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Opens the scrolled simulated dialogImportant Disclosures

Lot Closing Methods

Cost Basis

The IRS requires that brokerages report proceeds and cost basis for the transactions in your account. The resulting gain or loss on your investments determines how much you'll need to pay in taxes. When you make one purchase of stock, then sell it all at once, the math is pretty straightforward. If you trade more frequently, however, it can get a bit more complicated. The good news is that you have some control over the cost basis we report to the IRS.

Lot Closing Methods

Each time you make a purchase of stock (including the small purchases that occur when dividends are reinvested), you are purchasing a "lot" of stock. Since the market is always moving, your lots usually end up being purchased at different costs. If you decide to sell all of your shares, your costs are all added together to find the total cost - pretty simply, right? If you decide to only sell some of the shares you own, figuring out your cost basis can actually be done in several different ways. Let's look at an example.

You make the following purchases over the course of the year:

  • Jan 1st - 10 shares of XYZ at $12.00 per share ($120 total)
  • Feb 1st - 15 shares of XYZ at $13.00 per share ($195 total)
  • March 1st - 10 shares of XYZ at $15.00 per share ($150 total)
  • April 1st - 20 shares of XYZ at $10.00 per share ($200 total)
  • Total: 55 shares of XYZ for $665

To keep it simple, let's pretend you didn't pay commission - you purchased a total of 55 shares and paid $665. This means your cost per share is $665/55, or $12.09 - this is the cost basis we report to the IRS if you sell your shares all at once.

What if you decided to only sell 25 of your shares? There are actually multiple ways to calculate your cost basis, which are available to you through the Gain & Loss Tax Management Tool.

  • FIFO: First In, First Out
    • FIFO is the default lot closing method for all sales in your account. Since you sold 25 shares, we would assume you sold the shares you purchased first, and report to the IRS that you paid $120 + $195 for the 25 shares. This is a cost per share of $12.60.
  • HIFO: Highest In, First Out
    • HIFO tells us that you want to sell your most expensive shares first. When you sell 25 shares using HIFO, you would sell the 10 shares you purchased at $15.00 per share and the 15 shares you purchased at $13.00 per share. Your total cost basis would be $150 + $195, for a cost per share of $13.80.
  • Low Cost
    • Low Cost is the opposite of HIFO - your cheapest shares are sold first. In this case, selling 25 shares would include the 20 shares that cost $10.00 per share and 5 shares that cost $12.00 per share, for a cost per share of $10.40.

      Note: When Low Cost is chosen as a lot closing method, one additional consideration is made - shares that are held long term (over a year) are sold first.
  • Hand Picked
    • Hand Picked allows you to pick which lots you'd like to sell during a trade's settlement period (the three business days after a stock or ETF sale, or one business day for mutual funds and options). Since there's such a small window to make your lot selections, Hand Picked can't be the default lot closing method. With the Hand Picked method, you can choose exactly which shares are sold - you can even pick a couple shares from each lot if it meets your investment goals.

You can see from the examples above that the method you choose is going to affect the cost per share of your shares. By changing your lot closing method, you can report a bigger or smaller gain/loss to match your financial needs (please make sure to consult a tax advisor if you're not sure how to take advantage of these options). If you'd rather not think about each and every lot you buy or sell, your account is set to use the FIFO method for all transactions.

There's one last lot closing method that you won't come across as often - Average. The Average method is available for all mutual funds and most ETFs and uses the average cost basis for all of your shares, even if you are selling just a few of them at a time.