Cost basis reporting

How the cost basis of an investment is determined will have a significant impact on how the investment is taxed when sold.  Here we will provide an overview of some of the most common cost basis conventions which are currently being used in the tax code for the 2016 and 2017 year.

First in, first out (FIFO)

With this method, the shares or units which were purchased first are the ones which are used to determine the basis when the asset is disposed of.  Another way of looking at this is that the shares which remain are the shares which were most recently purchased.  As an example, let’s say you purchase 100 shares of XYZ stock on September 1, 2016 for $5 per share, purchase another 50 shares of XYZ stock on October 1, 2016 for $10 per share and then sell 100 shares of XYZ stock on November 1, 2016 for $15 per share.  When using the FIFO method the basis for these shares would be $5 per share, or the price paid for the first 100 shares of XYZ stock on October 1, 2016.

Specific share identification (Spec ID)

With this method, the specific shares are identified upon the disposal of those shares.  Using the example above: upon selling the 100 shares of XYZ stock on November 1, 2016, these shares could be identified as the shares purchased on October 1, 2016, resulting in a basis of $10 per share, in contrast with the basis of $5 per share which would be the result of using the FIFO method.

Average cost single category

With this method, the average cost of the shares is calculated by dividing the total dollar amount of the purchases by the total number of the corresponding shares or units.  Using the example above, the total number of shares purchased would 150 and the total dollar amount of shares purchased would be $1,000, resulting in an average cost basis of $6.67 per share.

Highest in, first out

With this method, the shares with the highest cost are the shares which are sold or disposed of.  The purpose of using this method is to minimize the taxable gain within a specified period.  Using the example above, the 100 shares sold on November 1, 2016 would be identified as the 50 shares purchased on October 1, 2016 for $10 per share plus 50 of the shares purchased on September 1, 2016 for  $5 per share.  The basis in this case  would be $7.50 per share, which is the total dollar amount of the shares purchased divided by the number of shares sold.

Minimum tax

Under the minimum tax method, shares are sold in the order which minimizes taxable gains and maximizes tax deductible losses.  Specifically, shares are sold in the following order:  maximum short term capital losses, maximum long term capital losses, minimum long term gains and finally minimum short term gains.

Maximum gain

This method is the exact opposite of the minimum tax method in that it will tend to maximize the taxable gains, and would only be used in a situation where such an outcome would be advantageous, for example to offset against losses.   Using the maximum gain method, shares are disposed of in the following order:  maximum short term gains, maximum long term gains, minimum long term losses an finally minimum short term losses.