Selling
methodologies
Every time you purchase a new stock, you
create another holding/position in your portfolio. If you
sell all the shares in one of these positions, you exit the
position. The sell
transaction results in either a
capital gain or capital loss. Simple
enough, right?
However, the process becomes more
complicated if you have multiple lots of the same security. A
"lot" is created when you instruct your brokerage to purchase
a security. For example, you used your online broker to
purchase 100 shares of MSFT on 1/1/99, you created a lot in
MSFT. Then on 3/1/99 you purchase 50 shares of MSFT,
without selling your original lot of MSFT created on
1/1/99. Now you have two lots of MSFT. Since these two lots
were purchased at different times and probably at
different prices, you must record the lots separately for
accurate capital gain/loss determination. Even if you
purchase two lots on the same day (and even
with the same price) you must track
these lots separately for tax
reporting.
For example:
·
Buy 1/1/99 100
shares of MSFT
·
Buy 3/1/99 50 shares
of MSFT
Sell
by FIFO Method:
Now, on 4/1/99, you instruct
your brokerage to sell 50 shares of MSFT without
specifying which lot you want to sell from. Your broker
will automatically default to First-in-First-out (FIFO)
accounting, and sell the 50 shares from the first lot of MSFT
you purchases, the 1/1/99 lot.
The
following is the result of FIFO
selling:
·
Buy 1/1/99 100
shares of MSFT
·
Buy 3/1/99 50 shares
of MSFT
·
Sell 4/1/99 50
shares of MSFT
Resulting
Current Holdings:
·
1/1/99 50 shares
remaining of MSFT
·
3/1/99 50 shares of
MSFT
Impact
of FIFO? There is nothing wrong with FIFO
methodology, but it doesn't allow the tax payer to
control how much gain or loss is recognized as taxable by the
IRS. FIFO sells
your oldest lots first,
which in a rising market have the
lowest cost, but the highest gain.
Sell by
Specific ID Method: This method requires that you designate which
shares you would like to sell. In order for the IRS to
recognize a Specific ID sell, you must at the time of the
sell transaction tell your broker which shares to sell by
referencing the purchase date and purchase price. Your
broker must then respond to you with a written confirmation of
these instructions. This means you can not decide during
year-end tax preparation which lots were sold by
Specific ID. You must specify a Specific ID sell method
at the time of the sell transaction. If you
don't, the sell must be
considered a FIFO sell.
For Example:
·
Buy 1/1/99 100
shares of MSFT
·
Buy 3/1/99 50 shares
of MSFT
·
Sell 4/1/99 50
shares of MSFT (by Specific ID on
3/1/99 lot)
Resulting
Current Holdings:
·
1/1/99 100 shares of
MSFT (original lot)
When should I use the Specific ID sell method?
It is possible to reduce the
taxes you have to pay the TaxMan by selling your highest
cost shares first. Better yet, sell a lot that has a
loss, so that you can offset a gain you realized on a
prior sale. In the above example, if on 4/1/99 you were
looking to sell 50 shares of MSFT, you must first
determine if you have any realized capital gains that you can
offset with a
loss. If you have a capital
gain, then determine if it is
characterized as a long-term or a
short-term gain.
Let's imagine that in the example above a
sell of 50 shares from the 1/1/99 lot would result in
a small short-term capital gain, while a sell of 50
shares from the 3/1/99 lot would result in a large short-term
capital loss. Furthermore, let's imagine you recognized a
short-term capital gain
from a different sale. In this case,
it is tax efficient to sell the most
recent lot of MSFT, 3/1/99,
for a loss and use this
loss to offset your short-term gain. Remember that if you
don't instruct your broker to sell by Specific ID on
3/1/99, FIFO will be used by default and you will be unable
to offset this gain on
your Federal tax return.
BACK
Mutual
Funds (Average Cost Selling)
Two other sell methodologies that are
only applicable for Mutual Funds are Single
Category Average Cost and Multiple Category Average Cost.
Using the Single Category method you add up the cost of
all your shares and divide that by the number of shares. This
is the cost per
share used to calculate a gain or loss.
