What it means
Imagine an investor who bought the same company's shares on three different dates at three different prices. When she sells some of them, the tax authority needs to know which shares were sold, because each batch (or lot) has a different purchase cost.
If the investor does not choose, a default method applies. A common default is first in, first out (FIFO), which assumes the oldest shares are sold first.
Specific identification lets the investor choose instead, for example selling the lot with the highest cost to reduce the gain. In some countries the investor must tell the broker which lot to sell at the time of the sale and obtain written confirmation.
The choice matters for tax. Selling high-cost shares produces a smaller gain or a larger loss in the year of sale, while selling low-cost shares produces a larger gain.
Many countries also tax gains on assets held for a long period differently from short-term gains, so the holding period of the chosen lot can change the tax bill. Not every country allows the method.
Some, such as the United Kingdom, use matching rules that pair a sale with same-day purchases, then purchases in the following 30 days and then a pooled average cost, and these leave little or no choice to the investor. Readers must therefore check the rules where they pay tax and confirm the detail with a qualified adviser.
Good record-keeping is essential. The investor needs the purchase date, quantity and cost of every lot, and any fees, to support the figure on a tax return.
Most brokers now track lots and let investors pick them online. Tax is not the only consideration.
Choosing shares simply to minimise tax can leave the portfolio with a worse mix of investments, or with a position that has dropped in value. Sensible investors weigh tax savings against their investment goals before they decide which lots to sell.
In practice
Real-world examples.
Example
A retiree holds shares bought over ten years at different prices. She instructs her broker to sell the lot bought at the highest price so that the gain on her sale is small and she stays within a lower tax band.
Example
An investor sees that shares in his portfolio have fallen below their purchase price for one lot. He identifies that lot to sell, realising a loss of $2,500 which he can use to offset gains elsewhere, subject to local rules.
Example
A founder with company shares granted in several tranches chooses to sell only those held for more than a year. The longer holding period qualifies the gain for a lower rate where the local law allows it.
Formula
Calculation
Gain or loss = Sale proceeds - Cost basis of identified shares
Suppose an investor bought 100 shares at $20 in January, 100 shares at $30 in June and 100 shares at $40 in November. She sells 100 shares at $50 each, receiving $5,000. Under first in, first out, the cost is 100 x $20 = $2,000, so the gain is $5,000 - $2,000 = $3,000. If she identifies the November lot, the cost is 100 x $40 = $4,000, and the gain is $5,000 - $4,000 = $1,000. Identifying the June lot would give a cost of $3,000 and a gain of $2,000.Case study
Seen in the real world.
Tallis Family Office is an illustrative, fictional firm that manages investments for a family. The family wanted to raise $40,000 by selling 1,000 of its 1,500 shares in a technology company, now trading at $40. The shares had been bought in three lots: 500 at $18, 500 at $32 and 500 at $50.
Under first in, first out, the sale would have used the two oldest lots, with a cost of 500 x $18 + 500 x $32 = $9,000 + $16,000 = $25,000 and a gain of $40,000 - $25,000 = $15,000. The adviser instead identified the $50 and $32 lots, with a cost of 500 x $50 + 500 x $32 = $25,000 + $16,000 = $41,000, which produced a loss of $41,000 - $40,000 = $1,000. He sent the broker written instructions before the trade and filed the confirmation with the family's tax records.
In this illustrative story the family raised the same $40,000 in cash but reported $16,000 less gain that year. The remaining 500 shares carried the low $18 cost, so a larger gain was deferred to a future sale, not removed. The lesson is to document the lots chosen before the sale and to remember that identification changes the timing of tax, not the economics of the investment.
Watch out
Common mistakes.
- Assuming the investor can pick the lots after the sale, when many countries require the choice at the time of the trade.
- Ignoring the holding period, which can change the tax rate on gains.
- Keeping poor records of purchase dates and costs, which makes the figure on a tax return hard to defend.
Questions
People also ask.
What is specific identification?
It is a method of working out cost basis by selecting exactly which shares were sold.
How is it different from first in, first out?
First in, first out assumes the oldest shares are sold first, while specific identification lets the investor choose.
Do all countries allow identified shares?
No, some use fixed matching or pooling rules, so check local tax rules before relying on the method.
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