFO, including LIFO, you must specifically direct your broker as to which shares to sell so that your taxes end up the way you want. According to Internal Revenue Service Publication 550, the burden is on you to prove that you informed your broker of which shares you wanted sold and that your broker followed your requests. If you can't prove that, you're treated as having sold your oldest shares first.
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