Many people have a favorite stock or stocks that they accumulate of over time in multiple blocks. Whatever the stock that is bought, it is important for the owner to have a selling strategy in place if they plan to sell only some of the same stock that they have accumulated.
The IRS assumes by Federal Regulation that if a person sells a stock that they have bought on multiple occasions, the first stocks they purchased are the first ones to be sold. This is something known as the FIFO method (First-In-First-Out). See 26 CFR § 1.1012-1. While the FIFO method may be advantageous as it will most likely result in long term capital gains treatment at lower rates (for stocks held for more than one year), it may result an unnecessarily high long term capital gains tax bill. Let me illustrate by example.
Bob purchased stock in XYZ Corporation in blocks of 1000 shares on two separate occasions. The first block purchased on January 1, 2014 at $10.00 per share, resulting in a basis of $10,000 ($10.00 times 1000 shares). The second block of 1,000 shares is purchased on January 1, 2015 at $20.00 per share, resulting in a basis of $20,000 ($20.00 times 1,000 shares). On September 1, 2017, Bob decides that he wants to sell half of his stock because the value of the stock is now at $30.00 per share. Bob instructs his broker to sell 10,000 shares of his stock without specifying which block of stock that he wants to sell. By default under the FIFO method, the first block of 1000 shares purchase is sold resulting in gross proceeds of $30,000 ($30.00 times 1000 shares). For tax purposes, under the FIFO method, the basis of $10,000 for the first block of stock is subtracted from the gross proceeds of $30,000 for a $20,000 long term capital gain. Assuming the highest long term capital gains tax rate of 20%, this results in a long term capital gains tax of $4000 (20% times $20,000). Had Bob contacted his broker and specifically directed them to sell his second block of 100 shares purchased at $20.00 per share ($20,000 basis), the amount of the long term capital gain would have been lower as the basis of the second block of stock was higher. In this case, the $20,000 basis is subtracted from the gross proceeds of $30,000 resulting in a long term capital gain of $10,000 Assuming again a 20% capital gains tax rate, this sale would only result in a long term capital gain tax of $2000 (20% times $10,000) compared to $4000.
If Bob wants to sell the second block of stock, not only does he need to specify to the broker that he wants the second block of stock sold, but the broker needs to confirm that specification in writing to Bob (See 26 CFR § 1.1012-1(c)(2) and (3)(i)).
For anyone to be prepared for the situation that Bob is in, it is important for them to be in contact with their broker to ensure that the proper procedures and documentation are done so that the desired block of stock is sold and resulting tax treatment are guaranteed. A broker should be able easily assist you and answer any questions you may have. As for tax planning, Holbrook & Manter will work with you to create a tax strategy that is advantageous to your needs.