Understanding Tax Lots

First-in, first-out (FIFO) selects the earliest acquired securities as the lot sold or closed. It is probably the most common and straightforward tax lot ID method. Absent a specific instruction from you by the settlement date of the sale to utilize a different tax lot ID method, we are required by the tax law to apply FIFO.

Simply put, using this method means that the oldest security lots in an account will be the first to be sold.

Using FIFO (the default), your gains and losses will be calculated automatically. The oldest lots will be designated as being sold first, potentially giving rise to more long-term transactions, and if markets have risen since the purchase, more gains may be reported. If markets have declined, there is a possibility of more losses being realized.

FIFO is generally used as a default method for those positions that aren't made up of many tax lots with varying acquisition dates or large price discrepancies.

TD Ameritrade does not provide tax advice. Please consult a tax advisor regarding your personal situation.

Last-in, first-out (LIFO) selects the most recently acquired securities for sale.

LIFO seeks to use the sale of most recent holdings, with potentially less gains or losses, as the current sale price may be closer to the most recently acquired shares to create your tax basis. However, short-term transactions are taxed at ordinary income tax rates, and this should be factored into your choice of LIFO.

Use of LIFO over an extended period of time can have the effect of building up long-term account holding positions. Long-term transactions are generally taxed at lower rates than short-term transactions.

TD Ameritrade does not provide tax advice. Please consult a tax advisor regarding your personal situation.

Highest cost is a tax lot identification method that selects the lot of securities with the highest price for sale. It is specifically designed to limit gains.

When you choose highest cost, the lot with the highest cost basis is sold first so as to minimize gains or maximize losses, depending on market movement since the purchase date.

Highest cost does not consider the length of time you held your shares. If your security position is made up of several tax lots and they consist of both long- and short-term holdings, highest cost may deliver the lowest gains but not the lowest tax rate, due to the difference between short- and long-term capital gains tax rates.

When selling at a loss, highest cost also fails to distinguish between two positions that may be similar in cost where one is a long-term holding and the other is a short-term holding. You may want to consult a tax advisor as to whether or not the use of the short-term holding is better for your particular situation. Should the market price of the security rise over time, holding the long-term tax lot will mean you will be taxed at long-term capital gains rates, should you sell those securities for a profit.

Highest cost is generally an attractive methodology for short-term holdings, except when the market has risen dramatically.

TD Ameritrade does not provide tax advice. Please consult a tax advisor regarding your personal situation.

Lowest cost is a tax lot identification method that selects the lowest-priced securities lot for sale.

Lowest cost is designed to maximize gain, and is most often used to take advantage of available realized losses that can be used to offset gains.

Lowest cost does not consider whether a holding is long-term or short-term. Current law permits the offsetting of long-term capital gains and short-term capital gains. Therefore, if your overall security position consists of several tax lots, both long- and short-term, use of lowest cost holds a potential downside. Retaining short-term lots may give rise to higher taxes in the future should the market change and the position becomes profitable, because short-term profits are taxed at ordinary rates.

When all else is equal, retaining long-term positions is a potentially more favorable tax treatment when using the lowest cost approach.

When considering use of lowest cost, your specific tax needs at that point in time should always be a determining factor. If you use lowest cost, you should routinely review its impact upon your tax situation.

TD Ameritrade does not provide tax advice. Please consult a tax advisor regarding your personal situation.

Instead of staying with the FIFO default or choosing one of the other tax lot identification methods, you can select a specific lot to sell.

You may select your specific lot from the day following your trade execution or, at the latest, before 11:59 p.m. ET on the settlement date of the trade.

Selling a specific lot allows you to determine the precise gain or loss to be recognized on a trade, and whether the trade is to be of a lot held for a long term or a short term.

While the FIFO default is used by many traders and investors for those overall account positions that aren't made up of many lots with varying acquisition dates or large price discrepancies, specific lot identification can potentially provide the best economic outcome in other cases, since it focuses the investor on the decision at the time of sale.

Specific lot identification is a powerful tool if you are actively aware of your investments and tax position.

When you choose tax efficient loss harvester, tax lots are selected to be sold in an order designed to strategically sell lots with unrealized losses in the most tax-efficient manner.

For long positions, the order in which this method sells the tax lots is as follows:

• Short-term loss– descending order by cost per share (highest to lowest), and as a result, taking the biggest short-term losses first
• Long-term loss– descending order by cost per share
• Long-term gain– descending order by cost per share (highest to lowest), and as a result, taking the smallest long-term gain first
• Short-term gain– descending order by cost per share
  
  

For short positions, the order in which this method buys to cover the tax lots is as follows:

• Short-term loss– ascending order by cost per share (lowest to highest), and as a result, taking the biggest short-term losses first
• Long-term loss– ascending order by cost per share
• Long-term gain– ascending order by cost per share (lowest to highest), and as a result, taking the smallest long-term gains first
• Short-term gain– ascending order by cost per share
  
  

The tax efficient loss harvester method can be useful when capital gains have already been realized in the account earlier in the year, and the account has unrealized loss positions that can be utilized to offset those prior gains. Please note: This method does not factor in the possibility that a lot sold via this method will cause a wash sale, and therefore disallow the loss on the trade.

TD Ameritrade does not provide tax advice. Please consult a tax advisor regarding your personal situation.

Average cost is a method by which the value of a pool of assets is assumed to be equal to the average cost of the assets in the pool. While a new average cost is calculated each time an acquisition is made, there is no change to the pool upon the disposition of an asset. When average cost is used, it is required that all lots be taken from FIFO.

Average cost is only applicable to qualified funds and DRIP equities. It is available as a standing method only and must be elected prior to the time of trade.

Please note: Once you choose average cost as the tax lot ID method for qualified funds and DRIP equities, you will not be able to select a different tax lot ID method at the time of a trade that includes these securities.

Changing average cost as the tax ID method for securities already purchased will require written notification within one year of choosing it as your standing method, or the date of the first sale it applies to (whichever occurs first). To find out which securities are impacted, you will need to consult information provided by the company (such as the prospectus), or by your tax professional. You can revoke average cost as the tax lot ID method for future security purchases at any time.

If you were enrolled in average cost for your mutual funds prior to Jan. 1, 2012, and have re-enrolled after Jan. 1, 2012, you will have two average cost pools. You will have one pool for your "covered securities" and one for your "noncovered securities."

TD Ameritrade does not provide tax advice. Please consult a tax advisor regarding your personal situation.