Specific Identification of Shares

Specific Identification of Shares

A few months ago, I wrote a couple of articles about harvesting investment gains/losses for tax purposes.

In the Tax-Loss Harvesting post, I described how it can be beneficial to sell investments for a loss in order to use that loss to reduce your taxable income.

Conversely, in the Tax-Gain Harvesting article, I showed that in some situations it may be a good idea to sell your investments for a gain to increase your cost basis.

What I didn’t tell you is how to structure your taxable portfolio so that you can easily sell the investments that have depreciated in some years and those that have appreciated in others.

Today, I will do that.

Cost Basis

When you buy an investment, the price you bought the investment for is the cost basis (note: the cost basis can be adjusted for stock splits, dividends, etc.).

The cost basis is important because it is used to calculate how much tax is owed when an investment is sold.

Accounting Methods

To determine the cost basis of an investment, there are various accounting methods that can be used. The three types that Vanguard offers are Average Cost, FIFO (First In, First Out), and Specific Identification.

To illustrate the differences between these various methods, let’s create an example scenario to play around with.

Assume you purchase 100 shares of investment x in your taxable portfolio every year for three years. In year one, you purchase 100 shares of the investment for $10 per share. When you buy the investment again the following year, the price has risen to $20 per share so you buy 100 shares at $20 per share. Finally, in year three, the price has risen again and you purchase 100 shares of the investment for $30 per share.

Cost Basis

Let’s take a look at what would happen if you decided to sell 50 shares using the three different accounting methods.

Average Cost

The Average Cost method simply takes all of your cost basis values and averages them to produce a single cost basis for all of your shares.

In the example provided, the cost basis using the Average Cost method would be $20 per share.

This is a reasonable way of doing things but what if the price of the investment falls to $20 in year five and you’d like to harvest those losses on the shares you bought in year three? With Average Cost accounting, you wouldn’t be able to because your average cost basis would be $20 so selling 50 shares of the investment for $20 wouldn’t result in any gains or losses.

Average Cost

First In, First Out (FIFO)

The second method uses the cost basis of the oldest shares in your portfolio first (i.e. the shares that go in first are the first to come back out).

So again, in our example scenario, you still wouldn’t be able to harvest your losses using the FIFO method either because if you sold 50 shares when the price dropped to $20, you’d actually create a taxable gain of $10 per share because you’d be selling the shares that you bought in year one for $10 per share!

First In, First Out (FIFO)

Specific Identification

Luckily, the final accounting method, Specific Identification, allows us to specify which specific shares we would like to sell.

To harvest our losses in year five when the price falls back to $20, we would simply specify during the sale that we would like to sell the shares that we bought in year three for $30 per share.

Specific Identification of Shares

What if we instead wanted to harvest our gains when the price was at $20? The Specific Identification method would allow us to do this as well because we could simply choose to sell the shares that we bought in year one for $10 per share instead.

Specific Identification (Tax-Gain Harvesting)

Changing Methods

At Vanguard, the default accounting method for mutual funds is the Average Cost method and the default for brokerage shares is FIFO.

Although you can change your cost basis method during the execution of a trade, it makes sense to update your default cost basis method for all taxable investments to the Specific Identification method.

To do this in Vanguard, you simply need to select the Account Maintenance option under the My Accounts tab and then click the Cost Basis Method link.

Taxable Accounts

Please note, you only need to worry about cost basis in your taxable accounts. Cost basis is irrelevant in tax-advantaged accounts (e.g. 401(k)s, IRAs, etc.) because gains within those types of accounts are not taxed.

Conclusion

As you’ve seen, Specific Identification of Shares is the best cost-basis accounting method for those wanting to minimize taxes. Although it adds an extra step when selling your investments, having contol over exactly which shares you sell is well worth the additional effort.

Related Post


Want to achieve FI sooner?

  1. Sign up for a free Personal Capital account to start tracking your net worth, monthly spending, etc.
  2. Enter those numbers into the FI Laboratory and begin charting your progress to financial independence
  3. Download the spreadsheet I used on my own journey to financial independence to determine which expenses are delaying your progress the most
  4. Reduce or eliminate those expenses and achieve FI even sooner!

33 comments for “Specific Identification of Shares

  1. January 14, 2014 at 11:06 am

    I’ll have to explore the specific identification of shares at Vanguard further. I’ve only sold things a handful of times at Vanguard, and I’ll usually call up the vanguard folks, tell them to sell, and that I want to identify specific shares. Then I secure message them with the specific lots I want to sell then print out that secure message and stick it in my tax files as the record of instructing my brokerage firm (as required by the IRS for recordkeeping).

    One problem I have had at Vanguard (and a caution to others!) is that once you sell under the specific identification of shares, Vanguard doesn’t properly report your cost basis on their website. I remedied this by creating my own “cost basis tracking” spreadsheet and I update it once per year. In January. It’s on the to-do list right now.

    Another excellent (and timely) post, Mr. FIentist!

    • Jameel
      January 14, 2014 at 2:49 pm

      Justin – does your comment on incorrect cost basis showing on the Vanguard website pertain to sales after the recent law change? My understanding is that since the law change, VG has changed their tracking to properly handle “covered shares” purchased after the switch. That’s unfortunate if there are still glitches.