With the Multiple Cost method, investors
need to average the cost of all their long term
shares and their short-term shares separately. When
selling shares an investor needs to identify whether
they are selling
long or short-term shares and use
the appropriate cost calculation.
BACK
Mutual Fund
Distributions
Numerous investors buy Mutual Funds with
the intention of holding long-term. They are surprised to find
out that they may owe capital gains taxes, if the funds paid
distributions, even though they did not sell any shares.
Mutual funds, by law, must distribute capital gains and
income back to shareholders. Unfortunately, they pass
these distributions to all shareholders on record date; this
is not necessarily the same group of shareholders who held the
mutual fund when it generated the gains. As a general rule,
investors should find out when the fund makes
these distributions before purchasing the mutual fund. If
possible, purchase funds after they distribute
and sell
funds before the distribution date.
BACK
Updating
positions for Stock Splits
A stock split is an increase in
the number of shares outstanding of a company without any
change in the shareholder's equity or market value. To
properly account for a
stock split:
·
Increase
your position by the stock split
rate on Ex Date
·
Maintain
your original total cost
·
Maintain
your original holding period
·
Decrease
your cost per share
Common
mistakes
shareholders make when updating for
stock splits:
·
Add
the new shares with zero cost basis
- creating 100% gain when you
sell
these shares
·
Set
the Ex date as the acquisition date
- creating an inaccurate holding
period
Both of these errors can have
significant impacts on the taxes you pay. First you are
creating a huge gain and because you used an incorrect
acquisition date, you may create a
short term gain, taxed at your
ordinary income rate, as
high as
35% instead of a long term gain,
taxed at 15%.
Here
is an example to illustrate the
proper accounting of stock splits:
On
5/3/00, EMC announced a 2 for 1
stock split. Ex Date is 6/5/00, set
by the NYSE.
Bill
Smith's position in EMC prior
to the stock split is:
|
Acquisition
Date
|
Shares
|
Cost
Per Share
|
Total
Cost
|
1/15/99
|
100
|
$24.25
|
$2,425.00
|
5/18/99
|
250
|
$26.50
|
$6,625.00
|
2/10/00
|
500
|
$58.75
|
$29,375.00
|
Bill
Smith's position on Ex Date:
|
Acquisition
Date
|
Shares
|
Cost
Per Share
|
Total
Cost
|
1/15/99
|
200
|
$12.125
|
$2,425.00
|
5/18/99
|
500
|
$13.25
|
$6,625.00
|
2/10/00
|
1000
|
$29.325
|
$29,375.00
|
BACK
Updating
positions for Mergers
A merger is a combination of two
or more companies. When updating
your positions for mergers, please note
the following information:
·
Calculate the shares you will receive of
the new company by using the
finalized merger rate
·
Read your prospectus to find out if the
merger is taxable or non-taxable to shareholders
-this information is necessary for
determining your new cost basis and
holding period
Common
mistakes shareholders
make when updating for mergers:
·
Incorrect
determination of the tax status of
the merger - impacts the cost basis
and holding period-without accurate cost basis and
holding period information, you
will have inaccurate gain/loss figures when you sell the shares
·
Assumption that the original cost basis
and holding period will transfer to the new shares
received -if the merger is taxable you will be taxed on the
full value of the merger and you will need to calculate
your new cost basis and holding period for your new shares
BACK
Updating
positions for Spin-offs
A
spin-off is a corporate
disposition of a subsidiary or
division of the company.
