Tax planning for stock sale in light of Senate Tax Bill provision mandating use of FIFO cost basis starting 01/01/2018

The provision in the Senate tax reform bill would eliminate the practice of ‘lot identification’ which allows investors to pick and choose which tax lots of a stock position they want to sell. At present investors can select highest cost basis lots to sell first.

However, if this provision is found in the final bill, you would be required to follow FIFO (first in, first out) which means the shares held the longest (and with the highest capital gain in most cases) would be required to be sold first. The new tax reform bill is planned to be effective 1/1/2018. As per the language in the bill “This provision, as amended, would increase revenues by $2.4 billion over 10 years.”

To take benefit of “lot identification” provision available to you at present, before year end you can sell your shares on LIFO (last in, first out) basis. Using LIFO cost basis may mean realizing short term capital gains (taxable at higher rate than long term capital gains), if the last lot was purchased less than a year ago. It may still prove beneficial for you to take this approach if you have carryover of losses from prior years. You can use those losses to set off realized capital gains from use of LIFO cost basis.

For example- Ben acquired XYZ company’s 1000 shares for $500 in 2010. He acquired 1000 more shares of XYZ in January 2017 for $4,000. The market price of 1000 shares of XYZ presently is $6,000. He has a loss carryforward of $5,000 from his 2016 tax return. Ben can sell 1000 shares of XYZ and use LIFO basis (using 1000 shares acquired at $4,000) to report short term gains of $2,000 ($6,000-$4,000=$2,000). He will not pay any short term capital gain tax on the sale of these shares since these gains will be offset by the loss carryforward of $5,000 from 2016.

Using the same scenario if he is required to use FIFO basis he will have realized gains of $5,500 ($6,000-$500=$5,500).

The final tax bill does not mandate FIFO tax basis starting January 2018. Irrespective of that the use of LIFO cost basis proves to be a very strong tax planning strategy. Especially if you have loss carryovers from prior years and the last lot you bought was less than a year old.

Written by: Mariya Luqmani, CPA, CA, MST