HIFO
What is HIFO?
HIFO is an acronym for highest cost in, first out. With HIFO, securities are sold from the lots with the highest cost basis first. Adopting this selling method may be a more tax efficient strategy to consider when you own multiple tax lots of the same security. GainsKeeper offers investors the option to have the trades in their accounts processed by HIFO.
Why would investors use HIFO?
Investors may use HIFO to:
Reduce reportable capital gains that result from trades in their taxable investment accounts.
Generate capital losses from their taxable investments to offset taxable gains (as long as wash sales are avoided).
How can HIFO reduce capital gains?
The following is an example of how HIFO can reduce capital gains:
Joe bought 100 shares of Stock A for $4,000, three months later he bought 100 more shares of Stock A for $6,000, and 4 months later he purchased another 100 shares of Stock A for $5,000.
Enough time has passed and Joe has had all 300 shares long enough for them to be considered long-term holdings. Stock A is now selling at $70 per share and Joe decides to sell 100 shares.
If he uses FIFO (first in, first out), he would sell the 100 shares he bought for $4,000 and realize a reportable capital gain of $3,000. Joe wants to reduce his capital gains. Using HIFO, Joe sells the 100 shares he purchased for $6,000 and realizes a reportable capital gain of only $1,000.
How can HIFO generate capital losses?
The following is an example of how HIFO can generate capital losses:
Joe bought 100 shares of Stock B for $3,000, three months later he bought 100 more shares of Stock B for $5,000, and 4 months later he purchased another 100 shares of Stock B for $4,000.
Enough time has passed and Joe has had all 300 shares long enough for them to be considered long-term holdings. Stock B is now selling at $30 per share and Joe decides to sell 100 shares.
If he uses FIFO (first in, first out), Joe would sell the 100 shares he bought for $3,000 and would not generate a reportable loss. Joe wants to generate a capital loss. Using HIFO, Joe sells the 100 shares he purchased for $5,000 and realizes a reportable capital loss of $2,000.
Does the IRS recognize HIFO?
The Internal Revenue Service does not recognize HIFO as an accounting method, but it generally permits an investor to specifically identify his or her shares at the time stock is sold for reporting capital gains and losses. Taking advantage of specific identification of shares sold effectively allows an investor to use HIFO by permitting the investor to select the right lot of stock to sell. However, in order to take advantage of specific identification, IRS rules generally require that an investor adequately identify the specific lots of stock that are sold either by delivering the proper lot for sale (in the case of stock held in physical form) or by maintaining adequate records of his or her stock lot purchases and instructing the broker or custodian of the specific lot (or lots) to be sold at the time of sale and, within a reasonable time after the sale, receiving from the broker or agent written confirmation that the proper lot was sold (in the case of stock held in street name or by a nominee). To simplify things for investors and brokers, the IRS has concluded that a written standing order from a customer to a broker to apply the HIFO method to sales of the investor's shares where written confirmations were provided to the customer that per instructions, highest cost shares were sold first, satisfied the adequate identification requirement.
It is important to note the steps that an investor (and the investor's broker or agent) must timely take in order to satisfy the adequate identification requirement. According to the IRS rules, if an investor does not adequately identify the specific shares to sell at the time of sale, all gain and loss calculations generally default to the FIFO (first-in, first-out) method. That is, the investor is treated for tax purposes as selling the oldest purchase first.
Is HIFO right for you?
HIFO is only one of several factors you need to consider when making an investment decision. While it is important to take taxes into consideration, you should also think about your risk tolerance, your overall financial goals, and the specific investment. To determine if HIFO is right for you, talk to your tax advisor.