What it means
When an investor buys the same share on several dates, each purchase has its own cost, known as the cost basis (the amount paid, usually including fees). When some shares are sold, the question is which purchase is treated as sold.
The default rule in many places is first in, first out, which treats the oldest shares as the first sold. The specific shares method lets you override that by naming the exact lot, which gives control over the gain or loss reported.
Choosing high-cost shares produces a smaller gain or a larger loss, and so a smaller tax bill this year. Choosing long-held shares may help qualify for lower tax rates on long-term gains, depending on local rules.
Investors must usually identify the shares clearly and in time, often at the moment of the sale, and brokers keep records. Poor records can force the tax authority's default method onto you, so documentation matters.
Keep trade confirmations, dates and prices for every purchase. Deferring tax is not the same as avoiding it.
Selling high-cost lots now leaves low-cost lots in the portfolio, and the larger gain will come later, so the benefit is mainly timing and flexibility. Tax rules differ by country and change over time, and some countries use average cost instead.
Check the rules that apply to you and ask a tax adviser before choosing a method.
In practice
Real-world examples.
Example
A retired teacher holds shares in an index fund bought over ten years. She needs $15,000 for a home repair and selects the most recently purchased shares, which have the highest cost, so her taxable gain for the year is small. She keeps the lower-cost shares for later, accepting that a bigger gain will come when she sells them.
Example
A small business owner invests spare cash in a company's shares and sees the price drop below what he paid for one lot. He sells that lot to realise a loss, which he uses to offset gains elsewhere in his portfolio. His accountant checks local rules on repurchasing the same shares soon after selling.
Example
A financial adviser reviews a client's portfolio and finds that the default method would sell low-cost shares that were held for years. She instructs the broker to sell specific lots that are subject to lower tax rates and creates a record in the client's file. Written notes on each instruction would help if the tax office ever asked for evidence.
Formula
Calculation
Capital gain = sale proceeds - cost basis of the shares sold
Tax payable = capital gain x tax rate
An investor owns 100 shares bought at $20 and another 100 bought at $50. She sells 100 shares at $60, so proceeds are 100 x 60 = $6,000. Under first in, first out, the cost basis is 100 x 20 = $2,000 and the gain is 6,000 - 2,000 = $4,000. Under the specific shares method, selling the $50 lot gives a cost basis of 100 x 50 = $5,000 and a gain of 6,000 - 5,000 = $1,000. At an illustrative tax rate of 20%, the tax falls from $800 to $200, a saving of $600 this year.Case study
Seen in the real world.
Linden Family Trust is an illustrative, fictional trust that bought shares in a single listed company across five years. Over time the lots had cost bases ranging from $12 to $48, and the current price was $60.
The trustee needed to sell 5,000 shares to fund a beneficiary's tuition. Using first in, first out, the trust would have realised a gain of about $48 per share on the oldest lot, or $240,000 on 5,000 shares.
By identifying the lots with a $48 cost, the gain fell to $12 per share, or $60,000 in total. The illustrative trustee recorded the instruction with the broker before the sale, and the lower gain reduced the trust's tax bill substantially while still raising the cash required. The trustee also kept a schedule listing every remaining lot with its cost and purchase date.
Watch out
Common mistakes.
- Assuming the broker will automatically pick the most tax-efficient lot, when the default is often the oldest shares.
- Failing to give identification instructions before the sale settles, so the default method applies, and the tax bill may be larger than it needed to be.
- Treating the method as a way to avoid tax permanently, when it mostly defers the gain to a later sale.
Questions
People also ask.
What is a tax lot?
A tax lot is a block of shares bought on the same date at the same price, and it is the unit you identify when you sell.
How is this different from first in, first out?
First in, first out sells the oldest shares automatically, while the specific shares method lets you choose which lots are sold.
Is it allowed everywhere?
Not always, because some countries require average cost or a pooling method, so check your local rules. Where pooling applies, the cost of all shares is averaged and no choice is available.
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