When shares of stock are sold, it may affect your tax liability. If the shares are sold at a loss, you may be able to use that loss to save money on your taxes. If the shares are sold at a profit, the money made on the sale is taxable income. To determine whether you had a profit or loss, you must know the cost basis of your investment — what you paid for it. This can get complicated if your investment is the result of multiple purchases and you are only selling part of the investment.
Average Cost — Double Category (ACDC)
ACDC is a method the Internal Revenue Service allows for calculating cost basis on mutual funds. It may not be used to figure the cost basis when selling individual bonds and stocks. With ACDC, the cost basis is calculated based on how long the shares were held. There will be one number for shares held over a year (long-term shares) and another total for shares held under 12 months (short-term shares).
Average Cost — Single Category (ACSC)
A second method of calculating cost basis approved by the IRS is ACSC. This is similar to ACDC except no consideration is given to how long the shares are held. The cost basis is figured as the average price for all the shares. Long-term profit or loss is calculated by assuming that the oldest shares are the first ones sold. As with ACDC, this method is only allowed with mutual funds. Mutual fund companies select which method they want to use. As an example, Fidelity uses the ACSC method.
First In, First Out (FIFO)
Unless you specify otherwise, the IRS assumes you sell your shares of individual stocks or bonds using the first-in, first-out method. In this method, the cost basis of the shares you sell today is the price you paid for the first shares that you purchased.
The fourth method allowed by the IRS — and the second method approved for the sale of individual stocks and bonds — is the specific share method. When you give your broker instructions to sell, you also provide, in writing, a notation of which specific shares you want to sell. You must also receive from your broker confirmation in writing that your instructions were followed and he sold shares from a specific purchase. The cost basis for your sale is the purchase price of the specific shares being sold.
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