The profit or loss on a security trade is the difference between the purchase price and the sale price, adjusted for any fees and commissions. If you purchase shares in the same company on more than one occasion, you can influence your gain or loss by identifying the shares you sell when you partially liquidate your position. The Internal Revenue Service sets the rules for adequate identification of shares.
Each time you buy shares, your broker’s accounting system creates a tax lot, which is a record of the date, time, security identification, number of shares, price and commission. The broker will append the stock certificate numbers to a tax lot. You can choose to take physical custody of the stock certificates or allow your broker to hold them for you. If you hold the shares, you can identify a tax lot by showing the stock certificates that you purchased on a particular date for a particular price. Tax lots determine the cost basis of the shares you sell. Many online brokers allow you to pick tax lots on the screen you use to enter a sell order.
If you’ve chosen to have your broker maintain your stock certificates, you can identify the tax lots by telling your broker the particular stock to be sold. You must also receive confirmation in writing from your broker within a reasonable time. The broker does not have to deliver the stock certificates that match the tax lots you identify -- the tax lot, not the certificate numbers, determines the cost basis.
Single Stock Certificate
Sometimes, your purchases of different lots of stock are reflected in a single stock certificate that you hold. To identify tax lots, you must give instructions to your broker when you deliver the stock certificate. Tell the broker the particular stock you wish to sell and obtain written confirmation within a reasonable time. Alternatively, you can endorse your single stock certificate directly to the buyer of a part of your position without going through a broker. In this situation, you must keep a written record identifying the tax lots you wish to sell.
If you are an active trader, you may repeatedly buy and sell shares of the same stock at many different prices. This may make it impossible to adequately identify the shares you wish to sell. Under these circumstances, the IRS directs you to use first-in, first-out sequencing -- the order in which you sell shares is the order in which you purchased them. You cannot use the average price per share as your cost basis when selling stock.
A corporation may declare a stock dividend, which is payment of additional shares to stockholders. If you have purchased shares of the corporation at various times and prices, you must allocate the dividend shares to the tax lots responsible for the dividend on a prorated basis. The new cost basis of the tax lot is the basis of the old shares divided by the number of old plus new shares.
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