When
updating your positions for a
spin-off please note the following
information:
·
Maintain
your shares and holding period of
the parent company
·
Calculate the shares you will receive of
the spun off company by using the finalized rate of distribution
·
Read your prospectus to find out if the
spin-off is taxable or non-taxable to shareholders
-this information is necessary for
determining your new cost basis and
holding period
Common
mistakes shareholders
make when updating for spin-offs:
·
Incorrect
determination of the tax status of
the spin-off - impacts the cost
basis and holding period -without accurate cost basis
and holding period information, you will have inaccurate
gain/loss figures
when you sell the shares of the
parent company and/or the spun off
company
·
Add
the new shares with zero cost basis
- creating 100% gain when you sell
these shares
BACK
Gifting stocks
Let's clarify the U.S. tax code
concerning the $11,000 gift exclusion. In short, the recipient
of a gift does not pay a gift tax on any gift valued at
$11,000 or less. No matter if it is a boat, car, cash or
stock. Not so fast! This means you don't owe taxes at the time
of the gift of a stock, but when the recipient sells the
stock, it is a taxable event. Like everything else related
to investing and taxes, a correct cost basis is the
key to resolving how much you owe when you sell a stock
received either as a gift or through inheritance. A local
library's microfilm archive might be the best resource to
find the value of shares on a particular date and determine
your cost basis, but be cautious about stock splits and
other corporate actions! Tax advisors suggest to consult
the S&P stock guide, the Value Line Investment Survey, or
the
company that issued the shares for a history
of the stock price, stock splits and
other capital changes.
What's your
Taxable Gain on Stocks Received
as a Gift?
Figuring out
your cost basis:
·
If you sell the shares for a gain, use
the donor's cost basis and purchase date as your cost
basis and purchase/acquisition date to characterize your
realized capital gain. In other words, if your donor
bought the gifted stock over a year ago from the time
you sell the stock, it can be considered
a long-term gain - maximum of a 15%
tax rate.
·
If you sell the shares for a loss, your
cost basis is the lower of: (1) the donor's basis or (2)
the Fair Market Value (FMV) as of the transfer date. Your
purchase/acquisition date will be the donor's purchase
date in case (1) or the transfer date in case (2). We
can thank Congress for this
rule; they feel people should be
prevented from giving away a
loss.
Note:
If the donor paid a gift tax on shares
given to you with a value over $11,000, you should adjust
the cost basis determined above. In the simplest case, adjust
it upward by the amount equal to the gift tax.
Specifically, the gift tax amount attributable to the stock
appreciation
before the date of the
gift.
What's your
Taxable Gain on Stocks Received
through Inheritance?
Determining your taxable gain on
inherited stocks is more straight forward than with gifted
stocks. To figure out your cost basis simply set the Fair
Market Value (FMV) of the stock on the date of your
benefactor's death to your new cost basis. Use the average of
the high and low prices of the stock on that date as the
FMV. Your holding period is always considered long-term
and qualifies for the 15% maximum tax rate. Remember,
when filing your Schedule D, enter "inherited" in the
space marked for the acquisition date for this stock. That
way, the IRS won't
confuse your holding
period with the date you received
the stock.
If you want to give a stock away as a
gift, always gift the particular lots with lowest cost
basis and short-term (if possible) - keeping the higher
cost, longer-term lots. In your portfolio, look
at the
‘Unrealized Views’ to identify
the best lot to gift.
BACK
Transferring
assets
No gain or loss is recognized if you
transfer assets within your account or to a spousal
account. The holding period and original cost basis
remains intact. Transferring ownership to other
parties or entities is considered a gift. There are
additional tax implications if you are transferring
assets to
related family members. Please
consult a tax advisor or IRS
Publication 550.
BACK
Holding
Periods
Long-term gains are defined as securities
held for more than a year. Short-term gains are
defined as securities held a year or less. Since
short-term gains are taxed at your income rate
(possibly as high as 35%) and long-term gains are taxed
at a fixed 15%, it is tax efficient to sell for a gain
after you have held a stock for more than a year (long-term)
and sell for a loss when you have held a stock for a year
or less (short-term). Smart investors will try to offset all
short-term gains with short-term losses before year's
end. In addition, after you offset all your capital
gains, you can use
any remaining losses to offset as
much as $3,000 in ordinary income.
BACK
Cost
Basis Calculations
Calculating cost basis is the foundation
of tax-lot accounting. To accurately calculate your cost
basis you need to track your holdings by the individual
tax-lot and not your aggregate holdings. Only by
tracking original cost and purchase
date can
you accurately calculate gains or
losses when you sell securities.
Cost basis
can be adjusted for
corporate actions or wash sales - you should familiarize
yourself with
both to ensure accurate cost basis.
BACK
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