      • January 14, 2014 at 4:00 pm

        No, I’m referring to the shares I acquired before the new cost basis tracking requirement started in 2012. On the “Cost Basis Summary” page, I can view detailed cost basis for each fund I own.

        The Vanguard page says “For shares acquired before January 1, 2012, Vanguard has only average cost information.” And then all shares acquired prior to Jan 1 2012 are lumped into one line and the acquisition date is listed as “various”.

        They never changed my cost basis on the pre-2012 shares in their system in spite of the fact that I provided them with a letter of instruction to identify specific lots. They told me the cost basis wouldn’t be correct, but it means I have to manually track and identify specific lots when it’s time to sell. Not a big deal, just clunky.

        I’m only a mutual fund client, not a brokerage client FYI.

    • The Mad Fientist
      January 15, 2014 at 8:53 am

      Hey Justin, good point about the separate recordkeeping. I didn’t want to complicate the article by talking about covered vs. uncovered shares but I probably should have mentioned that it’s a good idea to keep track of the lots yourself so that you have another record of the cost basis values. As Jameel indicated, it seems their cost-basis tracking for covered shares (i.e. shares purchased after Jan 1, 2012) is accurate but since it’s so easy to record the cost basis whenever you purchase shares, it makes sense to keep your own records as well.

  2. January 14, 2014 at 11:11 am

    Every time Mad Fientist! You always have insight that I hadn’t even DREAMED of thinking of. Thank you!

    • The Mad Fientist
      January 15, 2014 at 8:54 am

      Thanks very much, Dave! Glad you found the post useful.

  3. January 14, 2014 at 11:15 am

    Great information. I bought a mutual fund in my taxable Vanguard account in 2013. In looking at the Cost Basis method for that account, it says ‘Not established’. It’s unclear to me if I can change it now for that already placed trade. Any idea? I may give VG a call today.

    • Jameel
      January 14, 2014 at 2:57 pm

      The default for mutual funds is average cost, so I believe they treat it as average cost unless you specify otherwise. If you have sold any portion of the shares since 2013, then you are locked into average cost for those pre-existing shares, but I believe if you have not sold any, then you can elect specific ID, and it will use the proper cost basis for all shares you bought in 2013.

      • January 15, 2014 at 12:28 am

        I have not sold any shares so I think I’ll try to do my due diligence and pick the Cost Basis method that best suits us. Thanks for the info, Jameel.

    • The Mad Fientist
      January 15, 2014 at 8:56 am

      Hey Buck, I agree with Jameel that you should be able to switch to SpecID so give Vanguard a call if you aren’t able to do it on the website and they should be able to help you. Please let me know if you aren’t able to for some reason.

  4. Jameel
    January 14, 2014 at 2:54 pm

    One other topic is how to set up your automatic investments to play nicely with specific ID. I have traditionally done an automatic investment after every paycheck and used automatic reinvestment of dividends and capital gains. However, this results in many different lots of shares. I don’t know if this is a problem (I’m sure the VG hard drives are huge). Since changing to specific ID, I have changed my dividends and capital gains to be sent to the sweep account. I have also changed my biweekly automatic investments to go to Prime instead of directly into total stock market. Then, I have an automatic exchange of 100% of prime into VTSAX once a month. This results in only having 12 lots of shares per year. It has the downsides of only being able to invest in one taxable fund at a time, and funds sit in Prime longer.

    Does anyone know if Vanguard tracking of “covered shares” is good enough that I can quit worrying about minimizing the number of lots?

    • Garrett
      January 14, 2014 at 5:45 pm

      Everything I’ve read says that the tracking is good enough to handle it, but I don’t have personal experience with it.

      Your alternative is to let those dividends pay out into your checking (or whatever) account, and just add them to your regularly-scheduled transfer.

    • The Mad Fientist
      January 15, 2014 at 9:02 am

      Hey Jameel, as Garrett mentioned, I imagine Vanguard’s tracking would be good enough but I don’t automatically reinvest my dividends in my taxable account so I don’t know for sure (I don’t want automatic reinvestments conflicting with my tax loss/gain harvesting so I manually reinvest instead).

      Can anyone out there provide a definitive answer for Jameel?

  5. January 14, 2014 at 3:16 pm

    Nice one! Just updated my Vanguard cost basis to Specific Identification. I’ve been meaning to do it but this was a good reminder even though I don’t plan to sell any shares anytime soon.

    • The Mad Fientist
      January 15, 2014 at 9:12 am

      Yeah, I don’t plan on selling anything anytime soon either (unless we see a big drop, in which case I’ll harvest some losses) but it’s good to get your default cost-basis method set up anyway.

  6. January 14, 2014 at 5:08 pm

    Another great piece of information to fit into the investing puzzle! A generous tip of my hat to you sir!

    • The Mad Fientist
      January 15, 2014 at 9:12 am

      Thanks, FIREstarter (and good to see you around here after chatting over at 1500days.com)!

