About Tax Lot Selection

Most taxpayers recognize capital gain or loss for tax purposes when they close a position. If an asset is sold for less than its purchase price, then the difference is considered a capital loss. If an asset is sold for more than its purchase price, then the difference is considered a capital gain. Gain or loss is equal to proceeds minus the adjusted cost basis of the position.

Gain or Loss = Proceeds – Adjusted Cost Basis for Each Tax Lot

Gains and losses resulting from trades are based on “matching lots.” A tax lot is the record of details of a purchase. Each acquisition of a security, on a different date or at a different price, constitutes a tax lot. Tax lots are used to determine the cost basis and holding period when you dispose of securities.

When you sell a security, if you don’t sell all of the shares that you own you must match the sale to a tax lot or lots in order to determine your gain or loss as well as your holding period.

The IRS allows two basic methods for matching tax lots: First in, First out (FIFO) and Specific Identification.

• FIFO is the default method that will be applied if you do not choose another method. Under FIFO, the sale is matched with the earliest purchased lot or lots available.
• Specific Identification allows a trader to match sales with purchases in a different order than FIFO, as long as he or she can show that the tax lots were selected at the time of the sale. The Tax Optimizer lets you choose a method until 8:30 PM ET on the day of the trade.

The Tax Optimizer lets you use Specific Identification directly by letting you change the tax lot-matching method for a specific position, and manually select tax lots to match. You can also use Specific Identification by choosing among several available lot matching algorithms.

Once lots have been matched, the gain or loss for that lot equals the proceeds minus the adjusted cost basis for each lot.

The period from the purchase to the sale is the holding period.

• Gains or losses from securities held for one year or less are generally short-term and are taxed at ordinary income rates.
• Gains or losses from securities held for more than one year are long-term and may be eligible for preferred rates.