A number of folks have asked about the importance and methods of "identifying" stock. In other words, if you want to sell a portion of your shares in a company, how do you identify which shares you bought when, and at what price? This is very important to know because it may save you hundreds of dollars in taxes.

Let's look at the options. In this FAQ, we are dealing only with individual securities (and NOT mutual funds, which have their own rules). That means you have only two options when determining the basis (or cost, for tax purposes) of shares of stock. They are:

1. Specific Identification Method

2. First In - First Out Method (FIFO)

First, the specific identification method:

Let's say that you made the following purchases:

June 1, 1996 -- 100 shares @ $10

June 5, 1996 -- 200 shares @ $11

June 10, 1996 -- 300 shares @ $13

The stock is now worth $15 a stub. You decide you want to sell 300 shares. You also know that you want to sell those that you originally bought on June 10, 1996. You very emphatically tell your broker that those are the shares that you want to sell, and not the 100 shares bought on June 1, nor the 200 bought on June 5.

Why would you want to do this? Because of the tax implications. If you sell the first 300 shares that you bought, your capital gain will be $1,300. But by selling the later shares, your capital gain only amounts to $600. That could be a tax saving of almost $280 -- just by making a simple decision and specifically identifying the shares that you want to sell.

If you decide to use the FIFO method, you do not identify the specific securities to be sold. Instead, just as the name says, the first securities you bought are the first to be sold. The basis of the stock for capital gain purposes is the cost of the first securities you purchased. As you can see from the example, using the FIFO method could very well have cost you an additional $280 in tax dollars.

Note: You may not use the "average cost" method with individual stocks. That method applies only to mutual fund shares.

Using specific identification requires a certain amount of preparation and following regulations precisely. Generally, you'll make an adequate identification if you show that certificates representing shares of stock from a lot that you bought on a certain date or for a certain price were delivered to your broker. As long as the broker has the stock certificates, an adequate identification is made if you:

1. Tell your broker the particular stock to be sold at the time of the sale.

AND

2. You receive a written confirmation of this from your broker within a reasonable time.

Although the IRS (in Reg 1.1012-1(c)) requires this specific identification, the Tax Court has stated that these regulations are really a safe harbor, and not the "exclusive" means of adequately identifying stock sold to avoid the FIFO accounting method. In the case in question (Concord Industries Corp., (1994) TC Memo 1994-248), the stockbroker held the stock in "street" name, and had a standing oral instruction to sell the highest cost basis shares first in any sales transaction. While the monthly brokerage statements didn't indicate whether or not the highest cost basis stock was sold, the taxpayer maintained cost records of each lot of stock that was purchased, the date of purchase, and the price per share. This information was used to prepare the tax returns to compute gain or loss. The court ruled that the taxpayer had sufficiently identified the stock sold to avoid the FIFO method of reporting.

In general, whenever possible, try to do whatever needs to be done to keep the shares "identifiable." This will allow you to control your gains and losses to a much greater extent than using the FIFO method.

- Article 23

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