The Basics of Cost Basis
Anytime you’re looking to sell an investment, your gain or loss will be determined by calculating the difference between the cost basis—your purchase price plus trading costs and/or commissions—and the current market price. But when you’ve purchased the same investment several times over the years, you’re likely to have a different cost basis for each transaction—and which shares you decide to sell can affect not only your profit or loss but also any taxes you might owe.
When instructing your brokerage firm which shares to sell, you can choose from one of several methods for calculating your cost basis:
- First in, first out (FIFO) means your shares will be sold from oldest to newest.
- Last in, first out (LIFO) means your shares will be sold from newest to oldest.
- High cost means your shares will be sold from highest cost basis to lowest cost basis.
- Low cost means your shares will be sold from lowest cost basis to highest cost basis.
- Specific identification means your shares will be sold however you see fit.
So, which method is right for you? “Unless you specify otherwise, at Schwab the default method for everything except mutual funds is FIFO,” says Hayden Adams, CPA, CFP®, director of tax and financial planning at the Schwab Center for Financial Research. (For more on mutual funds at Schwab, see “What about mutual funds?” below.) “However, in many cases you’d be better served using specific identification, which allows you to sell particular shares and therefore gives you the greatest control over your tax bill” (see “Case in point,” below).
“It’s really just a matter of ensuring that whatever method you go with is in line with your specific goals for the sale,” Hayden says. When in doubt, discuss your options with a qualified tax advisor before taking action.