Cost Basis Strategy: Why FIFO is Costing You Thousands and How “SpecID” Saves It
Cost Basis Strategy: Why FIFO is Costing You Thousands and How “SpecID” Saves It
COACHING POINTS
- The Default Trap: Most brokerage accounts default to FIFO (First-In, First-Out). This means when you click “sell,” the system sells your oldest shares first. Since markets rise over time, these are usually your cheapest shares, triggering the maximum possible tax bill.
- The Solution: You must change your cost basis method to Specific Identification (SpecID). This allows you to cherry-pick exactly which shares to sell (e.g., the ones you bought recently at a high price).
- The Strategy: By selecting the shares with the highest cost basis (HIFO), you minimize your realized capital gains today, keeping more capital compounding in your account.
When you sell a stock, the IRS doesn’t care about the average price. They care about which specific share you sold. If you bought Apple at $10 in 2010 and at $150 in 2024, selling the 2010 share creates a massive tax event. Selling the 2024 share creates almost zero tax. Control the lot, control the tax. Source: IRS Publication 550 (Investment Income and Expenses)
Scenario: You need $20,000 cash. You own 200 shares of Stock X (Current Price $200).
- Lot A (Oldest): Bought 5 years ago at $50. (Gain per share: $150).
- Lot B (Newest): Bought 1 year ago at $190. (Gain per share: $10).
- FIFO Sale (Default): Sells Lot A.
Total Gain: $15,000.
Tax Due (20%): $3,000. - Specific ID Sale (HIFO): Sells Lot B.
Total Gain: $1,000.
Tax Due (20%): $200. - Result: Simply choosing the right lot saved $2,800 in immediate taxes.
What-If Scenario: Optimizing for 0% Tax
Comparison: Selling shares in a low-income year.
| Method | Shares Sold | Tax Implication |
|---|---|---|
| FIFO (Oldest) | Low Cost Basis ($20) | High Gain ($180). Pushes you out of the 0% capital gains bracket. |
| Specific ID (Newest) | High Cost Basis ($190) | Low Gain ($10). Keeps income low, preserving tax-free room for other sales. |
Visualizing the Tax Savings
| Method Used | Tax Bill ($) |
|---|---|
| FIFO (Default) | 3000 |
| Specific ID (Optimized) | 200 |
*By switching from FIFO to Specific ID (HIFO), the investor reduces the immediate tax liability by over 90% in this scenario.
Execution Protocol
Log in to your brokerage (Fidelity, Vanguard, Schwab). Go to “Account Features” or “Cost Basis Information.” Change the default disposal method from FIFO to Specific ID (or “Tax-Sensitive”). This forces the system to ask you which shares to sell every time.
When executing a sell order, look for a “Select Lots” or “Specify Shares” dropdown. Choose the shares with the highest cost basis (lowest gain) or shares with a loss (to harvest tax losses).
Check your trade confirmation the next day (T+1). Ensure the correct lots were sold. If the broker made a mistake and sold FIFO, you typically have 2-3 days (settlement period) to call them and correct the tax lot assignment.
COACHING DIRECTIVE
- Do This: Always use Specific ID for taxable brokerage accounts. Prioritize selling shares with Short-Term Losses first (max deduction), then Long-Term Losses, then Highest Cost Long-Term Gains.
- Avoid This: Using “Average Cost” for mutual funds if you plan to sell partially. Once you elect Average Cost, the IRS often locks you into that method for that fund permanently.
Frequently Asked Questions
What is HIFO?
HIFO stands for “Highest-In, First-Out.” It is a subset of Specific ID where you systematically sell the shares you paid the most for. This minimizes your taxable gain.
Does this apply to IRAs?
No. In IRAs and 401(k)s, there are no capital gains taxes on trades, so cost basis methods are irrelevant. This strategy applies only to taxable brokerage accounts.
Can I switch methods later?
Yes, for stocks and ETFs, you can switch methods for future sales at any time. However, you cannot retroactively change the method for a sale that has already settled and been reported to the IRS.