When you sell stock, you need to report the transaction to the IRS. If you bought your shares on different days and at different prices, the tax process gets a little tricky. You need to be able to identify which shares are being sold so you can figure out your total gain or loss. The IRS lets you choose between using the "last in, first out" (LIFO) or the "first in, first out" (FIFO) recording method.
When you buy a stock, the amount you pay is called your cost basis. This equals the original price of the shares plus any commissions and transfer fees. You get this money back tax-free when you sell your stock down the road. If you sell your stock for more than your cost basis, you make a taxable gain. If you sell your stock for less than your basis, you receive a tax-deductible loss. If you bought your shares on different days and at different prices, you need to match the different groups of shares with their original costs. This lets you calculate your gain or loss when you sell some shares in the future.
LIFO and FIFO
LIFO and FIFO tells the IRS the order in which you want to sell off your stock. If you sell off all your shares at the same time, this doesn't matter, as they'll all be gone. However, if you only sell off some of your stock, you need to choose one of these methods for your broker. The LIFO method tells your broker to sell off the newest shares first. The FIFO method tells your broker to sell off your oldest shares first.
Say you bought stock on three different days. You bought 10 shares in 2009, 10 shares in 2010 and 10 shares in 2011. In 2012, you decide to sell 15 shares. If you choose to use the FIFO method, your broker will sell off all your 2009 shares and five of your 2010 shares. If you choose the LIFO method, your broker will sell off all your 2011 shares and five of your 2010 shares.
LIFO and FIFO shift around the timing of your taxes. If your stock has gone up in value over time, selling off your older shares creates a larger tax bill than selling off your new shares. This is because the older shares were cheaper and create a larger gain when they are sold. If you want to delay your tax bill, choose the LIFO method. It pushes the more expensive sales to the future. If you can handle paying the higher taxes today and want to save your tax savings for later, choose the FIFO method.
David Rodeck has been writing professionally since 2011. He specializes in insurance, investment management and retirement planning for various websites. He graduated with a Bachelor of Science in economics from McGill University.