  7. January 14, 2014 at 7:59 pm

    I had no idea those options even existed. Thanks for the info. I now have some work to do for the small portion I have sitting in my Vanguard brokerage account.

    • The Mad Fientist
      January 15, 2014 at 9:14 am

      Nice seeing you over here as well, Micro. Glad the post was useful!

  8. jd
    January 15, 2014 at 12:25 am

    Unfortunately for Canadians, the “average cost” is the only method allowed by the CRA for calculating ACB: http://www.cra-arc.gc.ca/E/pub/tg/t4037/t4037-e.html#P1185_82580

    I was pretty sure that was the case, but decided to check to make sure I’m not missing out on a possible tax-saving strategy.

    • The Mad Fientist
      January 15, 2014 at 9:36 am

      Hey jd, thanks a lot for chiming in with that information! It looks like you read Ottawa’s mind (see comment below). Even though I live 1.5 hours from the Canadian border, I have no idea what’s going on up there as far as retirement accounts are concerned.

  9. Jared
    January 15, 2014 at 12:33 am

    This is a great intro, but what I’d really like to hear more about is how this all gets handled come tax time. The extra tracking work required for specific identification seems pretty cumbersome already, but what I’m more worried about is the tax implications (esp. what kind of records need to be kept in the event of an audit).

    • The Mad Fientist
      January 15, 2014 at 9:48 am

      I think you just need to keep track of the cost basis and which lots you sell from and I imagine you’d be fine. This is easier if you only have covered shares (i.e. those purchased after Jan 1, 2012) because Vanguard should help keep track of everything for you but I’d still suggest keeping your own records so that you aren’t relying solely on Vanguard.

  10. Ottawa
    January 15, 2014 at 8:38 am

    Hey Mad Fientist! I’m not sure that in Canada we are able to select the ACB accounting method. I believe we can only use the average method…can anyone confirm this?

    • The Mad Fientist
      January 15, 2014 at 9:42 am

      Hey Ottawa, it looks like jd answered your exact question (see above) but I just didn’t approve his comment in time for you to see it!

  11. Prob8
    January 15, 2014 at 10:20 am

    Another good post. Your loss harvesting post gave me the kick in the pants I needed to actually benefit from some of the loses in my portfolio.

    Readers should also note that taxable accounts will receive a step up in basis at death. This is a nice benefit to reduce the tax burden on the next generation.

    • The Mad Fientist
      January 15, 2014 at 11:57 am

      Thanks, Prob8. I’m glad my post spurred you into action.

      Thanks for pointing out the basis step-up at death as well. Might as well harvest those losses now and get that basis nice and low before kicking the bucket (which will hopefully be many many decades down the road)!

  12. January 16, 2014 at 10:46 am

    Do you see any advantage of investing in taxable stock investments if you have not yet maxed out your other tax advantaged accounts (401k/403b/etc)? I would think this strategy only makes sense if you have additional money to invest that you no longer can send to these accounts.

    • Garrett
      January 16, 2014 at 12:48 pm

      The short answer is that it depends on your situation, and especially your current income and your expected retirement income.

      Personally, my 401(k) is only worth investing until I reach a point where I can receive employer matching and utilize the tax-free rollover described in this MadFIentist post.

      I am currently in the 15% tax bracket, and will always be in this bracket unless my wife and I somehow suddenly starting bringing in 35% more income than we do (doubtful).

      This means that my long-term capital gains rate is 0%. So, effectively, a taxable account (assuming all investments are long-term capital gains) is a Roth IRA for me, without the limitations on when I can withdraw it.

      For me, the possibility of short-term capital gains is small compared to the added ease and comfort of having all my investments in liquid taxable accounts.

      Therefore, I have no plans to max out either my 401(k) or Roth IRA this year or any year in the future.

      The higher your marginal tax rate, the better the 401(k) or Traditional IRA options are. The lower your marginal tax rate, the less it really matters.

  13. January 19, 2014 at 7:23 pm

    Another excellent article! Where were you during my intermediate accounting class? You have horrible timing, sir.

    • The Mad Fientist
      January 21, 2014 at 9:49 am

      Haha, my apologies :)

  14. Andrew
    September 26, 2014 at 9:06 pm

    You can harvest a loss from a taxable account, say sell 100 shares of VTSAX and then immediately purchase the same number of shares in a tax deferred IRA account and not trip the washsale wire, right?

    • The Mad Fientist
      September 30, 2014 at 10:17 am

      No, that would actually trigger a wash sale. All of your accounts (and even your spouse’s accounts) are in play for the wash-sale rule.

Leave a Reply

Your email address will not be published. Required fields are marked *

FI Laboratory Access

FI Laboratory

Get free access to the FI Laboratory and join over 64,000 others on the fast track to FI!

Zero spam. Unsubscribe at any time. Powered by ConvertKit

FI Spreadsheet Access

FI Spreadsheet

Get free access to my FI Spreadsheet and join over 64,000 others on the fast track to FI!

Zero spam. Unsubscribe at any time. Powered by ConvertKit

Join the List

FI Spreadsheet

Get exclusive Mad Fientist content and join over 64,000 others on the fast track to FI!

Zero spam. Unsubscribe at any time. Powered by ConvertKit